Book Review: No-One Would Listen
No-One Would Listen
A True Financial Thriller
By Harry Markopolos
Harry Markopolos is the whistleblower who spent years trying to expose Bernie Madoff and the largest Ponzi scheme in history – but was stymied at every turn by the truly stunning incompetence and passivity of the U.S. regulator, the Securities Exchange Commission (SEC).
This is a gripping, well-written story that becomes more mind-boggling with each chapter, as Markopolos begins to glimpse the vast scope of Madoff’s secretive scheme, as he uncovers more and more evidence that Madoff must be a fraud, and as he repeatedly hands the case to the SEC on a plate – only to have them blow it. He confesses:
“… I began to realize that the SEC is a government agency that had been captured by the private industry it was created to regulate. The mission of the agency supposedly was to protect investors from the financial predators in the industry; instead it was protecting those financial predators in the industry from investors. … I realized that I had two opponents, Bernie Madoff, and this nonfunctioning agency that seemed to me to be doing everything possible to insulate him.”
Markopolos concludes that Madoff is untouchable and that the Ponzi scheme will continue until it cannot keep growing, at which point it will implode. When that time comes, Markopolos resolves, he will expose the SEC, with the aim of reforming the dysfunctional regulator and bringing proper oversight to a predatory industry: one that he sees as increasingly riddled with unethical and illegal practices that rob investors.
Markopolos’ quest started in 1999 when his bosses at an investment firm challenged him to design a ‘product’ similar to Madoff’s, figuring that this could make them a fortune. Markopolos, a so-called ‘quant’ or quantitative analyst, concluded within minutes that Madoff must be a fraud of some sort – no legitimate investment system could produce such consistent results, year on year, regardless of market fluctuations. But as to the nature of the fraud, there were many possibilities. It would take Markopolos (and a team of friends) several years to gather enough clues to figure this out.
As the evidence mounted, Markopolos submitted reports to the SEC five times: in 1991, 2000, 2001, 2005 and 2008. The number of warning signs increased over time: his 2005 submission contained 30 ‘red flags’, some of them childishly easy to verify. For example, a simple check of Madoff’s trading tickets (issued to his clients) against the OEX trading records would have revealed that, far from trading billions, Madoff was not doing any trading at all. In classic Ponzi scheme fashion he simply used money from new investors to pay fake dividends to existing investors – and kept some for himself. However, this rudimentary check was never done.
Why did the SEC fail so spectacularly? One of the problems was that its investigators were simply not up to the job. Markopolos explains that they were all lawyers who knew virtually nothing about the complex workings of the investment industry. Trained only to look for certain legally-required pieces of paper, they lacked the knowledge to recognize even common types of fraud.
Most investigators viewed their stint at the agency as a resume-filler to help them obtain more lucrative employment as compliance managers in the industry – they routinely asked for job application forms at the firms they were investigating. And they were encouraged to rack up large numbers of successful cases – by going after small firms for trivial matters, rather than tackling big crimes by powerful firms who could fight back.
The SEC also failed dismally to ‘connect the dots’ when it received warnings. Besides the clear, explicit reports from Markopolos, the SEC had also received numerous other warning signals such as: the discovery in 2004 of email correspondence between industry executives speculating as to what kind of scam Madoff was running (since it was obvious to them that he was a fraud); and an anonymous tip-off in 2008 claiming that Madoff kept two sets of books.
Although countless industry insiders – and apparently all of the major firms on Wall Street – had pegged Madoff as a fraud, the SEC was the last to know. Very few insiders attempted to warn the SEC, in part because the SEC provided no incentive for them to take such a serious risk.
According to the Association of Certified Fraud Examiners, whistleblower tip-offs are 13-times more effective than external audit in exposing fraud, yet the SEC’s bounty scheme to encourage such reporting was essentially defunct. It covered only one type of fraud (insider trading) out of dozens of possibilities, and gave the SEC complete discretion whether to pay out or not. The scheme had paid out only twice in 71 years.
When the SEC did investigate Madoff in 2005, even with all the evidence provided to them they still could not uncover the Ponzi scheme – one of the easiest types of fraud to detect. They did not even use their authority to conduct a proper investigation. The investigators knew that Madoff had lied to them on some matters but did not act on this – apparently they were unaware that this was a felony, punishable by up to five years in prison and a fine of $250,000. Their reports described Madoff as ‘a wonderful storyteller’ and ‘a captivating speaker’, but when they asked politely for certain documents he got so angry that ‘the veins were popping out of his neck’. Their bosses told them not to press the issue.
Some Canadians reading this Alice-in-Wonderland tale might feel a sense of national pride and complacency that we are better off here. This feeling would be totally unjustified: Canadian investors are even less protected, and the industry less regulated, than in the USA.
While the SEC may have become a captive of the industry and ineffective in policing it, Canadian regulators are funded and run by the industry, and seem to be highly effective at serving its interests: they certainly do little to protect investors.
In fact Canada resembles a third-world country when it comes to protecting its citizens from the predatory practices employed by some within the investment industry. Most Canadians are oblivious to this situation, but sophisticated investors know all too well and are leery of investing here – while criminals and scam artists are drawn here by the attraction of weak laws and non-existent enforcement.
Whatever the reader’s nationality, Harry Markopolos’ book is an excellent resource for anyone who wants to understand the investment industry: the endless opportunities that it affords for gouging investors, the forces that encourage industry insiders to cheat or turn a blind eye to cheating, and the industry’s hold over weak and dysfunctional regulators.
David Hutton
Executive Director, Federal Accountability Initiative for Reform (FAIR)
May 1, 2010
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