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Markopolos vs. SEC: Red Flags All Over The Field

Posted by Larry Doyle on February 6, 2009 5:30 AM |

The world of professional sports has adapted to the wonders of modern technology over the course of the last ten to fifteen years. Professional hockey and basketball have used video reviews for a while. football-field114Professional and college football have more recently utilized video reviews to “get the calls right.” Major league baseball only last year accepted the fact that it is a better game when certain key plays are ruled properly. Few if any lovers of the games do not fully appreciate the benefits of this review process. If our country were only so fortunate that the powers that be at the Securities and Exchange Commission had an equal appreciation for a series of red flags requesting a similar review.

On November 7, 2005 Harry Markopolos threw 29 red flags on the field for the purposes of reviewing Bernard Madoff Investment Securities. The fact that the SEC did not more fully investigate given this OVERWHELMING body of evidence leaves any individual of sound mind and body speechless and dumbfounded. The questions that need to be answered are whether “the reviewers in the box along with the referees on the field” at both the SEC and FINRA were in some way conflicted. Did they have a stake in the game being played? Were there other kinds of action going on away from the field of play that need equal review?

The MSM has given Mr. Markopolos’ tireless work and pursuit of the truth in this fraud a less than thorough review. To be perfectly frank, I am shocked and appalled that we have not seen greater focus on this story. I was sent a copy of Mr. Markopolos’ November 7, 2005 Submission to the SEC and reviewed it today. This submisson is a matter of public record. While I could write at length on the evidence presented, I will do my best to summarize and highlight items that may not have received as much public disclosure as others.

harry-markopolos1Harry Markopolos (HM) highlighted the following based upon his own analysis and that of his colleagues:

-every single head of various Wall Street equity derivative trading desks told HM that Bernie Madoff was a fraud.

-very few people have the mathematical backgrounds to manage Madoff’s split strike strategy but HM is one of them.

-there were two possible scenarios to explain Madoff’s results: he was front running his clients or he was running the world’s largest Ponzi scheme.

-“there is no SEC reward payment due the whistle blower so basically I’m turning this case in because it’s the right thing to do.”

-Peter Madoff (Bernie’s brother) served as vice-chairman of NASD, a member of the Board of Governors of NASD and Chairman of the NY region, and Chairman of NASDAQ Trading Committee. (LD’s comment….this MUST be further investigated!!)

-the feeder funds for Madoff were not allowed to name Bernie Madoff in their performance summaries. Why?? Any manager with such stellar returns would want publicity. Bernie wanted privacy.

-Madoff’s strategy should not have earned more than U.S. Treasury bills. -the volume of options traded by Madoff would have greatly exceeded the daily trading volume. -one feeder fund indicated Madoff did the bulk of his options business through UBS and Merrill Lynch. Did the SEC call these firms to request trading records? (LD’s comment….who ran those desks at UBS and ML?? Check them out)

-why didn’t Madoff use Goldman and Citi who ran much larger equity derivatives books than UBS and Merrill?

-a regression of Madoff’s strategy had a .06 correlation to the index it was supposedly tracking!! It is mathematically impossible to use this strategy with such a low correlation.

Bernie Madoff

Bernie Madoff

-if Madoff was in fact making consistently positive returns and using positive months to subsidize negative months in order to convey a low volatility style, then that is also illegal. Was it checked?

-Madoff would NEVER allow outside performance audits!! -why didn’t Madoff’s returns correlate with the handful of other funds that used this strategy?

-a Managing Director from Goldman Sachs said that Goldman would not deal with Madoff because they believed him to be a fraud.

-“the NASD and NASDAQ do not exactly have a glorious reputation as vigorous regulators untainted by politics or money.” (LD’s comment…FINRA was formed in mid 2007 from the regulatory arms of NYSE and NASD. Our new SEC chair Mary Schapiro headed FINRA. She should be forced to answer Harry’s allegations!! Additionally FINRA has investments in hedge funds and fund of funds. Which funds are they? Could Bernie’s brother Peter, who is very influential at FINRA, be involved here?)

-any fund like Madoff’s that would move to all cash at the end of a month or quarter is typically a fraud.

-a review of 174 months of Fairfield Greenwich (the lead feeder fund of Madoff) showed a mere 7 months of declines. This is a statistical freak of nature!!

-other funds that were exposed as frauds, including Refco, Manhattan Fund, Wood River, and Princeton Economics had far fewer red flags than Madoff!!

What follows is a summary of Harry Markopolos’ thoughts on potential fallout from this fraud. Keep in mind that Harry was presenting this in Fall 2005, so his projections of potential fallout are truly prescient!!

Harry Markopolos’ thoughts about potential fallout:

-doesn’t take a rocket scientist to figure out that the unraveling of this Ponzi scheme could force at least a few hundred billion in selling pressure on the stock market.

-hedge funds and feeder funds with greater than 10% exposure to Madoff will likely face forced redemptions which will lead to a cascade of panic selling in a variety of sectors.

-French and Swiss Private banks are the largest investors in Madoff. This unwind of a likely Ponzi scheme will have a huge impact on European Capital Markets as several feeder funds implode. HM figures that one half to three-quarters of Madoff’s funds come from overseas. -as feeder funds and hedge funds implode, there will be calls for increased regulation.

-major Wall Street bank internal funds are not invested with Madoff because they view him as a fraud. However, these houses own prime brokers and these operations will suffer losses on loans to hedge funds that are exposed to Madoff.

-the SEC will gain political power in Washington ONLY IF the SEC is PROACTIVE and launches an immediate full scale investigation.

-hedge funds will face increased due diligence from regulators.

Well, do you think Harry nailed it?!! If I could be so bold and assume the role of NFL referee, I would state, “upon further review, the call on the field needs to be overturned. The SEC needs to answer for their actions or lack thereof. Subpoenas will be issued as need be. The citizens of the United States and the world deserve nothing less.” It defies logic to think that, in the face of that body of evidence, there was not another “ballgame” being played on another field.



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