No One Would Listen: A True Financial Thriller (35 page)

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Authors: Harry Markopolos

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In late June I made my final submission to the SEC. The fact that I did that is probably a reasonably good definition of optimism. Actually, I wasn’t naive enough to believe the SEC would do anything, but I wanted to make sure they had a complete record. Hope dies hard. “Hello Meaghan,” I began an e-mail to Meaghan Cheung. I went on to say: “1. Attached are some very troubling documents that show the Madoff scheme is getting even more brazen. 2. Wickford is showing a monthly estimated pro forma set of returns of an investment in Madoff that is leveraged by a factor of 3.0 to 3.25 times and earns annual returns ranging between a low of 11.75 percent (2005) to a high of 33.42 percent (1997). 3. Madoff couldn’t possibly be managing billions in this strategy unlevered, much less levered. I thought you would want to see these Wickford documents. And 4. When Madoff finally does blow up, it’s going to be spectacular and lead to massive selling by hedge funds and funds of funds as they face investor redemptions. Regards. . . .”
 
The SEC’s inspector general found out that as far as Cheung was concerned, by the time she received this e-mail she considered the Madoff case “for all intents and purposes closed without the formalities.” She did claim that she forwarded it to Suh, the attorney, but Suh has no memory of ever receiving it.
 
The possibility that Madoff was in trouble was obviously very good news for me. I didn’t care how he collapsed as long as he was no longer a threat to me. The day he was arrested or went out of business or died would be the first day I could take a deep and very safe breath.
 
Maybe other people might have wondered what was going on in Bernie’s mind at this time. Was he panicking? Was he looking for an escape route? I knew that once he was exposed there would be no place in this world that was safe for him; if the legal system didn’t put him away, then his offshore investors who had lost millions certainly would. But throughout this entire investigation I never took the time to put myself in his position. I never wondered what he was thinking or when he started this Ponzi scheme or why he did it or whether his family was involved. All I had to know was that Bernie Madoff was the enemy of everything in which I believed and his continued existence was an insult to all the people in this industry who tried to do it right.
 
Besides, I didn’t have time to think about Bernie. I was much too busy investigating other crooks. By the summer of 2007 I had been working full-time on my fraud investigations for almost three years—without settling a single case. I was working with 20, 30, 40 whistleblowers on more than a dozen cases. What depressed me was how easy it was to find my cases. Fraud in the United States was a growth industry. Maybe I should figure out a good fraud and franchise it, I thought. There really wasn’t much risk of getting caught. I’d discovered that among government regulatory agencies the SEC wasn’t unusually inept. It was simply as bad as all the rest of them. It required an unusual level of stupidity or tremendous bad luck to get caught by any government agencies other than the IRS, the FBI, and the Department of Justice, which are highly competent but vastly underresourced.
 
Bernie wasn’t a genius, but he certainly wasn’t stupid—and his luck had held for decades. For my team, pursuing Madoff had probably become more of a hobby than a live investigation, something that came into our lives on occasion like an old friend showing up unexpectedly. He remained the link that held my team together, and whenever anything happened in the industry, we immediately related it back to him. For example, CNN reported in February that “The SEC confirmed that it was investigating whether the major brokerage houses were tipping off hedge funds to the trades the brokers handle for big clients like mutual funds.... The SEC is also likely to scour trading records to see if the brokers are using info about clients’ moves to invest their own capital.” Frank wrote to ask if that meant “Bernie is tipping himself off.”
 
As always, we tried to find the humor in everything Bernie. In April an article in
Absolute Return
entitled “To Catch a Thief” featured Fairfield Greenwich managing director Douglas Reid—but not the way any of us anticipated. “In the 1955 Alfred Hitchcock movie To Catch
a
Thief it takes reformed cat burglar Cary Grant to capture the thief responsible for a series of jewelry heists across the French Riviera. Douglas Reid, managing director and investment committee member for $12 billion alternative management firm Fairfield Greenwich Group, believes the same approach holds true in creating and operating hedge funds.
 
“‘Who better than a hedge fund manager to understand the business of another hedge fund manager?’ asks Reid.... FGG, which added $2 billion in capital last year, is keen to expand its global reach.”
 
Frank had sent it to me with the suggestion, “Maybe you should send him an e-mail on Bernie?”
 
“To Catch a Thief”? I wondered if Doug Reid had the slightest concept of how ironic that title was. I suspected he did. I responded to Frank, “If Doug Reid doesn’t know about Bernie I’d be surprised, since his fund is 2/3rds Bernie and 1/3rd other managers. Besides, what are the odds that Fairfield could pull $8 billion out from Madoff and see any of the money? My bet is BM would fold like a cheap tent if someone made a large cash call.”
 
I hadn’t given up completely on exposing him, but as I don’t believe in miracles I was realistic about the chances of that ever happening. I’d gone to the SEC in Boston—and gotten no satisfaction. I’d gone to the SEC in New York—and gotten no satisfaction. I’d gone to the SEC in Washington, D.e.-and gotten no satisfaction. I had no place else to go. If Madoff was going to be exposed, his luck was going to have to change. Nothing else seemed capable of stopping him. No matter what was going on in the market, he just kept rolling and rolling. In August 2007, for example, when the market declined, most hedge funds took a beating. Goldman Sachs’s largest hedge fund lost 22.5 percent, JPMorgan’s statistical hedge fund dropped 18 percent, and the $3 billion computer-driven statistical Tewksbury Investment Fund lost 8 percent. Overall, it was the worst month for hedge funds in almost a decade—except for Bernie. Fairfield Sentry still returned a profit! “Bernie’s the best ever!” I wrote Frank. “And to think I thought he’d show a loss just to prove he’s not an alien from outer space with perfect market-timing ability. Geez, the Sci-Fi channel should feature him.”
 
And then, just as I was about ready to finally give up, the SEC’s new director of risk management, Jonathan Sokobin, contacted me to see what I knew about emerging risks for the capital market. Emerging risks? That’s like worrying if Godzilla had fleas. I had been recommended to Sokobin by Rudi Schadt, the director of risk management at Oppenheimer Funds. Rudi was a friend, and although he did not know about the Madoff investigation, he did know that I had a broad knowledge of risky schemes in the derivatives world. I couldn’t warn him, because Oppenheimer Funds owned Tremont, which was the second largest investor in Madoff.
 
I had a long conversation with Sokobin in which we discussed several areas of possible concern. Although he had his PhD in finance from the University of Chicago, apparently he didn’t have a lot of industry experience. He didn’t seem to fully grasp the concepts that I was presenting to him. For example, I remember I told him there was a serious potential risk to the stock exchanges with investment banks owning too many seats. (If an investment bank filed for bankruptcy, it could put the entire exchange at risk.) He certainly seemed interested, but I got the feeling this was not what he was looking for.
 
I don’t remember whether I told him specifically about Madoff during that conversation. When we hung up, though, I knew I had his attention. On April 2, 2008, I sent him an e-mail, attaching to it “a submission I’ve made to the SEC three times in Boston. Each time Boston sent this to New York. Meaghan Cheung, branch chief, in New York actually investigated this but with no result that I am aware of. In my conversations with her, I did not believe that she had the derivatives or mathematical background to understand the violations.
 
“Interestingly, a former derivatives PM who I know is now Director of Research at an HFOF [this was Neil, but I didn’t identify him] tells me a counterpart at another HFOF pulled his money out of Madoff after asking Madoff to see his trade tickets. He then went to the OPRA [Option Price Reporting Authority] time and sales price feed and discovered that none of the Madoff trade tickets matched any time & sales reports on OPRA. He quickly concluded that Madoff was a fraud and pulled significant assets out of the fund.”
 
I attached the 2005 submission to the SEC and wrote in the subject line, “$30 Billion Equity Derivative Hedge Fund Fraud in New York.” It literally would have been impossible to provide any more evidence of risk to the director of risk management than I did in this e-mail. I was also handing him a set of directions—try to match Madoff’s trade tickets to the OPRA record of transactions. If he followed these instructions, he would discover they didn’t match. For the detectives at the SEC, that would have been considered a clue!
 
I also gave him a list of people in the media he might contact to confirm my accusations, finishing my e-mail “Best of luck in your new position.”
 
While I wasn’t optimistic, I did believe it was at least possible that he was too new to have become part of that entrenched system. Imagine what might have happened if he had followed up, and the first investigation of his career had exposed the biggest crime in financial history? You’ll have to imagine it because it never happened. I never received a response from him. I guess the director of risk management had managed not to take a risk. That was my final contact with the SEC.
 
There just wasn’t much more we could do to stop Madoff. All we could do was watch and wait for his inevitable downfall. And wait. And continue waiting. I never lost interest; whenever I had the opportunity I’d take a look at his returns—and always shake my head in disbelief. As I finally had to admit to Neil, “I hate to say it, but Bernie’s pulled off the perfect crime. He finds HFOFs that need his return stream to sell their stupid (high net worth) clients. He’s got to be managing at least $30 billion.” And as long as he was able to raise more money each month than he had to pay out, he could keep going indefinitely; by offering such a high and steady return, presumably he had attracted many clients who were using their investment with him as a savings account. Bernie was their bank; they invested their money with him and left it there, and it grew 10 percent a year, every year, far more than they possibly could earn anywhere else. As long as they didn’t need it to pay the mortgage or pay for college tuition or buy a new Porsche, there was no reason to take it out.
 
That’s exactly what Bernie was banking on, too.
 
We never stopped speculating on what would happen when he went down, how substantially the industry would be damaged; but we never considered the impact on individual investors. Oddly enough, after years of investigation we didn’t know that Madoff had opened up direct accounts, that individuals were involved other than through feeder funds. For example, while Mike Ocrant told me that in the Jewish community Bernie was referred to respectfully as “the Jewish T-bill,” none of us had any idea how deeply he had penetrated into the synagogues of New York and Florida.
 
When we got the opportunity, we did try to warn people. In 2003, just after Neil had started working at Benchmark Plus, he attended the annual Bank of America hedge fund conference at the Ritz in San Francisco. It was an opportunity for funds of funds to find fund managers. Each hedge fund had precisely 10 minutes to make a pitch. At this conference Neil met a man who had inherited several hundred million dollars and was a hedge fund investor. With his inheritance as the foundation, this investor had opened his own hedge fund of funds. Neil had heard that about half of the money in it was his own, and he had been successful enough to win several important awards. Neil met him at subsequent conferences and gradually the two men had become friendly. Neil had heard rumors that somewhere between 40 percent and 80 percent of his personal assets were invested with Madoff.
 
At almost every conference Neil ended up talking investments with him—and sometimes talking Madoff. Neil can’t directly recall telling him that Madoff was a fraud. Rather, he tried to find ways to warn him without revealing that he’d been investigating Madoff for several years and without handing him a long list of red flags. “You know, something about Madoff doesn’t look right,” Neil would tell him. “It doesn’t smell right. Look at his strategy; it doesn’t make sense. Look at the open interest. I think maybe it’s a fraud.”

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