Blowing the whistle on the world's largest financial fraud

Harry Markopolos was a US financial analyst. His job involved assessing and developing investment products, namely complicated packages of investments, for his employers. Markopolos knew his stuff, so when he came across Bernie Madoff's operation, he was immediately sceptical, even though Madoff was a towering figure in US financial circles and was widely respected.

Madoff was offering investors an unequalled deal. They would give him their money to invest and he would deliver returns averaging 1% per month - 12% per annum - month after month, with negative returns few and far between. This was too good to be true.

Markopolos knew Madoff's returns were impossible to achieve legitimately. Either Madoff was using inside knowledge of the market to make money from trades or he was running a Ponzi scheme. Markopolos thought it was a Ponzi scheme - and a big one, too. Madoff's operation was larger than any other in the market.

Ponzi schemes are named after Charles Ponzi, who ran an early pyramid operation. He solicited money from investors and paid them good returns. But actually Ponzi didn't make any investments - he just had the money from investors. To pay them a return, he had to obtain more money, so he continually needed new investors. There was always more money coming in to cover the payments to current investors. These schemes always go bust eventually, leaving a lot of unhappy investors, especially the ones who joined later.

Markopolos started gathering information about Madoff's operation and came across numerous suspicious signs. For example, if Madoff was making investments involving billions of dollars, there would be ripples in the prices of shares in the market - but somehow Madoff seemed to guess exactly where the market was going, month after month, through boom and bust, and never leave a trace of his activity. Markopolos thought, correctly, Madoff wasn't trading at all.

Markopolos wasn't alone. He worked with a small team of trusted analysts who shared his concerns. Each of them had jobs, eventually in different parts of the US. In the course of their jobs, each of them would casually ask people about Madoff, gradually collecting more information, which they shared with each other by email and telephone.

One of the lessons from this saga is that if a fraud is big enough, lots of people will know about it but few will be willing to do anything. Madoff's fraudulent Ponzi operation started in the 1990s. Madoff's returns were impossibly large, so something was fishy. But investors were hooked. They wanted those wonderful returns and so they queued up to give their money to Madoff. They didn't want to make any noise about their suspicions. They rationalised their inaction by assuming that Madoff was using inside knowledge to beat the market. Those investors who were wary wouldn't put any money with Madoff, but they did nothing to expose him.

Why did Markopolos care about Madoff? One reason is that he had been brought up to support the good guys and act against crooks, even if there was nothing in it for him personally. Secondly, his employer was pressuring him to develop a financial product that would compete with Madoff's returns. Markopolos wanted to expose Madoff to get rid of this unrealistic demand.

If investors weren't going to do anything about Madoff, what next? Why not try the regulators? Markopolos prepared a submission to the Securities and Exchange Commission (SEC), whose official purpose was to regulate US financial markets.

Over a period of years starting in 2000, Markopolos made five separate disclosures to the SEC. What did the SEC do? Usually nothing. Markopolos' submissions were dismissed without serious examination. This made Markopolos increasingly angry.

Markopolos expected that the SEC would set up an investigation, and he made it easy for them. All they had to do was ask Madoff a few informed questions or collect a few key bits of information and his whole operation would be exposed. It would only take a few hours. It was that easy. Why didn't the SEC act? If it had, it would have been hailed for bringing down a huge fraud.

There were two main factors. The first is that most of the staff in the SEC were incompetent. They simply didn't know enough about what was going on in the financial scene to understand Markopolos' analysis, nor have enough experience in doing investigations to know how to proceed. The second factor was that the SEC was a paper tiger. It went after small-time fraud but would not act against big-time corruption involving billions of dollars. In essence, the SEC protected major fraudsters from honest investors. In Markopolos' words, "the SEC was an out-of-control agency that served no obvious purpose other than to fool people into believing it was actually offering investors protection."

Markopolos kept making submissions to the SEC because there were some solid employees there who supported him. But they were unable to get their superiors to act.

Through the years 2000 to 2008, Markopolos and his team continued to collect information about Madoff and his operation, which became bigger every year. By 2008, something like $65 billion dollars was involved - and there were no actual investments, just money going in and out.

Markopolos also tried the media. One member of his team, Mike Ocrant, was a financial journalist and prepared a story for an investor magazine. It was published in 2001. Cautiously written, it provided alarm bells for anyone who understood the way the industry was supposed to operate.

Markopolos expected the story would blow Madoff out of the water - financial regulators would read the story and start investigating. But nothing happened. Big investors, who should have known better, were too hooked on Madoff's returns to start questioning his methods. Apparently the SEC didn't even subscribe to the investor magazine - it had no budget for monitoring the financial press, and employees had to buy publications themselves.

Later, Markopolos went to the Wall Street Journal, where he found an interested and knowledgeable journalist who wanted to run with the story. But the journalist kept putting the Madoff story on the back burner while working on other stories. This went on for a couple of years.

It was 2008 and the beginning of the global financial crisis. Madoff, with his steady returns, was still seen as a safe investment. However, some investors needed their capital urgently, and Madoff couldn't supply it, because his whole operation was a shell. In December, Madoff admitted he was running a Ponzi scheme, was arrested and sentenced to decades in prison.

The media soon found out about Markopolos and besieged him. He was a hero. Markopolos had one prime target: the SEC. He wanted it totally reformed or else abolished.

So what did the SEC do? Senior figures started saying there hadn't been a whistleblower about Madoff. Markopolos went into action, preparing documents to expose the SEC. He again worked with the Wall Street Journal - this time a different journalist. When the SEC found out that the newspaper was going to publish documents showing there was indeed a whistleblower, it capitulated.

In early 2009, Markopolos testified before a Congressional committee, and slammed the SEC heavily. Members of the SEC also testified, so poorly that the committee members were enraged. Heads rolled at the SEC, and Markopolos is hopeful that the new SEC might be better. It is too soon to tell.

Markopolos is a very rare species of whistleblower: he was totally vindicated. It was the collapse of Madoff's Ponzi scheme that made the difference, as well as the total failure of financial regulators.

Markopolos knew what he was doing. Some years before 2008, he quit the financial industry and became a fraud investigator. He worked with whistleblowers to challenge fraud. He learned both first-hand and through his fraud-investigation work all about what happens to whistleblowers, and became a vocal supporter of their role.

The only chance the SEC had to even the playing field was the extensive use of whistleblowers. The agency needed people on the inside to expose corruption, but it offered no incentives to encourage those people to come forward. This isn't true only in the SEC; it's pervasive throughout government agencies and private industry. People who come forward to expose corruption risk their jobs, their personal relationships, and even their lives. Rather than being celebrated for their honesty and integrity, too often they end up alone and embittered. The sad truth is that in too many cases whistleblowers have gotten badly screwed. In the past few years I've come to know several of them well, and this includes people who have received large rewards for exposing frauds that robbed the government of hundreds of millions of dollars, and the truth is that many of them are sorry they ever got involved. The money they eventually received wasn't worth what they had to go through simply to do the right thing. (p. 64)

Markopolos had several advantages as a whistleblower. He was independent: he didn't work for Madoff; his job was not at risk. He worked with a team of experts, all dedicated to the same goal. He knew the technical side of his work extremely well, and prepared authoritative treatments exposing Madoff.

But it wasn't easy. Markopolos protected his home with elaborate security and began carrying a gun. He was worried because it was likely that laundered proceeds of organised crime were being invested with Madoff, and the criminals would not want the scheme exposed.

Markopolos' book No One Would Listen is readable, comprehensive and exciting. As the subtitle indicates, it is a financial thriller. It leaves me with only two questions. Why didn't Markopolos think of putting all his information on the web? And if he had, what would have happened?

After Madoff's operation collapsed, investors from several continents lost their money - billions of dollars worth. This included banks, investment funds and individuals who trusted Madoff and had given him their life savings. They were broke.

It was by far the largest financial fraud in history. For eight years, Markopolos tried to expose it but, to quote the title of his book, no one would listen.

I thank Narelle Campbell, Rae Campbell, Ian Miles, Ben Morris and Kirsti Rawstron for helpful comments on drafts of this review.