Red Flags Ignored on Madoff’s Ponzi Scheme

Harry Markopolos, a money manager and fraud investigator who worked from 1991 through 2004 at Rampart Investment Management Co., in Boston, was among the first to raise doubts over alleged hedge fund fraudster Bernie Madoff.

“Madoff Securities is the world’s largest Ponzi scheme,” [NY Post] Markopolos wrote in a 2000 letter to the Securities and Exchange Commission. He pursued his claims with the federal regulators unsuccessfully for the next eight years.

In 2005 Markopolos submitted more analysis to the SEC on Madoff’s alleged fraud operations. His persistence prompted in 2006 the Securities and Exchange Commission to investigate the complaints. The regulators found some violations at Madoff’s firm, but the agency never brought charges.

From The Wall Street Journal:

“Of course, no one wants to take undue career risk by sticking their head up and saying the emperor isn’t wearing any clothes,” Mr. Markopolos wrote to the SEC in 2005. However, he immediately added: “That we have what is effectively the world’s largest hedge fund operating underground is plainly shocking.”
…

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 12% or so a year. He reportedly used a strategy of trading stocks as well as various stock index-options to create steady gains in any market conditions.

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 investment 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 math. 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.

‘Sounds Serious’

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 there weren’t enough S&P-100 options in existence at the time to support Mr. Madoff’s stated strategy, given all the money he seemed to be managing. So something else must be going on.
…
Over a year passed. Then, in late 2001, Mr. Manion told Mr. Markopolos the case appeared to have fallen through the cracks.

According to Yeshiva’s The Commentator – Axiom, a hedge fund due diligence firm, also investigated Madoff’s firm in 2005 and concluded that Madoff was running a Ponzi scheme. They too, wrote a letter to the SEC which apparently fell through the cracks again.

• Become A Funded Futures Trader