Madoff Ponzi Investigation: 10 Years of Blatant SEC Corruption

A global three-ring-media circus kicked into high gear when Bernard ‘Bernie’ Madoff surrendered himself to the FBI on December 11th, 2009. The operative phrasing in that statement is ‘surrendered himself to the FBI’.  After over twenty years of fraudulently and flagrantly deceiving investors, involving many of the largest and seemingly most prestigious investment banks, financial managers and investment advisers throughout the US and Europe, Madoff went down on his own terms without a single investigation ever being launched by the Securities and Exchange Commission (SEC). If the stock market hadn’t collapsed in 2008, losing over 40% of its value in the wake of the mid-September bankruptcy of Lehman Brothers, Madoff’s Ponzi scheme would probably still be in operation.
Madoff 2009

Madoff’s downfall put the spotlight on the SEC and its failure to protect taxpaying investors from fraudulent practices in the financial services industry.  As far as Wall Street and the SEC are concerned, ‘failure to protect’ is actually a euphemism for rampant corruption. Not only did the SEC fail to monitor investment activities on Wall Street; they literally looked the other way for eight years after a reputable portfolio manager, Harry Markopolos, submitted enough evidential information to warrant a full scale investigation as far back as the year 2000.

Wall Street corruption was no surprise to anyone on or before December of 2008. However, the Madoff Ponzi scheme exposed a deeper and wider-spread level of corruption and deception, involving investment firm payoffs, political influence and an impotent Securities an Exchange Commission that became part of the problem rather than taking any part in the solution.

It apparently became common practice for SEC agents to investigate allegations of wrongdoing and then confront corporate executives with preliminary evidence to explore possible opportunities that might arise from companies wanting to avoid further scrutiny.  Typically, respective SEC agents were offered lucrative positions with the firms, often including a generous signing bonus, and magically the incriminating evidence would disappear and the investigation mysteriously discontinued. In addition, the SEC rarely launches in-depth investigations involving the “too-big-to-fail” investment banking conglomerates, including the likes of Citibank, JP Morgan Chase and Bank America; all part of what I call the “Wall Street Machine”.

I am going the use the Madoff Ponzi scheme and the Harry Markopolos eight-year campaign to expose the extensive fraud perpetrated by Bernie Madoff as a means of demonstrating the blatant corruption and effectiveness of the SEC and the power of the Wall Street Machine.
Harry Markopolos

The “Chasing Madoff” saga began late in 1998 when Frank Casey, an investment analyst with Boston-based Rampart Investment Management, was trying to develop an options-based strategy to attract institutional investors. He approached portfolio manager Harry Markopolos to discuss his ideas. Their discussion led to Thierry de la Villehuchet, a principal in the New York firm, Access International Advisers.  Frank Casey went to New York to meet with de la Villehuchet to inquire about the strategy of his options’ funds.

Thierry was initially reluctant to discuss who handled his options’ investments, knowing Madoff preferred staying in the background, but eventually relented and confided in Casey about Bernie Madoff. De la Villehuchet then told Casey that Madoff managed his own clients’ options investments, and guaranteed him an amazing one to two-percent in monthly returns.

Upon his return to Boston, Frank reviewed Madoff’s performance statistics in amazement.  He asked Harry, who loved number crunching, to go over Madoff’s performance and volume in the options market. Markopolos responded to Casey an hour later and said “this has to be a fraud”.  The first thing Harry explained was that Madoff’s performance numbers showed gains each and every month which never happens in the investment world, especially in the options’ market.  Secondly, Madoff’s reported trade volumes and retained positions for his investors were significantly higher than the entire options market.

Markopolos, appalled by what he uncovered in a short while, became consumed with investigating Madoff’s investments further.  His assistant, Neil Chello and analyst, Frank Casey, joined forces in the investigation and unanimously concluded that Madoff was running a Ponzi scheme.  Harry carefully documented and charted all of their findings and submitted a 50-page report on May 1st, 2000 to alert the SEC Boston office of the Madoff financial scam.

After two or three weeks past without an indication of an SEC investigation being launched, Markopolis contacted the Boston’s Bureau chief, Edward Manion, to determine the status of the case.  He was told that the New York SEC office blocked any further investigation, stating that the ‘big boys’ in New York didn’t like receiving fraud complaints concerning New York based firms from their Boston office.

A year later, Markopolos went to the SEC’s New York office and submitted even more evidence and supporting statistical analyses that proved beyond doubt that Madoff was running a multi-billion-dollar Ponzi scheme.  The SEC still did not initiate an investigation, proclaiming that the case was not high on their list of priorities. While digging deeper, it became clear to Harry and his team that this was a financial scam of global proportions, implicating the involvement of many of the most prestigious investment banks in the world.  Individual investors were among the wealthiest and most influential people in the financial services industry.

There were also $100s of millions from offshore numbered accounts among which were suspected Russian mobsters and Latin drug cartel members.  Realizing the magnitude of what he had uncovered and the powerful people that stood to lose billions, Markopolos began fearing for his life and the safety of his family. He was the whistle blower; the proverbial David against Madoff’s giant.  Markopolos started carrying fire arms for self protection as he continued to try on numerous occasions, without success, to persuade the SEC to launch an investigation.

Whenever investment advisers would challenge or question Madoff about how he was able to consistently report 12% to 15% in annual gains while other option strategies were anything but consistent. Madoff would claim he was using a “split-strike conversion strategy”.  I actually applied this option-related strategy a few times when I was trading for my account between 1999 to 2001. It carries significant risk in a down market and would never produce consistent gains.

This strategy consists of maintaining a long equity position and ‘shorting’ a call option and a ‘longing’ put option to protect against a declining equity price. Supposedly, Madoff had utilized a version of this strategy by purchasing ‘naked’ put and call options without holding the underlying equity position.  I’m surprised that seasoned investment managers would ever believe this strategy could produce consistent gains. Harry Markopolos mathematically concluded after four hours of running the numbers on Madoff’s performance statistics were fraudulent.

In desperation, Markopolos began alerting investment managers, government agencies, and anonymously had his evidence delivered to Eliot Spitzer, the former governor of New York.  He then decided to take his story to John Wilke of the Wall Street Journal, known as Mr. Front Page for his incisive articles on the fraudulent activities on Wall Street and in the entire investment community. Wilke has exposed crooked politicians and illicit executives, most of which were successfully prosecuted.  John Wilke was enthusiastic about exposing the massive Ponzi scheme in the Wall Street Journal, allowing Markopolos to feel somewhat safer for the time being.

A week later, a noticeably disappointed Wilke contacted Markopolos to inform him that the Journal’s management was reluctant to give him the go-ahead on any further investigation or publication.  At this point, Harry became so frustrated with the rampant corruption that the regulatory bodies ignored and the media refused to challenge, he resigned from Rampart Investment’s and left Wall Street.  In 2006, Markopolos decided to take action  and become a certified fraud investigator.

As the financial crisis was coming to a head in December of 2008, Madoff was having increased difficulty raising money from new investors to cover the fraudulent profits and redemption requests from investors.  In late November and again in early December, Bernie told his wife to withdraw funds from his brokerage account, totaling $15.5 million.  Relenting to pressure from their clients to liquidate portfolio assets, suspicious financial advisers and investment managers demanded redemption payouts.  On December 10th, Madoff, realizing that he could no longer prevent exposure, confided in his two sons and told them to call the FBI to arrange his surrender on the following day.  On December 11th, as FBI agents marched him the federal building, the media frenzy began and went on for months.

Let us not forget that the SEC had absolutely nothing to do with bringing down Bernie Madoff.  If the investment banking industry had not caused the financial crisis, Madoff’s Ponzi scheme would still be prosperous.  It wasn’t until the wealthiest investors began demanding redemption of their shares, in an attempt to liquidate their accounts, did the scheme collapse under its own weight when those demands could no longer be met with fresh cash from new investors.

When Markopolos heard the breaking news of the Madoff’s surrender, he immediately realized that he was now in more danger from the Securities and Exchange Commission than previously from Bernie or anyone connected with his global investment scam.  Harry’s fear now stemmed the SEC, wanting to cover up eight years of negligence by not investigating Madoff’s activities when they were alerted with detailed reports several times dating back from the year 2000. Markopolos knew that the only way he could protect himself was to salvage the evidential documents and electronically stored data before the SEC had the opportunity to search his home and confiscate the incriminating information.  Harry was able to secure the evidence and move out of harm’s way.

The SEC proved equally inept when it came to Markopolos’s other cases. He gave the SEC 20 cases of market timing, proving that a number of investment firms had stolen billions of dollars from investors. The SEC turned down all of them, including a huge mutual fund that had monthly turnover percentages in its international equity funds of 1,100 to 1,300 percent range per month.

In the end, the SEC was called to answer for not investigating this massive financial fraud in front of the House Financial Services Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises.  Sounds impressive for a group of politicians that publicly admonished a panel of SEC representatives for the sole purpose of public relations and media coverage. They did not even recommend prosecution or punishment for a single individual at the SEC for enabling fraudulent practices that cheated investors in a $50 billion scam. Many investors lost their entire life’s savings.

The SEC tragically failed to prevent the French investment adviser, de la Villehuchet, from losing billions of his clients’ money as well as his own to Madoff.  Markopolos made every effort over the years to convince him that Madoff was a fraud.  Being an honest man of integrity, it was difficult for Thierry to believe that Bernie, the man he did business with over so many years, was capable of such a massive deception.  On December 23rd, 2008, Thierry de la Villehuchet committed suicide, unable to live with his failure in protecting his family, friends and other investors from fraud. Upon receiving the news of his friend’s death, Harry broke down and wept, feeling that maybe he could have done more to convince Thierry of the Madoff fraud.

There was a second unfortunate tragedy that ironically occurred exactly two years to-the-day after Bernie Madoff’s arrest, on December 11th, 2010, his elder son Mark Madoff, age 46, was found dead in his New York City apartment, an apparent suicide by hanging. Living with shame and guilt of his father’s actions, and dealing with constant harassment from friends and other investors, many of which lost their entire life’s savings, proved too painful for Madoff’s son.

It’s difficult to imagine a legal system that would punish, publicly disgrace and even deprive local law enforcement officers of their pension for accepting free meals at a diner in exchange for looking the other way when their customers park illegally, while merely giving a “slap on the wrist” to law enforcement agents that knowingly allowed the perpetration of a multi-billion-dollar scam to operate with impunity.  The SEC was an embarrassment to the industry and themselves.  However, to this day, no one at the Securities and Exchange Commission has been fired in disgrace, which was a disgrace in and of its self.  Several relatively low level agents and managers were allowed to resign as “sacrificial lambs” left to continue their careers within the very industry they were afraid to investigate.

Imagine yourself for a moment, as an honest, well educated and ambitious person (not unlike Harry) trying to become successful in a chosen field.  Then imagine discovering that you are trying to compete against others that are using deception to lure customers, clients or investors out of your reach.  This model can apply to anyone in any industry when confronted with competition for financial gain, e.g. bidding for construction contracts, selling cars……..well, you get the idea.  Life is a never-ending challenge of character and integrity.

“To thine own self be true”, William Shakespeare, –in Hamlet








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