Thursday, February 05, 2009

Madoff whistleblower's inside the SEC story

Here's how the Bernie Madoff whistleblower Harry Markopolos got a deaf ear from the SEC. Some of this has been reported in a Dec. WSJ piece, but his testimony provides more details. And SEC officials are not commenting at all, even to Congress. From the 2-4-09 House testimony by Harry Markopolos:

My first submission to the SEC was coordinated through Ed Manion, CFA, a member of the Boston Regional Office with 25 years of industry experience. Mr. Manion was a former trader at the Boston Company and a portfolio manager at Fidelity serving alongside Peter Lynch. He has been with the SEC for 15 years and, in my opinion, was the only person in the Boston Regional Office with the proper industry background to comprehend fully the size, scope and danger of the Madoff Ponzi scheme. Mr. Manion is a Chartered Financial Analyst (CFA) and is highly respected in Boston’s financial district and is considered the go-to person for securities fraud cases in Boston. We would call Ed “the SEC’s hit-man,” because when the SEC brought Ed in, people often ended up in jail via SEC criminal referrals to the DOJ. Throughout the past 9 years, Ed Manion was the only SEC staff member who ever truly understood the Madoff scheme

... SEC securities lawyers did not want to hear from a non-lawyer SEC staffer like Mr. Manion with 25 years of trading and portfolio management experience. As much as Boston’s financial community looks up to and respects Ed Manion, that’s how much the SEC looked down upon and ignored Mr. Manion’s repeated requests for SEC enforcement action against Mr. Madoff. Without Mr. Manion’s continued encouragement, I would have stopped the Madoff investigation after my October 2001 SEC Submission. Every time I threatened to quit the investigation, Mr. Manion would tell me I had a duty to the public to keep going no matter how badly the odds were stacked against us. I believe that the SEC would fire him if he were to testify before Congress about his role and that of the SEC during the past 9 years; but if the proper protections could be worked out in advance to safeguard his career and guarantee him another 3 years until his government retirement, I recommend that the Committee speak with him. I owe him much thanks for his dedication to the effort of sharing Mr. Madoff’s alleged fraud to the appropriate authorities within the SEC.

Late 1999 – 2000

I started the Madoff investigation in late 1999 and early 2000 as a result of Frank Casey,

Senior Vice-President of Marketing for Rampart Investment Management Company, Inc., telling me about the fantastic returns of one Bernard Madoff (hereafter referred to as BM).

...I spent hours writing my eight-page 2000 SEC Submission and arranged with the Boston SEC’s Ed Manion to meet with the Boston Regional Director of Enforcement (DOE), Attorney Grant Ward in May 2000. Given Mr. Ward’s position and my understanding of his mandate, I was shocked by his financial illiteracy and inability to understand any of the concepts presented in that submission. Mr. Manion and I compared notes after the meeting and neither of us believed that the Boston Region’s DOE had understood any of the information presented. Little did I know that over the next several years I would come to understand that financial illiteracy among the SEC’s securities lawyers was pretty much universal with few exceptions.


In 2001, the Boston SEC’s Ed Manion and I spoke often of the lack of follow up to my May 2000 SEC Submission. Immediately after 9-11, Mr. Manion called me, convinced that my work had somehow fallen through the cracks and never made it to the responsible parties in the New York Regional Office. In October 2001 or thereabouts, I resubmitted my original 8-page report, wrote an additional 3 pages and included 2 pages entitled “Madoff Investment Process Explained.” The New York Regional Office never contacted me after either my May 2000 or October 2001 SEC Submissions. To my mind, the mathematical analysis provided compelling proof that an investigation was required. Yet, none was conducted to my knowledge.


My records for 2003 & 2004 are non-existent due to my leaving my former employer at the end of August 2004 and not taking a copy of my e-mail archives with me. I am sure I worked on the case, but I don’t have any supporting documentation at this time.

... In late October, most likely on October 25, 2005, I met with Mike Garrity, Branch Chief, of the SEC’s Boston Regional Office. Mr. Ed Manion, CFA felt that Mr. Garrity was a conscientious, hard-working Branch Chief who would give me a fair and impartial hearing that might be what was needed to get this case re-submitted to the SEC’s New York Office. Ed Manion scheduled an appointment for me with Mr. Garrity and I thought that perhaps the third time submitting this case would turn out to be the charm.

I met with Mr. Garrity for several hours and found him to be very patient and eager tomaster the details of the case. Unlike my disastrous May 2000 meeting with that office’sDirector of Enforcement, Attorney Grant Ward, I found Mr. Garrity to be interested and fully engaged in my telling of the scheme. Some of the derivatives math was difficult for him to understand, so I went to the white board and diagrammed out Madoff’s purported strategy and its obvious failings until he understood it. A few of the more difficult concepts required repeated trips up to the white board but at the end of our meeting, it was clear that Mr. Garrity understood the scheme, it’s size, and it’s threat to the capital markets.

Mr. Garrity promised to follow up and he was true to his word. About a week or so later,

Mike Garrity called me back telling me that he did some investigating and found some irregularities but that he couldn’t tell me what they were, only that he was in contact with the New York Regional Office and wanted to put me in touch with a Branch Chief there for follow on investigation. He also said that I would have to identify myself as “the Boston Whistleblower” when I called because he wanted to protect my identity to the extent possible.

Perhaps the most impressive thing about Mr. Garrity was his willingness to think outside of the box. He was able to imagine the impossibility of Madoff’s returns and understand that BM’s returns were too good to be true and this obviously concerned him. He told me that if BM were located within the New England region, he would have had an inspection team inside BM’s operation the very next day.

On Friday, November 4, 2005, Mr. Garrity sent me the names and contact information for

Doria Bachenheimer and Meaghan Cheung. (Branch Chief). I called the latter and revealed my identity, and e-mailed her a revised 21-page report. I then e-mailed my thanks to Mike Garrity and informed him that I would be working the case with New York. On Monday, November 7, 2007, I sent Ms. Cheung the report which the Wall Street Journal has now posted on-line less everything past Attachment 1. This report further detailed BM’s fraud.

My experience with New York Branch Chief Meaghan Cheung was akin to my previous

discussions with Attorney Grant Ward, and demonstrated to me an SEC failure in providing appropriate personnel to understand the case I was submitting. Ms. Cheung also never grasped any of the concepts in my report, nor was she ambitious enough or courteous enough to ask questions of me. Her arrogance was highly unprofessional given my understanding of her responsibility and mandate. When I questioned whether she understood the proofs, she me that she had my report and that if they needed more information they would call me. She never initiated a call to me. I did follow-up. I was the one always calling her . She was unresponsive and mostly uncommunicative when I did call, demonstrating a lack of interest and acumen for this area of investigation.

In December 2005, I decided that the third time was not a charm and that the SEC was,

once again, not going to pursue the Madoff case. I also decided that if I was going to continue my investigation and attempt to involve the authorities, I should ensure my personal safety in case of possible efforts to silence me and end my investigation. I decided that I should go to the press. I went to Pat Burns, communications director at Taxpayers Against Fraud, an educational group that supports the False Claims Act, for advice and assistance on how to have my Madoff case materials investigated by the press. Mr. Burns put me in contact with John Wilke, senior investigative reporter for the Wall Street Journal’s Washington Bureau. Mr. Wilke and I would become friends over the course of the next three years. Unfortunately, as eager as Mr. Wilke was to investigate the Madoff story, it appeared that the Wall Street Journal’s editors never gave their approval for him to start investigating. As you will see from my extensive e-mail correspondence with him over the next several months, there were several points in time when he

was getting ready to book air travel to start the story and then would get called off at the last minute. I never determined if the senior editors at the Wall Street Journal failed to authorize this investigation.

On March 3, 2006, I had a 5-minute call with NY Branch Chief Cheung (Conversation

memo e-mail to Frank Casey and Neil Chelo, Friday, March 3, 2006, 3:23 pm). When I

mentioned that my derivatives expertise would be needed to break the case open, she dismissed me by saying that the SEC’s Washington Headquarters had Ph.D.’s in an economics analysis unit with derivatives expertise. When I pointed out that the SEC likely didn’t have any Ph.D.’s on staff with derivatives trading experience who truly understood how these financial instruments worked because a true derivatives expert couldn’t afford to work for SEC pay, she ignored me.

She was in “listen only mode.” A trained investigator would have kept me on the phone for as long as possible, asking me as many open-ended questions as possible in order to advance their investigation. But as is typical for the SEC, too many of the staff lawyers lack any financial industry experience or training in how to conduct investigations. In my experience, once a case is turned into the SEC, the SEC claims ownership of it and will no longer involve the investigator. The SEC never called me. I had to call the SEC repeatedly in order to try to move the case forward and with little to no response. This may go a long way in explaining the SEC’s long and consistent history of regulatory failures.

In the 2006 case materials you will see long strings of e-mails between myself, Neil

Chelo and Frank Casey as we pushed the investigation forward because we felt that the SEC was not doing any work to advance the case. At the time, the SEC’s reputation was slipping in the press, due to reports of its failure to investigate the Pequot insider-trading investigation.

... Perhaps the biggest breakthrough during the year was my September 29, 2006 telephone call to Matt Moran, Esq., Vice President of Marketing, for the Chicago Board Options Exchange. Mr. Moran confirmed to me that several OEX Standard & Poor’s 100 index options traders were upset and believed that BM was a fraudster. Mr. Moran said he couldn’t talk to either the Wall Street Journal. or the SEC without permission but that if these organizations went through proper channels and got permission from Lynn Howard, the CBOE’s Public Relations Head, then the CBOE staff and traders would be able to cooperate with an investigation and answer questions.

This was exciting news! Unfortunately, neither the Wall Street Journal. nor the SEC wereinclined to even pick up a phone and dial any of the leads I had provided to them. It is a sickening thought but if the SEC had bothered to pick up the phone and spend even one hour contacting the leads, then BM could have been stopped in early 2006. One hour of phone calls was the difference between almost 3 more years of fraud and untold billions of additional investor losses. That’s how close we were and how far we were from busting this case wide open in 2006.

2007 was apparently a tough year for BM. Frank Casey got a hold of key May 2007offering documents from Prospect Capital, a San Francisco based firm that was marketing the “Wickford Fund LP,” which promised to deliver a swap that paid out between 3 to 3 ¼ times whatever BM’s returns were less borrowing costs and management fees. Here I am using BM fund and Fairfield Sentry, a Greenwich, CT feeder fund interchangeably. This was a clear signal that BM was running low on new funds to keep his Ponzi scheme afloat.

In order to keep paying out funds to existing investors, a Ponzi operator must ensure that

new funds are continually coming in the door to offset the outflow of payments to old investors. Creating a leveraged swap product was a sign that the inflow of new dollars was insufficient to keep the scheme going and that BM needed to create additional incentives sufficient to attract new money.

In a June 29, 2007 e-mail document submission to New York SEC Branch Chief,

Meaghan Cheung I forwarded these offering documents to her office and copied Ed Manion of the Boston SEC Office. I also included updated April 2007 performance data from Fairfield Greenwich Group. The interesting thing about the performance data was that BM was noticeably stepping down his stated returns. If you look closely at the data, you will see that he went from double-digit returns from 1991 – 2000, but that all subsequent years returns were in single digits, a clear sign that he needed to cut back on the payouts to old investors in order to conserve cash and keep the scheme going. How the SEC could look at the same data we did and not arrive at the same conclusions that we did is hard to fathom. One would have to seriously question their industry experience and investigative expertise to have missed the red flags contained in the June 29, 2007 SEC Submission.

... Now Wickford Fund was allowing this same investor to invest her $1 million and borrow an additional $2 million so that she could now invest a full $3 million with BM. Nothing is free in finance and you can be sure there is a bank lending this investor the $2 million dollars she is borrowing and charging a profitable interest rate for providing this service. Wickford Fund LP is even happier to do this because they now get to charge 3 times as much in management fees because the investment amount is now $3 million and not $1 million. BM is also happier because instead of receiving $1 million, he’s taking in $3 million and cheating not only the investor but the bank that is lending the investor the additional $2 million. This leveraged performance return line as provided on the graph not only does not exist for any asset class but any student of biology will recognize it as denoting a growth curve for natural organisms such as for population. How can any capital market return over any length of time only go up and never down? How did socalled due diligence “professionals” at the Madoff feeder funds miss this? How did the SEC’s staff miss this? If a picture says a thousand words, then this picture said “FRAUD” a thousand times over.

In retrospect, perhaps I should have explained every single page to the SEC’s New York

Office. But, I was dismissed and ignored making any further attempts to explain on my part impossible. I do not know whether the cause was political interference or incompetence but the result was a refusal to look and an unwillingness to grasp even the simplest explanations for the red flags present in the “Wickford Fund LP” offering documents. Every phone call to Meaghan Cheung made me feel diminished as a person, so I consciously chose to e-mail her so that I didn’t have to undergo unpleasant and unsatisfying telephone calls.


2008 was a strange year for everyone in global finance and our team was no exception.

Because of market turbulence all of us were busy with other matters and let our BM investigation drop by the wayside with one exception which occurred in April. A good friend of mine, a University of Chicago Ph.D. in finance, Mr. Rudi Schadt, Oppenheimer Funds’ Director of Risk Management, ran into a fellow University of Chicago Ph.D., a Mr. Jonathan Sokobin who was the SEC’s new Director of Risk Assessment in Washington. Mr. Schadt, who was familiar with my work in the field of risk management, put Mr. Sokobin in touch with me in late March 2008.

Mr. Sokobin asked that I call him, which I did a couple of days later. I wanted to give him a heads-up on some new emerging risks that I saw looming over the horizon. After our call, I felt that I had established my bona fides as a risk expert and felt comfortable enough to send him my updated, 32-page, December 22, 2005 SEC Submission along with a short 4 paragraph e-mail. I tried calling back a few times but never got through and gave up. I never heard from Mr. Sokobin again. At this point I truly had given up on the BM investigation.

... For those who ask why we did not go to FINRA and turn in Madoff, the answer is simple: Bernie Madoff was Chairman of their predecessor organization and his brother Peter was former Vice-Chairman. We were concerned we would have tipped off the target too directly and exposed ourselves to great harm. To those who ask why we did not turn in Madoff to the FBI, we believed the FBI would have rejected us because they would have expected the SEC to bring the case as subject matter experts on securities fraud. Given our treatment at the hands of the SEC, we doubted we would have

been credible to the FBI.


SEC GC cites executive privilege

One of the most amazing and pathetic performances ever by SEC staff at a Congressional hearing--yesterday top SEC officials were grilled by House members over the Madoff fraud. They ducked questions, citing ongoing investigations.

At one point, acting SEC general counsel Andy Vollmer cited exectutive privilege, in part. Rep. Gary Ackerman (D-N.Y.) and Rep. Paul Kanjorski (D-Pa.) are quizzing Vollmer on where he gets off. Check it out:

ACKERMAN: ... Mr. Vollmer, I believe you were the one who thought that your people didn't have to testify here today. I don't know where you got that, but some of us think otherwise. Maybe -- maybe you could tell us. How did they miss all this?

VOLLMER: We're as committed as each of you...

ACKERMAN: That's not the question! We give you credit for being committed.

VOLLMER: Perhaps -- perhaps you could let me answer.

ACKERMAN: Perhaps you can try to answer.

VOLLMER: And what we -- what we're asking...

ACKERMAN: No, no. We're asking. You have to tell us things. You're forgetting what the -- what this procedure is. You're not coming here to ask.

VOLLMER: Let's let...

ACKERMAN: We're asking you! How did you screw up?

VOLLMER: ... the inspector general's process works. It's a process Congress set up to identify the facts that we all need to make these judgments. Let's let the system work that Congress created. There will be some recommendations. There will be time for this committee to look at the facts and to think of the recommendations themselves.

ACKERMAN: Tell that to the people who...

VOLLMER: And that's the appropriate way...

ACKERMAN: ... have lost their whole lives that they have time.

VOLLMER: ... to proceed in this matter.

ACKERMAN: People don't have time. We need to tell them something...

VOLLMER: And the other thing that matters...

ACKERMAN: ... instead of lecturing us, Mr. Vollmer.

VOLLMER: ... is that there law enforcement proceedings going on. There are personal rights at stake. There are the -- there is the integrity of the investigations to protect.

ACKERMAN: We wouldn't be in this mess if you people did your job.

VOLLMER: That's why we've asked the committee to bear with...

ACKERMAN: No, we're asking you. We are asking you.

VOLLMER: ... these investigations to allow them to proceed.

ACKERMAN: Could you cite whatever authority you're citing, and have cited?

VOLLMER: I'd be delighted. I'd be happy to do that. I'd be happy talk with...

ACKERMAN: Because you have a right not to answer our questions under the Constitution...

VOLLMER: ... your lawyers.

ACKERMAN: ... Fifth Amendment procedure.

I'm not a lawyer. I'm a citizen, though.

VOLLMER: I'd be happy to talk lawyer...

ACKERMAN: I'm a frustrated citizen.

VOLLMER: ... happy to give the references to you or to your lawyers.

ACKERMAN: I'm listening. Give us the references.

VOLLMER: There's a very important opinion from Attorney General Robert Jackson in 1941, where he explained the need to discharge the constitutional and statutory obligations of the executive branch in connection with law enforcement in civil litigation...

ACKERMAN: Are you citing executive branch immunity, Mr. Vollmer?

VOLLMER: ... in response to requests for information from the Congress.

ACKERMAN: Are you citing executive branch immunity, Mr. Vollmer?

VOLLMER: There are various protections at...

ACKERMAN: Are you citing executive branch privilege, Mr. Vollmer?

VOLLMER: I would like to let you allow me to answer your question.

ACKERMAN: It's a yes or no question, sir. Either you are or you are not.

VOLLMER: Well, no, it is not.

There are a variety of reasons and privileges and protections. One of them is executive branch protections. There's a deliberative process protection.

They stem from the same desires that you have. And we're asking that you allow those processes to work.

ACKERMAN: We are out of patience. And the question, obviously, is a yes or no question. Either you're citing executive privilege immunity, or you're not doing that.

VOLLMER: I just explained, there are a variety...

ACKERMAN: You know, if you're citing your Fifth Amendment privilege, you don't make a speech.

VOLLMER: ... and that's one of them, was the executive privilege.

ACKERMAN: You are -- was that a "yes," you're citing executive privilege immunity?

VOLLMER: In part, it is, yes.

ACKERMAN: I'm sorry?

VOLLMER: I said, yes, it is in part.

KANJORSKI: Have you inquired of the Justice Department or someone else that they have analyzed that position for this hearing today, and they found that the Securities and Exchange Commission, requested by Congress to discuss a very important pending piece of legislation is being established to protect hundreds of thousands, perhaps millions of people, that you have a right, representing the executive branch, the president of the United States, to stand on that authority?

Have you posed that question to the attorney general or...


KANJORSKI: Then, this is on your interpretation?

VOLLMER: This is the position of the agency.

KANJORSKI: And you're the general counsel for the agency. I assume you make the legal determinations for the agency.

VOLLMER: No. The commission makes the decisions for the agency...

KANJORSKI: So, this question has been passed through...

VOLLMER: ... (inaudible) from a variety of sources, and the general counsel's office is one of those...

KANJORSKI: So, this has been passed through the new director, or chairman, of the commission and the members of the commission. And they...

VOLLMER: (inaudible).

KANJORSKI: ... agree and have instructed you to instruct this panel not to respond to the questions of Congress, because of executive privilege, and maybe other privileges contained in the 1941 Supreme Court case. Is that correct?

VOLLMER: The commission supports this position.

ACKERMAN: That wasn't the chairman's question.

VOLLMER: Yes, I -- the answer to that specific question is "no."

ACKERMAN: The answer is "no." So, you're acting on your own volition.

VOLLMER: I didn't say that, no. And I would disagree with that.

ACKERMAN: You know, most of us speak English, and we're having a hard time getting an answer from you.

This is not the -- this was not discussed by the commission, but it's the commission's position. Is that what you just said? Do you divine that?

VOLLMER: The commission's approved taking this position.

ACKERMAN: The commission has voted the position that you will cite executive privilege, and not testifying before this committee and answering its questions.

VOLLMER: I couldn't say that to you honestly, because the specific reasons...

ACKERMAN: Obviously.

VOLLMER: ... weren't discussed and given by the commission. But the basis is that we were...

ACKERMAN: Your value to us is useless (ph).

VOLLMER: ... (inaudible) and accommodation. And we've tried to be accommodating...

ACKERMAN: Your value to the American people is worthless.

VOLLMER: ... with you. And...

ACKERMAN: Your contribution to this proceeding is zero.

VOLLMER: ... we ask that you take into account the concerns that have been well settled over many years. And we'd ask you to take those into account.

ACKERMAN: Our economy is in crisis, Mr. Vollmer.

We thought the enemy was Mr. Madoff. I think it's you.

You were the shield. You were the protector. And you come here and fumble through make-believe answers that you concoct, and attribute it to executive privilege that you've not consulted with executive branch on.

Mr. Chairman, I'm through.