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Authors: Harry Markopolos

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As it should—although she didn’t bother to add that I wrote in the submission that I believed Madoff was running a Ponzi scheme, and therefore I would not be able to collect any reward. But probably because these people weren’t smart enough to understand my message, they decided the problem had to be with the messenger. The fourth member of the SEC’s investigation unit was Peter Lamoure, who agreed with Cheung. “In short,” he wrote in an e-mail, “these are basically the same allegations we have heard before. The author’s motives are to make money by uncovering the alleged fraud. I think he is on a fishing expedition and doesn’t have the detailed understanding of Madoff’s operations that we do, which refutes most of his allegations.”
 
Simona Suh also admitted later that the staff had been skeptical of my claims because Madoff “didn’t fit the profile of a Ponzi schemer, at least as we—in the world that we knew then.” The prime requisite for someone to successfully run a Ponzi scheme is to not look like they are running a Ponzi scheme. I can’t even imagine what a profile of a Ponzi schemer would look like.
 
The real problem was that too many of the SEC’s investigators were lawyers, so they were expecting me to provide legal proof, which basically is the lowest standard beyond which you go to jail. Certainly a math proof is a much higher level of proof than a legal proof. In a legal case, two juries hearing precisely the same evidence can easily reach two different verdicts; but with a math problem there is only one correct answer. Two people or two hundred thousand people can do that math problem, and there still is only one correct answer. It’s an absolute answer, and even the greatest lawyers who have ever lived couldn’t change it; it isn’t trying to determine if the glove fits or find the legal definition of is. There is only one answer to an equation. For example, a man claims he is trading $30 billion in options and there is only $1 billion of these options in existence. There is an answer for that: It’s impossible. The math doesn’t work. This one red flag should have been sufficient evidence for the SEC to launch a full investigation of Madoff. But there were so many others. A split-strike strategy by definition couldn’t produce the returns Madoff was delivering. His basket of stocks had to have a reasonable mathematical correlation to the exchange on which the stocks were traded, and they did not. It shouldn’t have mattered whether the SEC liked me. Meaghan Cheung and her team just weren’t smart enough to understand that.
 
I never learned very much about the actual investigation, except for the fact that according to the FBI, Madoff operated his hedge fund on the 17th floor and his broker-dealer on the 18th and 19th floors of the same building, and the SEC team went to the wrong floors. As the agent told me, “They were conducting an investigation for two years and never even figured out there was a seventeenth floor; that’s how dumb they were. You really shouldn’t give them any more of your cases. Your quality of work is way beyond the SEC’s capabilities. From now on when you have a case, just give us a call.” After reading my entire submission the SEC officially opened a Matter Under Inquiry (MUI) of Madoff’s broker-dealer business to determine if he was in violation of government regulations by operating as an investment advisory service, a hedge fund.
 
Apparently Cheung’s team informed Madoff that the SEC had opened this investigation and intended to question him as well as some of the fund managers whose assets he was handling. It turned out that Bernie thought even less about the capabilities of the SEC than I did. During a December 2005 telephone conversation with Amit Vijayvergiya, the chief risk officer of the Fairfield Greenwich Group, and General Counsel Mark McKeefrey, Madoff warned, “Obviously, first of all, this call never took place.” Then he urged Vijayvergiya not to show any anxiety: “You don’t want them to think you’re concerned about anything. You’re best off, [if] ] you just be casual.”
 
According to transcripts, Madoff told Vijayvergiya that this was simply a “fishing expedition,” and the best way to handle the SEC’s questions was to avoid them. “You don’t have to be exact on this stuff because . . . no one pays attention to these types of things.” Later in the conversation he gave them some advice about how to handle the investigators: “These guys ask a zillion different questions and we look at them sometimes and we laugh and we say, ‘Are you guys writing a book?’ ”
 
Madoff told him how to answer the questions he anticipated they would be asked, primarily how the relationship between Fairfield Greenwich and Madoff theoretically was structured. “Your position is to say, listen, Madoff has been in business for 45 years, you know, he executes, you know, a huge percentage of the industry’s orders, he’s a well-known broker. You know, ‘We make the assumption that he’s doing everything properly.’ ” It appears from this conversation that Vijayvergiya had very little knowledge of what Madoff was actually doing, that he was little more than a middleman; he simply handed over his clients’ money to Madoff and distributed Madoff’s returns to those clients. So he needed to be told how their relationship would have worked if it was legitimate. For example, when Vijayvergiya asked Madoff how he would have been certain that his clients were receiving a pro rata allocation of profits based on their allocation if this was a real fund, Madoff replied that he should simply tell them that he knew it was correct because Bernie told him it was, but then Madoff reassured him: “You know, you don’t have to be too brilliant with these guys because you don’t have to be; you’re not supposed to have that knowledge and, you know, you wind up saying something which is either wrong, or, you know, it’s just not something you have to do.”
 
Madoff continually reassured Vijayvergiya that there was nothing to be concerned about, that the SEC basically was incompetent. “Fifty percent of the marketplace and the hedge funds operate in totally different ways than they used to. You know, you have all these funds; you know, it’s just, it’s just changed the landscape and the Commission has no idea what the hell is going on and of course they always think the worst, which is what they’re supposed to do.”
 
He concluded, accurately and derisively, “These guys, they work for five years at the Commission, then they become a compliance manager at a hedge fund.” And, he added, he knew that was true because every time an SEC investigator came up to his office he or she would ask for an employment application.
 
Remember, I didn’t know that my submission had led to an investigation. So I also didn’t know that Madoff testified voluntarily, without being represented by an attorney, on May 19, 2006. That was typical Madoff bravado; the natural assumption is that a man who is trying to conceal something certainly would bring his lawyer with him. There are many people who believe that in order to successfully manage this scam as long as he did without being discovered, Bernie Madoff had to be a genius. That reminds me of the story of the two hunters who were trapped by a bear. The first hunter said to the second hunter, “Don’t move. You can’t outrun a bear. Stand perfectly still and maybe he’ll go away.”
 
The second hunter looked at him, then took off running as fast as he could. “Don’t!” the first hunter yelled. “You can’t outrun a bear.”
 
As the second hunter picked up speed, he turned and yelled back, “I only have to outrun you!”
 
That was Bernie Madoff’s challenge. He didn’t have to be a genius; he just had to be smarter than the SEC. And as the inspector general summed up Madoff’s interview, “During Madoff’s testimony, he provided evasive answers to important questions, provided some answers that contradicted his previous representations, and provided some information that could have been used to discover that he was operating a Ponzi scheme. However, the Enforcement staff did not follow up with respect to any of the information that was relevant to Madoff’s Ponzi scheme.”
 
Madoff was smart enough to know that the lies he told could easily be checked by anyone with even moderate intelligence, and when they did check he would be finished. He made several statements that could have been confirmed or proven to be lies with just a single phone call. But there was no attempt to verify his claims. As he later admitted, “I thought this was the end game, over.” Fortunately for him, and unfortunately for the investors over the next two and a half years, he was dealing with the SEC. “I was astonished,” he said about not being arrested. “After all this, I got lucky.”
 
The SEC Division of Enforcement officially closed this investigation more than a year later, in November 2007. Their report acknowledged that Madoff had lied, or as they described it, “did not fully disclose” to the examiners “the nature of the trading conducted in the hedge fund accounts or the number of such accounts.” But even then they concluded, “The staff found no evidence of fraud. The staff did find, however, that BLM acted as an investment advisor to certain hedge funds, institutions and high net worth individuals in violation of the registration requirements of the Advisors Act. The staff also found that Fairfield Greenwich Group disclosures to its investors did not adequately describe BLM’s advisory role and described BLM as merely an executing broker to FFG’s accounts. As a result of discussions with the staff, BLM registered with the Commission as an investment advisor and FFG revised its disclosures to investors to reflect BLM’s advisory role.
 
“We recommend closing this investigation because both BLM and FFG voluntarily remedied the uncovered violations, and because those violations were not so serious as to warrant an enforcement action.”
 
In her 2007 performance review, Meaghan Cheung specifically cited her work in this investigation, writing, “In Madoff, we investigated the asset management services provided by a broker-dealer specializing in hedge funds who was not registered as an investment advisor. After our investigation, we conducted discussions among the staff, the Division of Investment Management, and Madoff’s counsel. We also held separate discussions with Madoff’s largest hedge fund client. As a result of those discussions, Madoff’s firm registered with the Commission as an investment advisor, and its hedge fund corrected its disclosure.”
 
What really bugs me is that the SEC caught Madoff lying to its investigators repeatedly, and making false statements to a federal official is supposed to carry a five-year (rarely imposed) maximum sentence; yet they never referred him to the Department of Justice for criminal prosecution. It seems that there is a double standard at the SEC where the big firms don’t get prosecuted for anything other than misdemeanors, but the small firms get shut down for anything more than minor infractions. Trained fraud examiners know to immediately expand the scope of their exam as soon as someone lies to them. That’s the signal to dig in and redouble your efforts, because once you catch them in a lie you know you have them back on their heels. One would think that SEC enforcement lawyers would at least comprehend that making false statements is a criminal offense and have the courage to stand up to a powerful Wall Street figure and send a deterrent message to industry that this sort of behavior will not be tolerated.
 
I like to tell a joke about the SEC that sometimes gets me into trouble. The difference between a male and female SEC employee, I explain, is that a male employee can count to 21—but only if he takes off his pants. That usually irritates the women, until I add, “But that assumes that he can find it, and unfortunately at the SEC none of them can actually find it. That’s how clueless they are.”
 
These were the people who knew my identity. And as I also learned later, they hadn’t hesitated to identify me by name in internal e-mails, e-mails that were seen by several people, which was precisely what I had tried so hard to avoid.
 
While this dubious investigation was taking place, I was regularly in contact with John Wilke at the
Wall Street journal.
On December 27 the
journal
ran his front-page investigative piece reporting that legendary mutual fund billionaire Mario Gabelli had set up phony small companies, fronts, to enable him to bid for Federal Communications Commission (FCC) cellular band wave licenses potentially worth hundreds of millions of dollars. This was a False Claims Act case brought by a whistleblower, and Gabelli and his associates eventually agreed to pay a fine of $130 million.
 
But as soon as I read the story I knew Wilke was about to start working on our story. I even sent an e-mail to the team, alerting them to Wilke’s Gabelli story and informing them, “He’s going to be writing the Madoff story starting in January, but I don’t know how long it will take. The Gabelli story took time and I’m sure this one will too.”
BOOK: No One Would Listen: A True Financial Thriller
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