There’s an intriguing and very long piece in this week’s Fortune magazine by James Bandler and Nicholas Varchaver delving into the psyche of Bernie Madoff, one of the largest Ponzi scheme crooks in American history, asking the question of “How Bernie did it?” And more importantly how did such a blatant Ponzi scheme, amounting to an astonishing $65 billion (on the cooked books anyways), escape the notice of the Securities and Exchange Commission for 20 years?
The answers are at once surprising and mundane. Any good Ponzi scheme survives on secrecy and a continuous infusion of new cash, both of which Bernie had in spades. Bernie treated his investment scheme like a private club, only open to the very wealthy, extracting a promise of secrecy from each new investor.
Bernie was also able to charm his way through two major scrapes with incompetent SEC regulators over the years and despite glaring warning signs pointing to fraud, the SEC never went the extra mile to conduct a deeper investigation into Bernie’s operations, leaving dozens of investors unprotected, with their life savings in many instances wiped out.
Bernie’s giant “feeder funds” captured the attention of the SEC twice, but both investigations ended without an extensive investigation into his hedge fund operations. The feeder funds were a merged block of individual investors, an ingenious way to keep billions flowing into the Ponzi operation, using the new cash to pay off current investors.
Bernie Madoff’s hedge fund operation first appeared on the SEC’s radar in 1992, when it shut down one of Bernie’s original feeder funds, Avellino and Bienes, accusing it of operating an unregistered securities operation, promising returns of 13.5 to 20 percent. Such high returns were a sure sign of a Ponzi scheme. Bernie calmly paid all the money back and the SEC just let the matter drop, issuing a small civil penalty.
A few years later in 2006, another giant Madoff feeder fund, Fairfield Greenwich came under scrutiny by the SEC for failing to disclose to its investors all of its investments were with one entity, Bernie Madoff’s hedge fund. Like the previous SEC investigation, Bernie talked his way out of it, but this time escaped prosecution by lying through his teeth. Despite providing obvious misinformation and misdirection to SEC investigators, again the SEC took no further action, except requiring Madoff to register as an investment adviser.
In the end, the one event that finally brought Bernie down was the financial crisis. The toothless SEC had nothing to do with uncovering the massive Ponzi hedge fund. When the financial sector came crashing down last fall, investors started to ask for their money, in a sense starting a run on the Bernie bank. With very little new cash coming in to grease the wheels of his Ponzi enterprise, the gig was up and now Bernie Madoff will sit in a jail cell for the rest of his life, leaving dozens of bankrupt former investors and his family members to pick up the pieces.
Once Bernie knew his carefully cultivated fraudulent hedge fund was about to come crashing down, he went home to his penthouse and confessed all to his brother, sons and wife, with his two sons, Mark and Andy calling the feds to arrest their father. The SEC is now looking to expand the case and seeking out assets to repay duped investors who lost billions.
Bernie claims he ran the Ponzi scheme all by himself. But many wonder how much, if any, Bernie’s family knew of the Ponzi scheme. His brother Peter and two sons were important members of Bernie’s firm, but not with the infamous hedge fund. They all claim, including Bernie’s wife, to have been completely unaware of the scheme until Bernie confessed. It’s hard to believe not one of the family members, even had an inkling that something was amiss. Bernie laundered millions of his dirty hedge fund money through the legitimate trading operations run by his brother and sons.
However, Fortune reports suggest Frank DiPascali, Bernie’s “number 2,” an henchman with just an high school education, is about to strike a plea deal with the feds to reduce his jail sentence in return for information on the Ponzi scheme. Fortune indicates DiPascali has no evidence that Bernie family members were involved with the scheme or knew it was going on.
DiPascali is also expected to testify to a few select feeder investors, who were provided with false investment records by Bernie to give them either non existent losses or profits for a better tax return. DiPascali’s revelations, when he starts naming names are sure to be explosive.
Lurking behind the 2006 SEC investigation was a private whistleblower, Harry Markopolos, a 52-year-old former options trader now working to uncover securities fraud conducting forensic accounting analysis. Ten years ago while with the Boston firm, Rampart Investment Management he tried to reverse engineer Bernie Madoff’s hedge fund, which for years was the talk of the investment world with its unheard of double-digit returns, despite any downturns in the market.
After investigating any information on Bernie Madoff’s hedge fund Markopolos could get his hands on, he concluded Bernie’s high returns were a statistical impossibility and the enterprise had to be a giant Ponzi scheme, perhaps one of the largest in the world. Markopolos tried to sound the alarm for years; constantly alerting the SEC to any new evidence he uncovered pointing to fraud.
The SEC enacted its 2006 investigation, based on information provided by Markopolos, but stopped short of an in-depth investigation of Bernie’s entire hedge fund enterprise, allowing him to defraud investors for another two years. Markopolos, being a determined securities gumshoe, never gave up and continued to warn the SEC about Madoff’s fraudulent operation, but it fell on deaf ears.
Some credit Markopolos with Bernie’s arrest, but the SEC took little notice of his warnings that extended over a decade. At least Markopolos can say, “I told you so.” Markopolos has also become something of a financial fraud-busting legend, since the extent of the Madoff Ponzi scheme has finally come to light.
Since the financial crisis, more Ponzi schemes have been discovered as the schemers ran out of ways to manipulate investor’s funds when the fresh cash stopped rolling in. The frightening part of this whole mess, is that Bernie and others would still be in business, were it not for the financial crisis.
It’s past time for a serious investigation into the incompetence of the SEC and its inability to recognize and shut down fraudulent investment schemes. The Bush administration set the stage for Ponzi schemers like Madoff to flourish in an unregulated market. During the course of its two “investigations” of Madoff’s hedge fund, the SEC investigators didn’t even bother to subpoena the firm’s records, instead relying on Bernie’s cooked books.
Following doubts are being raised :
- How could the SEC have failed so miserably in the Bernie Madoff case?
- Were its investigators cowered by Bernie’s legendary reputation on Wall Street?
- Was, is, the SEC institutionally inept? It’s time to clean house at the SEC, riding it of incompetent political appointees and get on with the business of protecting the public from fraudsters like Bernie Madoff
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