This is the presentation used for Trust, but Verify Webinar, N.1: Made-off Japan, in December 2013.

1. Trust, but Verify Webinar
N.1: Made-off Japan
The
Importance
of Being
Diligent

2. “The truth is rarely pure
and never simple.”
Oscar Wilde, The Importance of Being Earnest

3. Can you tell the similarity in
the following two charts?

4. Fairfield Greenwich Sentry
(A feeder fund for Bernie Madoff)
450%
250%
0%
May-02
Nov-02
May-03
Nov-03
May-04
Nov-04
May-05
Nov-05
May-06
Nov-06
May-07
Nov-07
May-08
Nov-08
May-09
Nov-09
May-10
Nov-10
May-11
Nov-11
Nov-90
Oct-91
Sep-92
Aug-93
Jul-94
Jun-95
May-96
Apr-97
Mar-98
Feb-99
Jan-00
Dec-00
Nov-01
Oct-02
Sep-03
Aug-04
Jul-05
Jun-06
May-07
Apr-08
500%
250%
AIM Millennium Fund
(A flagship fund of AIJ)
400%
200%
350%
150%
300%
100%
200%
150%
50%
100%
0%
50%
-50%

5. Excellent Track Record

6. Aug-08
May-08
Feb-08
Nov-07
Aug-07
May-07
Feb-07
Nov-06
20%
Aug-06
May-06
Feb-06
Nov-05
Aug-05
May-05
Feb-05
160%
Nov-04
Aug-04
May-04
Feb-04
Nov-03
Aug-03
May-03
Feb-03
Nov-02
Aug-02
May-02
Far Better Than Madoff
200%
180%
AIJ: 16.91% p.a.
140%
120%
100%
80%
60%
40%
Madoff: 7.20% p.a.
0%
-20%

7. In Reality…
Successful Business
2,500
AUM
AUM
Cumulative Losses
2,000
Confirmed Assets
1,500
1,000
500
-
(500)
(1,000)
(1,500)
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11

8. Fraud Ranking…
Case Name
Portfolio Manager(s)
Estimated Size
Madoff
Bernie Madoff
$60,000,000,000
Stanford
Alan Stanford
$8,000,000,000
Petters
Thomas Petters, et al
$3,650,000,000
AIJ
Kazuhiko Asakawa, et al
$2,400,000,000
Absolute Capital
Florian Homm, et al
$2,100,000,000
WG Trading
Steven Walsh & Paul Greenwood
$1,300,000,000
Millennium
Michael Balboa
$844,000,000
Weavering
Magnus Peterson
$639,000,000
K1
Helmut Kiener
$597,000,000
Manhattan
Michael Berger
$575,000,000
Bayou
Sam Israel
$450,000,000
Lake Shore
Philip Baker
$312,000,000
Beacon Hill
John Barry
$300,000,000
Scoop
Arthur Nadel
$300,000,000
PAAMCo
Paul Eustace
$278,000,000
Westgate
James Nicholson
$220,000,000
Top16 Total
$81,965,000,000

9. Made-off Japan…

10. Made-off Japan
• Background
• Japan’s Structural Problem
• How did they hide losses?
• There were Many Red Flags
• Q+A

11. Background
• Founded in 2000 by Kazuhiko Asakawa, a
legendary salesman at Nomura Securities.
• Marketed as an option-related strategy with
low volatility and low correlation to the
markets.
• AIJ had operated a $2.4 billion Ponzi scheme
for more than ten years until February 24,
2012. Most of investors are Japan’s small and
medium corporate pension funds.

12. Japan’s Structural Issues

13. Pension Problem
• Under pressure to find higher return
opportunities with limited resources… they only
generated a 2.97% p.a. from 1996 to 2010, far
short of the original target of 5.50% p.a.
Start of the zero % interest rate policy
300%
Average Pension Fund
250%
Target
200%
150%
100%
50%
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1987
1988
1985
1986
0%

14. Pension Problem (cont’ed)
• There are 1,395 corporate pension funds in
Japan (2011) and almost 1,000 funds (75%) are
managing assets less than $300 million.
• Only 12% of those pension funds hire a
consultant because they cannot afford to.
• Some pension funds invested almost 50% of their
assets in AIJ.

15. How did they Hide Losses?

16. Contractual Relationship
AIJ Investment
Advisors
Discretionary investment
contract
Customer
(pension fund)
Trust agreement
Investment Instruction
Japanese Trust Bank
Application for
subscription
Discretionary
investment
contract
ITM Securities
Application for
subscription
AIJ Funds
Cayman Islands

17. Money Flow
Customer
(pension fund)
Fund trustee bank
(HSBC?)
Overseas Fund
Japanese Trust Bank
Financial broker
ITM Securities
Derivative transactions on
Market (Nikkei
futures/options, JGB
futures/options)
AIJ Funds
Cayman Islands
Venture Investment Alpha &
Venture Investment Alpha II

18. Paper Chase
Monthly Statements
Investment Manager
(AIJ)
100%
Own
Annual Financials
Investment Manager
(AIJ)
Brokers
Brokers
80% Own
(indirect)
Administrator (AIA)
Fabricated NAV
Independent Auditor
Placement Agent (ITM)
Fabricated Financials
Trust Bank
Trust Bank
Investors
Investors

19. Hidden Facts
• ITM Securities, Global Fund’s placement agent
in Japan, was 80% owned by AIJ, directly and
indirectly.
• AIA was established, owned and controlled by
AIJ.

20. There were Many Red Flags

21. Criminal History?
• Shimpei Matsuki, a former head of Nomura’s
powerful equity department and Asakawa’s
long-term friend, was a principal of AIJ.
• Matsuki’s criminal record shows that he was
arressted in 1997 while he was at Nomura and
sentenced 8 years (with suspension of 3 years)
for his involvement with an infamous payoff
scandal.

22. Compliance Violation?
• AIJ began its operation in 2002 as a nondiscretionary investment advisor and was not
allowed to manage a fund by itself.
• Without permission, AIJ launched a Caymanbased fund in 2002 and lent a name of
Cigna, which had a discretionary advisory
license, to serve as an investment advisor of the
fund, until their merger in 2004.
• This is potentially a violation of the securities
law in Japan.

23. Suspiciously Little Revenue?
• In 2010, AIJ purportedly managed ¥390 billion.
• However, the firm earned only ¥423 million
(approx. $5 million) as revenue, including
management fees. This is only 11bps (0.11%) of
the firm’s AUM.

24. Option Arbitrage?
300%
AIM Millennium Fund
250%
Nikkei 225
200%
150%
100%
50%
0%
Jul-11
Feb-11
Sep-10
Apr-10
Nov-09
Jun-09
Jan-09
Aug-08
Mar-08
Oct-07
May-07
Dec-06
Jul-06
Feb-06
Sep-05
Apr-05
Nov-04
Jun-04
Jan-04
Aug-03
Mar-03
Oct-02
May-02
-50%
• AIJ claimed it generated returns through “writing put options on
TOPIX’… then, why could they make steady returns when TOPIX
continued falling in 2002 and 2007-2009?

25. No Prime Broker?
• In 2010, AIJ executed over ¥57 trillion (over
$700 billion) transactions through derivatives.
• The portfolio turnover was 146x a year.
Equity
futures
Bond
futures
Equity
option
Bond
option
Total
Transaction volume
(trillion yen)
227
18
2
36
57
Turnover
(multiple of AUM)
>1x
47x
5x
93x
146x
• However, there was no evidence that AIJ had
ever engaged with any prime broker.

26. A Little-Known Admin?
• It is unusual for a $2.3 billion fund to use AIA, a
little-known administrator.
Source: “2013 Survey Results – Hedge Fund Operational Due Diligence”, Bill Bogle, NEPC, LLC

27. A Little-Known Admin?
• Offshore administrators must be recognized by
local authorities to provide administrative
services.
• AIA was established in the BVI, but was not
recognized by the BVI Financial Services
Commission as a “Sub Cat. B – Admin of
Investment Mutual Funds.”

28. www.bvifsc.vg/en-gb/regulatedentities.aspx

29. Summary
• Obtain financials directly from an auditor
• Check legitimacy of an administrator
• Check reputation among broker society
• Investigate a history of an investment manager
• Check employee’s past record
• Check affiliation of a placement agent

30. Trust, but Verify!

31. Q+A

32. See you next month!
Trust, but Verify Webinar Series (No. 2)
From Minnesota with Lies: Petters Case