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conservative assumption assumes that he could get away with buying one OTC, at-the-money put per year. However, mathematically that one year at-the-money put would have a delta of .50, meaning that for each 1 point drop in the OEX index, the put’s price would only increase .5 of half that amount or 50 cents. Therefore if the market dropped 1.1%, a .50 delta put would increase in price by 0.55%, resulting in a -0.55% loss for the fund.

b. However, for all market drops greater than 1.1%, BM would experience a larger than -0.55% monthly loss and there were numerous instances of monthly market losses greater than -1.1 % during the time period.

c. Therefore, BM, in order to limit his losses would be forced to buy a series of shorter dated, higher delta put options with high gamma (a 2nd derivative term denoting that for each $1 change in index price, how much the 1st derivative term delta would change. Gamma is the change in price of Delta and Delta is the change in price of the Option with respect to the Index’s Price). If you aren’t intimately familiar with calculus, the English translation is that BM would need to be buying a continuing series of 1 day put options because these options and only these options would have the high gamma he would need to ensure that his delta changed rapidly enough to protect his portfolio enough so that he could never experience a greater than 0-0.55% monthly loss. If you’ve gotten this far, then if a one-year at-the-money OTC OEX index put option cost 8%, a continuing series of 253 (because that’s how many trading days are in a year) one-day, at-the-money puts, would cost the square root of 253 or 15.9 times the cost of the one-year put. 15.9 times 8% the one year put’s cost = 127.2% is the cost of a continuing series of one-day, at-the-money index put options if a one-year, at-the-money index put’s cost is 8%. And this is a very conservative set of calculations! Consider that one would be carrying over stock positions in this strategy over weekends, so therefore you’d want 365 one-day, at-the-money put options and the square root of 365 is 19.1, so a truer cost of put protection would be 19.1 x 8% = 152.8%. That would mean BM’s stock picking ability is not only the world’s best but that he’d likely have to be an alien from outer-space to be able to pick stocks that went up over 152.8% per year + the 16% gross returns to the HFOF investors + an assumed 4% he’s making in commissions. Therefore his stock picking ability would need to return 170% or so per year in order for him to be carrying out his strategy as he says he is in the HFOF third party marketing materials.

d. 170% per year from stock-picking is not likely for any human born on the planet earth so if BM’s achieving these types of returns then he may be an alien species from another planet. A DNA test would be sufficient to determine whether this might be the case. However, if BM is an alien being possessing superior stock-picking skills of this magnitude, this would be seen as an unfair advantage in the marketplace and likely would panic the financial markets. Or maybe he’s human and just a fraudster - take your pick.

e. Anyone capable of earning 170% per year from stock-picking would not need nor want any investors.

Conclusions:

1. I have presented 174 months (14½ years) of Fairfield Sentry’s return numbers dating back to December 1990. Only 7 months or 4% of the months saw negative returns. Classify this as “definitely too good to be true!” No major league baseball hitter bats .960, no NFL team has ever gone 96 wins and only 4 losses over a 100 game span, and you can bet everything you own that no money manager is up 96% of the months either. It is inconceivable that BM’s largest monthly loss could only be -0.55% and that his longest losing streaks could consist of 1 slightly down month every couple of years. Nobody on earth is that good of a money manager unless they’re front-running.

2. There are too many red flags to ignore. REFCO, Wood River, the Manhattan Fund, Princeton Economics, and other hedge fund blow ups all had a lot fewer red flags than Madoff and look what happened at those places.

3. Bernie Madoff is running the world’s largest unregistered hedge fund. He’s organized this business as “hedge fund of funds private labeling their own hedge funds which Bernie Madoff secretly runs for them using a split-strike conversion strategy getting paid only trading commissions which are not disclosed.” If this isn’t a regulatory dodge, I don’t know what is. This is a back-door marketing and financing scheme that is opaque and rife with hidden fees (he charges only commissions on the trades). If this product isn’t marketed correctly, what is the chance that it is managed correctly? In my financial industry experience, I’ve found that wherever there’s one cockroach in plain sight, many more are lurking behind the corner out of plain view.

4. Mathematically this type of split-strike conversion fund should never be able to beat US Treasury Bills much less provide 12.00% average annual returns to investors net of fees. I and other derivatives professionals on Wall Street will swear up and down that a split-strike conversion strategy cannot earn an average annual return anywhere near the 16% gross returns necessary to be able to deliver 12% net returns to investors.

5. BM would have to be trading more than 100% of the open interest of OEX index put options every month. And if BM is using only OTC OEX index options, it is guaranteed that the Wall Street firms on the other side of those trades would have to be laying off a significant portion of that risk in the exchange listed index options markets. Every large derivatives

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