A decade after Bernie Madoff’s arrest, FBI agents reveal more about his Ponzi scheme

[Sig]

Markopolos compiled his evidence and arguments in a fairly extensive write-up and more or less published it (made it widely available anyway). I'm sure I have a copy of it somewhere. I will dig it up and post it here and you can judge the pre-arrest evidence for yourself.

This main point, IIRC, is that Madoff's claimed strategy was not capable of either handling the size he was running nor producing the preternaturally consistent returns he was claiming.

Thanks for the book recommendation, I'll add it to my reading list.

Sounds like the Markopolos data may have risen to the probable cause level. A claimed strategy not being capable of the size you're running or preternatural returns are most definitely not probable cause and I can't imagine the screaming that would happen if you started asking federal agents to determine what exactly is a natural vs preternatural return or a capable size for a given strategy. It would really be an unfair ask on the agents as well, even if you were somehow able to get someone with enough actual experience at a hedge fund to be able to approximate those decisions to go work for $120K/year at the FBI.

 

[JSOP]

I'm not sure how any of those 3 letter agencies would have gone about figuring it out. I mean mechanically, what does that look like? They send an agent in to actually perform an audit? Of what, any firm that has positive returns for more than 5 years in a row? Can you imagine the cries of outrage? Where there any big issues that they should have been aware of from the required reporting that could have been sifted from the tens of thousands of other required reports? Victimless crime like a ponzi scheme that hasn't gone bust yet is incredibly hard to suss out from a LE perspective without a very high level of intrusiveness. Most of the guys who get caught are morons who are operating without the right licenses or something else obvious, Madoff knew enough not to make any of those catchable mistakes that could have led to more scrutiny.

Well that's the problem of those agencies then that they are not doing their job right in actually catching the criminals. That's exactly my point. All they are doing is just checking their documentation and their licensing requirement. Anybody can do that and that's not what the taxpayers have paid them to do. The taxpayers have paid them to catch the real crooks, the real criminals like Madoff and they failed. Even if they weren't sophisticated enough to figure out the scheme from the math point of view, they could've still audited Madoff for all the trades that his "fund" had done. He claimed that his "fund"' return was from covered options strategies so all they needed to do was to go down to any options exchange and check the trade records, T&S, and they would've discovered right there and then it was fraud cuz there would've been no records of any transaction. They could fabricate and make up all those phony records, statements or whatever to full the auditor but they wouldn't be able to fabricate transaction records in exchanges. So this is not incompetence; this is complacency and it's really no excuse.

You should read the book "Nobody Will Listen" by Harry Markopolos. It's a great book. It's an eye-opener and it would make you so angry.

 

[Sig]

Well that's the problem of those agencies then that they are not doing their job right in actually catching the criminals. That's exactly my point. All they are doing is just checking their documentation and their licensing requirement. Anybody can do that and that's not what the taxpayers have paid them to do. The taxpayers have paid them to catch the real crooks, the real criminals like Madoff and they failed. Even if they weren't sophisticated enough to figure out the scheme from the math point of view, they could've still audited Madoff for all the trades that his "fund" had done. He claimed that his "fund"' return was from covered options strategies so all they needed to do was to go down to any options exchange and check the trade records, T&S, and they would've discovered right there and then it was fraud cuz there would've been no records of any transaction. They could fabricate and make up all those phony records, statements or whatever to full the auditor but they wouldn't be able to fabricate transaction records in exchanges. So this is not incompetence; this is complacency and it's really no excuse.

You should read the book "Nobody Will Listen" by Harry Markopolos. It's a great book. It's an eye-opener and it would make you so angry.

Again it just doesn't work that way. You have to be sophisticated enough to figure out a scheme from a math point of view AND develop probable cause from that or else you need to audit every fund to the level that you examine their strategy and match trades to it. Neither of those is feasible from a staffing point of view, both the number of staff and the sophistication of staff you can hire on FBI level salaries. Believe me, I've lived the dream working in government and just trying to hire people with masters in Ops research is nearly impossible at a govt salary plus all the bullshit you have to deal with when working in govt, let alone trying to hire someone with enough experience to decode this type of stuff. There are lots of smart, driven people in government. However the Venn diagram of the type of smart, driven people who go work for the FBI and those who go work for hedge funds not only doesn't overlap but is probably two circles miles apart. Not saying one is better than the other, it's just a fact you deal with in government.

 

[JSOP]

Again it just doesn't work that way. You have to be sophisticated enough to figure out a scheme from a math point of view AND develop probable cause from that or else you need to audit every fund to the level that you examine their strategy and match trades to it. Neither of those is feasible from a staffing point of view, both the number of staff and the sophistication of staff you can hire on FBI level salaries. Believe me, I've lived the dream working in government and just trying to hire people with masters in Ops research is nearly impossible at a govt salary plus all the bullshit you have to deal with when working in govt, let alone trying to hire someone with enough experience to decode this type of stuff. There are lots of smart, driven people in government. However the Venn diagram of the type of smart, driven people who go work for the FBI and those who go work for hedge funds not only doesn't overlap but is probably two circles miles apart. Not saying one is better than the other, it's just a fact you deal with in government.

Like I said in the previous post, in this case, you don't even need the math to figure out Madoff's scheme. You just needed to check Madoff's "funds" options transaction records at the various options exchanges, OCC and you've found the fraud. Madoff claims his "funds" does covered options strategies so where were his options and stocks transactions at the exchanges at the OCC? That should've been part of the audit that those agencies do, just checking to make sure transactions really happened regardless whether they suspect scheme or not. WHY wasn't that audit done? Madoff provided the cooked books with all those transactions but no transactions ever recorded at the exchanges that matched against his books? Is it possible that all the options exchanges or the OCC just forgot or failed to record transactions from Madoff's "funds"? No, then why the discrepancy? There's your fraud right there. No math needed. This is lack of due diligence or a flawed audit process not lack of skill on those agencies' part.

 

[Sig]

Like I said in the previous post, in this case, you don't even need the math to figure out Madoff's scheme. You just needed to check Madoff's "funds" options transaction records at the various options exchanges, OCC and you've found the fraud. Madoff claims his "funds" does covered options strategies so where were his options and stocks transactions at the exchanges at the OCC? That should've been part of the audit that those agencies do, just checking to make sure transactions really happened regardless whether they suspect scheme or not. WHY wasn't that audit done? Madoff provided the cooked books with all those transactions but no transactions ever recorded at the exchanges that matched against his books? Is it possible that all the options exchanges or the OCC just forgot or failed to record transactions from Madoff's "funds"? No, then why the discrepancy? There's your fraud right there. No math needed. This is lack of due diligence or a flawed audit process not lack of skill on those agencies' part.

Inherent in what your saying is the requirement for 100% audits of every financial advisor to the point of examining their stated investment strategy and tracking at least a significant number of their trades up to the point of matching them with actual trades on the exchange, ensuring that the path leads all the way back to the fund AND matches the stated fund strategy which would have to explicitly state something like "we buy covered options", which I'll point out is uncommon and would become even more uncommon if this kind of audit happened at a 100% rate. Remember, Madoff had a legit market making operation going on upstairs so even if we went with your idea they would have had to get all the way to the point of disambiguating between the trades in the money market operation and the supposed fund trades which, as it turns out in the end, required a team of several people spending many months on-site digging through records. And that was after they knew that there was a problem and could be intrusive as hell in the audit.
There are tens of thousands of funds in the U.S. The idea that you could possibly hire enough people at $120,000 a year to do this level of audit on every single one of them....it's just not realistic. The SEC would have to be the size of GS with salaries to match. And have Gestapo like powers. That's simply not going to happen and I'm not sure even you would want it to. Not trying to win an argument here, just trying to get people to think through the actual logistics of actually making something like this happen when you're constrained by the actual reality of working within government. Think through how you would actually do this if I called you up tomorrow and asked you to put in into place, nuts and bolts of how you'd hire, how many you'd have to hire, how you'd set up your audits, what kind of legal and regulatory pushback you'd encounter..... Again, having lived the dream, it's easy to criticize but oh so much harder to actually do when it comes to working within government.

 

[Kevin Schmit]

Attached is the abridged Markopolos dossier. The full version is 12mb, too large for an ET upload. If you want the full version, PM me with an email address and I will send it to you.

 

[Kevin Schmit]

And here is the MAR Hedge article. You can see that the authors were strongly hinting that there was something fishy going on there.

It's from 2001, not the late 90's, so my memory was a little off on the date of it.

 

[Sig]

And here is the MAR Hedge article. You can see that the authors were strongly hinting that there was something fishy going on there.

It's from 2001, not the late 90's, so my memory was a little off on the date of it.

Thanks for tracking that down. One interesting passage "...the strategy, which claims to use OTC options almost entirely...". Which means that the audit matching trades to exchange trades cited by @JSOP wouldn't have been viable. It is interesting to read a 2001 article like that knowing the eventual outcome.

 

[ironchef]

And here is the MAR Hedge article. You can see that the authors were strongly hinting that there was something fishy going on there.

It's from 2001, not the late 90's, so my memory was a little off on the date of it.

I find this very interesting. Many of the "Market Wizards" in Schwager's books had very similar (or better) returns and low drawdowns?

Why didn't Schwager interview BM?

Hard for us little guys to tell one from the others.

 

[Kevin Schmit]

Many of the "Market Wizards" in Schwager's books had very similar (or better) returns and low drawdowns?

I've known a few of them. None had the low month-to-month standard deviation of returns that Madoff claimed year after year.