The Wall Street Journal has published a detailed account of private fraud investigator Harry Markopolos’s efforts over the past 10 years to persuade the SEC that Bernie Madoff was running a gigantic Ponzi scheme (or, at best, was front-running).
Markopolos submitted extensive analysis to the SEC in 2005, which we’ve embedded below. The SEC did conduct an investigation thereafter, in the course of which Bernie Madoff “mislead” them about the nature of some of his dealings with his primary fund-of-funds promoter Fairfield Greenwich Group.
The SEC subsequently interviewed both Madoff and members of FFG and required both firms to change the way they described their relationship. The SEC says it was specifically looking for evidence of a Ponzi scheme during this investigation, but didn’t find any.
An excerpt from the WSJ:
Mr. Markopolos says his suspicions started in late 1999, after a colleague returned from New York with tales of Bernard Madoff’s impressive trading gains. Whether the markets were up, or down, Mr. Madoff managed to clock in with steady gains. He reportedly used a strategy of trading stocks as well as various options to protect against losses.
Mr. Markopolos says his bosses liked the look of those returns — and asked him why he couldn’t do the same thing.
Under pressure to deliver, Mr. Markopolos and a colleague at their Boston trading outfit tried to reconstruct Mr. Madoff’s purported strategy. Their results paled in comparison.
“It doesn’t make any damn sense,” Mr. Markopolos, 43 years old at the time, then told a colleague, who confirmed the conversation. “This has to be a Ponzi scheme.”
His bosses told him to go back and check his maths. After all, Mr. Madoff by that time was renowned as a legendary investor.
Mr. Markopolos turned to Daniel DiBartolomeo, a top financial mathematician in Boston. Mr. DiBartolomeo says he spent hours poring through Mr. Markopolos’s data, and ultimately agreed: The strategy Mr. Madoff said he used couldn’t have achieved the returns he boasted of.
In early 2000, Mr. Markopolos shared his explosive concerns with Edward Manion, a staff examiner at the SEC’s Boston office.
“This sounds serious,” Mr. Manion told him, inviting Mr. Markopolos in for a meeting.
In May, 2000, Mr. Markopolos says he sat down with Mr. Manion and an SEC attorney.
Mr. Markopolos argued his case: A key part of Mr. Madoff’s strategy relied on buying and selling options on the Standard & Poor’s 100-stock index. But Mr. Markopolos said his research showed that weren’t enough options on the S&P 100 to support the strategy Mr. Madoff’s stated strategy, given all the money he seemed to be managing. So something else must be going on.
Mr. Markopolos, a native of Erie, Pa., who had trained in unconventional warfare as a reservist in the Army, says he came to “consider Madoff a domestic enemy.”… Keep reading >
The case fell through the SEC’s cracks. Markopolos kept hounding the agency for another five years until 2005, which the SEC requested more information. Markopolos sent them the following 21-page email, which is entitled “The World’s Largest Hedge Fund Is A Fraud.” (To make easier to read, click the “full-screen” icon in the lower right-hand corner of the player).
View SlideShare document or Upload your own. Sometime after receiving the email, the SEC conducted an investigation. Below are the case opening and closing descriptions written by the SEC. In the SEC’s own words:
The Staff received a complaint that Bernard L. Madoff…operates an undisclosed multi-billion dollar investment advisory business and that BLM operates this business as a Ponzi scheme…
[D]uring an SEC investigation of BLM (Madoff’s firm) that was conducted earlier this year, BLM–and, more specifically, its principal, Bernard L. Madoff–mislead the examination staff about the nature of the strategy implemented in the…customers accounts, and also withheld from the examination staff information about certain of these customer accounts.
The SEC, which is ordinarily extremely tough on those who mislead it (see Martha Stewart) offers no explanation of why it was not more troubled by this behaviour in this case.
View SlideShare document or Upload your own. As the SEC looks into its own conduct, the critical question will be why it failed to uncover the Ponzi scheme even though it was specifically looking for it. The answer probably lies in the failure to subpoena specific information instead of relying on voluntarily produced (fabricated) documents.
It is also hard to understand why, if Madoff “mislead” the SEC in the early stages of the investigation, the agency wasn’t more aggressive in its investigation.