- Markopolos, Harry.
No One Would Listen.
Hoboken, NJ: John Wiley & Sons, 2010.
ISBN 978-0-470-91900-2.
-
Bernard L. “Bernie” Madoff was a co-founder
of NASDAQ, founder and CEO of a Wall Street firm which
became one of the top market makers, and operator of a
discretionary money management operation which dwarfed
hedge funds and provided its investors a reliable return
in markets up and down which no other investment vehicle
could approach. Madoff was an elder statesman of Wall Street,
respected not only for his success in business but also for
philanthropic activities.
On December 10th, 2008, Madoff confessed to his two sons that
his entire money management operation had been, since
inception, a
Ponzi scheme,
and the next day he was arrested by the FBI for securities fraud.
After having pleaded guilty to 11 federal felony charges, he
was sentenced to 150 years in federal incarceration, which sentence
he will be serving for the foreseeable future. The total amount
of money under management in Madoff's bogus investment scheme is
estimated as US$65 billion, although estimates of actual losses
to investors are all over the map due to Madoff's keeping transactions
off the books and offshore investors' disinclination to make claims
for funds invested with Madoff which they failed to disclose to
their domicile tax authorities.
While this story broke like a bombshell on Wall Street, it was
anything but a surprise to the author who had figured out back in
the year 2000, “in less than five minutes”, that Madoff
was a fraud. The author is a “quant”—a finance
nerd who lives and breathes numbers, and when tasked by his
employer to analyse Madoff, a competitor for their investors'
funds, and devise a financial product which could compete with
Madoff's offering, he almost immediately realised that Madoff's
results were too good to be true. First of all, Madoff claimed
to be using a strategy of buying stocks with a “collar”
of call and put options, with stocks picked from the S&P 100
stock index. Yet it was easy to demonstrate, based upon historical
data from the period of Madoff's reported results, that any such
strategy could not possibly avoid down periods much more serious
than Madoff reported. Further, such a strategy, given the amount
of money Madoff had under management, would have required him to have
placed put and call option hedges on the underlying stocks which
greatly exceeded the total open interest in such options. Finally,
Madoff's whole operation made no sense from the standpoint of a
legitimate investment business: he was effectively paying 16% for
capital in order to realise a 1% return on transaction fees while
he could, by operating the same strategy as a hedge fund, pocket a
4% management fee and a 20% participation in the profits.
Having figured this out, the author assumed that simply submitting
the facts in the case to the regulator in charge, the Securities
and Exchange Commission (SEC), would quickly bring the matter to justice.
Well, not exactly. He made his first submission to the SEC in May of
2000, and the long saga of regulatory incompetence began. A year
later, articles profiling Madoff and skating near the edge of accusing
him of fraud were published in a hedge fund trade magazine and
Barron's, read by everybody in the financial community,
and still nothing happened. Off-the-record conversations with major
players on Wall Street indicated that many of them had concluded
that Madoff was a fraud, and indeed none of the large firms placed
money with him, but ratting him out to The Man was considered
infra dig. And so the sheep were
sheared to the tune of sixty-five billion dollars, with many
investors who had entrusted their entire fortune to Madoff or
placed it with “feeder funds”, unaware that they
were simply funnelling money to Madoff and skimming a “management
and performance fee” off the top without doing any
due diligence whatsoever, losing everything.
When grand scale financial cataclysms like this erupt, the inevitable
call is for “more regulation”, as if “regulation”
ever makes anything more regular. This example gives the lie to
this perennial nostrum—all of the operations of Madoff, since
the inception of his Ponzi scheme 1992 until its undoing in 2008, were
subject to regulation by the SEC, and the author argues persuasively
that a snap audit at any time during this period, led by a competent
fraud investigator who demanded trade confirmation tickets and
compared them with exchange transaction records would have
uncovered the fraud in less than an hour. And yet this never
happened, demonstrating that the SEC is toothless, clueless,
and a poster child for
regulatory capture,
where a regulator becomes a client of the industry it is charged to
regulate and spends its time harassing small operators on the margin
while turning a blind eye to gross violations of politically
connected players.
An archive of original source documents is available on
the book's Web site.
October 2011 