6. The SEC is slated to start overseeing hedge funds in February 2006, yet since Bernie Madoff is not registered as a hedge fund but acting as one but via third party shields, the chances of Madoff escaping SEC scrutiny are very high. If I hadn’t written this report, there’s no way the SEC would have known to check the facts behind all of these third party hedge funds.
Potential Fall Out if Bernie Madoff turns out to be a Ponzi Scheme:1. If the average hedge fund is assumed to be levered 4:1, it doesn’t take a rocket scientist to realize that there might be anywhere from a few hundred billion on up in selling pressure in the wake of a $20 - $50 billion hedge fund fraud. With the hedge fund market estimated to be $1 trillion, having one hedge fund with 2% - 5% of the industry’s assets under management suddenly blow up, it is hard to predict the severity of the resulting shock wave. You just know it’ll be unpleasant for anywhere from a few days to a few weeks but the fall out shouldn’t be anywhere near as great as that from the Long Term Capital Management Crises. Using the hurricane scale with which we’ve all become quite familiar with this year, I’d rate BM turning out to be a Ponzi Scheme as a Category 2 or 3 hurricane where the 1998 LTCM Crises was a Category 5.
2. Hedge fund, fund of funds with greater than a 10% exposure to Bernie Madoff will likely be faced with forced redemptions. This will lead to a cascade of panic selling in all of the various hedge fund sectors whether equity related or not. Long-short and market neutral managers will take losses as their shorts rise and their longs fall. Convertible arbitrage managers will lose as the long positions in underlying bonds are sold and the short equity call options are brought to close. Fixed income arbitrage managers will also face losses as credit spreads widen. Basically, most hedge funds categories with two exceptions will have at least one big down month thanks to the unwinding caused by forced redemptions. Dedicated Short Funds and Long Volatility Funds are the two hedge fund categories that will do well.
3. The French and Swiss Private Banks are the largest investors in Bernie Madoff. This will have a huge negative impact on the European capital markets as several large fund of funds implode. I figure one-half to three-quarters of Bernie Madoff’s funds come from overseas. The unwinding trade will hurt all markets across the globe but it is the Private European Banks that will fare the worst.
4. European regulators will be seen as not being up to the task of dealing with hedge fund fraud. Hopefully this scandal will serve as a long overdue wake-up call for them and result in increased funding and staffing levels for European Financial Regulators.
5. In the US Fairfield, Access International Advisors, Tremont and several other hedge fund, fund of funds will all implode. There will be a call for increased hedge fund regulation by scared and battered high net worth investors.
6. The Wall Street wire house FOF’s are not invested in Madoff’s strategy. As far as I know the wire house’s internal FOF’s all think he’s a fraud and have avoided him like the plague. But these very same wire houses often own highly profitable hedge fund prime brokerage operations and these operations will suffer contained, but painful nonetheless, losses from loans to some hedge funds that go bust during the panic selling. As a result, I predict that some investment banks will pull out of the prime brokerage business deeming it too volatile from an earnings standpoint. Damage to Wall Street will be unpleasant in that hedge funds and FOF’s are a big source of trading revenues. If the hedge fund industry fades, Wall Street will need to find another revenue source to replace them.
7. US Mutual fund investors and other long-term investors in main stream investment products will only feel a month or two’s worth of pain from the selling cascade in the hedge fund arena but their markets should recover afterwards.
8. Congress will be up in arms and there will be Senate and House hearings just like there were for Long Term Capital Management.
9. The SEC’s critics who say the SEC shouldn’t be regulating private partnerships will be forever silenced. Hopefully this leads to expanded powers and increased funding for the SEC. Parties that opposed SEC entry into hedge fund regulation will fall silent. The SEC will gain political strength in Washington from this episode but only if the SEC is proactive and launches an immediate, full scale investigation into all of the Red Flags surrounding Madoff Investment Securities, LLC. Otherwise, it is almost certain that NYAG Elliot Spitzer will launch his investigation first and once again beat the SEC to the punch causing the SEC further public embarrassment.
10. Hedge funds will face increased due diligence from regulators, investors, prime brokers and counter-parties which is a good thing and long overdue.
Potential Fall Out if Bernie Madoff is found out to be front-running customer order flow: 1. This would be just one more black eye among many for the brokerage industry and the NYSE and NASDAQ. At this point the reputations of both the NYSE and NASDAQ are already at rock bottom, so there’s likely little downside left for these two troubled organizations.
2. The industry wouldn’t miss a beat other than for the liquidation of Madoff Investment Securities, LLC. Figure it will be similar to REFCO’s demise only there won’t be a buyer of the firm given that they cheated customers who would all be embarrassed to remain customers once the news they’ve been ripped off is on the front-pages. These former customers are more likely to sue for damages than remain customers. Unsecured lenders would face losses but other than that the industry would be better off.
3. At least the returns are real, in which case determining restitution could keep the courts busy for years. The Class Action Bar would be thrilled. A lot of the FOF’s are registered offshore in places where the long arm of the law might not reach. My guess is that the fight for the money off-shore would keep dozens of lawyers happily employed for many years.
4. The FOF’s would suffer little in the way of damage. All could be counted on to say “We didn’t know the manager was generating returns illegally. We relied upon the NYSE and NASDAQ to regulate their markets and prevent front-running therefore we see no reason to return any funds. ”
Attachments: 1. 2 page Summary of Fairfield Sentry Ltd with performance data from December 1990 - May 2005.
2. Copy of the May 7, 2001 Barrons’ article, “Don’t Ask, Don’t Tell; Bernie Madoff is so secretetive, he even asks his investors to keep mum,” written by Erin E. Arvedlund.
3. Partial list of French and Swiss money-managers and private banks with investments in Bernie Madoff’s hedge fund. Undoubtedly there are dozens more European FOF’s and Private Banks that are invested with BM.
4. 2 page offering memorandum, faxed March 29, 2001, for an investment in what I believe is Fairfield Sentry Ltd., one of several investment programs run by Madoff Investment Securities, LLC for third party hedge fund, fund of funds. I do not know who the source was who faxed this document since the fax heading is blank. The document number listed at the bottom of the page appears to read I:DataWPDOCS|AG_94021597.
ATTACHEMENT 1: Fairfield Sentry Performance Data
Appendix C
Online Resource Guide for the Classroom and Beyond
The story of the Madoff fraud is far from over. Free downloadable resources are available for the general reader and for classroom use at www.noonewouldlisten.com, including:• Victims’ stories from news media
• Video clips
• Newspaper articles
• Research papers
• Written testimony
• The government’s criminal prosecution of the case
• Civil case proceedings against the accountants, banks, board members, custodians, feeder funds, fiduciaries, hedge funds of funds, plan administrators, and others
Additional materials will be added as they become available, so be sure to check back often.
A Note for Educators: These resources are intended for use in business, business ethics, business law, and forensic accounting courses at the undergraduate and graduate levels.
A Note on Sources
T
his book is a first-hand account of my experience investigating the Madoff fraud from 1999 through 2009. Direct quotations are to the best of my remembrance. As noted in the text, several sources provided valuable insight into what went on at the government organizations and financial firms during this time. Those interviewed for the research of this book include Inspector General David Kotz, Sergeant Harry Bates, and each member of my investigation team—Frank Casey, Neil Chelo, Michael Ocrant, and Gaytri Kachroo.
Other books and articles have been written on the subject of the Madoff investigation. Those referenced in this book include Erin Arvedlund’s article, “Don’t Ask, Don’t Tell,” (Barron‘s, May 7, 2001, http://online.barrons.com/article/SB989019667829349012.html); her book, Too Good to Be True: The Rise and Fall of Bernie Madoff (Portfolio, 2009); Michael Ocrant’s article, “Madoff Tops Charts; Skeptics Ask How” (MARHedge 89, May 2001, page 1)—also printed in full as Appendix A of this book; and Gregory Zuckerman and Kara Scannell’s article, “Madoff Misled SEC in ’06, Got Off,” (Wall Street Journal, December 18, 2008, page A1, http://online.wsj.com/article/SB122956182184616625.html). Portions of an August 10, 2007 posting on Greg Newton’s blog, Nakedshorts ( http://nakedshorts.typepad.com/nakedshorts/2007/08/weekend-reading.html), are also referenced.
Publicly available court documents and transcriptions from my February 4, 2009, hearing before the House Subcommittee on Capital Markets and September 10, 2009, hearing before the Senate Banking Committee are quoted at length, and can be accessed through government web sites or through the links available at www.noonewouldlisten.com.
About the Author
Harry Markopolos attended high school at Cathedral Prep in his hometown of Erie, Pennsylvania. He received his bachelor of arts degree in business administration from Loyola University of Maryland and then went on to Boston College for his master of science in finance degree.
He received a reserve commission as a second lieutenant, Infantry, in the U.S. Army and is a graduate of several Army postgraduate schools, including the Infantry Officers’ Basic and Advanced Courses, the Civil Affairs Officers’ Advanced Course, and the U.S. Army Command & General Staff College. Mr. Markopolos has commanded troops at every rank from second lieutenant to major during 17 years of part-time service in the Maryland Army National Guard and Army Reserve.
He earned his Chartered Financial Analyst designation in 1996 and his Certified Fraud Examiner designation in 2008. From 2002 to 2003 he served as president and CEO of the 4,000-member Boston Security Analysts Society. He has also held board seats on the Boston chapters of both the Global Association of Risk Professionals and the Quantitative Work Alliance for Applied Finance, Education and Wisdom (QWAFAFEW), a quantitative finance lecture group.
He was assistant controller, assistant manager, store manager, and district manager for his family’s chain of 12 Arthur Treacher’s Fish & Chips restaurants before joining Makefield Securities in 1987. In 1988 he joined Darien Capital Management in Greenwich, Connecticut, as an assistant portfolio manager, leaving to become an equity derivatives portfolio manager at Rampart Investment Management Company in Boston, Massachusetts. In 2002 he was promoted to chief investment officer but decided to leave the industry in 2004 to pursue fraud investigations full-time against Fortune 500 companies in the financial services and health care industries. He brings fraud cases to the U.S. Department of Justice, Internal Revenue Service, and various state attorney generals under existing whistleblower programs.
The Madoff investigation, which he started in early 2000, was his first financial fraud case. He’s been hooked ever since.
Acknowledgments
Many people contributed to this book, so it’s hard for me to consider it a singular effort. To my friends and teammates Frank Casey, Neil Chelo, and Michael Ocrant for your willingness to risk it all over so many years under the very worst circumstances. You contributed so much to this story that you deserve as much credit as I do for exposing the Madoff fraud and the weaknesses of the Securities and Exchange Commission (SEC). Your dedication to our nation’s core values speaks volumes about your character. I have led many whistleblower teams over the years, but never one that faced danger like this team did; yet each of you pressed on regardless. And you did it for zero compensation because it was the right thing to do, proving that some things are just so important that you know you have to do them for free. This country needs to produce more good citizens like you, because right now the bad guys are winning. I hope this book inspires others to follow in your footsteps.
To my personal attorney, Dr. Gaytri Kachroo. Thank you for representing me pro bono and sharing your experiences about this case. You have always been able to see three steps into the future and outthink our opponents.
To my wife Faith for allowing me to work on this case even after realizing how dangerous it had become. I promise I will never do another case that puts our family at risk. If I had known how bad this case would get I would never have pursued it. No husband should ever have to ask his wife to defend the second floor armed with a pistol.
To David Fisher, who put up with the five of us and our too many edits and rewrites. No one knows organized crime better than you do, and that’s what this was at its core—a criminal conspiracy that spanned the globe. It was a pleasure working with you. To Frank Weiman, our literary agent, whose patience we tried and tried again.
To the following partners at the Boston office of McCarter & English LLP, thanks for preparing me, pro bono, to testify before Congress: Burt Winnick, the Honorable Paul Cellucci, and Bill Zucker.
To Phillip Michael, my main qui tam attorney and confidant in working with so many brave whistleblower teams. Thanks for being a world-class enforcement attorney! Thanks also to the whistleblowers on Cases 81, 89, 92, 93, 94, 95, and 96. You are unsung heroes defending our nation’s citizenry against those companies that would loot this nation’s tax dollars. Thanks also to attorney Mike Lesser at Thornton & Naumes LLP for carrying on without me while this book was written.
To Pat Burns, Jeb White, and all the qui tam whistleblower attorneys at TAF.org for fighting the good fight against crooked corporations. Thank you for everything you’ve taught me.
Thanks to Joe Wells and Kevin Taparauskas at the Association of Certified Fraud Examiners for the excellent training and timely advice.
To Sergeant Harry Bates of the Whitman Police Department. Thanks for your help planning my personal security and keeping it a secret all these years. And my entire family thanks the townspeople of Whitman, Massachusetts, for being so protective and supportive after this case became public. I apologize for all the commotion this caused the town.
To my father Louie, thank you for teaching me to stand up and fight no matter the size of the opponent. You watched me lose and you were okay with it even while I was ashamed. To my mother Georgia for being a stay-at-home mom and superb educator.
To Colonel Michael N. Schleupner, my former battalion commander, thank you for the example you set for me. Your moral courage in always doing the right thing has always inspired me. Ditto for Colonel Ken Pritchard, Lieutenant Colonel James Berger, and Lieutenant Colonel Mike Tanczyn. I witnessed each of you stand up for what was right, and it hurt your military careers in the National Guard and Army Reserve but you did the right thing anyway. Moral courage is often the hardest to come by, and no one gives you a medal for having it; but without it the world quickly falls apart.
To some of the many good people in the financial services industry who helped me with this investigation: Dan diBartolomeo (Northfield Information Services), Andre Mehta (Cambridge Associates), Dave Henry (Carruth LLC), Nick Marfino (ConvergEx), Joel Kugler (Meridien Partners), Matt Moran (Chicago Board Options Exchange), Bud Haslett (CFA Institute), Tom Huber (Glenmede Trust), and Jeff Fritz (Oxford Trading Associates). Your help was invaluable in pursuing the case.
At Citigroup, thanks to Charlie Miles and Holly Robinson for your astute observations. To Leon Gross, thanks for your expert analys
is; I wish the SEC had bothered to call you—things might have been different if they had. All of you were helpful at various points during my team’s investigation, proving that plenty of honest people work on Wall Street.
I would like to thank the following people at Goldman Sachs for teaching me all about derivatives math: Dr. Joanne Hill, Dr. Emanuel Derman, Rebecca Cheong, Michael Liou, Jack Lehman, Mark Zurack, and Amy Goodfriend.
To the late John “Front Page” Wilke of the Wall Street Journal for your courage and inspiration on all those corruption cases you broke. Real investigative journalists are a rare breed, but you were one of the best. I miss you.
To Gregory Zuckerman of the Wall Street Journal and Ross Kerber of the Boston Globe, thank you for reporting the story when it first became public. You two went on faith and trusted me instead of the SEC as the case was breaking.
To Andy Court, Keith Sharman, and Reuben Heyman-Kantor at CBS News’ 60 Minutes, thank you for allowing me to explain to the victims what happened. Your investigative skills are unparalleled, and you discovered information that you wisely never reported because you know the difference between news and sensationalism.
No One Would Listen: A True Financial Thriller Page 40
