The abrupt closure of Bernard L. Madoff Investment Securities on Friday left some of its retail broker-dealer customers with losses and proved a windfall for the wholesaler’s competitors.
Madoff’s customers did not incur losses on trades the firm handled through Thursday, its final day of operation, according to sources. But some experienced losses on limit orders held by the firm on Friday morning, December 12.
Madoff employees advised their customers before the market opened on Friday, not to send any new orders. But, as late as 30 minutes before the opening, they also told them not to cancel their sitting limit orders.
Then one minute before the bell, Madoff unilaterally cancelled all sitting limit orders. The move forced agency desk executives to scramble to route these orders to other trading houses.
The surprise reversal by Madoff caused problems for brokers whose limit orders would’ve executed during early trading. They had to honor their customers’ instructions to trade at the limit prices.
At least one retail brokerage, D.A. Davidson & Co., based in Montana, reports losing $50,000 making good on its customers’ limit orders. Madoff cancelled 1,200 limit orders, Patrick Fay, Davidson’s director of equity trading, told Traders Magazine. “At one minute to the opening they kicked out all our orders,” he said. “And it wasn’t just us.”
It is unclear how many other brokerage firms lost money on their unexecuted limit orders. But Madoff has described its customer base as including “scores of leading securities firms, banks, and financial institutions.” Based on regulatory filings, they ranged from small firms such as Davidson to larger ones such as Morgan Keegan.
Another Madoff customer confirms the last minute snafu, but did not describe losses. “The cancellation process was cumbersome, the operations executive said, “because you had to look at them, find out who is close to the market and then get them delivered to another party.” His firm uses Thomson’s Beta back office system which “did wide-scale cancels and then put them back in the system for routing to another party.”
Madoff executives did not return telephone calls.
Sources report no losses on trades competed by Madoff in the three-day period between Tuesday and Thursday, partly because the National Securities Clearing Corporation “locks in” the trades and guarantees they will clear and settle.
Most sources report it was very easy to transfer their new orders to Madoff’s competitors. “There are plenty of fish in the sea,” Dan McMahon, co-head of equity trading at Madoff customer Raymond James Financial, said.
Most firms have contingency plans in place to route orders to other wholesalers if their primary venue is experiencing problems. Thomson’s Beta system makes that easy, they say.
Madoff, which has been accused of bilking customers of its money management arm out of $50 billion, is being liquidated by Irving H. Picard, at the behest of the Securities Investor Protection Corporation.
Madoff was best known as a wholesaler, a trading house that handles the orders of retail brokerages. Many of its clients are regional brokerages such as Raymond James, Wells Fargo Investments, Morgan Keegan and A.G. Edwards.
It operated in a highly competitive sector of the securities industry where large computer-driven firms have come to dominate. Chief competitors are Citi/ATD, Citadel Derivatives Group, Knight Capital Markets and UBS. Madoff was actually one of the smaller firms in the group.
Some or all of these firms are expected to benefit from Madoff’s demise. On Friday, Knight’s stock shot up 6 percent on a day the S&P 500 Index rose 1 percent. Analysts at Barclays Capital interpret the move as “driven by investors’ evaluation of potential opportunities for Knight to pick up market share from wholesale competitor” Madoff.
Despite is stature as one of the industry’s smaller wholesalers, Madoff was held in high regard by order senders. Davidson’s Fay says his firm had few problems with them and that they were always quick to fix any situation.
An executive from a clearing firm who has known Madoff executives for many years called them “straight shooters and the most honest people in the business.”