The Man Who Figured Out Madoff's Scheme

Harry Markopolos blew the whistle to the Securities and Exchange Commission about Bernard Madoff as early as 2000. Why were his warnings ignored?

(CBS) It has been two and a half months since Bernard L. Madoff was picked up and charged with what is believed to be the largest financial fraud in history. Yet we still don't know much more about the alleged $50 billion scam than what Madoff initially told the FBI agents who arrested him. There are still no indictments as federal prosecutors continue to unravel the case and try to figure out exactly what happened and who was involved.

But the proof that it happened can be found in the ruined lives of thousands of victims. The one person who knows the most and is willing to talk about it is Harry Markopolos, the man who figured out Madoff's scheme before anyone else.

Markopolos sat down with 60 Minutes correspondent Steve Kroft for his only television interview.

http://www.cbsnews.com/stories/2009/02/ ... 3667.shtml

Until a few months ago, Harry Markopolos was an obscure financial analyst and mildly eccentric fraud investigator from Boston who most people would never notice on the street.

But today he enjoys an almost heroic status, pursued by journalists and movie producers, and honored by colleagues as the man who went to the Securities and Exchange Commission and blew the whistle on Bernie Madoff and his $50 billion fraud.

But he seems uncomfortable with the attention, and knows that he is no hero. "I stand before you a 50 billion dollar failure," he said at an event.

Asked how many times he sent materials to the SEC, Markopolos told Kroft, "May 2000. October 2001. October, November, and December of 2005. Then again June 2007. And finally April 2008. So five separate SEC submissions."

"And in spite of all of the things that you did, it still ended up in disaster?" Kroft asked.

"There's nothing to be proud about in this case. I feel horrible about the result. It's been a total disaster for the victims," Markopolos replied.

It began a decade ago, when Markopolos was working for a Boston investment firm. His boss told him that Madoff, a former chairman of the NASDAQ stock exchange, was running a huge unregistered hedge fund that was producing incredible returns. He wanted Markopolos to reverse-engineer its trading strategy and revenue streams so the firm could duplicate Madoff's results.

"He had the patina of being a respected citizen. One of the most successful businessmen in New York, and certainly, one of the most powerful men on Wall Street. You would never suspect him of fraud. Unless you knew the math," Markopolos told Kroft.

"I mean, you're like a math guy, right?" Kroft asked.

"I've taken all the calculus courses, from integral calculus through differential calculus, as well as linear algebra. And statistics, both normal and non-normal," Markopolos said.

Asked how long it took him to figure out something was wrong, Markopolos said, "It took me five minutes to know that it was a fraud. It took me another almost four hours of mathematical modeling to prove that it was a fraud. "

It was the performance line that Markopolos said caught his attention. "As we know, markets go up and down, and his only went up. He had very few down months. Only four percent of the months were down months. And that would be equivalent to a baseball player in the major leagues batting .960 for a year. Clearly impossible. You would suspect cheating immediately."

"Maybe he was just good," Kroft remarked.

"No one's that good," Markopolos said.

Markopolos said there were only two plausible explanations: either Madoff was using insider information to rack up the huge profits or he was running a giant Ponzi scheme.

"So either way, he was doing something illegal?" Kroft asked.

"Either way, I knew he was going to go to prison," Markopolos replied.

In May 2000, Markopolos took his suspicions about Bernie Madoff to the Boston office of Securities and Exchange Commission.

Asked if he had any financial motive, Markopolos said, "Yes. He was a competitor of mine in 2000 to 2004, while I was still in the industry. And when someone's competing on your playing field, who's a dirty player, you want him tossed off the field."

He also thought he might be eligible for a sizable reward if the fraud involved insider trading, but that turned out not to be the case.

"In your first letter to the S.E.C. back in 2000, you're a little tentative. You say, 'Look, I have no hard evidence, no smoking gun,'" Kroft remarked.

"In 2000, it was more theoretical. In 2001, it was a little bit more real. By 2005, I had 29 red flags that you just couldn't miss on. By 2005, the degree of certainty was approaching 100 percent," Markopolos explained.

Over time and with some simple math calculations, Markopolos concluded that for Madoff to execute the trading strategy he said he was using he would have had to buy more options on the Chicago Board Options Exchange than actually existed, yet he says no one he spoke to there remembered making a single trade with Bernard Madoff's fund.

"I would talk to the people I had trading relationships with and ask, 'Did you have a trading relationship with Mr. Bernard Madoff?' And they all said, 'No. We don't think he's for real,'" Markopolos said.

He said he found no one who ever had traded with Madoff. "And I traded with some of the largest equity derivatives firms in the world."

And that's because Madoff's investment fund never actually made any trades, at least going back to 1993, and probably further - a fact confirmed last week at a meeting of Madoff investors by the trustee charged with liquidating Madoff's assets. No one knew the depth of the fraud but a lot of people had questions.

"Who else figured this out besides you?" Kroft asked.

"I would say that hundreds of people suspected something was amiss with the Madoff operation. If you look at who the victims were not, you'll notice that the major firms on Wall Street had no money with Mr. Madoff," Markopolos said.

"I'm quoting from the letter to the Securities and Exchange Commission, red flag number 20. 'Madoff is suspected of being a fraud by some of the world's largest, most sophisticated financial services firms.' And then you list some of the firms," Kroft said. "The biggest firms on Wall Street. And conversations with people high up in those firms."

"That is correct. And the SEC ignored that," Markopolos said. "All the SEC had to do was pick up the phone. They never did."

"If you had executives at the biggest investment houses on Wall Street that knew something was wrong, why do you think they didn't go to the SEC?" Kroft asked.

"Because people in glass houses don't throw stones. And self regulation on Wall Street doesn't work," Markopolos said.

In January 2006 the New York office of the Securities and Exchange Commission finally opened a case file to look into Markopolos' allegations about Bernie Madoff. Despite uncovering evidence that Madoff had mislead them about his investment activities, the SEC closed the case 11 months later without ever opening a formal investigation. The staff said there was "no evidence of fraud."

"What I found out from my dealings with the SEC over eight and a half years is that their people are totally untrained in finance; they're unschooled; they're un-credentialed. Most of them are just merely lawyers without any financial industry experience," Markopolos said.

"Well, if the people there aren't trained in securities work, what are they trained in?" Kroft asked.

"How to look at pieces of paper that the securities laws require. They can check every piece of paper perfectly and find misdemeanors, and they'll miss all the financial felonies that are occurring because they never look there," Markopolos replied. "Even when pointed to fraud, they're incapable of finding fraud."

No one at the SEC would talk to 60 Minutes on the record about Markopolos' allegations. But one person who seemed to have had a high opinion of the agency was Bernie Madoff.

"I’m very close with the regulators so I’m not trying to say that what they do is bad. As a matter of fact, my niece just married one," Madoff said in 2007.

Besides his niece's husband, who left the SEC last year, Madoff had longstanding ties to agency and was called upon to give advice. At a 2007 meeting of a non-profit group called The Philoctetes Center, he seemed to think the SEC was doing a great job.

"In today’s regulatory environment, it's virtually impossible to violate rules. This is something that the public really doesn’t understand. But it's impossible for a violation to go undetected, certainly not for a considerable period of time," Madoff said.


Watch the entire video of Bernie Madoff participating at a roundtable discussion at The Philoctetes Center in New York in October 2007

http://philoctetes.org/Past_Programs/Th ... ock_Market