Chartered financial analyst Harry Markopolos spent 10 years unsuccessfully trying to convince the Securities & Exchange Commission to investigate Bernie Madoff. Now that Madoff's $65 billion Ponzi scheme has been revealed as the biggest fraud in U.S. investing history, Markopolos is pushing for dramatic changes at the SEC, which oversees the brokerage and investment industries.
"The SEC was nonfunctional, captive to the industry," Markopolos told a dinner gathering of investment professionals at Boston College on June 4. "It was not going to take on anybody big or powerful."
The agency has too many lawyers on staff and not enough people with a background in trading or financial analysis, Markopolos argued.
Says SEC Is Changing
Amid a hail of criticism he directed at the agency, the reclusive whistleblower went out of his way to praise the SEC's new chairwoman, Mary Schapiro, who he met with in February. "The woman's on fire—she has changed that agency," Markopolos said. "I'm really impressed."
Schapiro took over the SEC in January. Previously, she ran the securities industry's self-oversight group, called the Financial Industry Regulatory Authority. Earlier, she served as a commissioner on the SEC from 1988 until 1994, when she was appointed to head the Commodity Futures Trading Commission, where she served for two years.
Much of Markopolos's speech consisted of critiquing the conduct of SEC officials from 1999, when he first looked into Madoff's seemingly amazing investing results, until the end of 2008, when the scheme came unglued of its own accord. Correcting a quote attributed to him after the scandal broke, Markopolos said he never said the SEC "roars like a lion and bites like a flea. I'd never give the SEC that much credit," he quipped. "The SEC roars like a mouse, not a lion."
Checking for Car Bombs
Markopolos first began looking into Madoff's investing record in 1999 when executives at his employer, Rampart Investment Management in Boston, asked him if the strategy could be duplicated. Markopolos says he became immediately suspicious because Madoff never reported losing money in any month. "I knew it was a fraud in about five minutes," he said. Further investigation showed that Madoff's claimed options trading exceeded by as much as 65 times the entire volume of the contracts he said he used.
While he failed to persuade regulators to investigate Madoff, Markopolos said he increasingly came to fear for his life. Though he had not received any threats from Madoff or any other parties, his nervousness reached the point where he was checking his car for bombs.
"If this gets out to Bernie Madoff, my life expectancy isn't very long," he said, explaining his state of mind at the time. "He'd have many billions of reasons why he doesn't want me around."
The Power of Compounding
Madoff, a former chairman of the Nasdaq, turned himself in to federal authorities in December 2008, admitting that his investment fund was a fraud. In March he pled guilty to 11 counts of fraud and other violations of securities laws. A sentencing hearing is set for June 16.
The vast majority of the missing $65 billion will never be recovered, largely because it doesn't exist, Markopolos explained to the Boston College audience. The figure represents the total amount Madoff told his investors they had invested in his fund by 2008.
But Markopolos says the number is vastly inflated because it reflects decades of fictional compound investment returns. As in any Ponzi scheme, new money deposited in the fund mostly went back out to any prior investors who were making withdrawals. The scheme broke down last December because Madoff didn't have enough money remaining to cover $7 billion of requested withdrawals.
A Tale of Two Whistleblowers
During his speech, Markopolos praised another whistleblower who was sitting in the audience, Peter Scannell, who helped blow the lid off the mutual fund industry's market-timing scandal in 2003. After the speech, the two shook hands and sat down for a private chat.