A number of folks have suggested that you could tell Madoff was a fraud simply by looking at his returns alone. We’ve wondered if, perhaps, one new regulation to come out of this will require hedge funds to send their monthly numbers to the SEC so that their computers could monitor returns that didn’t fit statistical pattern.
One neat way of catching cheats is Benford’s Law, a way of analysing the numerals in a dataset to see if results were created by hand, or if they were truly random.
Wikipedia: ….in lists of numbers from many real-life sources of data, the leading digit is distributed in a specific, non-uniform way. According to this law, the first digit is 1 almost one third of the time, and larger digits occur as the leading digit with lower and lower frequency, to the point where 9 as a first digit occurs less than one time in 20.
So did Bernie Madoff violate Benford’s Law? Nope. Paul Kedrosky ran the numbers found the distribution to be right in line with what Benford would predict for a legitimate fund:
Obviously, he was fund was a Ponzi scheme, so this doesn’t tell you anything except that this one forensic accounting technique would not have been enough to nail Bernie.