Madoff meets Lehman

In October, Tremont’s Rye Select Broad Market fund filed a lawsuit alleging that it was owed some $25 million on a derivatives contract that permitted it to borrow money from a Lehman subsidiary. The derivative contract enabled the Rye fund to leverage its investment in Madoff’s firm by a factor of 3 to 1—a move that enabled Tremont to generate higher returns and justify the fees it was charging investors.

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... the deal between Lehman and the Rye fund offers a glimpse into the way many funds of funds had come to operate in recent years. In order to justify an extra layer of fees, on top of the ones charged by the underlying hedge fund managers, funds of funds managers had to amp-up returns. And the only way to do that was by getting leverage from a bank.