Detect accounting fraud, invest safely.

Bernard Madoff’s funds have always been under close scrutiny because fellow fund managers are curious to the point of being suspicious as to how Madoff could have achieved such feat. Madoff did disclose to investors by simultaneously selling puts and buying calls while buying 30 - 35 blue chip stocks he could earn nominal returns in a short period. Rolling up these nominal returns over a one year period can yield fantastic results.

Tasked to duplicate Madoff’s success, Harry Markopolos, a former CIO of Rampart Investment Management, started his own investigation into Madoff beginning in 1996. After years of failed attempts to reproduce Madoff’s results, Markopolos was convinced that Madoff’s record of consistently outperforming the market 72 times in a row, to be precise, was simply impossible.

In May 2000, Markopolos sent the SEC evidence that would’ve implicated fraud at Madoff’s funds. But the SEC official who received the documents, Maeghan Cheung, had basically pooh-poohed the claims. Now that Madoff is exposed, Markopolos stepped up to identify shortcomings in the SEC that could’ve saved investors billions of dollars. Markopolos didn’t do so earlier out of fear for his family’s safety. This was well founded.

In his past life, before Madoff turned his focus onto his Ponzi scheme, he was the Chairman of NASDAQ. As Chairman, he championed the idea of greater transparency. To this extent, he worked very closely with the regulators. How close he was with the regulators was uncertain. The old adage “keep your friends close, but keep your enemies closer” seems to be in play here. Perhaps it was his reputation and public stand on greater transparency and accountability that had the regulators turn a blind eye.

What’s disturbing is it wasn’t just Markopolos who raised the alarm. Other rival money managers also attempted to duplicate Madoff’s returns to no avail. Complaints were filed with the SEC, but the investigations conducted were “inconclusive”.

The moral here is not to rely on the SEC to keep investors safe. The SEC can only react, not prevent. By the time the SEC can prosecute, the damage is already done. Prevention is better than cure, no? Learn how to identify the 5 Red Flags of Fraudulent Hedge Funds. Find out What Madoff Can Teach Us.