WSJ: Madoff Misled SEC in '06, Got Off
muggle...@googlemail.com
December 18, 2008
Madoff Misled SEC in '06, Got Off
By GREGORY ZUCKERMAN and KARA SCANNELL
Securities and Exchange Commission investigators discovered in 2006
that Bernard Madoff had misled the agency about how he managed
customer money, according to documents, yet the SEC missed an
opportunity to uncover an alleged Ponzi scheme.
The documents indicate the agency had Mr. Madoff in its sights amid
multiple violations that, if pursued, could have blown open his
alleged multibillion-dollar scam. Instead, his firm registered as an
investment adviser, at the agency's request, and the public got no
word of the violations.
Harry Markopolos -- who once worked for a Madoff rival -- sparked the
probe with his nearly decadelong campaign to persuade the SEC that Mr.
Madoff's returns were too good to be true. In recent days, The Wall
Street Journal reviewed emails, letters and other documents that Mr.
Markopolos shared with the SEC over the years.
When he first began studying Mr. Madoff's investment performance a
decade ago, Mr. Markopolos told a colleague at the time, "It doesn't
make any damn sense," he and the colleague recall. "This has to be a
Ponzi scheme."
For Mr. Markopolos, the arrest last week of Mr. Madoff was something
of a vindication after his long campaign. At a certain point, he says,
"I was just the boy who cried wolf."
A lawyer for Mr. Madoff declined to comment on Mr. Markopolos's
allegations.
On Jan. 4, 2006, the SEC's enforcement staff in New York opened an
investigation, based on Mr. Markopolos's allegations, into whether Mr.
Madoff was, in fact, running a Ponzi scheme. The SEC staff received
documents from Mr. Madoff and Fairfield Greenwich, a hedge fund that
placed money with Mr. Madoff on behalf of its clients. The SEC also
interviewed Mr. Madoff, his assistant, an official from Fairfield
Greenwich and another employee.
Among other things, the SEC found that Mr. Madoff personally "misled
the examination staff about the nature of the strategy" used by the
Fairfield funds and other hedge-fund accounts, and also "withheld from
the examination staff information about certain of these customers'
accounts," the SEC documents say.
The SEC report said that neither Mr. Madoff nor the Fairfield funds
disclosed to investors in the Fairfield funds that Mr. Madoff was the
investment adviser.
A lawyer for Fairfield couldn't be reached for comment.
The SEC report also said Mr. Madoff had violated rules requiring
investment advisers to register with the SEC, which makes them subject
to inspections and examinations. Investment advisers must register if
they have more than 15 clients.
The staff recommended closing the investigation because Mr. Madoff
agreed to register his investment-advisory business and Fairfield
agreed to disclose information about Mr. Madoff to investors. The SEC
report said the staff closed the case "because those violations were
not so serious as to warrant an enforcement action."
Mr. Markopolos says his suspicions started in late 1999, after a
colleague returned from New York with tales of Mr. Madoff's trading
prowess. Whether the markets were up, or down, Mr. Madoff managed to
clock in with steady gains of 12% or so a year, reportedly achieving
that by trading a mix of stocks and stock-index options.
Liked the Look
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, and Mr. Markopolos began
suspecting possible fraud.
His bosses told him to go back and check the math, given Mr. Madoff's
renown as a trader.
So 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.
In his documents, Mr. Markopolos said that there's a chance "I'm an
idiot for wasting your time." But he argued forcefully that "I believe
an SEC visit is warranted" to look into Mr. Madoff's practices.
"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.
Mr. Markopolos, a native of Erie, Pa., who had trained in
"unconventional warfare," including intelligence gathering, as a
reservist in the Army, says he came to "consider Madoff a domestic
enemy."
Outsized Gains
In the months after the initial meeting with the SEC, Mr. Markopolos
kept hearing about Madoff's outsized gains, and how the firm was
growing -- sparking frequent calls to Mr. Manion to discuss the case.
Over a year passed. Then, in late 2001, Mr. Manion told Mr. Markopolos
the case appeared to have fallen through the cracks. He asked Mr.
Markopolos to resubmit his documents and arguments, so they could be
passed on to the SEC's New York office.
Mr. Markopolos sent the documents, adding three pages arguing that the
fraud was growing in size as Madoff's assets under management grew
beyond $12 billion.
Mr. Markopolos also diagrammed how he believed the Madoff organization
seemed to work, using a Byzantine flow chart with circles, squares,
rectangles and arrows.
Mr. Markopolos continued to receive sympathetic calls from Mr. Manion.
"He's the one that kept me going, I would have stopped long ago," Mr.
Markopolos says.
But Mr. Manion pointed out that any investigation would have to be
conducted by the New York office, where Mr. Madoff's firm was based.
Mr. Markopolos says that worried him. "I was told that the
relationship between the SEC's Boston and New York offices is about as
warm and cordial as the Yankees-Red Sox rivalry," Mr. Markopolos says.
Mr. Markopolos left his firm in 2004, and started a fraud-
investigation practice. Mr. Markopolos's old colleagues, prodding him
not to give up, spoke by phone for hours at a time about Mr. Madoff.
"Some people play fantasy sports, that was how it was with us --
Madoff was our fantasy sport," Mr. Markopolos recalls. "We wanted him
nailed."
In 2005, an SEC official in Boston called to say the agency was again
looking into the case, and told Mr. Markopolos to contact Meaghan
Cheung, a supervisor in SEC's New York office, Mr. Markopolos recalls.
In November 2005, Mr. Markopolos sent Ms. Cheung a 21-page report
outlining his concerns.
He presented a series of 29 "red flags," ranging from in-depth
mathematical calculations that purported to show the Madoff investment
strategy couldn't work, to little more than rumor or innuendo -- such
as claims that a group of Arab investors were barred from using a
major accounting firm to examine Mr. Madoff's books.
He also questioned the fact that Mr. Madoff, unlike most money
managers of his stripe, didn't charge his investors a fee for handling
their money. Instead, he seemed to make profits on commissions
generated by the trades on investors' behalf.
"Bernie Madoff's returns aren't real," Mr. Markopolos said. "And if
they are real," it's because Mr. Madoff might be engaging in "front
running," or buying shares for his investors' accounts just before
filling orders for other clients that have the potential to send the
price higher, an illegal practice.
Mr. Markopolos's allegations against Mr. Madoff were far from
bulletproof. Mr. Markopolos provided no definitive evidence of a
crime. His reports were laden with frothy opinions.
In his lists of "red flags," he occasionally got things wrong.
Sometimes he even misstated the starting date of his own campaign
against Mr. Madoff.
Ms. Cheung was a respected attorney known for quickly bringing high-
profile charges against executives of cable-television company
Adelphia Communications several years earlier, after that company
issued a questionable earnings report.
Mr. Markopolos thought he had a chance for his campaign to succeed.
"I had my hopes up, I thought it was a good enough package that they
would go and shut this man down," Mr. Markopolos recalls.
He sent an email adding more evidence -- noting that he might be
eligible for the SEC's bounty program if it turned out that Mr. Madoff
was, in fact, front running.
An SEC spokesman wouldn't comment on the agency's communication with
Mr. Markopolos.
In its resulting investigation, the SEC searched for evidence of
"front running" but found no indications that was happening, according
to an individual familiar with the matter.
Investigators also checked out Mr. Markopolos's claim that Mr. Madoff
was running a Ponzi scheme. But the billions of dollars of assets held
by Mr. Madoff's asset-management unit appeared to match those that
various investment firms said they had placed with Madoff, suggesting
that there weren't problems.
Today, it is now known that that Mr. Madoff had many more investors --
such as individuals and charities -- which weren't disclosed in
regulatory filings, making it harder for investigators at that time to
ascertain precisely how much money he was managing.
On Tuesday, SEC Chairman Christopher Cox also said that Madoff kept
several sets of books and false documents. That, too, could have
thrown off investigators a few years ago.
Rules Violations
As part of the inquiry, the SEC did find that the firm had violated
technical rules about executing trades.
Early this year, Mr. Markopolos made one last major effort after
receiving an email from Jonathan Sokobin, an official in the SEC's
Washington, D.C., office whose job was to search for big market risks.
Mr. Sokobin had heard about Mr. Markopolos and asked him to give him a
call, according to an email exchange between them.
With low expectations, Mr. Markopolos got in touch. "The way I figured
it," he says, "if they didn't believe you at $5 billion, and not at
$10 billion, they didn't believe you at $30 billion, then why would
they believe you at $50 billion?"
Funds Pulled
Mr. Markopolos also sent Mr. Sokobin an email -- with the stark
subject line "$30 billion Equity Derivative Hedge Fund Fraud in New
York" -- saying an unnamed Wall Street pro recently pulled money from
Mr. Madoff's firm after trying to confirm trades supposedly done in
his account, but discovering that no such trades had been made.
It was his last try. He never heard back about his allegations
regarding Mr. Madoff.
"I felt pretty low," Mr. Markopolos recalls.
Mr. Sokobin, through an SEC spokesman, declined to comment.
Last Thursday, as Mr. Markopolos watched his children take a karate
lesson near his home in Whitman, Mass., 20 miles outside Boston, he
checked his voice mail, trying to ignore the noise from the children.
Walking out to the foyer, Mr. Markopolos returned one of the calls,
and heard an old friend tell him that Mr. Madoff had been arrested.
"I kept firing bigger and bigger bullets" at Mr. Madoff, "but I
couldn't stop him," Mr. Markopolos says. With the SEC's mea culpa and
Mr. Madoff's arrest, "I finally felt relief."
mc...@pitt.edu
Great article.
Mick
JessicaG
> probe with his nearly decadelong campaign to persuade the SEC that Mr.
> Madoff's returns were too good to be true. In recent days, The Wall
> Street Journal reviewed emails, letters and other documents that Mr.
> Markopolos shared with the SEC over the years.
Has Obama named his Attorney General yet? He should pick Markopolos for AG!