It’s a little overdue, but I’ve just finished reading Diana Henriques’ The Wizard of Lies: Bernie Madoff and the Death of Trust. It’s an in-depth look at the biggest Ponzi scheme in history.
Henriques goes to great lengths to document Madoff’s life and retrace the beginnings of the Madoff scam and the feeder funds that kept the fraud going for so many years. In part, Henriques was able to pull the vast web together with Madoff’s help, having conducted two jailhouse interviews.
It’s no secret that everyone missed Madoff’s fraud – the Securities and Exchange Commission (SEC), institutional investors, and some of the wealthiest and most sophisticated investors in the world. The SEC investigated Madoff no fewer than three times; institutional investors privately questioned Madoff’s scheme and could not replicate his trading strategy; and the wealthiest, most sophisticated investors in the world blindly trusted a man who later was exposed as spouting nothing but lies.
As with any tragedy, there are lessons, some of which are easily seen in hindsight: his one-person accounting firm, a trading strategy that nobody could understand questions raised in 2001 by Barron’s and a complete lack of transparency, among other things.
As an investigator, there are several critical lessons I took from the book.
￼Poke and Prod Until You Get Answers
One of the most compelling stories in the book is that of a New Jersey businessman who, after a half-dozen calls, finally got a meeting with Madoff to discuss making an investment. When Madoff was ultimately presented with difficult questions about his operations and strategy, Madoff turned on the investor, telling him, “You ask a lot of questions. I just want to make one thing clear: With all due respect, once you invest, you can’t call me. You’ll deal with someone else.”
Asking tough questions isn’t easy. Some people have a gift for it; some people don’t. The way people react to difficult questions is as telling as how they don’t react. In the example above, this investor poked and prodded and ultimately didn’t get the answers he wanted to hear and walked away (a richer man).
￼If It Doesn’t Make Sense to You, It Probably Doesn’t Make Sense to Someone Else
As a student, I would always hear teachers tell their students, “If you have a question, somebody else probably has the same question.” It takes courage and a bit of guts to swallow your pride and ask questions when you don’t understand something.
Nobody could make sense of Madoff’s trading strategy, including institutional investors, quantitative analysts and some of the most sophisticated investors in the world. But very few people had the guts to question it, and this failure ended up costing them dearly.
￼Follow Up on Leads
The book provides several examples of the SEC not following up on leads that would have exposed Madoff years before he was turned in. Frankly, it’s sad. The fact is that billions of dollars could have been saved if the SEC had followed up with the central stock clearinghouse to confirm Madoff’s stock trades. Even Madoff thought his time ran out in 2006, but was astonished to find that the SEC didn’t check his trades with the DTCC, which would have found less than $24 million in blue-chip stocks, not billions.
During any investigation, it’s critical to follow up on leads and to “close the loop.” Sometimes, it’s difficult to see the forest for the trees and the small details get lost. Staying on track may be as simple as keeping a running list of action items, keeping a diary of critical follow-ups, taking a fresh look at the case every so often or discussing the case with someone not involved knee-deep, to get a different perspective.
￼When in Doubt, Go with Your Gut
Madoff clearly had many gifts, including a unique ability to lie to people to their faces (even to his own family). But even the most faithful Madoff followers could have found red flags, including the 2001 Barron’s article, his highly unusual fee structure or his “secretive” investment strategy.
Prior to frauds being identified, there is rarely any “evidence,” only small clues. We all have a gut, and sometimes, you just need to use it…