I feel sorry for her the way I feel sorry for everyone who does spectacularly stupid things, but it's hard to muster any special sympathy given her extensive whine that the Post ought to pick on someone else:
"Why are you taking a mid-level staff person and making me responsible for the failure of the American economy?" an upset Meaghan Cheung, with eyes tearing up, told The Post.
No one's blaming Ms Cheung, I hope, for the collapse of the entire American economy, but it's hardly crazy to blame her for the failure of the Madoff investigation, given that she signed off on it. The Post's implication that this was some sort of payoff deal is overblown and almost certainly wrong--I imagine it's more a matter of being awed by his persona and reputation, plus some sort of colossal internal screw up. But she was the head of the New York branch that ordered the investigation. Who does she think should take responsibility for its utter failure?
I don't understand how the fraud could NOT have been detected, if they already had good reason to suspect it was a Ponzi scheme and actually looked at the (nonexistent) trades that were supposedly made. It sounds to me like they didn't take the whistleblower's memo seriously.
This is a systemic issue, not a question of an individual. It's stunning that people (maybe it's only journalists?) seem not to recognize the difference. The problem is akin to locating a needle in a haystack when you don't believe one exists there to begin with. Doesn't really matter who looks--one is unlikely to find it. Identical in structure to the failure to discover and prevent 9/11.
This is why regulation is never going to solve financial market "problems", whether they are of the Madoff kind or of the subprime mortgage kind.
I think you are wrong. If you look at the FAA/NTSB and the fact that there were no fatalaties on a commercial aircraft in 2008 and I think you can see how it can be effective.
When a plane goes down, you find out why and suggest rules and regulations to ensure it doesn't happen again. It's never going to be perfect, but if you look at the system in 1959, 1969, 79, 89, 99 and now in 09 you'll see that new policies, procedures, rules, regulations, and technologies can help mitigate the inherint dangers in any man made system.
--A Yale grad chooses to go into public service, doesn't find a massive fraud that she should have found, and suffers public disgrace. Is this likely to cause future Yale grads to go into public service, or not? Will it cause other SEC staffers to do a better job or not? Will this kind of thing stop happening when Bush leaves office? Isn't this Cox's fault, since he didn't fire Cheung, and Bush's fault for not firing Cox for not firing Cheung? Isn't that the best way to get accountability?
--This isn't about systemic risk, it's about a ponzi scheme. Someone made not-crazy allegations that Madoff was running a ponzi scheme, and it was Cheung's job to investigate that. That's much different from trying to identify systemic risks. For one thing, it's backward looking, not forward looking. It's much easier than the other Thomas makes it sound. But still apparently too much for Cheung.
I agree that if someone just said 'FRAUD!', it's a difficult case. But with ponzi-schemes, verifying the trades shouldn't be rocket science.
It seems like the folks here made the same mistake that the investors did, they trusted Madoff because of his reputation.
Harry K has been sounding off on the Madoff "hedge fund" for the past decade or so. Cheung has not been at the wheel at the NY Sec for that long a time. Why pick on her? What happening to the person previous to Cheung in NY Sec in charge of investigating Madoff?
Why we're on the topic, doesn't Mrs McArdle has a penchant for Asian-bashing?
ttt: I have not noticed a penchant for Asian bashing at this blog. What are you referring to?
Megan, Ms. Cheung brings up a point in the article which you have brought up here before when she says: "If someone provides you with the wrong set of books, I don't know how you find the real books." As you've said, it's more difficult to prove an out-and-out lie than it is to prove that somebody is just fudging the numbers.
They should have done the work of verifying trades. I too have little sympathy for her.
Eh. I don't know for sure but I've got a feeling that the SEC gets hundreds of "whistle-blower" e-mails every day claiming that this or that company is nothing but a fraud/Ponzi scheme/boiler room/long con/tool of the Elders of Zion.
The staff then investigates a few of these hundreds of allegations but I suspect 95%+ of the investigations turn out to be wild goose chases (or at least they're unable to prove anything other than the existence of wild geese). Which inevitably means future investigations are tainted by feelings of "the boy who cried wolf".
Basically, the fact that a former competitor of Madoff sent the SEC a note alleging a Ponzi scheme doesn't impress me as much as the New York Post hopes it might, and I'm inclined to cut Ms. Cheung a little slack. Especially as Madoff had apparently been investigated seven (7) times before by the SEC and each time received a clean bill of health. I wouldn't be surprised if the "Ponzi scheme road map" e-mail came in and the SEC staff rolled their eyes, groaning about yet another useless, bi-annual investigation of old Bernie Madoff.
As I recall, Coopers and Lybrand ceased to exist after missing the fraud at Phar-Mor, as did Arthur Andersen after they signed off on the Enron fraud.
Partners in those firms lost everything. The SEC should be held to the same standard.
Has anybody actually read the Markopolos memo?
I have, and given that there were no investors complaining, none whatsoever, I am not surprised that the Markopolos memo failed to excite any investigator.
The 8 or 9 standard features of a Ponzi were not identified in the Markopolos memo.
You have to put yourself in the shoes of the ordinary investigator who believes that the chances of the former head of NASDQ is running the biggest ponzi scheme must be low. (That is is not the proper investigative technique may relevant.)
The problem is akin to locating a needle in a haystack when you don't believe one exists there to begin with.
No. I'm a CPA and there are audit techniques that are designed precisely to discover this sort of thing. Missing it in seven investigations is some combination of rank incompetence and gross negligence.
A simple audit of actual values versus stated should have uncovered this. There's no reason a Ponzi scheme this big should go on until the principal runs out of money.
I'll bet dollars to doughnuts you'll find some kind of incestuous relationships were in play here, the same kind that killed AA in the end.
Ms. M.,
This mid-level functionary is legion in America, indeed throughout the world. There is no way (From Enron to Madoff) that this sort of outright fraud could be accomplished without the acquiescence of people like Ms. Chung. Auditors who turned a blind eye, analysts who saw smoke and flame but did not call the fire department, salesmen who KNOWINGLY lied to prospective investors and regulators. All to keep their little corner of the world (and income) safe, while the big boys made off with fortunes.
I am not rich. I have nothing against rich people who honestly make (even inherit) their money. I detest people who enrich themselves through means immoral and illegal. So should we all, and seek to end that practice wherever we find it. There are a lot of great rich people out there. Hitch your star to one, and let the dirtbags do their own lying and cheating.
Ms. Chung should be fired.
Regards,
Brian Reilly
Just curious. Why is outright corruption dismissed in this case? Why is it so difficult to believe that somebody will take money or other favors in exchange to look the other way?
It doesn't have to be a brown envelope and sign here. It can be much more subtle. Like gifts and favors over a period of time, and subtle intimidation "Hey, I am grabass friend with your boss", that would be enough for her to not to press for more information.
Sigh... I sort of feel sorry for her on the one hand and not on the other. The problem as Markopolous wrote, was that the SEC is made up of lawyers who just don't have the math skills to figure out the web of complicated derivatives transactions. Sure, Madoff wasn't claiming to be dabbling in Energy Hybrids or Callable Daily Range Acruals. Sure, but he supposedly was trading options. Cheung said that they had experts to help them when they lack the expertise, but I'd be curious who those are. I don't know of a single well-respected quant in academia or industry who has done much work for the SEC. Perhaps they have, but don't advertise it in their CV's.
But suppose someone came along and said RenTech or AQR or any other number of quant funds were Ponzi schemes or lying to investors about something or other. How could the SEC even begin figuring that out? Most of the staff at these funds are Ph.D.'s and their investment strategies rather complex.
I think this is why I get so ticked off when the US Attorney for the Eastern District (or Southern District for that matter... see Michael Garcia now of Kirkland and Ellis) decides to parade some Wall Street dudes past the cameras. I know AUSA's are often really smart, but please, they don't have expertise in complex derivatives. How could they even evaluate whether a crime has occurred? How can they even determine whether it is possible to engage in complex derivative product trading without violating some sort of byzantine law?
I found the video of the interview here:
http://www.youtube.com/watch?v=-Sd-j0rKeKw
"If someone provides you with the wrong set of books, I don't know how you find the real books." You don't need to - you only need to prove that the false books are false.
"If someone provides you with the wrong set of books, I don't know how you find the real books." As you've said, it's more difficult to prove an out-and-out lie than it is to prove that somebody is just fudging the numbers.
The books are full of entries like "gave $X to Y in exchange for Z" and "received $A from B in exchange for C". You randomly pick a bunch of entries from the books. You call up the Ys and Bs and find out if their records match those on the books. If they don't -- and they won't -- you know that either the books are faked or everybody ELSE is faking THEIR books.
Making a mid-level staff person do that? Now that's just crazy talk...
Here's the Markopolous report. I found the title to be a bit unclear, perhaps if they took the time to read all 19 pages, it would make more sense.
Brian Reilly should be forced to read the article. He would he go about firing something not currently employed?
These second rate lawyers are no match for a Madoff. If you believe the highly educated and compensated staff at Tremont was duped, and not part of the ponzi, how do you expect a government lawyer to get to the bottom of it?
That said, she deserves all the abuse she gets. She did screw up royally, even if it was to be expected. And the whimpering self pity is contemptible.
What a mess, what's next?
"I think you are wrong. If you look at the FAA/NTSB and the fact that there were no fatalaties on a commercial aircraft in 2008 and I think you can see how it can be effective."
Correlation doesn't equal causation. Airlines have a massive amount of self-interest in ensuring that their planes do not crash. The pilots and staff in particular. To think that without government regulation that pilots and airlines would consciously risk their own lives strikes me as rather absurd. Even if they don't care about the lives of their staff an airline that has a reputation for crashing would reach a swift demise.
The reason for any rise in airline safety is likely far more attributable to new technologies and perhaps training methods than anything else.
I was recently on an airline that was delayed for 30 mins and almost missed a connecting flight because one chair was broken (it leaned back too far) and FAA rules prohibited the plane from taking off in that state even if no one was sitting there. I wasn't one iota safer because of that regulation, it was just an unnecessary hassle. I suspect there are others like it.
The firm was structured in a closed loop with no external checks and balances. Madoff was the investment adviser, the broker, custodian, and administrator to these managed accounts. An outside auditor would find it challenging to uncover fraud because there is no independent entity to verify trades or assets. That aside, this absurd structure itself was a mushroom cloud begging attention.
I'm reminded about the two ladies at the FBI assigned to be domestic terror threat analysts.
They had reports of Islamic extremists intending on using airplanes to smash into buildings since 1995 when French DST reported GIA wanted to hijack and slam a plane into the Eiffel Tower, the Louvre, or a French military base. They had reports that Arabs were on US planes doing suspicious things, possible "dry runs" for hijackings. Reports of suspiciously high numbers of radical Islamists learning how to fly planes. Then the arrest of Zackarias Moussaoui, who the French told us was associated with the people behind the Embassy bombings and who urgently wanted to learn how to fly a 747 but not the parts about landing one or taking off.
The two "counterterror" ladies had access to all this, but failed to "connect the dots". Ignoring some of the stuff as irrelevant, other stuff as "the FAA lawyers and officials" balliwick, or binning it as overseas-only threat of hijacking that other nations were affected by..They didn't appear to have studied or learned the Jihadi threat in a holistic manner, just reacting to the daily traffic.
Of course, neither, nor others with an opportunity that was missed - were reprimanded in any fashion....
Which brings up Meaghan Chung...another person (two other lawyer-ladies also signed off on Madoff's 2006 clean bill of health.) that missed the whole reason she HAD the job...which was to perform a certain societal safety function. Now, with such analysts and regulators, we know they cannot be superhuman, cannot catch everything. But it seems their job ratings should rest on how well they do that safety function..not process and dispose of daily paper load like some glorified secretary, on how well they conform to PC and how they don't ruffle anyone's feathers - like Muslim activist groups or a beloved pillar of the Jewish community with powerful backers...
Or as ambitious young power lawyers, needlessly piss off prospective future employers in banking, politics, corporations -that might be concerned that they decided investment ratings on mortgage derivatives of all the top Wall Street guys too harshly, ticked off the Father of the Jewish T-Bill, or had a civil rights lawsuit filed on them by angry Muslims about some silly investigation they had that Muslims intended to actually fly planes into buildings.
It isn't them so much as the system. If we want these hungry careerists to do their jobs, we need to have the apropriate rewards and punishments..you stop a terrorist plot that should be a big, big plus and even a considerable bonus. You screw up, past honest misjudgment - to deliberately whitewashing or rank incompetence, you leave..
We also need their bosses to also manage for organizational success rather than "getting along" with the people they regulate and investigate, and we need to have managers that will back their people up to the hilt and not fret the lawyers urge "not to make trouble" at regulatory agencies and law enforcement ones where "trouble is their business".
Many countries to not have a "revolving door". You go into the Ministery, you stay. In America, we also have very good investigatory agencies that do not use the revolving door (mostly non-lawyers), and consistently put out good product and serve the societal safety mission well - the NTSB, NOAA, military "lessons learned" teams.
Not being lawyers like the FBI analysts or Meaghan Chung, they do not view the truth as a malleable instrument - or as good or bad for an "optimum career path". They actively seek it. And generally have leaders that back them even when they get non-PC, or admit they don't have a clue why a plane went down, or when they say an Egyptian pilot went nuts (which pissed off the whole Land of the Nile).
An outside auditor would find it challenging to uncover fraud because there is no independent entity to verify trades or assets.
If there was no trading with outside entities then that itself would constitute proof that the fund was a Ponzi scheme. If there WAS outside trading then there would be records held by those other corporations, not subject to Madoff's control.
They must just not have looked outside of Madoff's own records.
LEAVE MEAGHAN ALONE!!!!!!!!! I MEAN IT!!!!!!!!!!
Leave Meaghan alone right NOW!!!!!!!!
(sob)
michael webster writes: Has anybody actually read the Markopolos memo? I have, and given that there were no investors complaining, none whatsoever, I am not surprised that the Markopolos memo failed to excite any investigator. ... You have to put yourself in the shoes of the ordinary investigator who believes that the chances of the former head of NASDAQ is running the biggest ponzi scheme [ever] must be low.
Amen to this. The point that the memo makes most strongly is that because this well-respected industry figure wasn't charging his investors the enormous fees other hedge funds charge, he must be crooked. That is not the sort of thing that is likely to arouse the interest of an SEC staffer. There are other points made in the memo that really do raise questions (see in particular pp. 6-7) but they assume a level of expertise in the derivatives business that an SEC staffer is just not going to have. (If they did, they would be in the derivatives business.)
Of course, Markopolos had it right, and he doesn't deserve my nitpicking for the way he wrote his memo. But it is very flattering to imagine that if only you had been there at the time, you would have known that you should take your staff off cases where little old ladies had demonstrably lost their life savings, and instead investigate the respected industry figure with the extremely sophisticated, wealthy and satisfied customers.
Sorry if my cynicism shows.
My experience in the corporate world has been that mid level managers never make the really big decisions on their own. They are usually the fall guy whose job is to justify the decisions made by the executive office.
Government is even worse in that respect. That's where elected officials make the big decisions based upon politics, and not what is rational or correct or best, and the bureaucrats are stuck justifying it.
Bernie Madoff had celebrity status among the wealthy Jewish up until just months ago. Madoff's clients and friends were billionaires who could easily call a dozen Senators or Congressmen and have them jumping through hoops. These people didn't want the SEC sticking its nose in Madoff's investment business and possibly destroying a good thing.
If ANYONE believes that Ms Cheung and her 2 or 3 subordinates made the final decision as to proceeding or not proceeding with the SEC investigation of Bernard Madoff they are out of their ever loving mind.
This investigation was shut down before it ever started by some big Congressional names. Some of them may have participated at the hearing on Monday.
Unless the government and media aggressively goes after and squeezes Cheung and others, the really big fish who caused the SEC to stand down which resulted in this financial debacle are going to go scott free.
The thing that twigged Markopolos (and apparently many others) to fishy business by Madoff was his unbelievably consistent returns over a long period with a stated strategy that could not, mathematically, deliver those returns.
If it could raise the hackles of wide parts of Wall St. (some of whom invested hoping to reap the rewards of an effective scam), why didn't it raise SEC hackles? Markopolos presented a strong prima facie case for corruption; what books could Madoff possibly have presented that would have made it look legit?
Yeah all government lawyers are 2nd rate, and its just SO OBVIOUS it was a ponzi scheme.
That's what happens when you have an obvious scam--- it lasts 15 years and suckers highly sophisticated investors and fools the government for the whole time.
"The bigger the lie, the more it will be believed."
It's fun to be an armchair investigator after everyone knows whodunit.
If ANYONE believes that Ms Cheung and her 2 or 3 subordinates made the final decision as to proceeding or not proceeding with the SEC investigation of Bernard Madoff they are out of their ever loving mind.
But Cheung isn't blaming higher-ups for discouraging the investigation. She's saying it was impossible for her to find anything wrong, and she did the best she could. The only way to reconcile that with the "the powers that be didn't want an investigation" theory is to posit that Cheung was bought off by the higher-ups rather than simply being threatened. If she'd been discouraged, she'd be saying so, and she'd have a CYA memo or two written by her to back it up. That's how the bureaucracy works.
Does enforcement of regulation in the financial sector suffer from negative skewness? Meaning that if you are a regulatory agent, the blow up of one of your observational responsibilities causes a disproportionate risk to your job. As Megan said: finance is weird.
Basically, don't be a sucker; don't become a regulatory agent.
Shouldn't we be making sure Madoff actually committed fraud? If the money was lost due to fraud it may be subject to protection from the federal government. If it's due to a very bad turn of the market, then everyone loses their money. Is it possible that Madoff that one of his more "persuasive" clients convinced him to cook his books and admit to fraud or else?
The SEC have certainly been MIA in a big way. Whether this was just incompetence or the accumulated effects of defunding, government indifference, corruption and/or intellectual capture by the people there were supposed to be regulating will take years to unravel. One things for sure, right now you wouldn't hire them to run a popsicle stand, in August, in the desert.
I'm pleased that the Post, the duped investors, and of course the self-righteous blog commentariat now have their villain. She screws up at work (it appears), and it's appropriate to stake out her house, an electronically tar and feather her? There but for the grace of God...
Robertbe, well, we do know the answers to some of your conjectures: the SEC budget has increased dramatically in recent years, so, no, defunding it wasn't. Indifference? Ms. Cheung says she's passionate about the mission. Corruption? There's no evidence of that. Intellectual capture? Again, Ms. Cheung is passionate about the mission--she thinks the point is to protect investors. She just wasn't able to find this huge ponzi scheme. She's bright--probably smarter than the average staffer, and certainly than the average civil servant. She's probably a liberal Democrat. Incompetence is the answer, Cheung is what that looks like.
The books are full of entries like "gave $X to Y in exchange for Z" and "received $A from B in exchange for C". You randomly pick a bunch of entries from the books. You call up the Ys and Bs and find out if their records match those on the books. If they don't -- and they won't -- you know that either the books are faked or everybody ELSE is faking THEIR books.
FWIW, back in the 70's, the auditors of Equity Funding did just that, but computerized accounting standards weren't what they are today, and it didn't work. Most of the company's insurance policies were fake, but the auditors lacked the data processing capacity to handle all the data, so they asked Equity Funding to provide a random sample. Naturally, they only got samples of the real policies.
Windypundit, Dan said "you randomly pick", not "you ask the company you are investigating to randomly pick". As you point out, there's an important difference.
All right, I'm not that sophisticated in these things, but I have a question. As I understand it, the essence of a Ponzi Scheme is that the money taken in by later investers is used to pay the early investors, who usually make out pretty well.
Doesn't it follow that, by definition, if there is a Ponzi Scheme going on, the alleged schemer won't have the money? So why couldn't the SEC just ask to see the money? I know they don't have a big pile of bills in some vault somewhere, but presumably in this case "the money" consists of various securities they're suppposed to be holding. Forget understanding complex derivatives, just say "show me the money."
1. As someone who considers herself an economist and believes we are in a depression, perhaps you should sneer a little less often. I sincerely doubt you would have had a prayer of catching Mr. Madoff.
2. It's not as though the SEC only gets a stray letter every now and then from the public. They cannot thoroughly investigate each complaint.
3. You have no idea of Ms. Cheung's work load, staff support or general level of competence. Neither do I. Therefore, I reserve judgment. So should you.
@cheerful iconoclast: Doesn't it follow that, by definition, if there is a Ponzi Scheme going on, the alleged schemer won't have the money? So why couldn't the SEC just ask to see the money? I know they don't have a big pile of bills in some vault somewhere, but presumably in this case "the money" consists of various securities they're suppposed to be holding.
This is a point I personally wish I understood a little better.
My understanding is that if I ran an investment advisory business, I wouldn't be able to show my clients the physical stock certificates and bonds in which I had invested their money; rather, I'd have an account with some broker-dealer that held securities. (The broker-dealer would also not hold paper; rather, it would have an account with a trust company that holds the certificates and bonds (e.g., Depository Trust).)
If the SEC were going to inspect my investment advisory business, I expect that they'd ask me for my brokerage statement, and then they would call my broker to verify that the statement was correct.
In the case of Madoff, he also ran a brokerage business, so that method wouldn't work (he could just provide phony brokerage statements). Presumably there is something the SEC does in such cases, because lots of broker-dealers also run investment advisory businesses, but I don't know enough about back office operations in the securities business to know what that is. (I suspect that Ms. Cheung wouldn't have known either. She was in the enforcement arm of the SEC, which is not the arm that performs those kind of inspections.)
It did cross my mind that perhaps the SEC could have asked to see the cash account for the investment advisory business. An investment advisor is usually has a percent or two of assets under management in cash. On a $30b portfolio that would be a very large account, and I am guessing that there would be bank statements that you could verify with the bank. But I don't really know.
The short version of all of the foregoing may be that you'd have to know a lot more about the back office operations of the securities business than I do to understand how easy or how difficult it would be to detect the fraud here.
Henry:
It shouldn't. Just look at the Department of Interior. It had all the drugs and sex you could want.
So Chris Cox will slink back to California to enjoy his pension and perhaps get a cushy job with Gov. Arnold. So what does anyone know about this Mary Schapiro who Pres. Obama has nominated to fill Cox's shoes at SEC? How much more experienced is she in these matters? Did her previous experience involve any paths crossed with Madoff or other swindlers? Can we now Hope to sleep soundly with this Change?
alkali et al.: As a broker-dealer, Bernard L. Madoff Investment Securities would have been a participant in (i.e., had an account at) Depository Trust Company ("DTC") which actually is the owner of record for most of the nation's securities. The SEC only needed to drill down to the DTC level and match what DTC said Madoff owned with what Madoff said the investors owned. Since, as I understand, those numbers weren't even close, the fraud should have been readily detected.
Now, I still don't know all the facts. It's possible that in 2006 Madoff had, say $7 billion at DTC, and presented the SEC with $ 7 billion in customer account records, while meanwhile sending the customers statements showing total assets of $20 billion or whatever. In that case, more work would be needed, to track a few year's worth of transfers into and out of Madoff's bank accounts and show that he was supposed to have more than $7 billion. But so far, it seems that the SEC simply did no actual audit (in the sense of performing verification with third parties) at all.
y81:
Madoff had his investment advisory business, which we now know was a sham, and his broker-dealer business, which appears to have been legitimate. I assume he could have said, look, at point in time X DTC was holding (say) $200 billion in securities for my company, and that DTC would have confirmed that.
I agree that in theory, the SEC should be able to look at the books of Madoff's broker-dealer business and say, hey, the broker-dealer business accounts for all $200b; there's nothing left over at DTC for Madoff's investment advisory business; therefore it's a fraud.(*)
In practice(**), actually doing that accounting is a tall order. A broker-dealer business is in constant motion -- securities are coming into and out of the business 24/7 -- so it's not like the SEC can walk in to the broker-dealer and say, "OK, everyone freeze for six weeks so that I can count up your positions." Indeed, I don't know if the SEC ever undertakes to do such an accounting for any broker-dealer that also has an investment advisory business.
(* At least some of Madoff's holdings -- and/or fake holdings -- were options and other things that aren't held at DTC, but I'll ignore that.)
(** To quote Yogi Berra: "In theory there is no difference between theory and practice. In practice there is.")
y81,
Brilliant!! That would make sense. So Madoff has $7 billion but he is telling his customers he has $50 billion. The SEC comes to investigate - "show us your books!" Madoff shows books that indicates his has 100 accounts totalling $70 million each - every penny is accounted for.
In reality, he has 500 accounts and is telling his customers they have $100 million on average in each one.
How would the SEC ever find that? They have no way of knowing the true number of customers or what the account balances should be. Only Madoff knows that.
The only way it might have happened is if people had sent satements to the SEC complaining of something. But, in reality if anyone had susupicious circa 2005 they would have transfered their money - Madoff would have done it and they would have assumed they were mistake to be suspicious.
I've read the Markopolos letter. The part where he alleges Bernie must be lying because he's not disclosing how much money he personally is making is not persuasive, but then the letter lists 28 other red flags and even describes exactly how to check on them.
I've only known one person who worked for the SEC, a very nice young woman who also retired to motherhood and who would not have been able to spot a fraud if it bit her. It's possible the culture at the SEC led only to the hiring of people who never rocked the boat, and who knew how to please their bosess first and foremost. Also I agree with Thomas, above, that this married stay-at-home mom may be taking the fall for someone higher up in the foodchain.
alkali, Bloomberg reported on December 14 that Madoff's audited (hah!) financial statements showed total assets of $1.3 billion, of which $700 million or so was marketable securities. It doesn't seem to me that the apparently legitimate market maker business was big enough to hide the phoniness of the investment management business. But admittedly, I don't know all the facts, and, in particular, I can't find, in five minutes search, copies of the financial statements on-line.
Incidentally, it is my understanding that a proper audit of a broker-dealer will involve an inventory of the broker-dealer's exact holdings on a particular day (like December 31). The auditor doesn't just throw up its hands and say, "O my, securities come in and out all the time, it's just impossible to figure out."
jmo, I still think an analysis of a year of Madoff's transactions should have penetrated the fraud. New investors had to be constantly recruited to keep the Ponzi scheme, so there should have been hundreds of millions, if not billions, coming in each year from Fairfield Greenwich et al. Remember, although Madoff was investment advisor, broker, and custodian, he wasn't a bank, so transfers of actual cash had to go through a third party (his bank).
Everyone (almost) here is talking about how obvious it is that this was a Ponzi scheme. We still don't even know how it happened! So how do we know whether Ms. Cheung should have known or not with the skills and knowledge she had. My argument is that likely, the only obvious piece of evidence is that Madoff's investment strategy seemed to not be able to ever yield such returns. But you need to be pretty mathematically savvy to figure that impossibility out. She's not a mathematician or financial engineer. She's a lawyer. Most of the issues the SEC is tasked with, I bet, are things like, "did asset manager X market security Y to grandma, for which she was clearly not a qualified investor". This is not a mathematical question, rather a legal one. That's why the SEC staff is mostly lawyers and a few accountants. Again, I ask. Could the SEC ever try to figure if there is fraud at a quantitative hedge fund? Would they have the ability to understand the strategy being used?
@y81: Interesting. But would the $700mm include securities he held as custodian or in trust (e.g., for brokerage and investment advisory clients)?
I don't know what a broker-dealer audit by an independent accounting firm involves, although note that an annual audit by an accounting firm is different from what the SEC does.
@Gene2: By way of analogy, restaurant inspectors are not microbiologists, but they are trained to observe whether kitchen employees are washing their hands with soap. Similarly, we shouldn't expect the SEC to be able understand the details of a particular trading strategy or to evaluate whether it could work. The question that y81 and I are kicking around is what the SEC could have done at a more mechanical level to bring the fraud to light. Maybe looking at cash flow would have done it.
Perhaps the most remarkable observation in the Markopolos memo is that there wasn't enough options trading volume in the world for Madoff to be using an options trading strategy (as he claimed) with the huge amount of money he had under management. In retrospect, perhaps it would have been better if the memo had made only that single point.
"To think that without government regulation that pilots and airlines would consciously risk their own lives strikes me as rather absurd."
You must never have flown on a third-world airline.
good thing Madoff wasn't a gun owner or gun dealer. The ATF has thrown people in jail for mis-spelling a states name.
Re the note by ZT:
"To think that without government regulation that pilots and airlines would consciously risk their own lives strikes me as rather absurd."
You must never have flown on a third-world airline.
Posted by ZT | January 8, 2009 5:05 PM
Oddly I was thinking the same thing, and as well generally the rather human cognitive quality of underestimating risk. Consciously risk their own lives is to misformulate a question, consciously underestimate risk, even significantly, for a near term gain? Not an absurd propos at all.
I don't feel a bit sorry for Ms. Cheung, who is much more privileged than I am. And she did sign off on this business, so she is the one responsible. If she thought she was going to be made to take the fall for something, she could have quit at any time.
On the other hand, why was a lawyer sent to investigate this problem?
Also, there were people who figured out ahead of time that something was wrong, and if they could do it, the SEC should have been able to do it, too.
I get so depressed reading these comments. Just one example. Just one:
"-A Yale grad chooses to go into public service, doesn't find a massive fraud that she should have found, and suffers public disgrace. Is this likely to cause future Yale grads to go into public service, or not?"
The brilliant logic of that just overwhelms me. Actually, it is really quite terrifying.
Who does she think should take responsibility for its utter failure?
Certainly not a government worker.
Why isn't it obvious? It's Chimpy McBu$hitlerburton's fault! I mean, he hired her boss...
She didn't do her job and we're supposed to feel bad for her? Whatever.
"When a plane goes down, you find out why and suggest rules and regulations to ensure it doesn't happen again."
It is all incentives. An airplane crash kills the crew and costs the airline hundreds of millions of dollars. Everyone in the regulatory cycle has ample incentives to make sure it never happens.
A securities fraud usually has a negative impact only on people who are outside the regulatory cycle. The incentives for the insiders at the SEC or any other Government agency are mostly to not cause trouble and to make sure their subordinates move the paper. They obtain no reward from being aggressive investigators.
Further, since the Government looses nothing in a fraudulent securities scheme, it has no incentive to expose one.
I have thought of the Madoff victims who have year after year paid taxes on 1099s that Madoff sent them, about transactions that existed solely on paper. The IRS has collected hundreds of millions of dollars on this deal. They will keep most of that.
The SEC exists to give its regulated clients the appearance of regulation without doing anything substantive. It expends enormous efforts on issuer fillings that no-one who is not paid too will ever read. The agency should be abolished.
Creech asks about Mary Schapiro, whom Obama has nominated to succeed Cox at the SEC.
Ms. Schapiro is the CEO of the Financial Industry Regulatory Authority which is the non-governmental regulator for most US securities firms. FINRA was created in July 2007 through the consolidation of NASD and the member regulation, enforcement and arbitration functions of the New York Stock Exchange. About FINRA.
FINRA regulated Madoff, and, investigated him, without effect. Ms. Schapiro was a senior SEC staffer, before she went to NASD, FINRA's predeccesor.
We can rest easy knowing that the SEC will be hands of this capable professional.
Change. Hope.
Pour encourager les autres.
Perhaps her discomfort will bring about a little more diligence by others in the future.
Bernie Madoff was one of the reputable characters on Wall Street, so I'm not sure how a hard-hitting investigation based on a couple e-mails would fly. Blaming Ms. Cheung is like blaming the doctors who signed off that Roger Clemens was clean of steroids. You can't just browbeat a guy in that position and demand the truth.
There are plenty of actors here at fault. The moral of the story is that the hardest part of due diligence remains actually doing it. All the regulation in the world isn't going to change that.
You must never have flown on a third-world airline.
Small airlines are willing to gamble; it is the only way they can compete with the big boys. Big airlines are not willing to gamble like that, as they have too much to lose.
I don't feel a bit sorry for Ms. Cheung, who is much more privileged than I am.
What a beautiful sentiment.
"You can't just browbeat a guy in that position and demand the truth.
There are plenty of actors here at fault."//
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I recommend the "Vertical Stroke" system used by the Red Army. When someone screws up bad, the three next higher levels of supervisor are demoted a grade, or even dismissed. ;)
There seems to be a mistaken belief here that a "branch chief" is the head of an SEC "branch office." An SEC branch chief is like the head of a squad -- pretty much the lowest management rank, with about 4 attorneys working under him or her. A branch chief should be in a position to spot dodgy material, but if you are relying on someone at this level to spot a complicated fraud, you've got a serious problem. They will look over the books, interview a few people, and if there is any evidence of wrongdoing, suggest to an assistant director that a formal investigation be initiated. The most convincing evidence of wrongdoing an SEC branch chief will consider is a complaint by an investor or evidence that somebody lost some money. As someone noted above, the SEC receives dozens of complaints by competitors each day. These don't way that heavily as "evidence".
I think it's cultural. She's Chinese-American, and probably got straight As, never got in trouble, and now has messed up for the first time ever, and in public, too. Her family is probably mortified, and she's never screwed up before in her life, so she has no idea how to either apologize, pass the buck, or cobble together a cogent excuse. Plus mean people are picking on her.
Mid-level SEC manager vs. Bernie Madoff: Who wins?
Better yet - more realistically:
Mid-level SEC manager vs. her boss who knows Madoff: Who wins?
I read one of H. Markopolos's letter to the SEC. It is very detailed, list a blueprint of many red flags. Also, I have heard his monthly statements to clients were not at all descriptive. Should have raised many questions. If he had to prove his trades for any qtr the Ponzi scheme would have been revealed. No law degree, or MBA required. Just market experience and common sense.
"If you do not have a derivatives and quantitative finance background, it would have been very difficult to figure this out..."
Mr. Markopolos made it very clear that Ms. Cheung, despite her Yale degree, did not have that experience or background. I think we have put any number of the commentators here in her position, and assuming they got Markopolos' point that something was amiss with Madoff, they would have gotten the help they needed to pursue it. They could have taken up to a year to do it, and they would still have done a far better job than Ms. Cheung.
In her defense, she would not have been able to pro-actively suspect anything. Someone needed to point it out to her. But that happened.
She's off Facebook and LinkedIn. She'd better stay in hiding forever.