1The Human Cost Thousands of direct victims Suicides, depression, mistrust…Families who invested 100% with Madoff are now impoverished – from riches to ragsMillions of indirect victims:A. Charitable services eliminatedB. Medical care not being providedC. Medical research eliminatedC. Scholarships eliminated
2Reality I’m no hero I’m not an accountant, I’m a CFA and CFE I’m not an army special ops commando, I was reserve civil affairs officerI did not pay my way through college, my parents didI really said “The SEC roars like a mouse and bites like a flea”4 ordinary men faced with an extraordinary challengeUnfortunately, we were the only thing standing between Madoff and his victims because the SEC was non-functionalMadoff’s organization was too large & powerful for us to stop aloneThe investigation was highly successful, we proved Madoff was a PonziBut the case was a $65 billion failureI feel horrible about the results
3The Investigative Team Frank Casey, North American CEO, London based Fortune Asset Management (Boston)Neil Chelo, CFA, FRM, CAIA; Director of Research, Benchmark Plus (Tacoma)Harry Markopolos, CFA, CFE (Boston)Michael Ocrant; Director of Conferences Group, Institutional Investor (New York)
43 Places where the $65 Billion went 1. Most went to pay off Old Investors who were receiving 12% / year on average2. ≅4% went to luring in new victims: Feeder Funds, Fund of Funds & Private Client Banks3. Way less than 1% / year went to Madoff
5Obvious Red Flags Part I Ultra-low 6% correlation to the OEX S&P 100 stock indexBM was 7 – 65 times the trading size of the OEX index options market at various points in timeWall Street Firms never saw his “trading volume”BM only picked stocks that went up or stayed the same> 96% of months were positiveBM’s performance chart was upward 45 degree straight lineWhy did BM allow the Feeder Funds, FOF’s & Banks earn the 1% & 20% hedge fund fees when all they did was market?BM in T-bills for most of the year but T-bills never yielded 16%
6Obvious Red Flags II BM couldn’t afford Put options he said he bought BM stock picks would have had to be > 30% per yearFeeder Funds said BM subsidized down months but this would have been illegalFeeder Funds said BM “benefited from his broker-dealer arm’s trading volume” which was code for illegal front-runningFeeder Funds said that BM had perfect market-timing ability thanks to his access to his B/D’s order flowBM never allowed outside auditsBM self-custodied assets
7Fund of FundsSource: “Who Invested with Madoff?” by George A. Martin; Journal of Alternative Investments; Summer 2009339 Fund of Funds via 59 Management Co’s investedUSA: 79 of 740 (10.7%)Switzerland: 77 of 267 (28.8%)UK: 52 of 546 (9.5%)Italy: 27 of 77 (35.1%)Brazil: 25 of 68 (36.8%)Germany: 24 of 145 (16.6%)
8Feeder Funds = Pure Evil Madoff’s accomplices were the FeedersMadoff was the octopuses’ body & headThe Feeders were Madoff’s tentacles & they spanned the globeWithout the Feeders Madoff would have collapsed long agoAll pretended to conduct due diligenceThey lied to clients about who was managing their moneySome pretended to be multi-strategy but were 100% MadoffThey received 3% - 4% per year in fees to not ask questionsNone asked tough questionsNone questioned the obviousNow we’re finding out that some received 300% - 950% returnsHedge Fund investors need to be more wary & less trusting
9Don’t Blame the Victims 30 – 35 Blue Chip companies that you would be proud to ownGM, Citigroup, Bank America, AIG, Fannie Mae, Freddie Mac, Merrill Lynch, Lehman, Bear Stearns, Wachovia….BM said he held “OEX stock index put options” to protect against market crashesEarned “only 1% a month”Most individual investors were not finance people and did not know these sorts of returns did not existLessons Re-Learned:1. 0 – 25% is the proper allocation to hedge funds2. Never put all of your eggs in one basket
101998 - 1999 1998: My Firm “discovers” Bernie Madoff Late 1999: I am asked to reverse engineer Madoff’s returns
112000 I knew he was a fraudster in 5 minutes 4 hours of mathematical modeling proved he was a fraudMay: 8 page submission to SEC Boston Regional Office’s Director of Enforcement with 12 Red Flags
122001 JAN: Casey recruits Ocrant onto team in Barcelona, Spain March: SEC Submission includes 1st submission + 3 additional pages of how I think he’s running the scheme + 2 pages on the Madoff investment processI offer to go under-cover to assist the SECAPRIL: Ocrant interviews MadoffMay 1st: MAR Hedge publishes Madoff expose, “Madoff Tops Charts; skeptics ask how”May 7th: Barron’s publishes, “Don’t Ask, Don’t Tell: Bernie Madoff is so secretive, he even asks investors to keep mum”SEP: Boston SEC’s Ed Manion asks me to re-submit case
132002 JUNE: Key trip to UK, France & Switzerland Met with 20 Fund of Funds & Private Client Banks14 have MadoffAll 14 report “special access to Madoff”2 have admitted Madoff losses – Dexia Asset Management & Fix Family Office12 have not admitted Madoff lossesAll 12 turned into SEC Chairwoman 02/05/2009Off-Shore funds attract 3 types of investors who won’t report losses or file SIPC claims with the US government
142003 - 2004 Investigation continues at same pace records of investigation lostAttempting to recover data from non-functioning hard drivesInformation from builds the 2005 SEC Submission
152005JUNE: Casey discovers Madoff attempting to borrow $ from European banks (1st sign that Madoff scheme is in trouble)OCT: Boston SEC’s Ed Manion arranges for 3rd SEC SubmissionOCT: I meet with Boston SEC Branch Chief Mike GarrityOCT: Garrity quickly investigates, finds irregularities, & forwards my submission to SEC’s New York OfficeNOV: Boston Whistleblower calls NYC Branch Chief Meaghen Cheung & reveals his identityNOV: 29 Red Flags submittedDEC: I doubt NYC SEC’s ability, fear for my life, contact Wall Street Journal
162006JAN: Integral Partners $40 Million derivatives Ponzi Scheme goes to trial, 5 years & 5 months after discovery causing us to further doubt SEC competenceMAR: 5 minute call with NYC SEC’s Meaghen CheungSEP: Chicago Board Options Exchange VP tells me that several OEX option traders also think Madoff is a fraudster. If SEC had called the CBOE’s marketing office, they would have cooperated. SEC never calls. Madoff scheme continues.
172007FEB 28th: Chelo obtains a Madoff portfolio which shows zero ability to earn a returnJUNE: Casey obtains Wickford Fund LP prospectus showing Madoff is short of cash & offering 3:1 leverage via bank loansJUNE: Wickford Fund LP Prospectus ed to NYC SEC Branch Chief Meaghen CheungJULY: Chelo obtains Fairfield Greenwich Sentry LP financial statements for 2004 – 2006; 3 years with 3 different auditors!AUG: Chelo conducts 45 minute telephone interview with Fairfield Greenwich’s head of risk managementAUG: Hedge funds all lose money except for Madoff!
182008Financial markets in turmoil, team loses interest, no activity until…APRIL: Jonathan Sokobin, SEC’s Director of Risk Assessment calls me per a recommendation from a mutual friendAPRIL 2nd: Undelivered to Sokobin entitled, “$30 Billion Equity Derivatives Hedge Fund Fraud in New York”FALL: Stock Markets crumble, panicked investors rush to redeemDecember 11th: Madoff runs out of money, turns himself in
192009FEB 4th: Hearing with myself followed by SEC’s senior staff and FINRA acting CEO; 375 pages of my testimony is available at under House Financial Services Committee, 111th Congress, Archived Hearings, Feb 4, 2009 along with over 2 hours of video or you can go to youtube.comFEB 5th: I provided a day of sworn testimony to the SEC’s IGMAR 10th: I meet with SEC Chairwoman Mary ShapiroSEP 4th: 477 Page SEC IG Report on the Madoff FiascoreleasedSEP 10th: I testify before US Senate Banking Committee withSEC IG
20SEC Investigative Errors I Little or No Industry Experience SEC Mission is to protect investors yet almost none of the staff were Certified Fraud Examiners or trained in investigations!The junior most examiner sat on an options trading desk for a while but didn’t have much experience in industry or at the SECNone of the senior examiners or enforcement attorneys had any asset management or trading experience!SEC sent intellectual equivalent of guppies to chase sharksSEC staff did not know how to use the Wall Street Journal, Bloombergs or OPRA tapes to track trading volumesSEC staff did not know that Over-the-Counter (OTC) derivatives are more expensive to trade and that the hedging takes place in the listed markets
21SEC Investigative Errors II Unwillingness to obtain 3rd party verification New York SEC never asked me or other BM whistleblowers any questionsSEC never phoned any of my witnessesSEC afraid to call reporters for backgroundSEC never verified BM’s bank account informationBM told them he custodied assets at Barclays & HSBC but they never checked to verify accountsSEC never verified time & sales volume of his trades with DTC or OCCSEC asked who BM’s counter-parties were but never followed up & asked them if they traded with BMSEC never traveled to BM’s accountant Frieling & HorowitzSEC never contacted UK’s FSA for assistanceBM says he traded thru Barclays, SEC gets docs back from Barclays that say BM had no positions with them & doesn’t think this suspicious
22SEC Investigative Errors III 19 May 2006 SEC’s Madoff Deposition BM says executions happen electronically but then describes picking up the phone and negotiating the price which is not electronic tradingBM says he shops his stock trade packages to 50 European stock brokers and his options trade packages to 12 European options brokers because there isn’t enough liquidity in the USA. Can’t do this because you’d be front-run to death! Plus there were not 50 capable brokers in Europe.BM says he trades stocks at different times & prices, then calculates an average price for clients but he trades the options all at once so he can deliver one average price for his clients. Mathematically these are functionally equivalent so it’s an obvious lie if you can count.BM says he pays 4 cents per share on this stock trades but only 1 cent per share equivalent for his options contracts (i.e. $1 per contract) because there’s no value added for his options trading. He doesn’t know options lingo or options commission math.
23SEC Investigative Errors IV 19 May 2006 SEC’s Madoff Deposition BM says he trades the stocks first in London, then trades the options in London between 8 am – 9 am (US Eastern Time) before the US markets are open. (Too much price risk if stocks drop before he buys his puts. Plus these size trades can’t be done overseas.)BM says his returns are not high enough to justify setting up a hedge fund. This ignores the fact that 339 FOF’s are set up to market BM’s chart-topping Sharpe Ratios which beat all hedge funds.SEC asks BM a series of questions about his Depository Trust Clearing Corp account and even obtain his DTC Number. However, they fail to follow up and ask DTC for his trades (there weren’t any!). If they had spent an hour going to DTC they would have proof he was a Ponzi operator…SEC only allowed 1 Examiner in the room. Examiners & Enforcement Attorneys knew BM was lying but did not challenge him.