Introduction: A Generation of Missed Signals
On December 11, 2008, federal agents arrested Bernard L. Madoff at his Manhattan apartment after he confessed to his sons, the day before, that the investment-advisory business he had operated for at least sixteen years was, in his own words, "one big lie." He pleaded guilty in March 2009 to eleven felony counts — securities fraud, investment-adviser fraud, mail fraud, wire fraud, money laundering, false statements, perjury, false filings with the SEC, and theft from an employee benefit plan — and on June 29, 2009, was sentenced by Judge Denny Chin to 150 years in federal prison. He died at FMC Butner in April 2021.
The bare facts are easy. The scholarly conversation they triggered is not.
The firm and its two faces
Bernard L. Madoff Investment Securities LLC ("BLMIS") was founded in 1960 as a market-making broker-dealer trading over-the-counter equities at narrow spreads. By the 1980s the firm was a legitimate force in the electronic-trading revolution; Madoff himself served as chairman of NASDAQ in the early 1990s and sat on advisory committees at the SEC. The brokerage occupied the eighteenth and nineteenth floors of the Lipstick Building on Third Avenue. On the seventeenth floor — physically and operationally segregated — a separate business calling itself an investment advisory operation generated paper account statements for a client base that grew from a handful of country-club acquaintances in the 1970s to thousands of individuals, charities, university endowments, and feeder funds by the time the fraud collapsed.
The seventeenth-floor operation never executed a single trade for advisory clients. The "split-strike conversion" strategy it claimed to run — buying a basket of large-cap equities, selling out-of-the-money index calls, and buying out-of-the-money index puts — was a plausible institutional product, which is precisely why it was so durable a cover. Frank DiPascali, the operation's chief lieutenant, fabricated trade tickets and account statements from a back-office terminal. Annette Bongiorno, who had joined the firm in 1968 as a secretary, ran the client-statement function. David G. Friehling, the sole practitioner who audited BLMIS from a strip-mall office in New City, New York, signed the firm's annual financial statements without performing meaningful audit work.
The misses
The SEC examined or investigated BLMIS at least eight times between 1992 and 2008. Two formal examinations — one in 2004-2005 and one in 2007 — got close enough to the truth to ask Madoff directly about the suspicious smoothness of his returns and the implausibly small number of counterparties he claimed to be trading with. Harry Markopolos, a Boston-based derivatives analyst, submitted three separate written warnings to the Commission's Boston and New York offices in 1999, 2000, and 2005, the last of them titled "The World's Largest Hedge Fund is a Fraud" and containing twenty-nine specific red flags. None of the submissions produced action. In August 2009, the SEC Office of Inspector General, under Inspector General H. David Kotz, published Investigation of Failure of the SEC to Uncover Bernard Madoff's Ponzi Scheme, Report No. OIG-509, a 477-page reconstruction of the regulatory misses that remains the indispensable factual baseline for everything that follows.
The numbers
Three figures circulate in the popular literature and are easily confused. On the day of his arrest, Madoff told his sons the losses would total roughly $50 billion. The November 30, 2008 account statements issued to BLMIS clients aggregated to approximately $64.8 billion — the fictional paper balance. Irving H. Picard, the SIPA trustee appointed by the Securities Investor Protection Corporation, ultimately calculated that approximately $17.5 billion in principal had actually been deposited by net-loser investors and lost. Each figure has a different evidentiary and doctrinal status, and the distinction matters enormously when one reaches the net-equity litigation in the Second Circuit (see [second-circuit-net-equity-madoff]).
The cast
The reader will meet, across the chapters that follow: Madoff himself; DiPascali and Bongiorno on the inside; Friehling the auditor; Markopolos the unheeded quant; Picard the trustee, whose clawback campaign would in turn generate its own moral and doctrinal literature; the Fairfield Greenwich Group and its flagship Fairfield Sentry Limited feeder fund; H. David Kotz of the OIG; and a generation of academics — finance, law, sociology, accounting — whose work this book gathers.
The conversation this book traces
The scholarship arrived in waves. First came the post-mortems: the OIG's institutional autopsy (see [sec-oig-509-madoff-investigation]) and Markopolos's own indictment of the Commission that ignored him (see [markopolos-no-one-would-listen]). Then the quants explained why the returns themselves were the evidence (see [bernard-boyle-amazing-returns]; [clauss-roncalli-weisang-risk-lessons]). The auditors and operational-due-diligence scholars asked how the basic professional infrastructure of fund administration had failed (see [fuerman-solo-auditor-red-flag]; [gregoriou-lhabitant-riot-red-flags]). Sociologists and accountants then asked the harder question of how trust itself was manufactured (see [stolowy-trustworthy-investment-opportunity]; [owens-shores-informal-networks]). Finally the lawyers arrived to assess the gatekeeping collapse, the SIPA litigation, and the moral weight of the clawback campaign (see [rhee-madoff-market-regulatory-failure]; [second-circuit-net-equity-madoff]; [sepinwall-righting-others-wrongs]), and the economists measured how badly the fraud had reshaped American household trust in financial intermediaries (see [gurun-stoffman-yonker-trust-busting]).
We begin where the regulatory autopsy begins: with the Inspector General's reconstruction of sixteen years of missed signals.