When searching for a wise and timeless quote to illustrate one of the two great lessons from the $490 million collapse of the Shield Master Fund, I couldn’t go past a line espoused by one of America’s most successful white-collar criminals.
Convicted fraudster and Ponzi scheme mastermind Bernie Madoff was at the peak of his fund-raising powers in October 2007 when he told a small audience at the Philoctetes Centre in New York about the conflicts at the heart of investing.
“You have to understand. Wall St is one big turf war … by benefiting one person you’re disadvantaging another person,” Madoff said, according to The Wizard of Lies by Dianna B. Henriques.
Her book describes how, within a few months of that speech, an unstoppable run of redemption requests hit Madoff’s hedge fund, culminating in its closure in December 2008 with losses to investors of $US65 billion ($93 billion).
Almost 20 years after Madoff went bust, US capital markets remain rife with conflicts of interest, which are defended using the lame excuse that it all depends on how they are managed.
In Australia, conflicts of interest have been a common feature of every major collapse of a non-bank financial entity for the past 40 years, according to a comprehensive analysis conducted by legal scholar David Millhouse as part of his PhD at Bond University’s law school.
Millhouse’s analysis of 199 senior court judgments published between 1984 and 2018 shows a high correlation in the top decile and top quartile samples between related party transactions and egregious behaviours.
He estimates that about $52 billion in investor funds were lost or impaired during the 34-year period covered by his analysis. That is a huge loss of productive capital that could have supported the economy.
Turning to conflicts of interest at Shield, I should say upfront that Shield was not shut down following a run on redemptions. Instead, it was closed because the Australian Securities and Investments Commission initiated interim stop orders in February 2024.
Also, it was not, as far as we know, a Ponzi scheme, and any allegations of fraud are yet to be fully tested in court.
But it is clear from multiple court filings lodged by ASIC and Jason Tracy, one of the joint liquidators of Shield’s responsible entity Keystone Asset Management, that this particular managed investment scheme was riven with conflicts of interest.
Not all of those conflicts were obvious from reading the product disclosure statements lodged with ASIC or the favourable research reports published by SQM Research.
The PDS and SQM documents were relied on by investment advisers who recommended Shield to 5800 clients who pumped about $500 million into the fund between April 2022 and February 2024.
The PDS and SQM documents make it plain that Keystone’s founders, Ilya Frolov and Paul Chiodo, were directors of Shield’s responsible entity as well as directors of Shield’s investment manager, CF Capital Investments.
In effect, Frolov and Chiodo, as trustees, were guarding the best interests of Shield investors against the actions of themselves, as fund managers.
But scratch below the surface and you find that there were some related party disclosures not made known to retail investors.
The Shield PDS says the direct property component of the “multi-asset fund” is invested in the Advantage Diversified Property Fund, a wholesale property fund which, in turn, “invests in individual property development and financing projects” managed by a company controlled by Chiodo, the Chiodo Corporation.
What the PDS does not reveal is that nine of the 11 property projects financed by the ADPF, with a book value of $214 million, were controlled by Chiodo or companies he was a director of.
Chiodo says that information was freely available to anyone who requested a copy of the ADPF information memorandum. Also, he says he did not attend CF Capital investment committee meetings which discussed investments in the ADPF.
SQM Research founder Louis Christopher says he was unaware that Chiodo controlled the ADPF properties.
“The Shield collapse should be the catalyst for federal government reform of our treatment of conflicts of interest.”
The CF Capital investment committee has an interesting history. Its only independent member, Werner Stals, only lasted about a year, and his successor as an independent member of the committee, Robert Talevski, says he was not a member of the committee despite his name being listed in a Shield 2023 PDS and in a 2024 SQM report.
Chiodo says Talevski became a member of the CF Capital investment committee after doing asset consulting work.
But Talevski says during the consulting engagement he became aware of inaccurate representations in certain materials of his role, at which point he issued formal legal notice requiring immediate correction and removal. Subsequently, he terminated the engagement.
Meanwhile, there is extensive legal action by ASIC and Tracy to protect the interests of Shield investors, recover funds for distribution and hold people to account.
Tracy is suing City Built Pty Ltd and its owner, Roberto Filippini and their related parties who were paid approximately $158 million in respect of ADPF property developments. Chiodo and Chiodo Corporation are also parties to the claim. Tracy says this could take two years, but Chiodo says it will take five years.
Tracy, who is managing director of consulting firm Alvarez and Marsal, is suing Frolov and his related entities for $17 million paid to them from investor funds. Tracy says this case will go for two years.
Caveats have been lodged on a number of properties owned by Chiodo, Frolov and Filippini to protect recovery from those assets in the event the above proceedings are successful.
Separate from all that, Chiodo Corporation has also filed an application in the Supreme Court against Tracy, setting aside the liquidator’s rejection of Chiodo Corporation’s proof of debt in the sum of $8,939,426. Tracy is fighting that claim.
I agree with Millhouse when he says that the Shield collapse should be the catalyst for federal government reform of our treatment of conflicts of interest.
At the moment, conflicts of interest are statutorily permitted in Australia, provided there is a prioritisation of members “interests” with their “informed consent”. Millhouse says there is no prohibition which applied traditionally in trust law and which applies in other jurisdictions.
“What this means is that it is open to the directors to determine what the statutory best interest duty under section 601FC(1)(c) of the Corporations Act means, or whether they have allegedly exercised it rather than their own self-interest,” Millhouse says.
Banning conflicts of interest in the investment supply chain ought to go hand-in-hand with a new statutory definition of fiduciary duty, which can be enforced throughout the investment chain. This is already law in Singapore, Canada and several European Union countries.
Unfortunately, the vested interests that would argue against these changes to our financial system infrastructure are extremely powerful, especially the industry super funds who would be unable to continue with their highly conflicted investment strategies.