Harry Markopolos Cost Investors Millions

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MarkopolosHarry Markopolos caught Bernie Madoff eight years before he turned himself in. Markopolos offered all that he knew to the Securities and Exchange Commission, the government agency in charge of regulating fraud on Wall Street. But no one would listen. Was it because the agency was completely inept or could Markopolos have done something better? It’s said that people with autism live in the moment. Is that the trait Harry Markopolos needed to stop the largest ponzi scheme in history?

The Real Price of a Con

Rene-Thierry Magon de la Villehuchet lost over $1.4 billion. It wasn’t all his. In fact most of it wasn’t, it was friends, relatives and clients who had asked him to invest their money safely. He was relied upon by everyone from his direct family members to European royalty. Villehuchet was dignified and proper in the fashion of French aristocracy. He loved sailing and was always well groomed. The man personified what the French upper echelon trusted. But in 2008 that trust died, along with the billions he had invested. So 3 days before Christmas, Mr. Villehuchet locked his office door on the 22nd floor of his Manhattan office. He put his feet up on his desk and swallowed a lethal dose of pills. Just to make certain the suicide worked he opened the veins on his left wrist and bled out into a trash can he had considerately placed under his arm to contain the mess.

Just a few weeks earlier Villehuchet watched, with the rest of us, as the largest ponzi scheme in history unraveled. The numbers are still being calculated today. But when Wall Street collapsed in 2008, somewhere around $65 billion was gone. $1.4 billion of that coming directly from Villehuchet. It was gone, not because of the adjustment in the market, but because the unassuming, former chairman of the NASDAQ was running a decades-old ponzi scheme.

When authorities arrested Bernie Madoff he said, “There is no innocent explanation.”

Bernard L. Madoff Investment Securities LLC opened in 1960. The company became one of the top market maker businesses on Wall Street. In a nutshell, a market maker establishes both the buy and the sell price for a commodity or a financial product and makes money on the difference, or the spread between the two prices.

Market Makers

Investopia explains it this way.

Market makers compete for customer order flows by displaying buy and sell quotations for a guaranteed number of shares. The difference between the price at which a market maker is willing to buy a security and the price at which the firm is willing to sell it is called the market maker spread. Because each market maker can either buy or sell a stock at any given time, the spread represents the market maker’s profit on each trade. Once an order is received, the market maker immediately sells from its own inventory or seeks an offsetting order. There can be anywhere from four to 40 (or more) market makers for a particular stock depending on the average daily volume. The market makers play an important role in the secondary market as catalysts, particularly for enhancing stock liquidity and, therefore, for promoting long-term growth in the market.”

As an example, if the bid/ask for Facebook is $185.00/$185.05, the market maker can put in a bid for Facebook at $185.01. If everything falls into place in this scenario the market maker can sell 1000 shares of FB at $185.05 and buy them back at $185.01 making $.04 on each share or a total of $40. In a basic nutshell this is what Madoff did on the legitimate side of his business for decades.

The 17th Floor

But this wasn’t the problem. This all happened on the 18th floor of the Lipstick Building on Third Avenue in Manhattan. It was what Bernie was doing on the 17th floor of the same building that brought thousands to financial ruin. Bernie had a few dozen staff helping him run the largest ponzi scheme in history.

 

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Charles Ponzi

Charles Ponzi may not have invented the scam, but he made it so famous that we named it after him. He found a loophole in the mail system. He would buy international reply coupons in one country. These could be exchanged for much more expensive stamps in other countries. This turned out to be profitable for Ponzi, but when he learned that people would pay him for the initial investment of the IRC’s and then share a portion of the profit after the exchange, everything changed.

Ponzi began taking investors money and spending it on himself. Then to appease the initial contributors, he would take on more investors and use their money to pay off the first investors, while pocketing some himself. At one point he is credited with making $250,000/day in 1919! As long as he had more people paying into the scheme than wanting money back, he was fine.

But, as with all scams, this one collapsed. Eventually Ponzi had to pay out more than he was taking in. Too many people wanted there money back and not enough were investing to make the payment. So the scheme fell apart, Ponzi went to prison and eventually died broke in Rio de Janeiro in 1949.

Modern Day Ponzi

Madoff was running an identical operation, only rather than being based on postage, it was based on stocks and Wall Street. Bernie was being funded mainly by foreign banks and what are called feeder funds. These funds have the responsibility of making sure their clients money is invested safely.

Fairfield Sentry was the largest feeder fund, blindly supplying Madoff with mountains of cash to mishandle. They collected billions of dollars from investors and handed it to Madoff to invest. This fund had really only one job to do, and that was to ensure the safety of their clients money. They should’ve known better, and many people on Wall Street think they knew something was wrong. They turned a blind eye to their own verification policies when it came to Madoff because the returns were just too good. So investors continued handing over their money.

Madoff would invest it in the finer things for himself and his family. Then when the investor wanted their money back, Madoff would write them a check, complete with fake gains, from the money new investors were giving him. There was such a high volume of money coming in he that was “making” some of the largest returns in the industry. He was also able to raise so much money from these feeder funds because he offered the lowest fees available. Which makes sense. Who needs to charge high fees when you are just spending the principle?

Market Correction

But in 2008, when the sub-prime lending bubble burst and Wall Street went into a tailspin people wanted their money back. Bernie could not write those checks because not enough people were investing during the market collapse to make up the difference. So in December of 2008 the gig was up. Mark and Andrew Madoff called the FBI and turned their father in after he allegedly admitted the fraud for the first time to them.

In 1999, nine years earlier, Bernie Madoff was actually caught by a small team of people. Harry Markopolos worked for Rampart, a direct competitor to Bernie Madoff. They functioned along the line of Fairfield Sentry only with a little more sense.

When the staff at Rampart saw the numbers Madoff was “generating” for his customers, they knew they had to find a way to compete. Markopolos was trying to build a financial product that would rival the amazing returns Madoff was claiming for his clients. When he did the math on Bernie’s investments, he realized that what Madoff was offering was impossible to replicate.

Markopolos compiled his calculations, found some serious flaws in the technicalities around Madoff and discovered a real lack of evidence that there was any trading goin on at all.

The SEC

So Harry Markopolos took his information to the Securities and Exchange Commission. The SEC is the government agency charged with the task of protecting investors from fraud and investigating the snakes in suits who steal from grandma’s 401K. Markopolis offered detailed reports from the incredibly thorough digging he did into Madoff and the math that didn’t work. He submitted reports that showed Madoff making money every single month for years, even when the market and all of the competition lost money. He gave them the names of people who could corroborate the information.

And in 1999 Bernie Madoff was stopped in his tracks. thanks to the information offered by this brave whistleblower.

At least that is what should have happened.

 

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Yavapai County Juvenile Probation

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MGE Underground

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New York Times Bestselling Author

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The Reaction to Harry Markopolos

But no one at the SEC would listen to Harry Markopolos and his small team of friends. The little group of weekend sleuths had created an absolute masterpiece of an investigation, but had been completely ignored by the people whose job it was to actually do the investigation. At this point the Madoff ponzi scheme was estimated at a few billion dollars. Huge by any standard, but dwarfed by what was stolen when Madoff was finally taken down.

Harry Markopolos wasn’t done yet though. He had another outlet that could take down Bernie. The media in the world of investing is a small, valuable community, in which Markopolos had a few friends. MARHedge, a huge publication in the industry at the time, charged $1000 per year for a subscription. Their readership ate up every word they published. The Wall Street Journal breaks stories of corruption every chance they get. These reporting agencies love to out criminals to their readership and Bernies victims were their readership.

So Markopolos took his story to the media.

(Insert cricket noise here.)

Who Listened

Over the course of the near decade of work the small team put into uncovering Madoff they were able to get exactly zero investigators, journalists, financial professionals and SEC employees to take action on their material. In fact, it is speculated that, had it not been for the sub-prime financial crisis in 2008, Madoff may still be at large. His organization collapsed, as ponzi schemes do, when too many people wanted their money back after the markets collapsed, not because of the barrage of red flags Markopolos was sending to everyone who would listen.

But why?

This was a career making investigation, a pulitzer prize story and the retirements of millions of people. Why were the signs sent by the small team ignored?

The answer is that people listen to the messenger before they listen to the message.

Unfortunately in this case, that messenger was Harry Markopolos.

No One Would Listen

Harry Markopolos wrote an explosive and descriptive book about the entire affair. It is aptly named, ‘No One Would Listen.’ The narrative is a wild braid of arrogance, paranoia and revenge mixed with the most incredible financial story of our time. The audio version of the book comes with the requisite amount of distastefulness along with a strange blend of various voices reading different portions of the book for reasons unknown.

At times the book had me cheering for the SEC. The group of government officials, charged with protection the public who were proven to be completely inept were often more attractive as a hero than the man doing their job for free in the book.

And the book is written by Markopolos.

Examples

Here are just a few excerpts from the story as examples. He opens with the blatant truth about his work when he writes, “This, then is the complete story of how my team failed to stop the greatest financial crime in history, Bernie Madoff’s ponzi scheme.”

Regarding derivatives he writes, “Occasionally a situation arrises 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.”

The statement seems to only have one of two purposes. Either to prime us for the eventual math required to understand Madoff’s scheme, or to prove to the reader we aren’t as adept at math as Markopolos.

Then his next sentence clears up the author’s intent.

“You certainly won’t need to know (the equation) to understand how Bernie Madoff successfully ran his worldwide ponzi scheme for decades.

Boondock Saints

In fact the entire purpose of the book seems to point to the complete pre-occupation Harry Markopolos had with proving to the reader he brilliant, and his own paranoia. He explains how he felt his life may have been in danger, which is understandable. But Markopolos gets very strange when describing his decision not to wear a bullet-proof vest.

“There were three things you had to be able to do to protect yourself, shoot, move and communicate. I certainly was trying to communicate. I had been trained pretty well to handle the shooting part. That left mobility, which was why I decided not to wear a bullet-proof vest. I actually tried on several different types but all of them restricted my movement. If Madoff wanted to kill me he was going to use professionals. That meant a double tap, two bullets to the back of my head.”

This sounds silly now. Most of us have heard the story of how Madoff hung his head and gave up as quietly as possible. I’m sure in the moment Markopolos had legitimate reasons to fear for his life. But this story was written after the grandfatherly Madoff walked into handcuffs and spilled his guts. Even after we all know what a coward Bernie was, Markopolos is attempting to paint a picture of his life to resemble a scene from Boondock Saints.

Pre-Occupied

In the book Markopolos seems much too pre-occupied with stories like this to connect with the reader and help us understand what happened. It becomes clear why Markopolos wasn’t able to persuade the right people. Rather than building the relationships he needed to save tens of billions of dollars, he approached these vitally important interactions with a chip on his shoulder.

Keep in mind, I arrived at this opinion by reading only what he wrote about these interactions. If he comes off this arrogant and preoccupied in his own book, I wonder how bitter these interactions were in person.

Harry Markopolos wasn’t a reporter serving the readership of his publication. He was a representative from a rival fund to Madoff. Looking back it is easy to think the man pointing to the largest ponzi scheme in history should’ve been given the floor. But at the time Madoff was well respected, a pillar of big finance and had a massive successful, legitimate arm of his business which had operated longer than many of his rivals had been alive. Markopolos was a preoccupied, yipping, arrogant competitor whose main complaint was that he couldn’t replicate what Madoff was doing.

First Submission

Here is the beginning of the first submission Markopolos made to the SEC about Bernie Madoff in 2000.

“In 25 minutes 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 one being advertised, in which case and investigation is in order.
  3. The entire case is nothing more than a ponzi scheme.”

It goes on.

“My firm’s marketing department has asked our investment department to duplicate Madoff’s split/strike conversion strategy in hopes of duplicating their return stream. We know from bitter experience this is impossible.”

In other words, since we can’t do it, no one can.

Getting Paid

Then there is the pre-occupation Markopolos seemed to have with collecting a bounty from his whistleblowing. Many different times he has vehemently claimed that he never wanted to make a penny from Madoff. In fact, at the time of his first submission to the SEC it was not possible for him to collect a bounty from this type of case.

The bounty program at the time allowed for up to 30% of funds gathered from insider trading cases to be offered to the whistleblower. But this wasn’t an insider trading case. Markopolis outlines this very clearly in his book, as if to prove to us once again that he has the purest heart.

But consider the next part of his submission to the SEC.

“I would like to prove Madoff is a fraud so I don’t have to listen to any more nonsense about split/strike conversions being a risk free absolute return strategy. If there is a reward for uncovering fraud I certainly deserve to be compensated.”

And, to further cloud the water he says this. Remember he is speaking directly to the SEC in this submission.

“There is no way the SEC would uncover this on their own.”

Grant Ward

His arrogance comes off very strongly when describing his first meeting with Grant Ward, the SEC Regional Director of Enforcement.

 

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He says, “As I explained this massive fraud to Ward, it very quickly became very clear he didn’t understand a single word I said after hello.”

What He Could Do

At no point does Markopolos admit that perhaps it was his fault that he wasn’t someone with whom the SEC cared to hear. I came to this conclusion, just from reading his account of the investigation. I walked away believing that he is grating, arrogant and preoccupied with proving his intelligence and the incompetence of the SEC. Even though I believe he is intelligent and the SEC is incompetent, I completely understand why no one would listen.

And as most people who have ever talked with other people know, we are mirrors to the people with whom we interact. If we put off confidence the people around us will be more confident. It we are angry our close circle will become angry. And if we are more concerned with proving we are smart and the counterpart is incompetent, that is exactly the  reaction we will get from them. They will be too busy proving we are not as intelligent or right as we are acting.

Which is exactly what happened every time Harry Markopolos interacted with the SEC. They mirrored him. His smugness, pre-occupation and arrogance came back to him. When you need the help of the entity you are dealing with, it’s best not to insult them first or appear condescending.

Mirroring

But it isn’t just giant, apathetic government bureaucracies that mirror our actions. In fact, every small twitch, gesture or even emotions very likely come back to us in social interactions. Mirroring is one of the crucial steps in building rapport. Science has uncovered what they call mirror neurons in our brain that automatically take on the speech and gestures of those around us. We act, speak and often feel similar to those with whom we interact. This is the study of mirroring. One of the forerunners in the study and use of mirroring was Dr. Milton Erickson.

One story has it that a 17 year old, polio stricken Erickson overheard the doctor telling his mother that Milton would not live through the next day. So he asked his mother to place a mirror in his room so he could watch one more sunset.

Fortunately for us, young Milton Erickson survived much longer than one more sunset. But the mirror remained. Eventually Milton began to notice small muscle movements of his own. He also had the time to watch people as they interacted with each other. The little twitches and movements he saw in the mirror watching himself became clear in other people.

He realized that when people got in a state of rapport, they often mirrored the movements, words, tones and even breathing of each other. Eventually he used this knowledge of mirroring in his practice as a therapist. He was able to quickly build a sense of belonging in the clients who hired him by mimicking their tone, words and gestures.

Mirror Neurons

Erickson learned that these subconscious actions are powerful, which opened doors to the healing of patients through subconscious means. Most times we aren’t aware of mirroring. It doesn’t matter if we are the mirror or the mirroree, we usually don’t see it. But it happens anyway. Erickson found what scientist know know is the result of mirror neurons.

The American Pshychological Association explains it like this.

You’re walking through a park when out of nowhere, the man in front of you gets smacked by an errant Frisbee. Automatically, you recoil in sympathy. Or you’re watching a race, and you feel your own heart racing with excitement as the runners vie to cross the finish line first. Or you see a woman sniff some unfamiliar food and wrinkle her nose in disgust. Suddenly, your own stomach turns at the thought of the meal.

For years, such experiences have puzzled psychologists, neuroscientists and philosophers, who’ve wondered why we react at such a gut level to other people’s actions. How do we understand, so immediately and instinctively, their thoughts, feelings and intentions?

Reading People

Now, some researchers believe that a recent discovery called mirror neurons might provide a neuroscience-based answer to those questions. Mirror neurons are a type of brain cell that respond equally when we perform an action and when we witness someone else perform the same action. They were first discovered in the early 1990s, when a team of Italian researchers found individual neurons in the brains of macaque monkeys that fired both when the monkeys grabbed an object and also when the monkeys watched another primate grab the same object.

Neuroscientist Giacomo Rizzolatti, MD, who with his colleagues at the University of Parma first identified mirror neurons, says that the neurons could help explain how and why we “read” other people’s minds and feel empathy for them. If watching an action and performing that action can activate the same parts of the brain in monkeys–down to a single neuron–then it makes sense that watching an action and performing an action could also elicit the same feelings in people.

The concept might be simple, but its implications are far-reaching. Over the past decade, more research has suggested that mirror neurons might help explain not only empathy, but also autism and even the evolution of language.

In fact, psychologist V.S. Ramachandran, PhD, has called the discovery of mirror neurons one of the “single most important unpublicized stories of the decade.”

Practice

The next time you are speaking to a friend, hold your arms in a certain pose, different than theirs. You will notice that eventually they will mimic your stance. Or try to replicate their breathing pattern as you speak. If you get this right, the other person will open up, be more forthcoming and yo will develop rapport almost immediately. This is just the tip of the iceberg when it comes to mirroring.

But mirroring works both ways. People not only mirror our positive actions, but our distasteful behaviors as well, and Markopolos offered heaps of distasteful actions for the SEC to mirror. His preoccupation with paranoia, arrogance and snatching a paycheck took away from the amazing story he was telling in his book. I’m sure these distractions were evident in person as well.

Throughout the book Markopolos explains his indignation towards being blown off, but seems to be oblivious as to why it happened.

On June 20th, 2002 Markopolos traveled to Europe with Rene-Thierry Magon de la Villehuchet. He had built a financial product that was to be marketed as an option for investors who had too much of their portfolio with Madoff. If they wanted to diversify, this was the vehicle. Villehuchet planned to introduce Markopolos to some of his high-level investors. The pair wanted to offer them an option to diversify away from Madoff using the product Markopolos created.

Dinner

The first meeting was to be with Prince Charles.

But Harry wasn’t invited.

The following is a verbatim transcription from the account in No One Would Listen about that incident, and the entire trip afterwards.

“…(they said) they hadn’t invited me to this meeting because I didn’t know how to curtsy. Obviously that was their joke and so I responded, ‘Of course I do, but by tradition Americans don’t curtsy to British royalty because they have never defeated us on the battle field. That’s why Americans don’t bow when meeting the Queen.”

Remember, this is a man trying to convince British royalty to hand him millions, if not billions of dollars to invest in a product he created out of thin air. It was also not offering as much of a return as what they were already invested in, on paper.

He goes on,

“I don’t think they liked my joke. I was scheduled to have dinner with the two of them that night but it never happened. In fact, throughout the entire trip, after the last meeting of the day I got kicked to the curb. We didn’t eat a single dinner together. Obviously I was good enough to have breakfast and lunch with them, but I didn’t make the dinner cut. I wasn’t particularly pleased with that but I was polite enough not to remind them who won the Revolutionary War.”

Foot In Mouth Disease

But that last sentence isn’t true. His first stupid comment was a staunch reminder of how that war ended. He said it while he was standing in their homeland, with his hand out asking for money.

Imagine how he acted while he was accusing someone of theft.

Bernie Madoff stole billions of dollars from innocent people and the SEC was complicit in the theft. They are the criminals in this situation. But Markopolos had the opportunity to shut it down at a tenth of size it was when it collapsed. His preoccupation with proving his own brilliance, paranoia and trying to get paid killed the influence he needed to stop the crime. He made very poor impressions around the industry, which they mirrored back to him.

If it is true that people on the spectrum live in the moment, perhaps the genius, Wall Street mathematician, Harry Markopolos could’ve taken a note from them. Maybe a smile and the offer of help would have been returned in the same manner. If he had been more focused and pleasant, perhaps billions of dollars would have been saved.

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