No One Would Listen: A True Financial Thriller

by Harry Markopolos

  It got very scary. As he explains, “I was scared. I’ll bet I rotted out a dozen shirts from sweat. I was drinking heavily. One night in Boston, I remember, I’d been drinking and I was driving home late at night. I looked in my rearview mirror and realized a car was following me, tailgating me. Whoever was driving made no attempt to hide the fact he was trailing me. I took back roads I knew and he stayed right on my ass. Finally I got to my house. I raced into the driveway and slammed on my brakes, rolled down my window, and leaped out of the car. As the other stopped by my driveway I scrambled to get behind my door for protection. As I did I pulled out my .357, and as soon as I got behind the door I pointed it through the open window at the driver. He just sat there, staring at me, then pulled away. I never saw his face. I do believe they were sending me a message: They knew where I lived. I got the message; believe me, I got it.”

  Gradually, Frank’s strategy began working. He took his gains in small pieces—$10,000, $15,000, occasionally $100,000. It was painfully slow, but it was working. Finally the lawyer called again. As Frank remembers, “He said, ‘This isn’t fast enough. You got one week or we’re gonna have to do something about it.’

  “That was it for me. I called the broker who brought me into the deal and told him, ‘You call that lawyer in Carteret and you tell him if I receive one more call I’m coming down to get them. Trust me—they won’t even know what hit them.’ I never got that call. I successfully moved $1.1 million of the one and a half million dollars before the end of the year. I wanted to get out then, but these people loved the profits and insisted we stay in. I had positions that were worth millions of dollars and I did not have discretion over the account so there was nothing I could do about that. They wouldn’t let me out. They thought it was a money-making machine; they didn’t understand it simply deferred taxes. I told them this was designed for one purpose, to move $1.2 million in two weeks. ‘I just built you the atom bomb,’ I said. ‘Trust me—you don’t want to use it.’ But all they saw were the profits.

  “Of course they eventually lost most of it and left me with a debt of a hundred twenty thousand dollars. I actually wanted to sue them for the money, but Merrill Lynch was beginning to understand that this was potentially a bigger problem than it was worth to them and pushed me into arbitration. I got most of that money back. Merrill Lynch eventually absorbed the remaining losses.

  “But there was no question in my mind that my life was at risk if this strategy had failed.”

  Professionally, the European trip was a failure. For my product to be profitable we had to raise at least $10 million, and we came home with commitments of slightly more than $6 million. It wasn’t going to be profitable enough to pursue. And the truth was that these funds didn’t need me; they had Madoff. There was no reason for them to invest in riskier products. At no time during the trip did I even consider revealing what we knew to any of these asset managers. There was no reason for them to believe me, and they were already addicted to his returns. Just like the American funds, they needed him to survive—and they needed him a lot more than they needed me. Who knows what they might do if they knew I was trying to expose him? So it was just too risky, and in retrospect that probably was one of the most intelligent decisions I made during this whole investigation.

  When I got home from Europe, I did two things: First, I told my team, “You wouldn’t believe it. He’s bigger in Europe than he is here. Fourteen of the twenty funds we met with there have him, and obviously there are a lot more.” And second, I began seriously upgrading my home security.

  From that moment on there wasn’t a day I didn’t consider the security of my family and my team before taking any action. It wasn’t just money—I believed that lives were at stake. I had been careful to keep the names of my team secret. Mine was the only name on my submissions. If someone in the SEC was revealing information to Madoff (and considering how close he was to the SEC in New York that certainly was a possibility), Markopolos was the only name they could give him. I’d learned in the army that a leader leads. I’d gotten Frank and Neil into this, so it was my responsibility to protect their identities. And personally, I began carrying a gun.

  I really didn’t know what to do next. My two submissions to the SEC had been ignored, the two articles that should have prompted an investigation of his operation were long forgotten, and Forbes had ignored me. The only thing I knew for sure was that until my information was made public my life would be in jeopardy. Once it was published or the SEC took action, I would be safe. So I had to find some means of exposing Madoff to the public. I was just beginning to feel the first tinges of desperation.

  Only three people have impressed me with their efforts to regulate the worst practices of Wall Street: William Galvin, who was elected Massachusetts secretary of the commonwealth in 1994, which put him in charge of the state Securities Division, and New York State’s attorney generals: Andrew Cuomo and Eliot Spitzer. These are the only people who have brought big cases against the sacred cows of Wall Street. They were doing the job the SEC should have been doing but wasn’t. So in late 2002 when I learned from Chuck Hill, who would succeed me as president of the Boston Security Analysts Society, that Spitzer was going to be speaking at the J.F.K. Library in Boston in its Profiles in Courage lecture series, I decided to personally deliver my material to him. Obviously this was years before his personal scandal erupted. Kitty Kennedy, the Analysts Society’s executive director, secured an invitation for me.

  Admittedly, I had some reservations. While I admired Spitzer for what he’d accomplished as the attorney general, I was also aware from my own research that his family had invested heavily in hedge funds and that he was a trust fund baby. It was quite possible that he was a Madoff investor and even more probable that he knew Madoff. In fact, I thought that was likely, as they were both members of the wealthy Jewish community in New York City. For all I knew they might even attend the same prestigious synagogue. So I knew it was a big risk for me. But I had to do something, and Spitzer appeared to me to be honest and ambitious. He was in the perfect position to initiate an investigation of Madoff. And the headlines he would earn by exposing him could make his political career.

  The safest thing to do, I decided, was to get this information to him anonymously. I had identical twin sons due to be born in just a few months, and those boys were going to need a father. It wasn’t just my wife and me; now I had a family to think about.

  I took a lot of precautions. In retrospect, I suppose, it may seem like I was overly cautious, but that’s only in retrospect. At the time all I knew for certain was that when our investigation was made public, many thousands of lives were going to be changed—and not one of them for the better. I certainly wasn’t looking for personal credit. I was hoping for justice.

  I started by printing out my entire submission on clean sheets of paper, taking out my name or any information that could identify me. I made certain I didn’t leave any fingerprints on those pages. I put on a pair of gloves and slipped the submission into a 9 × 12 manila envelope and wrote Spitzer’s name on it. Then I slipped that inside a larger 10 × 13 envelope. I was ready to hand it off.

  It was cold that December night. I put on extra-heavy clothing and the biggest coat I owned. I was careful to dress down; I didn’t want anyone to notice me. I sat quietly for Spitzer’s speech. When he was done, as he stood near the podium speaking personally to members of the audience, I put on my coat and my gloves as if I was ready to go out into the cold, then walked to the front of the room. A library staff member was standing a few feet away from Spitzer. I took the 9 × 12 envelope out of the larger envelope and handed it to her. “Would you do me a favor, please?” I asked. “Could you please make sure Mr. Spitzer gets this?”

  “Of course,” she said.

  “It’s important,” I added. Then I turned around and walked out into the blackness of a cold wintry night.

  There is no evidence that Eliot Spitzer ever read my submission. I don’t
even know for sure that he got it. But he never acted on it. Maybe this was a tactical error on my part. I should have realized that few people take anonymous submissions seriously. Perhaps if I had walked up to him and looked him in the eyes and said, “Mr. Attorney General, my name is Harry Markopolos. I’m president of the four-thousand-member Boston Security Analysts Society, and I have evidence here of the largest fraud in history,” and handed the envelope to him, he might have taken it seriously. But I did what seemed safest at that time.

  Slightly more than three years had passed since we had discovered Madoff. We had compiled a strong case against him. Our original reason for trying to bring him down—that he was competition we couldn’t compete against—had ended with the failure of the Rampart Options Statistical Arbitrage strategy. But we were so deeply into this thing that it became impossible to put it down. We had actually developed into a pretty good team. We had two investigators in the field, Frank and Mike, and two quants in Neil and me able to find the defects in the materials they collected.

  And they did continue to add to our growing pile of evidence. Frank’s new job at Benchmark Plus caused him to spend most of his time with hedge fund and risk managers, and at some point in each conversation he never failed to ask them, “What do you know about Bernie?” As he remembers, “I was in their office talking about other things but eventually we’d start talking about the industry in general and the rates of return in the marketplace, and I would ask them what they knew about Bernie. I wouldn’t even have to use his last name. They knew Bernie. Most of them told me, ‘I got money with Bernie,’ or ‘I know somebody who has money with him,’ or ‘This fund is raising a lot of money for Bernie.”’

  At least several of those funds had ceased operating as traditional hedge funds and had become nothing more than Madoff’s sales force. They did nothing for their clients except shovel the money directly to Madoff. They didn’t do any due diligence, they didn’t make any other investments, and they certainly did not diversify to protect their clients’ money. Instead, they thought they had the deal of the century. They raised money and handed it to Bernie, and in return he paid them substantially higher management fees than they could possibility have gotten anywhere else, which, combined with the percentage of the profits they were taking from their investors, meant they were making huge profits. Notice I said “making,” not “earning,” because they earned nothing. But Bernie was paying 16 percent gross returns and keeping way, way less than 1 percent per year for himself to keep his clients satisfied—and trapped. These feeder funds were earning almost 4 percent per year in fees while passing along 12 percent to their investors. It was a merry-go-round that stopped only to let new people get on, because nobody wanted to get off. Everybody was happy—the investors who were getting a regular return, the fund managers who were making a fortune without having to do any work at all, and Bernie. Who really knows what was going on in his head? Or how truly insane he was?

  Let me explain how brilliant Madoff was in letting the feeder funds earn well over 90 percent of the available fees to lure in new victims. By being the top bid for new money, Madoff was every feeder fund’s best relationship. Bernie had great returns with low volatility, and he effectively paid the most for new investors. And Madoff didn’t need a lot of money for himself personally. For example, if I challenged you to spend a billion dollars, could you do it? Probably not unless you got a divorce is my guess. By offering unbelievably steady returns with almost no volatility he was providing the holy grail of investment products, and he was paying the feeder funds more than anybody else to sign up new investors. That’s what kept the scheme going for so long, and that’s why it was able to get so big.

  What continued to amaze us was his size. He was already significantly larger than any other fund in existence, yet he just kept growing. We calculated that the minimum amount of money he was handling had to be at least $15 billion, possibly $20 billion. The numbers kept ratcheting up. They had long passed from unbelievable into fantasyland. At times Neil and I would just sit there and speculate about what would happen when Madoff blew up. There were no historical references to look at, as nothing like this had ever existed before. Compared to Madoff, the most infamous crimes in the world were small potatoes. I was certain that his arrest would put a lot of hedge funds of funds out of business. We assumed that most of the funds had 5 to 20 percent of their assets invested with him. It never even occurred to us that some of these funds would be almost all Madoff. We didn’t believe that any responsible asset manager would have 100 percent of its funds with one man with one strategy. Even investing 20 percent of a fund in one manager is extreme; 25 percent is insanely extreme, and anything beyond that is just plain crazy. But even those funds with a limited investment would be in trouble because their investors would panic and immediately withdraw the rest of their funds. That would cause the market to go down, which subsequently would force the innocent hedge funds to sell assets. My best guess was that the impact was going to cause the U.S. markets to fall between 7 percent and 10 percent in a relatively short period of time. It would be a category 2 or 3 hurricane. It would cause some damage, but most industry people would recover.

  After I returned from Europe we knew it would have a worldwide effect. The French, who loved him, would be slaughtered, while places like Turkey, which stayed away from him, would not be hurt as badly. I also knew that we would never know the full extent of European losses. As I had learned, a great percentage of the European investments were made through offshore funds, funds that traditionally are used to hide pretax income. People who had put their money in those funds to avoid being taxed by their countries would not be able to acknowledge their losses; they couldn’t admit to having the untaxed money, so they certainly couldn’t admit to losing it. That group, I believe, includes everyone from European royalty to drug lords. And I still believe we’ll never know the full extent of the European losses, but they’re substantially more than losses in the United States.

  We knew a lot of investors would be devastated, and many of them wiped out, but what we didn’t realize was how many people that included. We had assumed that most people invested in Madoff through the funds, and as we later found out we had assumed wrong. Although Mike Ocrant had told us that Madoff was so well known in the New York Jewish community that he was referred to as “the Jewish T-bill,” we really had no concept of the size of the affinity scheme. That was my fault for not realizing it. An affinity scheme targets people with similar affiliations; Bernie was Jewish, so he targeted the New York metropolitan area and Florida Jewish communities. Historically, almost by definition Ponzi schemes start within a well-defined community, often an ethnic or religious community. If I were trying to start a Ponzi scheme, for example, I would do it inside the Greek community. The reason for that is trust; nobody thinks one of their own is going to cheat them, not when they can cheat so many others. We were focused on the institutional accounts, so we didn’t have the slightest concept that Madoff was using separately managed accounts to ransack the synagogues for every cent he could pull out of them. I should have guessed that.

  We also knew that the SEC would be roasted for not doing its job, although again at that time we still hadn’t realized how nonfunctional it was. My mistake was assuming that the problem was mostly with New York, when in fact it was systemic. While there was nothing we could have done to save investors beyond alerting this agency and trying to go public, the SEC could have shut Madoff down as far back as 1992, when it first investigated him and let him off the hook. This was certainly one of the most expensive mistakes in history. Had the SEC stopped him then, depending on the way you choose to calculate the total losses, it could have saved investors more than $60 billion.

  So Neil and I believed that Madoff’s fall would cause a temporary disruption in the markets but that was all. There was no way we could have anticipated that Madoff’s fall would be caused by a worldwide recession that resulted in stock markets collapsing and
led to investors desperately trying to pull their money from hedge funds to meet other demands. The moment a Ponzi scheme has to pay out more money than it is taking in, it’s done. But Madoff still had a few more years before we began to see signs of that.

  While our investigation continued, all of our lives were changing. Over the next few years my wife and I had three children, which completely changed my perspective on the world. And Neil, who had started as my intern and become a trusted friend and collaborator, had decided to leave Rampart.

  There were several reasons for his decision. After George Devoe’s death the dynamic had changed. Without him to act as a buffer for Neil and me, we really lost our voice within Rampart. Any input we’d had into the decision-making process disappeared, which at times caused some resentment. We also were forced into dealing with a trading group we didn’t particularly like, rather than the people we’d been working with for a while. But probably more than that, it was time.

  Although Neil had been named a vice president and had a wide range of responsibilities, as long as he stayed at Rampart he was going to be my assistant and he had outgrown that role. At least partially because of our investigation, he’d become fascinated with hedge funds and hedge fund strategies. So when Frank Casey heard that the company he was raising money for, Benchmark Plus, was looking for a senior analyst, he tossed Neil’s hat into the ring. He thought it would be a perfect fit.