One thing that's notable, from this report and others, is that there were a class of investors who knew that Madoff was doing something illegal to get these kind of returns, and were bragging about it. These investors didn't think it was a Ponzi scheme; they thought he was using insider knowledge from his broker-dealer's access to order flow.
And they were happy to go along with this obviously illegal practice.
I don't think it's too much of a jump to speculate that the ones who knew there was something illegal going on were the managers of the so-called Funds of Funds and other hedge funds. These include managers of our public pension funds. These managers are too knowledgeable not to know something's up when these kind of returns are being posted, and when red flags were being raised, and they were happy to go profit from it because they figured they were at a safe enough distance from the illegal trading.
It is a fascinating report. Yes, it seems like Madoff was able to able to convince his investors based on the implications that he made his money with insider trading,
The classic approach of con-man is to attract the mark with the promise of ill-gotten gains.
The report shows everything we've seen in the news and more. Remember, the report's scenario is for a Madoff scheme collapse in 2005. One would have to assume that in three years, the money hole has gotten bigger while market conditions have gotten far worse.
One point of the report is that most reputable funds managers avoided Madoff but didn't actually help bust him. So we have not seen large US banks or pension plans hit by this, just small but wealthy individuals and European private banks. But as the report says, the hit these folks will take can affect everyone else.
No, there's a 1% difference between 99 and 100 percent certainty.
Or are we working with the log odds here? Are you going to tell me there's a big difference between 99.999999% certainty and probability 1? I think at some point you become morally liable and that's well before 99% certainty.
A tangent. I wanted to copy and paste a paragraph that I thought was interesting, but the ability to select text is broken in the Scribd document viewer. I then tried to find a link to download the document in PDF form, but almost couldn't. After a bit of searching, I found the PDF download link hidden behind the "download" dropdown menu. When I clicked on it, Scribd dutifully notified me that I was required to sign in before I was allowed to do that. At that point, I gave up and took a screenshot of the paragraph: http://dl-client.getdropbox.com/u/315/random_pics/Markopolos... ... specifically, it's interesting that Markopolous feared for his personal safety because of this report.
Markopolos actually tipped the SEC off in 1999. His complaint is actually quite readable and gives good insight into the split-strike conversion strategy and why it cannot possibly account for Madoff's reported gains.
I wonder if the SEC did not take the report seriously because of his somewhat sarcastic tone, e.g. mention of tooth fairy, etc.
My hunch is that stuff like SOX is not whats going to stop this, rather, properly funding the SEC so that they can actually investigate cases like this would. Of course, SOX doesn't require a tax increase, whereas funding the SEC would.
We should privatize the SEC. Put a bounty on fraud detection, and then make the following deal: the government puts up a lump sum now, and the recipient must make whole all parties harmed by fraud, but only if the organization approved the fraudulent financial statements.
You probably need to tweak the numbers to avoid some bad incentives, but the general principle is sound: treat it as an insurance problem, rather than a regulatory problem, and the funding you get will approach the point where the marginal utility of more fraud detection falls below the cost.
The bounty system exists: it is called short selling. The SEC just needs to stop demonizing short sellers and start paying attention to who their shorting and why.
The same thing that happens when any insurance company goes bankrupt.
Fraud is a normal, insurable risk. We just have a bizarre, underfunded, overambitious regulatory apparatus bolted on to where insurance is supposed to fit.
Regulators could game this system by taking their lump sum and not
doing the work involved with sniffing out fraud. If there's no fraud,
they win, and didn't have to do any work.
If there is fraud, maybe they can squirrel some of that bounty into an
offshore bank account and sneak out the back door like bernie madoff
was hoping to do.
You'd probably end up with layers of insurance. So one company might give IBM's financial statements a Seal of Approval, stating that any investor can pay the company, say, $1,000 a quarter to insure up to $1 million in restatement-related losses. Then, they double-reinsure this (every $1 million they lose gets them $2 million from a reinsurer) and offer a bounty for anyone who catches fraud.
Or you could just expect people who suspect fraud to short the relevant stock, announce their findings, and make money if they're judged correct.
You're right that it's hard, by the way. I just think it would be easier if we were able to have multiple voluntary levels of insurance against fraud, instead of a single insurer -- especially because, in many cases, the SEC fines a company when management lies to shareholders. So if XYZ Co. overstates earnings by $100 million, investors are poorer -- and then the SEC makes the company give up another $20 million in restitution.
If it were effective, its benefit to investors might exceed the cost to companies; in that case it wouldn't be a tax increase but, effectively, a decrease along with a change in the tax structure.
To read this document, I would either need to install Flash or sign up for a Scribd account to download the PDF. Is there another place where the document can be found? Is it possible to redirect the original article link to a place with an open-access version of the document?
This is indeed a set of specific and credible allegations that the SEC should have investigated thoroughly. The level of detail is far above that of the usual letter indicating suspicions about an organization, and the author shows knowledge of the relevant law.
Nice post. The section on fallout on page 15 is interesting and worth reading. Anyone know how highly leveraged the front-running hedge funds actually were? The 4:1 seems somewhat low given recent economic press coverage.
And they were happy to go along with this obviously illegal practice.
I don't think it's too much of a jump to speculate that the ones who knew there was something illegal going on were the managers of the so-called Funds of Funds and other hedge funds. These include managers of our public pension funds. These managers are too knowledgeable not to know something's up when these kind of returns are being posted, and when red flags were being raised, and they were happy to go profit from it because they figured they were at a safe enough distance from the illegal trading.