The New York Times Magazine has interviewed Harry Markopolos, an investment manager and math whizz who spent nine years to track the machinations of Bernie Maddoff’s hedge fund. He concluded early on that Madoff must be a fraud. In November 2005 he sent a memo to SEC regulators titled “The World’s Largest Hedge Fund is a Fraud.” It described his suspicions about Madoff in more detail and asked the SEC to check his fraud theory.
In the NYT interview, Markopolos judgement of the SEC is a harsh one:
Q: “Why do you think the S.E.C. failed to wake up to Madoff’s $65 billion Ponzi scheme until he turned himself in?”
A: “They weren’t even asleep at the switch; they were comatose. They didn’t respond to heat and light, much less evidence of wrongdoing. They were not engaged in the fight.”
The whole story is a great example how dysfunctional huge regulatory administrations have become in the financial industry. They are not even able to uncover a fraud scheme when someone else does the analysis for them.
Governments around the world are busy these days to develop grand schemes for new regulatory bodies and laws. No doubt, they will be even less functional. The dysfunctionality will most likely be proportional to the complexity of the law and the number of new bureaucrats hired.
Yet, ordinary investors should really take one learning from the Madoff story: Don’t trust the government to see the red flags and protect investors. It won’t happen. Or more precisely, it will happen but far too late. There is only one way for investors to protect themselves from fraudsters - do the critical analysis yourself, and keep a very skeptical eye on the ocassional fund management Wunderkind.