Could Trade Messages Help Unravel Madoff Fraud?

April 27, 2009
John Sandman

As law enforcement agencies work to untangle the $65 billion Ponzi scheme operated by Bernard Madoff, the trading technology of his firm's broker-dealer arm could potentially offer a window into the fraudulent activities.

Madoff last month pleaded guilty to defrauding investors through his firm's asset management unit. The investigation that has been underway since his actions came to light in December is a complicated, multi-agency affair, and details have been slow to emerge. It is not yet clear whether or to what extend the illicit activity extended to Bernard L. Madoff Investment Securities' market-making business, which is being probed by the Justice Department. That unit, which had a reputation for cutting-edge technology, has been shut down, although Boston-based broker-dealer Castor Pollux Securities has offered to buy its assets for as much as $15.5 million.

According to industry sources, a state-of-the-art trading system--particularly one that uses the FIX protocol to submit pre-trade indications of interest and execute transactions--could be used to perpetrate fraudulent trades. Records of those transactions could be maintained or replaced with other trades, either phony or legitimate. By the same token, the absence of such records could be deemed suspicious. The DOJ is not commenting on its investigation.

FIX Logs

FIX, the global standard for buy-side-to-sell-side communications in equities, automatically creates trade records as part of its functionality, obviating the need for a separate recordkeeping mechanism. "FIX logs would contain the results of every execution, including the security, price and identification of the counterparty," said Jim Northey, co-chair of the FIX Protocol Ltd. (FPL) Americas regional committee. A firm could disable logging, he noted, "but FIX sits in front of order routing and trading systems. The assumption is that transactions would persist there."

Unless they are using the protocol for high-frequency applications, "almost everybody" saves the FIX log, said Northey, principal of consultancy LaSalle Technology Group. A longtime FIX consultant who asked not to be identified added that "most firms I work with archive these log files for a specified period of time."

Since FIX 2.7 rolled out in 1993 the protocol has included an optional field, applicable to both order and execution messages, that is commonly populated with the name of the trader involved, according to Scott Atwell, co-chair of the FPL technical committee and head of FIX connectivity at American Century Investments.

"I think FIX logs could be important in trying to determine what actual trading took place," added Northey.

Madoff built its own FIX engine in the 1990s, which was then considered a difficult achievement. Homegrown FIX connectivity was not only considered more problematic, but also less transparent.

In 2004, the firm began using FIX technology from Cameron Systems. In an interview with Securities Industry News that year, Liz Weintraub, former head of information technology at Madoff Securities, said that the firm could no longer keep up with its client-testing needs and opted to sign on with Cameron, whose FIX engine was then viewed as among the fastest and most scalable.

In 2006, Cameron was acquired by Orc Software; whether Madoff was still using the technology at the time of its blowup could not be confirmed.

If trader log files or their equivalent did not exist at Madoff, it likely would have been a red flag to the regulators that something was amiss. But were regulators looking?

Recordkeeping Requirements