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Chasing Bernie Madoff WAISC


  • pg 1
									Chasing Bernie Madoff

   Harry Markopolos, CFA, CFE
   Chartered Financial Analyst
    Certified Fraud Examiner

               The Human Cost
1. Thousands of direct victims
2. Suicides, depression, mistrust…
3. Families who invested 100% with Madoff are now
    impoverished – from riches to rags
4. Millions of indirect victims:
   A. Charitable services eliminated
   B. Medical care not being provided
   C. Medical research eliminated
   C. Scholarships eliminated

•   I’m no hero
•   I’m not an accountant, I’m a CFA and CFE
•   I’m not an army special ops commando, I was reserve civil affairs officer
•   I did not pay my way through college, my parents did
•   I really said “The SEC roars like a mouse and bites like a flea”
•   4 ordinary men faced with an extraordinary challenge
•   Unfortunately, we were the only thing standing between Madoff and his
    victims because the SEC was non-functional
•   Madoff’s organization was too large & powerful for us to stop alone
•   The investigation was highly successful, we proved Madoff was a Ponzi
•   But the case was a $65 billion failure
•   I feel horrible about the results

           The Investigative Team
• Frank Casey, North American CEO, London based Fortune
  Asset Management (Boston)

• Neil Chelo, CFA, FRM, CAIA; Director of Research, Benchmark
  Plus (Tacoma)

• Harry Markopolos, CFA, CFE (Boston)

• Michael Ocrant; Director of Conferences Group, Institutional
  Investor (New York)

 3 Places where the $65 Billion went
1. Most went to pay off Old Investors who were
   receiving 12% / year on average

2. ≅4% went to luring in new victims: Feeder
    Funds, Fund of Funds & Private Client Banks

3. Way less than 1% / year went to Madoff

            Obvious Red Flags Part I
• Ultra-low 6% correlation to the OEX S&P 100 stock index
• BM was 7 – 65 times the trading size of the OEX index options
  market at various points in time
• Wall Street Firms never saw his “trading volume”
• BM only picked stocks that went up or stayed the same
• > 96% of months were positive
• BM’s performance chart was upward 45 degree straight line
• Why did BM allow the Feeder Funds, FOF’s & Banks earn the
  1% & 20% hedge fund fees when all they did was market?
• BM in T-bills for most of the year but T-bills never yielded 16%

             Obvious Red Flags II
• BM couldn’t afford Put options he said he bought
• BM stock picks would have had to be > 30% per year
• Feeder Funds said BM subsidized down months but this would
  have been illegal
• Feeder Funds said BM “benefited from his broker-dealer arm’s
  trading volume” which was code for illegal front-running
• Feeder Funds said that BM had perfect market-timing ability
  thanks to his access to his B/D’s order flow
• BM never allowed outside audits
• BM self-custodied assets

                 Fund of Funds
• Source: “Who Invested with Madoff?” by George A. Martin;
  Journal of Alternative Investments; Summer 2009
• 339 Fund of Funds via 59 Management Co’s invested
• USA: 79 of 740 (10.7%)
• Switzerland: 77 of 267 (28.8%)
• UK: 52 of 546 (9.5%)
• Italy: 27 of 77 (35.1%)
• Brazil: 25 of 68 (36.8%)
• Germany: 24 of 145 (16.6%)

             Feeder Funds = Pure Evil
•   Madoff’s accomplices were the Feeders
•   Madoff was the octopuses’ body & head
•   The Feeders were Madoff’s tentacles & they spanned the globe
•   Without the Feeders Madoff would have collapsed long ago
•   All pretended to conduct due diligence
•   They lied to clients about who was managing their money
•   Some pretended to be multi-strategy but were 100% Madoff
•   They received 3% - 4% per year in fees to not ask questions
•   None asked tough questions
•   None questioned the obvious
•   Now we’re finding out that some received 300% - 950% returns
•   Hedge Fund investors need to be more wary & less trusting

         Don’t Blame the Victims
• 30 – 35 Blue Chip companies that you would be proud to own
• GM, Citigroup, Bank America, AIG, Fannie Mae, Freddie Mac,
  Merrill Lynch, Lehman, Bear Stearns, Wachovia….
• BM said he held “OEX stock index put options” to protect
  against market crashes
• Earned “only 1% a month”
• Most individual investors were not finance people and did not
  know these sorts of returns did not exist
• Lessons Re-Learned:
  1. 0 – 25% is the proper allocation to hedge funds
  2. Never put all of your eggs in one basket

                  1998 - 1999
• 1998: My Firm “discovers” Bernie Madoff

• Late 1999: I am asked to reverse engineer Madoff’s

• I knew he was a fraudster in 5 minutes

• 4 hours of mathematical modeling proved he
  was a fraud

• May: 8 page submission to SEC Boston
  Regional Office’s Director of Enforcement with
  12 Red Flags
• JAN: Casey recruits Ocrant onto team in Barcelona, Spain
• March: SEC Submission includes 1st submission + 3 additional
  pages of how I think he’s running the scheme + 2 pages on the
  Madoff investment process
• I offer to go under-cover to assist the SEC
• APRIL: Ocrant interviews Madoff
• May 1st: MAR Hedge publishes Madoff expose, “Madoff Tops
  Charts; skeptics ask how”
• May 7th: Barron’s publishes, “Don’t Ask, Don’t Tell: Bernie
  Madoff is so secretive, he even asks investors to keep mum”
• SEP: Boston SEC’s Ed Manion asks me to re-submit case

• JUNE: Key trip to UK, France & Switzerland
• Met with 20 Fund of Funds & Private Client Banks
• 14 have Madoff
• All 14 report “special access to Madoff”
• 2 have admitted Madoff losses – Dexia Asset Management &
  Fix Family Office
• 12 have not admitted Madoff losses
• All 12 turned into SEC Chairwoman 02/05/2009
• Off-Shore funds attract 3 types of investors who won’t report
  losses or file SIPC claims with the US government

                   2003 - 2004
• Investigation continues at same pace

• E-mail records of investigation lost

• Attempting to recover data from non-functioning
  hard drives

• Information from 2003-2004 builds the 2005 SEC
• JUNE: Casey discovers Madoff attempting to borrow $ from
  European banks (1st sign that Madoff scheme is in trouble)
• OCT: Boston SEC’s Ed Manion arranges for 3rd SEC Submission
• OCT: I meet with Boston SEC Branch Chief Mike Garrity
• OCT: Garrity quickly investigates, finds irregularities, &
  forwards my submission to SEC’s New York Office
• NOV: Boston Whistleblower calls NYC Branch Chief Meaghen
  Cheung & reveals his identity
• NOV: 29 Red Flags submitted
• DEC: I doubt NYC SEC’s ability, fear for my life, contact Wall
  Street Journal

• JAN: Integral Partners $40 Million derivatives Ponzi Scheme
  goes to trial, 5 years & 5 months after discovery causing us to
  further doubt SEC competence

• MAR: 5 minute call with NYC SEC’s Meaghen Cheung

• SEP: Chicago Board Options Exchange VP tells me that several
  OEX option traders also think Madoff is a fraudster. If SEC had
  called the CBOE’s marketing office, they would have
  cooperated. SEC never calls. Madoff scheme continues.

• FEB 28th: Chelo obtains a Madoff portfolio which shows zero
  ability to earn a return
• JUNE: Casey obtains Wickford Fund LP prospectus showing
  Madoff is short of cash & offering 3:1 leverage via bank loans
• JUNE: Wickford Fund LP Prospectus e-mailed to NYC SEC
  Branch Chief Meaghen Cheung
• JULY: Chelo obtains Fairfield Greenwich Sentry LP financial
  statements for 2004 – 2006; 3 years with 3 different auditors!
• AUG: Chelo conducts 45 minute telephone interview with
  Fairfield Greenwich’s head of risk management
• AUG: Hedge funds all lose money except for Madoff!

• Financial markets in turmoil, team loses interest, no activity
• APRIL: Jonathan Sokobin, SEC’s Director of Risk Assessment
  calls me per a recommendation from a mutual friend
• APRIL 2nd: Undelivered E-mail to Sokobin entitled, “$30 Billion
  Equity Derivatives Hedge Fund Fraud in New York”
• FALL: Stock Markets crumble, panicked investors rush to
• December 11th: Madoff runs out of money, turns himself in

• FEB 4th: Hearing with myself followed by SEC’s senior staff and
  FINRA acting CEO; 375 pages of my testimony is available at under House Financial Services Committee,
  111th Congress, Archived Hearings, Feb 4, 2009 along with
  over 2 hours of video or you can go to
• FEB 5th: I provided a day of sworn testimony to the SEC’s IG
• MAR 10th: I meet with SEC Chairwoman Mary Shapiro
• SEP 4th: 477 Page SEC IG Report on the Madoff Fiasco
• SEP 10th: I testify before US Senate Banking Committee with
              SEC IG

                  SEC Investigative Errors I
             Little or No Industry Experience
1.   SEC Mission is to protect investors yet almost none of the staff were
     Certified Fraud Examiners or trained in investigations!
2.   The junior most examiner sat on an options trading desk for a while but
     didn’t have much experience in industry or at the SEC
3.   None of the senior examiners or enforcement attorneys had any asset
     management or trading experience!
4.   SEC sent intellectual equivalent of guppies to chase sharks
5.   SEC staff did not know how to use the Wall Street Journal, Bloombergs or
     OPRA tapes to track trading volumes
6.   SEC staff did not know that Over-the-Counter (OTC) derivatives are more
     expensive to trade and that the hedging takes place in the listed markets

              SEC Investigative Errors II
     Unwillingness to obtain 3rd party verification
1.  New York SEC never asked me or other BM whistleblowers any questions
2.  SEC never phoned any of my witnesses
3.  SEC afraid to call reporters for background
4.  SEC never verified BM’s bank account information
5.  BM told them he custodied assets at Barclays & HSBC but they never
    checked to verify accounts
6. SEC never verified time & sales volume of his trades with DTC or OCC
7. SEC asked who BM’s counter-parties were but never followed up & asked
    them if they traded with BM
8. SEC never traveled to BM’s accountant Frieling & Horowitz
9. SEC never contacted UK’s FSA for assistance
10. BM says he traded thru Barclays, SEC gets docs back from Barclays that
    say BM had no positions with them & doesn’t think this suspicious
             SEC Investigative Errors III
        19 May 2006 SEC’s Madoff Deposition
1.   BM says executions happen electronically but then describes picking up
     the phone and negotiating the price which is not electronic trading
2.   BM says he shops his stock trade packages to 50 European stock brokers
     and his options trade packages to 12 European options brokers because
     there isn’t enough liquidity in the USA. Can’t do this because you’d be
     front-run to death! Plus there were not 50 capable brokers in Europe.
3.   BM says he trades stocks at different times & prices, then calculates an
     average price for clients but he trades the options all at once so he can
     deliver one average price for his clients. Mathematically these are
     functionally equivalent so it’s an obvious lie if you can count.
4.   BM says he pays 4 cents per share on this stock trades but only 1 cent per
     share equivalent for his options contracts (i.e. $1 per contract) because
     there’s no value added for his options trading. He doesn’t know options
     lingo or options commission math.

             SEC Investigative Errors IV
        19 May 2006 SEC’s Madoff Deposition
5.   BM says he trades the stocks first in London, then trades the options in
     London between 8 am – 9 am (US Eastern Time) before the US markets
     are open. (Too much price risk if stocks drop before he buys his puts.
     Plus these size trades can’t be done overseas.)
6.   BM says his returns are not high enough to justify setting up a hedge
     fund. This ignores the fact that 339 FOF’s are set up to market BM’s
     chart-topping Sharpe Ratios which beat all hedge funds.
7.   SEC asks BM a series of questions about his Depository Trust Clearing
     Corp account and even obtain his DTC Number. However, they fail to
     follow up and ask DTC for his trades (there weren’t any!). If they had
     spent an hour going to DTC they would have proof he was a Ponzi
8.   SEC only allowed 1 Examiner in the room. Examiners & Enforcement
     Attorneys knew BM was lying but did not challenge him.


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