When you read the 2005 “Markopolos letter” to the SEC, which warned the regulator about Bernard Madoff, what jumps out at you is how many professionals on Wall Street were actually suspicious of Madoff's business. Harry Markopolos quotes a number of them (without using their names) in his letter. Markopolos was an options expert at a rival firm that was not doing business with Madoff, but he really nailed Madoff by backtesting his results. Using data from Fairfield Sentry Ltd. (a feeder fund), Markopolos was able to conclude, “Madoff Securities is the world's biggest Ponzi scheme.” Markopolos was even in the stadium on the amount of money Madoff was running. (Just Google “Harry Markopolos” for more on his letter to the SEC.)
Markopolos wasn't the first skeptic. Back in May 2001, our friend Erin Arvedlund, then working for Barron's, wrote a story quoting professionals who, granted anonymity, questioned Madoff's stated strategy. While Markopolos and others openly wondered, “Is this a Ponzi scheme?” most reckoned Madoff was front running, using his b/d's market-making business to front run for his own trades. Of course, it turns out it was worse than that. I've heard other consultants say, “It took me about five seconds to step away from Madoff.” Why? Family members held positions in the firm that should have been held by disinterested parties (Madoff's son was head of compliance); the returns on his strategy were too perfect and his accounting firm was a tiny unheard-of one-person shop in upstate New York. Hmm.
So why didn't more of these doubters raise their hand and call bull to the SEC? According to two partners at Venable, a Washington, D.C. law firm, if you are not a fiduciary to an investor who is investing in Madoff, you only have an obligation not to invest with him. That's probably too bad, since, as you'll see by turning to page 20, the “Madoff Effect” has hurt the market in general — by destroying $50 billion (or so) of capital — and Wall Street's reputation in particular. After Madoff, retail investors are a bit more skeptical about their financial advisors. To them, you're all potential Madoffs now.
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