Helmut Kiener: Germany's mini-Madoff

Convicted hedge-fund manager Helmut Kiener has been described as Germany's mini-Madoff. Kiener duped the giants of the banking system out of millions. But were the banks - blinded by greed - partly at fault?

Amongst financial fraudsters, Bernie Madoff has achieved pretty much legendary status. Any comparison with the $65bn swindler has become a sort of perverse compliment. That's the accolade' now being foisted on a newly jailed replica of the ex-Wall Street Ponzi super-schemer (we explain Ponzi schemes below).

This latest "mini-Madoff" is to be found in Germany. Helmut Kiener, the founder of the K1 hedge fund and a psychologist by training has just been sentenced on 86 counts of falsification of documents and ten of fraud and tax evasion "after one of Germany's most spectacular cases of financial crime to be revealed by the global economic crisis", says James Wilson in the Financial Times.

Former advertising salesman Kiener, 52, isn't quite in the same league as Madoff numbers-wise. From his base in the small Bavarian town of Aschaffenburg, he got away with less than $500m. But like the American, Kiener proved very adept at racking up huge losses to pay for a lifestyle that became more and more extravagant. Much of the money once managed by his funds was siphoned off into aircraft, boats, cars and property in Florida and, unsurprisingly, it's understood that most has since vanished.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

Like Madoff, Kiener fooled some big names: Barclays Bank was stung for €147m while BNP Paribas lost €42m, according to German court prosecutors. In addition, between 2006 and 2009, private investors were defrauded out of €121m. The alarm was raised by US investment bank JP Morgan over deals involving Bear Stearns (which it had taken over) and K1. But since his October 2009 arrest, Kiener has put up quite a fight. At the time, his lawyers noted that "this man is not insignificant", citing "a private audience with the Pope" and "a €60m jet at Frankfurt airport" as evidence. He even tried to claim immunity as a Guinea-Bissau-registered diplomat. Dieter Frerichs, a former managing director of two K1 funds, committed suicide a year ago in Spain as police tried to serve him with an extradition order.

As the trial approached, Kiener claimed the banks should have known what they were getting into and that "greedy" clients were also at fault for being ripped off. The judge appeared to agree, opining that these banks had made it easy for Kiener to continue his Ponzi scheme perhaps that's why he got a sentence of just ten years and eight months. It's perhaps even more surprising that he didn't get caught earlier, given that in 2002 the German financial regulator Bafin barred him from portfolio management for failing to register his fund. He responded by registering two funds from the British Virgin Islands instead. But, having tried every defence in the book, reality is dawning. "I don't know what drove me with hindsight one is always wiser," Kiener said post-verdict. "I didn't have the courage to end it all earlier. Now I have to pay'.'

What are Ponzi schemes?

Helmut Kiener's exploits have brought Ponzi schemes right back into the news. But what are they?

The US Securities & Exchange Commission describes a Ponzi scheme as a pyramid that functions on the "rob Peter to pay Paul" principle. In short, a fraudster promises big returns to lure in the punters. As more pile in, the fraudster pays off earlier investors with newcomers' money. So anyone who joins early may appear to make the advertised returns and then ideally (from the fraudster's point of view) brag about them. The ruse works until the scheme runs out of new victims: then the whole thing collapses and the latest investors to join lose out big time.

The scheme is named after 1920s crook Charles Ponzi who promised a 40% return in just 90 days based on trading US mail coupons. His scheme was so successful that during a three-hour period in 1921 he took in $1m. But when it crashed, it transpired Ponzi had only ever bought a small number of coupons and investors lost more than 70% of their money.

Fast forward and hedge-fund manager Kiener boasted on his website that by using the "K1 Allocation System", his fund had achieved an overall return of 825% between 1996 and 2009. The S&P 500 index gained just 49% over the same period. But, as the German court that convicted him noted, "Kiener's system only worked as long as he managed to acquire fresh funds... his investors' chance to earn any return was almost zero". Kiener admitted forging statements for his K1 Invest fund as soon as it was set up. But he claimed the banks involved had to approve both his investment proposals and also the funds he chose. They "could have protested against the investment", he said. Indeed, as the court later noted, "this case is extraordinary because of its size and the number of cheated investors". Many, it appears, couldn't resist a seemingly free lunch.