|Bernard Madoff Was Identified as a Fraud As Early as 1999
The World's Largest Ponzi Scheme Was Exposed and Ignored
Paul Kiel, ProPublica
It just keeps getting worse for the SEC. Documents obtained
by the Wall Street Journal show the agency was downright lethargic
in investigating allegations that Bernie Madoff was
running "the world’s largest Ponzi Scheme."
And when it did probe, its investigation was half-hearted, almost apologetic, a
lame attempt that appears to have been easily thwarted.
Harry Markopolos, an independent
fraud investigator and derivatives expert, made it his hobby for nine years to
uncover Madoff’s fraud. "Madoff was our fantasy sport," he tells the Journal. "We wanted him
Starting in 1999, Markopolos sent
detailed memos to SEC staff outlining his case against Madoff.
It had all started, he said, when he was working as a money manager at a rival
investment firm. His bosses wanted him to match Madoff’s
remarkable returns. But when he tried to replicate Madoff’s supposed strategy (trading a mix of stocks and stock-index options), he found
that he couldn’t. And when he asked other derivatives experts, they agreed it
was impossible to match Madoff’s legendarily steady
From there, he built a massive circumstantial case. He
presented it in 1999, again in 2001 (an SEC official told him it appeared to
have fallen through the cracks), and then again in 2005. The Journal has
helpfully posted Markopolos’ 19-page memo, titled
"The World’s Largest Hedge Fund is a Fraud."
It features no fewer than 29 "red flags." Those
ranged from his inability to replicate Madoff’s returns to statements like "I have also spoken to the heads of various
Wall Street equity derivative trading desks and every single one of the senior
managers I spoke with told me that Bernie Madoff was
It was "highly likely," he wrote, that "Madoff Securities is the world’s largest Ponzi Scheme."
This time, the SEC did act. And the Journal has also posted
the SEC’s investigation opening and closing documents. In many ways, it’s an even more remarkable
document than Markopolos’ memos.
The opening SEC memo, dated January, 2006, is brief and
emphasizes the fact that Markopolos’ case was
circumstantial: his memo "did not contain specific facts about the alleged Ponzi scheme, and the complainant was neither a [Madoff firm] insider nor an aggrieved investor." And
so the SEC was not about to go in with guns blazing. It was only investigating
in an "abundance of caution," because of "the substantial
amounts at issue."
It did not issue subpoenas, rather making requests for
voluntary production of documents from Madoff. (In
his statement on Tuesday, SEC Chairman Christopher Cox noted this as one of the
mistakes the agency had made.)
This is made all the more remarkable by the fact that Madoff had apparently already shown that he might try to
thwart regulators. In 2005, the SEC had inspected Madoff’s
broker-dealer business, and during that inspection, Madoff "did not fully disclose to the examination staff either the nature of the
trading conducted in the hedge fund accounts or the number of such
accounts," the memo says.
The investigation closed in 2007, finding "no evidence
of fraud." SEC investigators had searched for evidence of a Ponzi scheme, and couldn’t find any.
The reason the investigation failed is fairly clear. It only
focused on Madoff’s hedge fund clients, accounts for
which Madoff apparently could provide a satisfactory
paper trail. Left out of that selection were a large number of Madoff’s other clients. The fact that the SEC did not issue
any subpoenas helped constrain the scope of the probe.
But the investigation evidently convinced investigators that
Madoff had "misled" SEC examiners during
that 2005 inspection. This, however, did not trigger greater scrutiny.
The investigation closed in 2007, with no penalty for Madoff. He was required to register with the SEC as an
investment adviser, because investigators found that he’d been wrong in failing
to register separately from his broker-dealer business before then.