Book Excerpt: Investigating Bernie Madoff

In 1999, local financial analyst Harry Markopolos was asked to figure out how Wall Street titan Bernard Madoff managed to achieve his spectacular investment returns. After concluding it was impossible — that Madoff was a fraud — Markopolos reported his findings to the SEC. Over the next nine years, Markopolos would warn the SEC four more times, to no avail. As this exclusive excerpt from Markopolos’s new book details, the audacity of Madoff’s scheme was matched only by the SEC’s unwillingness to investigate it.

A few weeks later, at Access’s Madison Avenue office, Tim introduced Frank to the CEO of Access, a Frenchman named René-Thierry Magon de la Villehuchet. When Frank asked Thierry about the manager who was producing such spectacular returns, Thierry nodded. “It’s true. He’s my partner.”

If that was the case, it was a major find, and Frank told Thierry that Rampart might be interested in doing business with Access if he could put together a portfolio that included managers like that. Thierry liked that concept.

“His name is Bernie Madoff,” he said.

Anyone who had worked in the stock market knew that name. Madoff’s company, Bernard L. Madoff Investment Securities LLC, was among the most successful broker-dealers on Wall Street. It was also a well-known market maker, meaning he both bought and sold stocks, generating profits by selling for a few cents more per share than his purchase price, a strategy that had made Madoff a very rich man.

When Frank got back to the office, he handed me the copies of the revenue stream. This comes from that manager in New York we were wondering about, he said. “Harry, if we do something similar we can make a lot of money,” he added.

I glanced at the numbers, and I knew immediately they made no sense. The problems popped out as clearly as a red wagon in a field of snow. “This is a fraud,” I told Frank. “You know there’s no way in hell this guy’s getting these returns from this strategy…whatever it is, it’s total bullshit.”

And that’s when we began chasing Bernie Madoff.

 
THE INVESTMENT STRATEGY MADOFF claimed to be using was a technique known as split-strike conversion. There was nothing unique or exotic about it. In Madoff’s case, it involved buying a group of 30 to 35 blue-chip stocks and then protecting them with put options. The downside is that you limit your potential profit if the market rises sharply. The upside is that you protect yourself against devastating losses should the market drop.

Looking at Madoff’s returns was like trying to solve a jigsaw puzzle using pieces that didn’t fit. In certain markets, a split-strike conversion strategy can produce great returns, but it can’t make money in all types of markets. Yet month after month, year after year, no matter how the market performed, Madoff’s returns remained steady. In fact, over seven years, he reported only three down months. He was the slot machine that kept coming up cherries.