Insight & Analysis

Remembering Madoff: have lessons been learned?

Published: May 2021

Following the death of disgraced financier Bernie Madoff in April, Treasury Today takes a look at the lessons that have been learned since his Ponzi scheme collapsed in the midst of the global financial crisis.

Wall Street road sign in New York

The recent death of Bernie Madoff, the architect of a multi-billion-dollar Ponzi scheme, closed a chapter in the history of financial fraud, one that many would prefer to forget. In the years leading up to the collapse of the scheme in 2008, many were unaware that Madoff was actually managing money, or that he was effectively running the largest hedge fund in the world. In fact, some investors did not realise their money, which was invested in other funds, had ended up with him.

The whistleblower Harry Markopolos, however, did know it was a scam. In his book No One Would Listen he recounts his dogged pursuit of Madoff and how he raised more than 30 red flags in a document he sent to the regulator, the Securities and Exchange Commission. But, as the title of his book says, no one would listen. In the wake of the scandal, Markopolos testified to US Congress and urged the nation to wake up to the scourge of white-collar crime: “It’s not the armed robbers or drug dealers who cause the most economic harm, it’s the white-collar criminals living in the most expensive homes who have the most impressive resumes who harm us the most. They steal our pensions, bankrupt our companies, and destroy thousands of jobs, ruining countless lives,” he said.

Could such a scandal happen again? In light of the passing of Madoff in April, it is worth reflecting on Markopolos’ account of the Madoff fraud to draw on the lessons that can still be applied today.

  1. Don’t rely on a reputation. Madoff was considered a king of Wall Street, a former chairman of the Nasdaq stock exchange, and he also had all the trappings of success. With such credentials, many were reluctant to question his integrity.

  2. Secrecy is a major red flag. Many of Madoff’s clients were sworn to secrecy, which enabled the fund to operate under the radar and prevented questions from being asked.

  3. Don’t be bamboozled. Although Madoff wasn’t actually investing any money – he was operating a pyramid scheme where existing clients were paid with the fresh funds from new investors – he marketed himself as a sophisticated investor. He claimed to be operating a split strike conversion strategy that invested in 35 to 50 stocks from the S&P100; index, and through his management of put and call options was able to limit losses. Also, he claimed that he was using some kind of financial wizardry, which acted on signals coming from a proprietary ‘black box’, which meant he was able to get in and out of the market at just the right time. Because of the complexity of his purported strategy, many did not wish to reveal their lack of understanding or ask probing questions.

  4. Check the audit trail. Despite the size of the fund, its auditor was Madoff’s brother-in-law, which was another red flag that Markopolos raised. Also, when potential investors asked questions, they often received evasive answers, and Madoff did not allow outside performance audits. Also, there was no one checking whether the trades that Madoff claimed to be doing had actually taken place.

  5. Add up the numbers. Markopolos was asked to replicate Madoff’s strategy for his employer, Rampart Investment Management, which is how he became convinced it was impossible to achieve the returns that Madoff was claiming. In more than 14 years there were only seven extremely small losses, the largest one-month loss being a mere -0.55%, and there was never more than one month of losses in a row. Also, Madoff’s returns were incredibly consistent even when there was volatility in the market. As the adage goes, if it’s too good to be true, it probably is.

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