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.

THE U.S. SECURITIES AND EXCHANGE commission is supposed to police the financial industry. Yet the commission has a lot less power than most people assume. While it can bring civil actions against corporations or individuals, it has limited authority. In criminal cases, the most that SEC investigators can do is refer suspect activities to state or federal prosecutors. Because the SEC also has the power to revoke licenses and prevent companies or individuals from participating in the market, though, I figured it could at least prove I was right — that Madoff was a fraud — and shut him down, eliminating the pressure on me to create a product that mirrored his returns.

I had established good relationships with two men I respected in the SEC’s Boston office, Ed Manion and Joe Mick. One day, I called up Ed. “I’ve got something really serious I need to talk to you about,” I began. “I discovered this huge scheme…it’s bigger than anything you can imagine — unbelievably huge.”

In his typically understated manner, Ed replied, “That sounds rather serious. When can you bring it in?”

I spent the next few weeks preparing a written report to reinforce the points I intended to make during my oral presentation. In the end it was only eight pages long, which didn’t seem like much, considering who I was going after, but it was what I had. My expectation was that my explanation of Madoff’s operation would at least put the SEC on his trail. “In 25 minutes or less,” my report began, “I will prove one of three scenarios regarding Madoff’s hedge-fund operation: (1) They are incredibly talented and/or lucky and I’m an idiot for wasting your time; (2) the returns are real, but they are coming from some process other than the one being advertised, in which case an investigation is in order; or (3) the entire case is nothing more than a Ponzi scheme.” I included six red flags that, taken together, made it clear that Madoff’s whole operation was a fraud.

After reading my submission, Ed Manion believed it was strong enough to persuade the SEC to investigate. I don’t get nervous very often, but I was nervous. Going forward officially with this accusation represented a big step for me. If my bosses at Rampart found out about this meeting, it would cause me some serious difficulty. I suspect I would have been asked to drop the investigation, and if I had persisted it might have cost me my job. But I also knew it was the right thing to do.