YU Endowment Shaken By Madoff Storm, Loses $110 Million

Yeshiva University's endowment, already battered by the tough economic environment, took another major blow this past weekend, losing approximately $110 million, or 8% of their endowment's assets.

In a mass email to YU students, staff and many alumni, President Richard M. Joel acknowledged they invested approximately $110 million in Ascot Partners, a $1.8 billion hedge fund managed by J. Ezra Merkin, although they asserted that the exact figure was difficult to ascertain. Mr. Merkin, who recently resigned from his positions as a trustee on YU's board and chairman of YU's Investment Committee, sent a letter to investors Thursday, December 11th, stating he had invested "substantially all" of the fund's capital with Bernard Madoff; the fund is now virtually worthless. Before President Joel's letter clarifying that the loss was $110 million, sources had located the losses between $100 and $140 million, while some unsubstantiated rumors around campus had ranged far higher.

The endowment once stood at $1.8 billion, according to pronouncements by President Joel; at January 1st, it held $1.7 billion, according to his email. Today, President Joel estimated the endowments' value at approximately $1.2 billion, and revealed a loss of 28% since earlier this year, compared to an S&P loss of 38% and Dow Jones loss of 32%.

Mr. Madoff, who resigned this past weekend from his positions of treasurer of the Yeshiva University Board of Trustees and chairman of the board of Sy Syms School of Business, was arrested on Thursday on charges that he had swindled $50 billion in a Ponzi scheme which shocked Wall Street (see related article, "Former YU Treasurer Bernie Madoff Runs $50 Billion Ponzi Scheme").

Mr. Merkin served with Mr. Madoff on Yeshiva's board, and was a member of several other prominent instiutions. For the last few years he has served as the chairman of the investment committee at the UJA-Federation of New York, as vice chairman for the Ramaz School of Manhattan, and as a member of the Columbia College's Board of Visitors.

Many Unhappy With Merkin Prior to Ascot's Demise

While Mr. Madoff's scandal reverberates across the front pages of the world's newspapers, more relevant to YU's future have been the revelations about Mr. Merkin's exposure to Mr. Madoff. After the collapse of Ascot Partners, Mr. Merkin resigned from his position on the board this past Friday, as first reported by the The Jewish Week.

However, Yeshiva's problems with Mr. Merkin allegedly began well before Ascot collapsed. One board member at Yeshiva related that several trustees and President Joel been looking into Merkin's management of the endowment prior to the events of this past Thursday. While some were discomfited by returns they found disappointing, others seemed to be rubbed the wrong way by a leadership style described by several as secretive and overbearing. A friend and supporter of Merkin acknowledged that "he has a hard edge to him."

Some sources were particularly troubled by Merkin's tactic of directing substantial amounts of YU's endowment to a fund that he himself managed. Figures ranged for how much money was invested with Merkin, but it appears the best estimate is that roughly $200 million was invested in Merkin-managed funds.

Kenneth Reed, director of research and policy analysis at the National Association of College and University Business Officers, called this tactic "a definite conflict of interest." Mr. Reed explained that endowment investment committees customarily provide guidelines to ensure a healthy degree of diversification, but do not set more specific details for where and how to invest.

Numerous professionals in the hedge fund and endowment world felt there was both an ethical and management problem with the setup at Yeshiva. One declared that it was "not only a major ethical problem" but also felt that it led to a situation where Mr. Merkin became only answerable to himself. "He eliminated all the checks and balances," he said, "that should have secured YU's money." While some felt that the investment committee's controls were adequate, one hedge fund professional deeply familiar with board procedures felt that the committee was hard-pressed to truly place Merkin in check. "He was more powerful than the normal chairman of an investment committee," this source related.

The UJA-Federation of New York, where Mr. Merkin had formerly served on the board's investment committee, did not lose money with Ascot Capital because a conflict-of-interest policy prevented Mr. Merkin from directing their endowment towards his own funds, according to their recent statement.

Several financial professionals further expressed surprised over Merkin's self-compensation for his work with Yeshiva's endowment funds. One source close to trustees alleged that Merkin took a full management fee and did not give YU any discount for the size of their investment, which is out of character for most investors in the hundreds of millions of dollars according to financial professionals.

YU board members who expressed such concerns were reportedly ignored or berated by Merkin. They often found it difficult to get information from him. "He can be intimidating, and didn't feel the need to tell everyone what was going on," one source related. "He's a screamer." Another source close to the situation revealed that administration officials found Merkin difficult to work with, and searched for tactics to deal with Merkin for months before Thursday's events.

Questions Over Merkin's Lack of Due Diligence Into Madoff

Although Mr. Madoff's fraudulent tactics escaped scrutiny from the SEC and much of the financial world, some felt that appropriate due diligence revealed that Mr. Madoff's reported earnings were at least suspect, and that investors with Mr. Madoff should have been more wary. A few articles over the past decade examined Madoff's investments and raised questions about his credibility, including in-depth pieces by Barron's in May 2001 and Mar/Hedge Newsletter in October 2001.

Skeptics doubted Madoff because his gains were too consistent - the approximately 12-15% annual gains appeared like clockwork -- and his quarterly losses too rare. Madoff also refused to disclose his holdings to investors. When pressed, he claimed to be using a split-strike conversion strategy, buying a basket of 30 to 35 stocks from the S&P 100, and selling related out-of-the-money call options and buying out-of-the-money put options representing the same number of underlying shares. However, several options experts asserted the strategy would not regularly attain the gains Madoff claimed.

The case of those skeptical of Madoff was only further buoyed by the fact that Madoff used a three-person accounting firm and held the funds' documentation in his office under lock and key.

Numerous reports surfaced since this past Thursday of investors who had investigated Madoff's funds and found his explanations for his success too dubious and vague to be entirely credible. In 1999, Harry Markopoulos, a money manager and fraud investigator, wrote a letter to the SEC declaring that "Madoff Securities is the world's largest Ponzi scheme," and pursued his claims with the federal authorities unsuccessfully for the next nine years. Axiom, a hedge fund due diligence firm, investigated Madoff's firm in 2005 and were sufficiently concerned that that they wrote their own letter to the SEC concluding that Madoff ran a Ponzi scheme. Furthermore, numerous money managers have recently announced this past week that they have long harbored suspicions about Madoff's operations.

One hedge fund manager familiar with the situation expressed outrage with Mr. Merkin's behavior. "He didn't seem to diversify at all, and he obviously didn't do enough vetting of Madoff," he said. "If this fund was just a pass-through so less connected investors could get to Madoff, YU could have gone to Madoff directly - he was the treasurer of their board," he emphasized. "For what exactly was Merkin earning his fee from YU here? And for what was YU paying him?"

Further, sources alleged that Merkin did not disclose to the board that the Ascot Fund was nearly exclusively invested with Madoff, which would fit with the description of several other investors. The Wall Street Journal quoted Harry Susman of Houston law firm Susman Godfrey LLP, who asserts that "a pattern" emerged among 10 Merkin investors that were not aware the money was going to Madoff. According to The Jewish Week one private investor said that that several years ago he had asked Merkin directly if his investment in Ascot was going into the Madoff fund and was told it was not.

One manager of a small Jewish nonprofit which placed the majority of their endowment, $1 million, in Ascot Partners told The Commentator that these characterizations seemed too harsh. "It's true we didn't know that he was pretty much exclusively invested in Madoff," she said. "But Merkin made it clear that Madoff was a significant investment vehicle for him - he said that Ascot was invested in either Madoff or Morgan Stanley."

Some investors are exploring legal action against Merkin and Madoff in order to recover their funds. Mort Zuckerman, whose charity organization has suffered a loss of $30 million, announced that he plans to pursue legal avenues against Merkin, and William Shepard of Shepherd, Smith, Edwards & Kantas LLP told GlobeNewswire that they were exploring "four or five sources of recovery" for those invested in Madoff.

While Yeshiva's legal team has not declared any intent to file suit against Merkin to recover their assets, YU officials have been exploring their options with their legal team.

Mr. Susman told The Commentator that the primary issue for those seeking restitution would be Merkin's financial viability. "The case for [Merkin's] investors against Merkin is strong," he said

Questions Raised About Merkin's Endowment Performance

Madoff's Ponzi scheme has revealed longer-running problems with the management of YU's endowment. While YU's endowment earned a healthy clip of 10.7% last year, it was far below its peers; according to NACUBO's Endowment Study, of the top 100 endowments, Yeshiva was tied with the University of Nebraska and Foundation for the lowest return on assets. Mr. Reed of NACUBO said that "scoring seven points below the benchmark is very significant." He said that even if the director had a successful track record in past years, "If I was on the managing committee, I would immediately want to know what's going on."

At the same time, YU officials and financial professionals noted that Mr. Merkin is known to achieve lower peaks in boom years yet higher troughs in down years. In the fiscal year 2006 YU's endowment earned 10.9%, exactly on par with the national average, while in the fiscal year 2005 the average rate was 9.3% and YU earned 14.5%.

Moreover, before the collapse of Ascot Partners, his performance in the bearish market this year was considered positive relative to comparable managers and endowments, and one board member suggested granting additional money to Mr. Merkin's funds.

While Mr. Merkin is reputed to be a well-regarded manager of his own, financial professionals speculated that Mr. Merkin's reputation for earning solid returns in bad years now appear to at least in part derive from his investments with Mr. Madoff, whose supposed gains are now known to be illusory.

While Mr. Merkin's funds initially appeared to be performing well this year, sources say that this performance may not only be damaged due to the collapse of Ascot Partners, but may be further harmed by his holdings in private equity firms - which do not trade publicly and are therefore often difficult to accurately assess. This obscurity does not allow the equity's holders to fully gauge the performance of their investments.

In particular, Mr. Merkin is known to be a significant investor in Cerberus Capital Management, a major private equity firm that privately owns several companies, most prominently Chrysler and GMAC. Through his substantial investments, Mr. Merkin is the chairman of the board of GMAC.

One source close to a board member revealed that Yeshiva's endowment invested money in Cerberus. YU officials did not comment on whether YU invested with Cerberus. Both Chrysler and GMAC are in danger of bankruptcy, although a proposed swap with GMAC bondholders may allow GMAC to accept help from the Temporary Asset Relief Program.

Still, hedge fund managers told The Commentator that they are wary of Cerberus because the private equity firm can declare what its private companies are worth. "Since [Cerberus'] assets aren't traded on the open market, they have far more leeway in deciding how much their assets are actually worth," one explained. "They can be secretive about their whole process, and no one will know the true value of their holdings."

While Chrysler may receive government bailout money which would increase its value, Daimler announced that they currently value their 19.9% stake in Chrysler at zero, giving one estimate of the value of a minority stake in Chrysler.

While Mr. Merkin has been heavily criticized for his management of Ascot Partners, one Jewish community leader who dealt regularly with Mr. Merkin in the past said that the recent developments shouldn't expunge Mr. Merkin's accomplishments prior to this past Thursday, nor erase the Jewish community's debt of hakarat hatov (gratitude) towards Merkin. "I'm not prepared to forget the tremendous amount of energy, time, thought and creative leadership that Ezra Merkin has given to the Jewish community," he said, although he acknowledged that "in light of what happened, another picture may emerge."

YU's Financial Response

Although YU's endowment has been shaken, President Richard M. Joel adamantly maintains that YU stands on solid financial ground. "Our finances are sound," he declared at YU's annual Hanukkah Dinner, referring to the "800-pound elephant in the room" of their recent losses without specifically mentioning the endowment, Madoff or Merkin by name. "We will survive this," he emphasized.

In the email, President Joel further underscored the university's financial stability, sayng that the endowment's losses will have "minimal impact" on Yeshiva's day-to-day operations. He further comforted those worried about financial commitments, declaring that YU's "levels of scholarships and financial aid will not diminish," and that "YU staff pensions are not impacted by this revelation."

Yeshiva officials also trumpeted the approximately $3.2 million they raised at the dinner, over a million dollars more than the 2007 dinner, and the roughly $125,000 they saved in planning the event. Still, officials acknowledged that given the scope of the projected losses, further cuts will likely be necessary, on top of those recently implemented after the $24 million budget deficit and economic downturn. President Joel's letter stated that the efforts to cut budgetary operations "will continue."

At this point, it is unclear how YU plans to respond to the larger issue of managing its endowment. Merkin's resignation leaves YU without its longtime investment committee chairman and devoid of a clear investment strategy to deal with the financial crisis. The five campuses as well as the larger Jewish community are abuzz with rumors regarding the extent of Yeshiva's losses and the potential ramifications. President Joel's recent email should quell some of the more extreme rumors - that the losses are in the billions or that scholarships and pensions will be sharply cut.

Additionally, without explicitly stating that the current conflict of interest policy was a factor in the recent losses, or that it was not considered among the industry's best practices, President Joel recognized the need to raise conflicts policies and governance standards to the "gold standard." Towards that end, he engaged Sullivan & Cromwell and Cambridge Associates, institutions with expertise in governance issues, to help Yeshiva establish governance standards beyond reproach.

Significant, though, was the tone of President Joel's letter and speech at the dinner. Several students appreciated that while President Joel acknowledged the challenges facing YU, he emphasized maintaining perspective, comparing YU's performance to the overall market, and highlighting the ability of YU to continue on without the lost funds. He desires to use the endowment's drop "to address all concerns that this situation has illuminated," apparently including a bid to further professionalize Yeshiva. And in both his dinner speech as well as his letter, he attempted to strike a chord of optimism and return the focus to YU's educational mission. One student expressed the opinion of several when he said that he is pleased "President Joel appears to recognize that YU's primary goal is not to maximize the endowment but to educate its students."