No One Would Listen: A True Financial Thriller

by Harry Markopolos

  Mike Ocrant’s story was published in MARHedge on May 1, 2001. It was a very low-key story, extremely well written, simply laying out the facts and offering Madoff’s explanations. He wrote that Madoff’s $6 billion to $7 billion in assets “would put it in the number one or two spot in the Zurich (formerly MAR) database of more than 1,100 hedge funds, and would place it at or near the top of any well-known database in existence defined by assets.

  “More important, perhaps, most of those who are aware of Madoff’s status in the hedge fund world are baffled by the way the firm has obtained such consistent, non-volatile returns month after month and year after year.”

  Point by point Ocrant laid out the arguments we’d made. “Skeptics who express a mixture of amazement, fascination, and curiosity about the program wonder, first, about the relative complete lack of volatility in the reported monthly returns.

  “But among other things, they also marvel at the seemingly astonishing ability to time the market and move to cash in the underlying securities before market conditions turn negative; and the related ability to buy and sell the underlying stocks without noticeably affecting the market.

  “In addition, experts ask why no one has been able to duplicate similar returns using the strategy and why other firms on Wall Street haven’t become aware of the fund and its strategy and traded against it, as has happened so often in other cases; why Madoff Securities is willing to earn commissions on the trades but not set up a separate asset management division to offer hedge funds directly to investors and keep all the incentive fees for itself, or conversely, why it doesn’t borrow money from creditors ... and manage the funds on a proprietary basis.”

  And then he presented Madoff’s responses, describing him as appearing “genuinely amused by the interest and attention aimed at an asset management strategy designed to generate conservative, low-risk returns that he notes are nowhere near the top results of well-known fund managers on an absolute return basis.

  “The apparent lack of volatility in the performance of the fund, Madoff says, is an illusion based on a review of monthly and annual returns. On an intraday, intraweek, and intramonth basis, he says, ‘the volatility is all over the place, with the fund down by as much as 1 percent.”

  An illusion? Only magicians do illusions. Maybe that was right—magic was as good an explanation for his returns as anything he said. As Ocrant wrote, “Market timing and stock pricing are both important for the strategy to work, and to those who express astonishment at the firm’s ability in those areas, Madoff points to long experience, excellent technology that provides superb and low-cost execution capabilities, good proprietary stock and options pricing models, well-established infrastructure, market making ability, and market intelligence derived from the massive amount of order flow it handles each day.”

  And how does he make his massive stock and options moving invisible so that no one ever sees it? “Avoiding market impact by trading the underlying securities, he says, is one of the strategy’s primary goals. This is done by creating a variety of stock baskets, sometimes as many as a dozen, with different weightings that allow positions to be taken or unwound slowly over a two-week period.

  “Madoff says the baskets comprise the most highly capitalized liquid securities in the market, making entry and exit strategies easier to manage.”

  And why doesn’t he simply open a hedge fund, which would enable him to make even bigger profits? He even had an answer for that one: “Setting up a division to offer funds directly, says Madoff, is not an attractive proposition simply because he and the firm have no desire to get involved with the administration and marketing required for the effort, nor to deal with investors.”

  “Many parts of the firms’ operations could be similarly leveraged, he notes, but the firm generally believes in concentrating on its core strengths and not overextending itself.”

  Finally, as for all the rumors in the industry about the way he conducts his business, he dismissed them completely: “[T]hose who believe there is something more to it and are seeking an answer beyond that are wasting their time.”

  As Frank, Neil, and I read Ocrant’s article, we started high-fiving each other. We’d gotten him! We were certain there was no way SEC investigators could read it without opening an investigation. I was ecstatic, but Frank was exuberant because once Madoff was gone he had a clear path to Thierry’s $300 million. “This is it,” Frank said. “The SEC’s gonna ride into town with a posse and they’re gonna shut him down!”

  Hidden within the story was even more evidence of Madoff’s deception. He had admitted for the first time that he was running as much as $7 billion, which meant he had to have an established line of credit from some bank, and there wasn’t a bank in the world that was going to give a multibillion-dollar line of credit to a single broker-dealer without equity and without completely revealing the nuts and bolts of the entire operation.

  We waited expectantly for the response. It never came. Mike received more than a dozen phone calls from industry people who confirmed that their investigation of Madoff had shown that something strange was going on, and they were glad Mike had made it public, but he didn’t get a single phone call from any regulatory group interested in pursuing this story or from any investors who were dissuaded from giving Madoff their money because of it.

  The silence from the SEC was particularly discouraging. It was difficult to believe that they could read this story and not open an investigation. As I later learned, the answer was that they didn’t read the story. Apparently the SEC does not have a publication budget, meaning staff members have to pay out of their own pockets for any industry material. They even have to pay for their own subscriptions to the Wall Street Journal, so obviously very few of them would be reading MARHedge, which cost more than a thousand dollars annually.

  One phone call Ocrant did get the day after his story appeared was from a reporter at Barron’s magazine, Erin Arvedlund, who told him she had been working on a similar story about Madoff. To our surprise, amazement, and delight, her story was published six days after the MARHedge piece. Although Arvedlund later claimed she had been working on the story for months and had done her own research, in essence the story was little more than a summation of Mike’s. She did have a conversation with Madoff, though, presumably on the phone, in which he called claims that he was front-running, “ridiculous,” and she did interview at least one investment manager who refused to be identified. Arvedlund reported, “Madoff’s investors rave about his performance—even though they don’t understand how he does it. ‘Even knowledgeable people can’t really tell you what he’s doing,’ one very satisfied investor told Barron’s. ‘People who have all the trade confirmations and statements still can’t define it very well. The only thing I know is he’s often in cash’ when volatility levels get extreme.

  “This investor declined to be quoted by name. Why? Because Madoff politely requests that his investors not reveal that he runs their money. ‘What Madoff told us was, if you invest with me, you must never tell anyone that you’re invested with me. It’s no one’s business what goes on here,’ says an investment manager who took over a pool of assets that included an investment in a Madoff fund. ‘When he couldn’t explain how they were up or down in a particular month,’ he added, ‘I pulled the money out.”’

  Although Ocrant was justifiably upset by what appeared to be basically a rewrite of his reporting, we were elated. We knew there was no way Madoff could remain standing after two articles this devastating were published within a week of each other. While MARHedge had a limited and exclusive readership, Barron’s was a business magazine for the consumer. It had a large circulation. This was a double-barreled shotgun. We had reached the Wall Street insiders and the general public. We didn’t think there was any way he could survive it.

  I remember speaking with Ed Manion’s wife, Mary Ann; we were both confident it was finally over. The SEC would have to take action. In fact, just to make sure that the S
EC could connect the dots, the day Barron’s published Arvedlund’s article someone from the BDO, presumably Ed Manion, called the New York office and spoke to the director. The caller told him about the Barron’s article, reminded him that they had my second submission in their office, and volunteered to send the director a copy of the article. This was no longer just a road map; it wasn’t even a GPS. This was a guide dog leading a blind man to the Promised Land.

  I believe that the director wasn’t interested, that he wouldn’t even reconsider initiating an investigation, and I know of no evidence that he ever read either Ocrant’s piece or the Barron’s article.

  The two magazine stories together made as much impact as a single snowflake. We were astonished, shocked. It was like watching the monster march into the city and seeing the bullets bounce harmlessly off him. That’s when we first began to wonder exactly what we were dealing with. How powerful was Bernie Madoff? How could he have remained standing after these attacks? Who did he know? What strings was he pulling? It was a chilling thought.

  Mike Ocrant spoke with Madoff once more. After the Barron’s article was published, he called Madoff’s office. This time Madoff was unavailable, out of town. But a few hours later Madoff returned the call. He was on a golf course in Europe, he said. Ocrant wanted Madoff to know that he had nothing to do with the Barron’s piece, that he wasn’t trying to attack him. He also acknowledged that there was a minor factual error in that article. This was Ocrant’s way of keeping the door open in case he needed to do a follow-up.

  Madoff was extremely gracious about it. No problem, don’t worry about it, everybody’s just doing their job, and thanks for the call.

  We had shot our biggest guns, and our target hadn’t even been wounded. In the movies good always triumphs over evil, and sometimes there’s a tendency to believe that’s also true in real life. As we were being taught, that isn’t true. Not only didn’t we slay the monster, but it was growing. And it would soon become more dangerous than ever.

  Chapter 4

  Finding More Peters (to Pay Paul)

  At the height of my frustration I sent this e-mail to Neil, outlining my new plan to expose Madoff: “You know, maybe we should launch a fund just like Bernie’s only we’ll offer slightly higher returns with a 4 percent annual volatility. We raise $2 billion in maybe a year or 18 months, divide it equally and flee to a country without extradition. We then sell our story to Larry King and point out that we only did it to alert investors to the much larger Bernie Madoff Ponzi scheme and that Bernie is our hero for teaching us how to run a really good Ponzi. Bernie then goes down, we look like heroes, and we live happily ever after in Switzerland.”

  Ah, that Neil. He thought I was kidding.

  But I didn’t know what else to do. Nobody was listening. Even at Rampart the only thing management cared about was finding a product that could compete with Madoff. When I explained once again that it was impossible, they agreed with me, and then asked when I was going to have it ready.

  After it became clear to them that I didn’t want to do it, they began looking outside. Finally, through a web site Frank found an options trader on the Pacific Exchange who appeared to have created a very interesting product. It looked like he had found that elusive inefficiency in the market structure. Basically, until the turn of the century the major options exchanges in Chicago, New York, Philadelphia, and San Francisco really didn’t compete with each other. They would each trade options on specific stocks and the other exchanges would honor that exclusivity. But as the big institutions began to move into the options market that tacit arrangement broke down. When the volume increased, the competition got a lot tougher—and so did the risks traders were forced to take. To protect themselves they had to lay off some of their risk. The whole business was changing, and this trader Frank found believed there was the opportunity to make a lot of money by taking some of that risk in exchange for a piece of the profits—but he needed a lot of seed capital to build his business.

  It was an interesting concept. This trader came into the office to explain it to Neil and me. We weren’t impressed. But when Neil and I offered to examine this strategy and determine if it was any good, management blocked us. For a reason we’ve never discovered, they did not want us digging into it. It was very strange. We spent all day, every day, researching and trading options; they found someone with an options product and they never even asked our opinion about it. Neil kept pushing them to let us rip it apart to see if it made sense, but they wouldn’t allow us to do it. One afternoon we sat down with the three founders of the firm and asked them, “Explain a trade to me. Just one.” They would explain loosely how they believed the strategy worked. But no one could actually answer any of our questions about it. The fact that they couldn’t didn’t seem to bother anyone; they had dollar signs in their eyes.

  Frank thought it could work and brought Thierry de la Villehuchet of Access into the deal. He’d found an options trader, he explained. “He’s got a theory that sounds like it might have some traction. I’m going to need capital to fund him. We want to bring him in-house and form a fifty-fifty joint venture with Access.”

  Thierry also needed a new product. He had all his nest eggs in the Madoff basket and wanted to spread them out. Rampart Managing Director Dave Fraley, Frank, and Thierry heavily recruited this trader, eventually convincing him to give up his seat on the exchange and move to Boston. The Rampart office was too small for these big plans, so they rented an office for him—and gave him the $75,000 he demanded up front. Frank had done some background research. He had spoken with people this guy worked with on the floor, and they’d said that this trader showed up every day, did his trades, and appeared to be making money. Frank wanted to do a little more investigating before the deal was finalized, but the trader gave Rampart a deadline to make a decision.

  Frank, however, couldn’t get rid of his uneasy feeling that something was wrong. The guy just grated against him. Once Frank had connected him to the traders the guy turned around and tried to push Frank out of the deal. So when it was done, Frank took him aside and said firmly, “If you’re screwing us, I promise you, we’re gonna go after you like a pack of wild dogs.” That’s not typically the way Frank talks.

  While these negotiations were in progress, Frank spent considerable time with Thierry. They bonded over their love of ocean sailing. At some point Frank sat down at dinner with him and told him flatly that Madoff was a fraud. Thierry just couldn’t accept that. “He can’t be,” Thierry insisted.

  Frank was trying to save him. “But listen, what if you’re wrong about him?”

  “If I’m wrong, Frank,” he said, “then I’m a dead man.”

  Frank forced a smile. “You don’t mean that literally?”

  Thierry didn’t answer directly. “I’m totally committed to him. I’ve done my own form of due diligence. I’m comfortable with it. He comes with an impeccable reputation. I mean, my God, he’s one of the biggest market makers in the U.S.” He paused and then said softly, “I’ve got all my money in it. I’ve got most of my family’s money in it. I’ve got all my friends—the wealthy families of Europe—they’re all with Madoff. I’ve got every private banker that I’ve ever dealt with in this damn thing.”

  As Frank remembered this conversation later, he couldn’t be certain that Thierry mentioned royalty. But several months later we would confirm that among Madoff’s European investors were the rich, the royal, and the noble. We did know that Prince Charles had been approached by his distant cousin, Prince Michel of Yugoslavia.

  When Thierry insisted, “You just don’t have all the facts,” Frank backed off. He never mentioned it to Thierry again.

  Thierry remained excited about the potential of the new coventure. The agreement was that Rampart would run the trading operation and Access would raise the capital. To get it started, the two companies each put up $125,000. Then we began seeking other investors. Several risk managers from a major international bank flew into B
oston for a presentation. They were intrigued by the trader’s explanation—although they weren’t sure it actually could be done the way he described it. They wanted to see several trades done, and if it worked as well in practice as it did in the presentation, they offered to leverage it at 7:1 the first day and after two to three months they would go up to 10:1. They wanted in.

  While less than a complete vote of confidence, it was a strong indication of enthusiasm. That’s a tremendous leverage potential. What made the deal so appealing was that the risk was controlled and the potential profit was tremendous. Frank was hoping for a return in the high teens. I was thrilled, of course, because it took the pressure off me. This was a product that would give funds an alternative to Madoff.

  Rampart and Access moved the trader to Boston. But the more time Frank spent with him, the less he liked him. I think his precise words were: “This guy is an arrogant son of a bitch with an ugly personality.” And Rampart was about to place a sizable aspect of its business in his hands—without giving Neil and myself a legitimate chance to review the nuts and bolts of the strategy.