No One Would Listen
A True Financial Thriller
By Harry Markopolos David Einhorn
John Wiley & Sons
Copyright © 2010
John Wiley & Sons, Ltd
All right reserved.
ISBN: 978-0-470-55373-2
Chapter One
A Red Wagon in a
Field of Snow
On the morning of December 11, 2008, a New York real estate
developer on a JetBlue flight from New York to Los Angeles
was watching CNBC on the small seat-back television. A crawl
across the bottom of the screen reported that Bernard Madoff, a legendary
Wall Street figure and the former chairman of NASDAQ had been
arrested for running the largest Ponzi scheme in history. The developer
sat silently for several seconds, absorbing that news.
No, that couldn't be
right, he thought, but the message streamed across the screen again. Turning
to his wife, he said that he knew that she wasn't going to believe what
he was about to tell her, but apparently Bernie Madoff was a crook and
the millions of dollars that they had invested with him were lost. He was
right-she didn't believe him. Instead, she waved off the thought. "That's
not possible," she said, and returned to the magazine she was reading.
The stunned developer stood up and walked to the rear of the plane,
where the flight attendants had gathered in the galley. "Excuse me,"
he said politely, "but I'm going to be leaving now. So would you please
open the door for me? And don't worry-I won't need a parachute."
* * *
At about 5:15 that December afternoon, I was at the local dojo in
my small New England town watching my five-year-old twin boys
trying to master the basic movements of karate. It had been a gloomy
day. Rain continued intermittently, and there was a storm in the air.
I noticed there were several voice mails on my cell phone.
That's curious,
I thought; I hadn't felt it vibrate. I stepped into the foyer to retrieve
the messages. The first one was from a good friend named Dave Henry,
who was managing a considerable amount of money as chief investment
officer of DKH Investments in Boston. "Harry," his message said
clearly, "Madoff is in federal custody for running a Ponzi scheme. He's
under arrest in New York. Call me." My heart started racing. The second
message was also from a close friend, Andre Mehta, a super-quant
who is a managing director of alternative investments at Cambridge
Associates, a consultant to pension plans and endowments. I could hear
the excitement in Andre's voice as he said, "You were right. The news
is hitting. Madoff's under arrest. It looks like he was running a huge
Ponzi scheme. It's all over Bloomberg. Call me and I'll read it to you.
Congratulations."
I was staggered. For several years I'd been living under a death sentence,
terrified that my pursuit of Madoff would put my family and
me in jeopardy. Billions of dollars were at stake, and apparently some
of that money belonged to the Russian mafia and the drug cartels-people
who would kill to protect their investments. And I knew all
about Peter Scannell, a Boston whistleblower who had been beaten
nearly to death with a brick simply for complaining about a million-dollar
market-timing scam. So I wouldn't start my car without first
checking under the chassis and in the wheel wells. At night I walked
away from shadows and I slept with a loaded gun nearby; and suddenly,
instantly and unexpectedly, it was over. Finally, it was over. They'd
gotten Madoff. I raised my fist high in the air and screamed to myself,
"Yes!" My family was safe. Then I collapsed over a wooden railing.
I had to grab hold of it to prevent myself from falling. I could barely
breathe. In less time than the snap of my fingers I had gone from being
supercharged with energy to being completely drained.
The first thing I wanted to do was return those calls. I needed to
know every detail. It was only when I tried to punch in the numbers
that I discovered how badly my hand was shaking. I called Dave back
and he told me that the media was reporting that Bernie Madoff had
confessed to his two sons that his multibillion-dollar investment firm
was a complete fraud. There were no investments, he had told them;
there never had been. Instead, for more than two decades, he had been
running the largest Ponzi scheme in history. His sons had immediately
informed the Federal Bureau of Investigation (FBI), and agents had
shown up at Madoff 's apartment early that morning and arrested him.
They'd taken him out in handcuffs. It looked like many thousands of
people had lost billions of dollars.
It was exactly as I had warned the government of the United States
approximately $55 billion earlier. And as I stood in the lobby of that
dojo, my sense of relief was replaced by a new concern. The piles of
documents I had in my possession would destroy reputations, end
careers, and perhaps even bring down the entire Securities and Exchange
Commission (SEC), the government's Wall Street watchdog-unless, of
course, the government got to those documents before I could get them
published. I grabbed my kids and raced home.
My name is Harry Markopolos. It's Greek. I'm a Chartered Financial
Analyst and Certified Fraud Examiner, which makes me a proud Greek
geek. And this, then, is the complete story of how my team failed to
stop the greatest financial crime in history, Bernie Madoff's Ponzi
scheme. For the previous nine years I had been working secretly with
three highly motivated men who worked in various positions in the
financial industry to bring the Bernie Madoff fraud to the attention of
the SEC. We had invested countless hours and risked our lives, and had
saved no one-although eventually, after Madoff's collapse, we would
succeed in exposing the SEC as one of this nation's most incompetent
financial regulators.
For example, it was well known that Madoff operated his legitimate
broker-dealer business on the 18th and 19th floors of the Lipstick
Building on New York's East Side. But what was not generally known
was that his money management company, the fraud, was located on
the 17th floor of that building. Months after Madoff 's collapse, the
FBI would reveal to my team that based on our 2005 submission providing
evidence that Madoff was running a Ponzi scheme, the SEC
finally launched an investigation-but that its crack investigative team
during the two-year-long investigation "never even figured out there
was a 17th floor." I had provided all the evidence they needed to close
down Madoff-and they couldn't find an entire floor. Instead they
issued three technical deficiency notices of minor violations to Madoff's
broker-dealer arm. Now, that really is setting a pretty low bar for other
government agencies to beat. But sadly, all of this nation's financial
regulators-the Federal Reserve Bank, the Federal Deposit Insurance
Corporation, the Office of the Comptroller of the Currency, and the
Office of Thrift Supervision-are at best incompetent and at worst
captive to the companies they are supposed to regulate.
As I would later testify before Congress, "The SEC roars like a
mouse and bites like a flea." In retrospect, considering how much I have
learned since then, and how much my team has learned, that probably
was inaccurate: I was being too kind. Tens of thousands of lives
have been changed forever because of the SEC's failure. Countless people
who relied on that agency for the promised protection have lost more
than can ever be recovered. In some cases people lost everything they
owned. And truthfully, the SEC didn't even need to conduct an extensive
investigation. My team had given them everything they needed.
With the materials we submitted, it would have taken investigators no
more than the time it took to ask Madoff three questions for his fraud
to be discovered and his operation to be shut down. The magnitude of
this Ponzi scheme is matched only by the willful blindness of the SEC to
investigate Madoff.
* * *
This was not my first fraud investigation. My first investigation, which
had a much more satisfying conclusion, concerned stolen fish. At one
time my dad and two uncles owned a chain of 12 Arthur Treacher's
Fish & Chips restaurants in Maryland and Delaware. Eventually I became
the assistant controller, which was basically a glorified bookkeeper.
Then I became the manager of four units in Baltimore County. If you
own a chain of restaurants, you will learn more about retail theft than
you care to know. We had one manager who was using the restaurant
as a front for his major income activity, which was selling drugs out
of the drive-through window. Customers would place their order with
him and find something other than fish and chips in their bags. We had
another manager we knew was stealing from the restaurant, but we
couldn't figure out how he was doing it. Finally my uncle parked across
the highway in the International House of Pancakes parking lot and
watched him through a pair of binoculars. He discovered that when the
cashier took her break, this manager would literally bring in another
cash register from his car, and for the next hour he would ring up sales
for himself. He had a nice business going; unfortunately, it was my
family's business.
We had a limited number of family members; so to eliminate fraud we
had to rely on professional management, using the most advanced computers
available at that time, to manage inventory. We had formulas
for the components that went into every order: the amount of fish,
chicken, shrimp, and clams. Every portion was controlled by size.
I learned accounting in those restaurants. We continually matched
our inventory to our sales and in that way could determine where our
shortfalls were. Our goal was 3 percent waste. We wanted some waste,
and some leftovers, because at the end of the night if you don't have
waste it means you've given your customers cold fish or spoiled shrimp
that should have been thrown out. Too little waste meant you were not
providing a quality product; too much waste meant there was theft.
When I discovered more than 5 percent waste in my district, I began
examining the numbers. The numbers told me that something was
fishy in one of our fish and chips stores. I appreciate mathematics, and
I knew the answer was in front of me; I just had to be smart enough
to find it. I enjoy watching the choreography of the numbers. There is
a certain satisfaction I get from it. I wasn't always that way; in seventh
and eighth grades I struggled with math and needed a tutor to lead me
through algebra. In high school I excelled in math and enjoyed it. I
studied finance in college and had terrible calculus teachers. They were
PhD's who didn't know how to teach. I couldn't understand them,
and I dropped the subject three times. I finally hired a PhD student in
physics to tutor me, and eventually I was doing differential equations.
I turned out to be a natural in math.
More than a natural, in fact. I'm a quant, which is the slang term
for a quantitative analyst. Basically, that means I speak the language
of numbers. Numbers can tell an entire story. I can see the beauty, the
humor, and sometimes the tragedy in the numbers. Neil Chelo, a member
of my Madoff team and a close friend, describes quants as people who
conceptualize things in the form of numbers. As he says, quants look at
numbers and see associations that other people aren't even aware exist,
and then understand the meaning of those associations in a unique way.
A lot of my friends are quants. Neil is a quant; he can be obsessive about
balancing not only his monthly bank statements, but even his credit card
bills-to the penny. Quants are nerds and proud of it.
I look at numbers the way other people read books. For example,
obviously computers are pretty darn fast doing math and calculating the
value of derivatives, but even today there are certain calculations that are
so math intensive that even a computer can choke on them. Occasionally
a situation arises in which there is a second derivative, called gamma,
which is the rate of change in the first derivative, delta. Don't try to
understand this calculation, unless you intend to trade options. You'll
never need to know how to do it and there is no test at the end. And
you certainly won't need to know it to understand how Bernie Madoff
successfully ran his worldwide Ponzi scheme for decades. Bernie's fraud
was much less sophisticated than that. But in those situations prices can
move literally at an infinite rate. A computer can't track it very quickly.
I can. After working in the financial industry for several years I could
calculate those prices faster than a computer. Generally there were a
couple of times every year when I had to throw out the computer and
look at the price of a stock or the market and calculate my own option
prices in a few seconds. In one of those situations, my ability to do
the calculations rapidly and correctly could salvage our investment
or even allow us to make a lot of money. Actually, it was that same
combination of ability and experience that enabled me to look at the
returns of Bernie Madoff and know almost instantly that his claims
were impossible.
It was my ability to understand the numbers that allowed me to
catch the thief in my fish and chips store. I started by inventorying
every shift for a week or two, which allowed me to pinpoint those
shifts on which the thefts were occurring. That allowed me to identify
the suspects. Finally I determined that there was only one person
working all those shifts. Once I knew who the thief was, I was careful
not to catch him. He was putting food in a shopping bag and carrying
it out to his car. If I had caught him doing it I would have had to
fire him, which probably would have meant paying unemployment.
The amount of money involved was too small for law enforcement to
become involved, but significant for my business. So rather than firing
him, I didn't say a word. Over time I just cut back his hours until he
was working only one shift a week-not enough to survive on-and
he quit.
Bernie Madoff was a much bigger fish, but oddly enough not
much more difficult to catch.
Actually, it was another fraud that first brought me into the financial
industry. My father's former banker, the man who got the family
into fast food, was working as a registered representative, a salesman,
at a firm called Yardley Financial Services. It was shut down after the
CEO was caught selling fake London gold options. The former banker
joined several other former Yardley employees and opened Makefield
Securities. My dad bought a 25 percent interest in the firm, and I went
to work there in 1987.
I began by doing oil and gas partnership accounting, completing
depreciation schedules, matching trade confirms-all relatively basic
and often very boring work. I probably was underpaid for the work
I was doing, but whenever you work for family you're going to be
underpaid. Look at Bernie Madoff's two sons. Their father was running
the most successful fraud in history and-at least according to Bernie-he
wouldn't let them participate.
My first day as a licensed broker was October 19, 1987. I remember
it well because that was the day the stock market crashed. Makefield
was an over-the-counter market marker that traded between 12 and 25
stocks. We relied on Harris terminals-dumb terminals I called them
because they did not automatically update prices. They simply provided
the quote at the moment you hit the stock ticker. But they showed who
was bidding and asking on shares at different prices. I came in to work
that morning ready to begin my career as a broker, and instead walked
into chaos.
(Continues...)
Excerpted from No One Would Listen
by Harry Markopolos David Einhorn
Copyright © 2010 by John Wiley & Sons, Ltd.
Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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