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How Not To Be Part of Bernie Madoff’s World

Business Week had a special feature section recently on “How To” ideas.  One highlight of the section was a short piece by Harry Markopolos, the financial analyst who for years tried to alert the regulatory authorities that Bernard Madoff was generating his investment returns by operating a Ponzi Scheme.

Mr. Markopolos says this about investment mangers that perform very well.

“Whenever somebody has outstanding performance, Wall Street assumes genius. I assume fraud until genius is proven.”

And illustrates his point very nicely

“A decade ago, there was one energy company head and shoulders above all the others. That was Enron. There was also an insurance company above the rest. That was American International Group. In telecommunications, there was one company above all others. That was WorldCom. They were all accounting frauds.”

And the best part of his advice

"if your money manager refuses to answer questions, or gives you overly complex answers, assume deception. If you don’t understand the strategy, even after a manager explains it, don’t assume you’re stupid; assume your manager is trying to pull one over on you."

And why did he conclude that Mr. Madoff was not playing by the rules

"Bernie Madoff said his performance was roughly seven and half times better than the stock index he pretended to be benchmarking himself against. If you’re seven times better, two things can be true: One, you’re a fraud. Or two, you’re an alien from outer space and have perfect foreknowledge of the capital markets."

So the explanation of how Mr. Madoff was able to fool so many investors and so many regulators for so long is now known.  They thought he was an alien from outer space who had perfect foreknowledge of capital markets.  Really, they did.