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Educational Alpha
S3: Conversation with Harry Markopolos, Managing Member, Forensic Decisions PR LLC
00:46:53
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- [00:05]
Bill Kelly
Welcome to Educational Alpha. I'm Bill Kelly, your host, bringing you on the ground conversations with business leaders, educators and industry colleagues from around the globe. Educational Alpha is sponsored by iCapital, the financial technology company with a mission to power the world's alternative investment marketplace. Part innovator, part educator, and part navigator of the alternatives industry, iCapital offers intuitive, scalable digital solutions that have transformed how private market and hedge fund investments are bought and sold. With iCapital, financial advisors, wealth managers and asset managers around the world now have access to everything they need to deliver the return and diversification potential of alternatives to high net worth investors. To learn more, visit icapital.com in this.
- [01:01]
Harry Markopoulos
Episode, Bill welcomes Harry Markopoulos, the renowned financial fraud investigator and whistleblower best known for uncovering the Bernie Madoff Ponzi scheme. Harry shares his journey from portfolio management to forensic finance, detailing his relentless pursuit of exposing fraudulent financial schemes. The conversation covers the challenges he faced in getting the SEC to act on the Madoff case, the inner workings of Ponzi schemes, and how financial professionals failed to conduct proper due diligence. Harry also discusses the systemic weaknesses in financial regulation, the rise of new financial frauds, and the ongoing battle against deceptive investment and practices.
- [01:39]
Bill Kelly
Harry Markopoulos, welcome to Educational Alpha.
- [01:43]
Harry Markopoulos
It's about time we finally got together. We've been planning this for a few years, so it's great to finally be here and see it happening live, you know, my pleasure.
- [01:51]
Bill Kelly
And I think the last time I did see you in person, I believe was down in the Cayman Islands, probably pre Covid. You were speaking at a CFA event and you're very kind to talk about some of your varied experiences at a lot of events, particularly in associations like Kaya, like the cfa. And I think we can learn a lot and have learned a lot from you. So I appreciate that giving back and that might have been the last time I saw you, but Boston's a small city. We're going to get into some of that as we get through the conversation today. But many of the listeners will know you and if they don't, they'll quickly realize they do. But maybe a little bit in your background. We're going to walk a little bit through Madoff, which I think is a signpost to show maybe we don't learn anything from these very painful lessons. But maybe we'll start with your background for first, Harry.
- [02:37]
Harry Markopoulos
Undergrad, business administration major, Loyola College, Maryland. Jesuit school, Graduate school, Boston College, another Jesuit school. Master of science and finance, chartered financial analyst, earned that in 1996. Then started teaching derivatives the following year for the Boston Security Analyst Society, now the CFA Society of Boston. Became vice president of education for two years and then became the chairman of the society from 2002 to 2003. I started in Boston as a portfolio manager for equity derivatives for Rampart Investment Management, managing several billion dollars in equity derivatives overlay portfolios. Later became chief investment officer. Ran across Bernie Madoff. He was competing in my space and I knew he was nothing but a fraud. I tried to prove that case time and time again with the sec and of course they didn't listen because Bernie was so well respected on Wall street. He was one of five co founders of NASDAQ, the electronic computerized trading market for the 21st century. He was chairman of NASDAQ for two years. His brother Peter was vice chairman. And they just didn't believe me because Bernie was advising the sec. He was sitting on their advisory boards. He knew the commissioners personally at the sec. And everybody on Wall street knew Uncle Bernie. He was trading 5 to 10% of the daily stock exchange volume in the U.S. so everybody assumed that he was too wealthy to steal. But that's never the case. There's never enough for a fraudster. And I ran across him in late 99 early 2000, turning him into the SEC. But I came in with math proofs and accounting proofs. And what do we know about the sec? They're not very good at accounting and they're not very good at finance because they're over lawyered. And the place is owned and operated by lawyers. And so they have no diversity of thought. And if you are a finance person or a CFA or a cpa, you don't really have a voice in that type of organization. And when the commissioners are all securities lawyers, all five commissioners, that's a problem. I mean those dogs just don't know how to hunt on Wall Street. And me, I could spot a fraud from across the room. So can you, so can anybody with years of experience in finance. But that's not who they are. And so that case failed spectacularly and led the SEC into a total reorganization. Because that was a fiasco. And it was coincided with the global financial crisis in 2008. And so everybody had a place to blame somewhere. And it was on our banking regulators and our securities regulators that were totally asleep.
- [05:22]
Bill Kelly
And just to orient the listeners, you were the whistleblower in this case. And if memory serves me correctly, and I looked some of this up in advance of this conversation to remind me Harry Madoff was arrested in December 2008. It was a $65 billion Ponzi scheme was then, and you can tell me if it still is the largest. But his sons turned. So that was 17 years ago. But you went to the SEC 25 years ago for the first time in 2001 and 2005, and you were met with maybe not resistance, but you were speaking to them in Latin and they only know Italian. So I think that there was a failure to communicate. But what did you see? And I know you traveled overseas and who had access, but was it so obvious when you looked at it? I know there's a competitive bent to it too, so maybe spend a little bit of time on that backstory.
- [06:14]
Harry Markopoulos
Oh, the SEC assumed it couldn't be real because I was a disgruntled competitor who wasn't as successful as Madoff because I was actually running portfolios and he was just pretending to run them. And they didn't know. They're the lawyers. What do they know about derivatives? They went to law school for a reason because they can't do math, just like I wouldn't go to law school for a reason, because I don't think with their side of the brain, I'm ill suited to become an attorney. I just don't have what it takes to be an attorney. Just like they couldn't do finance. And so I respect them for who they are. I just don't think an agency should be full of lawyers running the show to police finance. Lawyers can't catch finance people. They just don't have the background and training for it. And so there's a total mismatch in abilities and motivation. And I think that was a problem for them. For the people on my team tracking Madoff, it was so obvious. When we first started tracking Madoff, he had 3 to 7 billion, we thought, assets under management, and we found that out through conferences. So Neil Cello, also a chartered financial analyst and a Kaya, Frank Casey, marketing guy, and Mike Okrant, who was the managing editor for the largest hedge fund publication, Mar Hedge, in the world and had all the connections. We'd go to the conferences and you say, who has Madoff? Where you don't even have to use the last name. You say, who has Bernie? And you would just total up the aum. And we did that throughout North America and Europe, and it was clear to us that Bernie was way bigger in Europe than he was in North America. And when you meet the people that had made off, you could tell that they hadn't done any due diligence. Because Bernie never allowed due diligence. He would allow social meetings. You could have breakfast, lunch or dinner with him, you could golf with him, but you couldn't ask any questions because his formulas and his trading strategy were so called proprietary. And he wasn't going to educate you so that other people could copy his patented or not patented, but his proprietary trading strategy, duplicate his returns and arbitrage them down to nothing. And so he had good excuses. And people said they had due diligence, they had done due diligence, they had the big checklist, but they didn't have anything filled out in those checklists. They just pretended to do due diligence because it was a closed loop. Madoff wouldn't tell you what he was doing. It was take it or leave it. And I can tell you that people in Boston who knew Madoff was a fraud, because I showed them the math and they said, yep, this is a fraud. People would come in prospective large clients on the high net worth spectrum and they'd say, this is our portfolio. And my friends, including my wife, would say, we don't take Madoff portfolios here. And without exception, that prospective high net worth client would say, you guys are crooks. You're scammers. Madoff's the best portfolio manager I have, he's the best investor. And you don't have them. You guys aren't worth listening to that get up and leave. And they'd walk out of the room. Thank God they did. Because you could imagine the lawsuits after Madoff turned himself in. And that was a very common theme in Boston, that my friends knew and wouldn't take Madoff portfolios. And unfortunately the investors, they don't know. And the people that did have Madoff, they didn't do due diligence. Their checklists were blank.
- [09:31]
Bill Kelly
And it's interesting, Harry, without even getting into maybe even the more complex arithmetic behind some of these trades, where I think somebody of your ilk and others would argue or see very clearly it could not happen. But where in the world can you find a product with very low volume, little to no drawdown, and pretty steady high single digit returns? It does not exist. So that right away should have been a flag.
- [09:58]
Harry Markopoulos
Well, maybe it does exist. I've seen people in private credit saying they can get over 10% with low volume. They can have Sharpe ratios of 10. I've seen them advertise that. How is that possible? They're better than Bernie. You always see that. You don't think you will. I did a case in 2016, eight years after Madoff turned himself in and it was Platinum Partners. And I got it two ways and it's really interesting story. One was I looked at this inside cover, maybe two second or third page of Barron's and it had the top 10 hedge fund managers and Platinum was number one. So they were a 10 year track record, 18 annualized returns, one down month. Better than Madoff. Way better. And then coincidentally I get a LinkedIn message from some guy I never heard of. Nathan Anderson, chartered financial analyst.
- [10:51]
Bill Kelly
Yeah, just retired.
- [10:52]
Harry Markopoulos
Yes, he did. He called me. So he contacts me and says, harry, I got this Ponzi scheme. I read about him in Bloomberg and he said something more red flags than a Spanish bullfight, something like that. And I think he copied something from my book. I think I wrote that in my book. Anyway, he contacts me and he says, you know, I turned this case in. So I called him up and I said, what'd you turn? And he goes a couple of pages. Did you write it in finance? He said, of course, I'm a finance guy. I said, send me what you got. I looked at it, I said, see, you made the same mistake I made and made off that you rate finance. Lawyers don't understand finance. We got to simplify this and put it in like cartoon format. And so him and another portfolio manager, he's a hedge fund manager. I'm not going to tell you who he is. He's a hedge fund manager in special situations by day and Ponzi Hunter by night. Just putting people in jail left and right for many years. And he's still in the closet. He hasn't come out of the closet and admitted he's a Ponzi Hunter. He's really good at it. And so we keep him undercover because sometimes we need access to information and he's good at getting it because he has a lot of aum and people won't turn him away. And so the three of us go after that case. And this was, I think I spoke to Nate in February of 2016. We file in mid April, just a few months later, and we turn it into the sec. Unfortunately, I knew the head of White collar for the FBI field office in New York, David Shops, who's actually a Massachusetts native from the Plymouth county area. He understood this case and he did not know that Platinum Partners was a Ponzi case because they knew it was a public corruption case and they were getting ready to arrest the co founder of Platinum Partners, Murray Hooberfeld, for bribing the head of the corrections officers union In New York, Norman seabrook with an $800,000 bribe in a Ferragamo Italian leather bag. And Seabrook put 20 million of the corrections officers $100 million pension fund into the Ponzi scheme. He's serving a long prison term. How do you think the prison guards are treating him? You think he might be getting special treatment, like, every night? I think so. You screw the union, screw the corrections officers. I think they would have long memories. And so he gets arrested in early June, and I come in in mid April, and Dave says, you got to come down here right away. And a couple days later, we're in New York. They batch us through 26 Federal Plaza, the federal building where the FBI headquarters is in New York. And we go up and clear FBI security, and we're just ghost as we go in there, and we go into the conference room. It's super crowded. There's agents everywhere. They're sitting against the wall. Big, long conference table that's full of agents. And I couldn't figure out what's going on. I thought maybe they wanted us to train them on Ponzi's because I'd done the Madoff case. Well, that wasn't it. It was because there was two squads in that room. One was the white collar squad, one of their white collar squads, I should say, and the other was a public corruption squad. And so they're listening for public corruption, which that wasn't part of our case. We just knew the $1.6 billion Ponzi. So they arrest Murray Hooverfeld in the first week in June of 2016. Two weeks later, they go back in for our case, the Ponzi, with the postal inspectors and the FBI, and they raid the offices, take out the computers and all the documents, and a week before Christmas in 2016, they're arresting everybody. Seven people get arrested. Six go to jail. One dies soon after getting arrested, and the rest is history. $1.6 billion Ponzi scheme with better numbers than Madoff.
- [14:37]
Bill Kelly
Amazing. So as you reflect on that story and Madoff as well, Harry, and we talked a little bit about Ed Manion before we came on. He's a portfolio manager that I had worked with, but he was somebody at the. That probably was not a lawyer and maybe was maybe the closest thing to somebody that was going to understand what you put together, advocate for you. But at the end, after Madoff is arrested, he goes to prison. Does anybody from the SEC ring you up and say, thank you, Harry. We must do better the next time around?
- [15:06]
Harry Markopoulos
Officially, no. Unofficially, all the time. And I've gone to book signings, given speeches. People come up from the SEC asking me to sign the book and apologize. Many, many times I've had senior people at the sec, mainly from the Inspector general's office, thanking me for the cooperation. I had to give testimony. And it was interesting to give testimony to the SEC because the day before I had to testify against them for the House Financial Services Capital Markets subcommittee. And the night before my testimony, I got called into chairman of the committee, Paul Kanjorski, tough old Democrat from Scranton, Pennsylvania. And I grew up in Pennsylvania. And they're very matter of fact, those folks. And he's tough, he's Pennsylvania tough. And he says, I want you coming in here tomorrow and I want to tell you somebody's coming in not to testify, not to tell the truth. Well, I knew I was coming in to testify and tell the truth. And I knew who I was sitting with. I was sitting with five staff directors from the sec. So I knew it had to be them. And he says, I don't want you pulling any punches, young man. I want you to be hard hitting. I want you to hold their feet to the fire and hold them accountable. And I don't want any maybe this, that or one on one hand or on the other hand, I want you to be factual and direct and I want you to give it to them with both barrels. Well, I grew up hunting in Pennsylvania and I knew that he was referring to both barrels from a shotgun and he wanted me to be shooting and not stop. And he said, you know, would you like to see the SEC's testimony tomorrow? And I said, sure. He says, well, here's some copies. And he handed them out to my legal team. And I was in that room with two attorneys. One was civil and one was criminal. Former federal prosecutor. And so we took those copies with us. And it was late at night and I had to be up there early in the morning to testify. So we went to a restaurant and we opened up the testimony of the sec and I realized that I recognized every word. They taken their website for their staff directors and printed out their mission statement and handed that in as their testimony and that was going to be their testimony. So when he said they were coming in not to testify, I realized he was right. And so we had two testimonies prepared for the next day. One was written by my civil attorney and it was very mealy mouthed and indirect and wordy. And then I had mine that I wrote myself and it was just, I take the knife I stick it in your gut, and I got you, and then I put you on the ground and I stomp on your throat, and then I start pulling out your gold fillings. I mean, I was not going to have any mercy in my testimony. I called for Mary Shapiro, the incoming SEC chair, to clean house and sweep the place clean with a wide broom. And I told it like it was. And I told him exactly the treatment I received at the hands of the SEC in New York. My treatment at the hands of the Boston SEC was much better. I got to work with Ed Manion, who was a chartered financial analyst, had 25 years of industry experience. He understood the case backwards and forwards. And I went in, but unfortunately, the Director of Enforcement didn't understand the case. And I got turned down at the SEC my first couple of times there. And it wasn't until I went back in 2005, Ed Manion kept inviting me back. He knew it was a serious case. And so I went in in 2005, and I got to meet Mike Garrity, who's since retired. And Mike was a former journalist, so he sort of knew how to investigate. He was a lawyer, but he knew how to investigate. And I met with him, and he understood the case, and he had me go up and draw things to simplify it. So we were using colored markers, and I was drawing out the Madoff strategy and why it couldn't work and how mathematically, there weren't enough options in existence for the strategy to exist. And he understood that. And so as I leave, he says, this is a very serious case. If this was in Boston, we would be in there tomorrow with two teams, not one team. We'd have an exam team and an enforcement team. We would double up the teams. But unfortunately, this case is in New York. So I promise you I'll get back to you as soon as I can with some information, because I have to go to New York with this. And so Boston was pressing this case on New York, and New York was thinking, there's no way Boston, our fiercest rival, will give us a great case like this. It has to be a crappy case before they would give it to us. And the Boston was just following procedures. Their jurisdiction was New England. Their jurisdiction extended as far as Greenwich, Connecticut. Once you cross the New York border into Fort Chester, New York, it was the New York City Regional Office of Turf. And unfortunately, The New York SEC, they read my report. The 30 red flags, most of them were mathematical. And I said, highly likely to be a Ponzi. Highly unlikely to be front running. Because front running does things that you don't want a scam to do. The bigger you get in our front running scheme, the lower your returns get and the higher your odds of getting caught. And so it would be unlikely to be front running. So what did the SEC do? They send in a broker dealer team to investigate for front running. On the 19th floor, there was no front running. It was all taking place on the hidden 17th floor hedge fund down below. And it was a Ponzi scheme, just like I told them it was. But they never went there. And so that case was a true disaster. I can't tell you how many supposedly professional, highly educated finance people with MBAs, CFAs, missed this. They were marketing this case. No one did due diligence, especially the Europeans. They felt like moths to a flame. The kill ratios over there for fund of funds was very high. You had a lot of family offices blow themselves up. A lot of fund of funds blew themselves up. A lot of people lost their life savings. There was a lot of suicides. It had a horrible, horrible ending. And we spent a lot of time in Europe and they had well over 200 feeder funds in the Madoff. In the US we only had like 78 because they're a lot less sophisticated in Europe than they are in the US And Bernie was just getting started in Asia. And if the Europeans are poorly educated and finance, it's even worse when you get to Asia. And so if he would have gotten into the Asian market, he would have gotten a lot bigger. But eventually he'd run out of clients because he pretty much saturated the US And Europe. And so the final frontier for him was going to be Asia. And eventually he would have gotten stopped.
- [21:59]
Bill Kelly
Yeah, it becomes so big, you can't feed the beast. So one last fun fact before we lead this, and I want to talk about the future of fraud. And unfortunately it looks very bright. But there is a Netflix series out there. Harry and I looked up to say, who's playing Harry Markopolis? And I recognize the actor, Frank Wally. He was in Pope Francis, so he sounds like a tough guy and maybe like you, but were you hoping for Leonardo DiCaprio? Are you happy with Frank?
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Harry Markopoulos
I was really hoping for Pee Wee Herman, but he was unavailable.
- [22:32]
Bill Kelly
Did you participate in the making of that? Because the more that resembles reality and not just Hollywood, with whatever spin they want to put on it, the better. Were you able to actively participate in the production? I think it was a movie as well. I've not seen the Netflix series. I'm Just curious as your involvement. There's.
- [22:48]
Harry Markopoulos
I didn't on that one. We would split those up so there'd be American greed, there'd be this show, that show and that one. They never really contacted us. I did help with Madoff, the Monster of Wall Street a couple years ago, I think. That came out on Netflix in January of 2023 and was really highly rated. It got a lot of views, that one. I worked extensively with the director and the producer on fact checking and giving them people to talk to because I knew the people in the case. So I knew the FBI agents that were leading the task force. I knew the people at the SEC that would talk and those people did appear on the air. I knew people that would be willing to talk about this case. And those people did very, very good job. And they put a lot of money into. That was a high value production. It took a warehouse in Jersey City and they recreated the trading floor and the hidden hedge fund on the 17th floor. And they did it with FBI cooperation. The FBI press office gave 100% cooperation and made the agents who worked that case, both retired and those still on active duty, available as technical experts. And two of them did appear. The task force leader, Keith Kelly, he was a cpa, and Steve Garfinkel, his deputy. They both appeared on the program and there were other agents that were helping in the background and they opened up their archives to. Well, most of the archives. There were some things in that case have never been made public. The FBI knows them, my team knows them, and we just don't talk about certain aspects of that case. But I think the public has a pretty good flavor for what really did happen on that case. But there's some things that are still hidden from view that was pretty eerie to be in those type of environments. You would look out the windows and you would see Manhattan. That's how much money they spent on it. They had a set that was perfect to every detail.
- [24:41]
Bill Kelly
Wow, amazing. So moving on, and we may come back to it in bits and pieces, but moving on from Madoff, what lessons did we learn? And I would like to think that this would never happen again. And that's foolish thinking, obviously. This is a seminal case we cover in the kayak curriculum, Harry, as you know. So we have it there ingrained on people's minds. And I know you don't cover the crypto space, but Sam Bankman, Fried and FTX was a classic case of, well, I thought you did the due diligence. I thought you did. And everybody trusted him. So Time and time again it's alive and well. And I was just saying to you somewhat in jest, but maybe meant in earnest when I looked at your business model. I think you're a bit of a free agent and I want to talk about what the job description of a whistleblower specialist looks like. But your typical cases are $1 billion or more where the CEO and the CFO are involved. And I would say, well, Harry must never have to work. But in fact you are quite busy. So it is amazing. Frauds of this size are still out there in the marketplace on a semi regular basis. How big is this industry? Can you put a size on it? And it is an industry unto itself.
- [25:51]
Harry Markopoulos
Professional bull market. It's fantastic. Fraud's taking off because it doesn't get punished, it doesn't get caught, it rarely gets prosecuted. The big guys always go free. And that would be the banks and the accounting firms and the major corporations. They never get punished. And little guys like SBF, they go to jail for 30 years. As a poor woman, she sells a company with a fake client list to J.P. morgan for $173 million and J.P. morgan has the Jews to get her prosecuted in Manhattan by the federal prosecutors. Well, they shouldn't. I mean they missed on due diligence, they wasted $173 million. They should have fired everybody who did the due diligence who was part of that transaction. And they shouldn't be in the criminal courts because this is a company that was responsible for trillions in fraud in the mortgage backed securities crisis. And not one person at JP Morgan went to prison. So they shouldn't have access to the judicial system like that. They should be suing her civilly in civil court and get their money back that way. So she's certainly less of a criminal than the people at JP Morgan that were involved in mortgage backed security. So I think there's a lot of unfairness out there. But as far as due diligence, it's pretty much fake. I think it's more marketing than reality. For instance, I always challenge people when I meet with industry professionals. I say, how many of you on your income statement have a line item for due diligence as an expense? And no one's ever raised their hand yet? Well, it was important you'd be measuring it. Right? So where is it covered under? Unfortunately it's covered under marketing. And so people think due diligence is. Let's go into the conference room, meet the portfolio manager, the chief investment officer and maybe the CEO of The firm in the conference room, that's not due diligence. And you're going over their presentation materials and their track record and you're getting a dog and pony show with smoke and mirrors included. And that's not the way to conduct due diligence, is it? I'll give you some examples. One Ivy League endowment, headquartered in Boston in the financial district. But we're not going to name names invested in property trees in a Latin American country that didn't exist. I mean, how does that happen? If you're going to spend, I don't know, let's say you're going to spend $200 million, $500 million. What's the proper amount to spend on due diligence? Is it 20 basis points? Is it in dollars? You measure it. What did you do? How do you end up buying trees that maybe they exist but are not owned by you? It's a scam. The manager doesn't have title to them. There's a mutual fund in Boston that bought a fake gold mine in Canada. Remember BRE X? They were salting the gold mine with gold shavings. Person ended up getting, who did due diligence, apparently got tossed out of a helicopter in the Philippines on that one. So I had a buddy, classmate of mine at Boston College, at grad school, and he ends up getting a job because of BRE X. Because the Canadian oil and minerals analyst gets fired after BRE X. And that analyst wore a suit and tie for it. And my buddy, he wore jeans and hip boots and heavy winter coat and mittens. And he didn't go to work by subway. He didn't go to work by car. He went to work by helicopter. He had a fly to every mining site, every oil well, he had to check to see if there was oil. He had to go down in the mine with a headlamp and make sure there were miners down there because that firm didn't want to get fold again. I would say that that firm learned how to do due diligence. And it took painful experience to learn how to do due diligence for that firm. It's embarrassing when you buy into a fake gold mine. And so the stories abound just in Boston, much less the rest of the world. And I have read your materials on Kaya from the Madoff case because my wife is a Kaya. And as she's reading through her material, studying for the exam, she says, hey, read this section. So I did. So that was well done.
- [29:45]
Bill Kelly
Well, hopefully we did a thorough job, but it's interesting as you say this, Harry. I'm thinking back in the course of my career. I'm a CPA from way back when I'm not active anymore. But they used to send out the brand new staff accountant out to the hinterlands to count the inventory. And if there's going to be a fraud perpetuated a company, usually it starts on the balance sheet and inventory is a perfect place to do it. And I think they diminish maybe some of the most obvious signs to the least common denominator because how bad could it be? But then I think your other point about the punishment not fitting the crime, it almost becomes more of a cost to doing business. And I'm not saying that every Fortune 500 CEO is criminal, quite the opposite. I think there is a latitude of a gray area where you can push very, very far. And if somebody says, well, you stepped over the line, you pay a fine and you don't admit or deny any guilt and you move on. Nobody's in a helicopter, nobody's being pushed out, nobody's going to prison. And I just don't know, is it that the rules of engagement and the punishments are just not where they need to be?
- [30:58]
Harry Markopoulos
Yes. Accounting fraud now has a 99 to a 98% profit margin. And no one goes to jail, no one admits guilt. The audit committee gets to keep their job. The C suite gets to keep their job. You're earning a higher profit margin than the Latin American drug cartels with no risk. The SEC is actually fostering and encouraging more accounting fraud just by not punishing correctly. They should go in and clean house. Everybody involved should take a lifetime ban from the industry never to be an officer director again. The accountants, the engagement partner and the quality assurance partner should be gone from the accounting field. We don't need bad accountants. We have plenty of those. It should be next person up, fill those slots with people that know how to do the job. And so we're not punishing fraud, we're not catching fraud, and we haven't done meaningful accounting fraud prosecutions in over two decades. They haven't been any since 2004 when you had Adeltia, WorldCom, Tyco, Enron, HealthSouth. I was the victim there on that one. You wanna hear that story?
- [31:56]
Bill Kelly
Yeah, go ahead.
- [31:56]
Harry Markopoulos
Oh, God. It's embarrassing, but I'll tell it. The best stories are the ones that are painful. So we had a quant strategy so my portfolio manager had devised. It was pretty good and I helped them, but it was a good strategy. It Was volatility based. We'd take 50 stocks equal weighted by a 2% position. And it was working. We were outperforming by about 225 to 250 basis points over the S&P 500. So we take the 50 names in the S and P and we. Hell, south gets crushed one day. It goes way down. Looks like a screaming buy. Looks like a good buy. Well, goodbye. Yes, as a G, O, O, D, B, Y, E, not B, U, Y at the end. So we buy at 6 because our model told us to, and we got out at 9. Unfortunately, we bought at $6 and got out at 9 cents.
- [32:55]
Bill Kelly
Wow. Painful lesson, but it was a 2% position.
- [32:58]
Harry Markopoulos
It was a 2% position. And I said to the portfolio manager, said, neil, the only way we can lose money on this trade is if it's an accounting fraud. Well, truer words were never spoken because it was, in fact, the company had no cash because it was paying taxes, income, corporate income, taxes on income it never had. And it was paying property, personal property taxes on inventory. It didn't hold. And so they had no cash. Wow.
- [33:24]
Bill Kelly
Wow. It's interesting. Maybe these are lessons learned as you grow through your financial career. But you mentioned Nate Anderson, and I tried to get in touch with him. I'd love to have him on, but I did not notice Hindenburg very recently announced they're shutting down, and he's had a very successful run. And usually these short houses, it can be a very painful end because you could be very, very right, but the market doesn't believe it. So it's a lonely business. I'm not suggesting you have to get into your business model if you don't want to get into the specifics. And I don't think you're the same as Hindenburg. But if you see this fraud, you know it's there and you're taking a short position. If the market doesn't see it, it can be very, very expensive. Hindenburg had an awesome run, but many of these short firms don't. But it can be a lonely business. You saw it in Madoff. We see it time and time again where nobody wants to listen, nobody wants to believe it. If this guy is in it, how bad could it be? So it's got to have its moments where you look into the mirror and say, harry, why am I banging my head against the window like this?
- [34:25]
Harry Markopoulos
I think truth matters. And without truth, without accountability, capitalism's days are numbered. And we may be approaching those days as fraud is running out of control. And when good people like Nate Anderson pack it up, and he didn't pack it up for being wrong. He packed it up because he was too busy. He had too many cases and it was burning out. You know, he's doing 15 to 18 cases a year and it's always a constant battle. And the company saying that you're lying when the ones lying are companies, management. And the frauds were so obvious that he was working on. Take a look at Tingo. It had a market capitalization, very high market capitalization. It was out of Nigeria. It should have been a high risk factor. And it reported hundreds of millions in cash and it had a Big four auditor. And if you looked at the cash at the bank statement, it said that it had hundreds of millions. But if you looked at the line, you'd see that they'd used white out and they used a different font to type in the cash number. And it was slanted. It wasn't even. How do you get more obvious than that? Instead of having hundreds of millions in the bank account, they had, I think $9. And that was a big four audit. And that's the quality of the audit. When most of the audit hours are performed by somebody between the ages of 22 and 27 years old, I would say that's an upside down profession. What do those kids know? They're not getting trained. They're working terrible hours, seven days a week. They're burned out. They're using audit procedures that are carefully designed never to catch fraud. My sons are both fourth year accounting majors in Boston. And at one of my son's schools, Bentley, the kids were interviewing, were actually interning last summer at a Big four firm in Boston. And they were told, whatever you do, if you see fraud, don't say anything. Is that a way to train your interns at a Big four firm? Is that what it's come down to?
- [36:19]
Bill Kelly
Frightening. So maybe, Harry, before I let you go, one other area I do want to cover in the business of fraud. And I have a fear that it's going to accelerate it more than slow it down. But Generative AI has been on the tips of everybody's tongue and now Deep Seek has come out and it briefly brought Nvidia down. I think they lost close to 600 billion in one trading session, maybe just a week or so ago in late January. But we're just amping up, I think in an investment process. Perhaps it could help to some degree. But I also wonder about deep fakes and AI in the hands of fraudsters, particularly in Financial services, where you've got this great transfer of wealth, less sophisticated people inheriting money. I think the situation is very, very ripe. And I do fear that there might be some useful benefits to AI, but it might be maybe bending the arc of opportunity more toward the person looking to commit the fraud than adding value to the client's portfolio.
- [37:20]
Harry Markopoulos
I'm a longtime quant, and we were looking at AI type models years ago, and the problem that you run into there was a lot of factor modeling on Wall Street. And you remember in the, in the 90s, quants were doing quite well and they would mine those databases to the nth degree. And the problem became that as more people got into it and discovered the same factors, the alpha was arbitraged away. And I think what AI, what they're going to run into is how much of the financial research, even though it's peer reviewed, is actually accurate. And it's not a high percentage, is it? And how much fraud is there in academic research? Turns out that there's a lot. And we just discovered that in Boston recently at several of our universities, didn't we? More on the scientific journal side and the medical side. And so if the data is wrong and if everybody's using the same databases like Crisp and Faxed and Bloomberg, what's the source data look like? And what if it's wrong and misreported? And then let's think about the data that does get reported. When the government reports economic figures early in the mornings usually, how many revisions are there? If it's gdp, there's going to be the initial revised and then a final. You're going to get three different numbers. Well, what does the market trade on? It trades on the first number, doesn't it? The initial, it doesn't trade on the actual, because that's going to come a couple months later, isn't it? And so a lot of people don't even know where the data comes from. And is AI going to know? Because it's programmed by IT guys and it has always promised you the moon and delivered a lot less than a moon. And they've done that a lot, a lot over the decades because they have stock options. We're incentivized to sell you a bill of goods. How many of you have upgraded your phones recently and AI is on your phone? I discovered it the other day. It's been sending out texts to buddies of mine that I never wrote. And so I had to kill that as soon as I could. And so we're going to have Problems with AI and AI generated fraud and deep fakes. I guarantee you the scammers are evolving. The dollars are getting bigger. The incentives are high. Especially for foreign based fraudsters in countries without extradition to the United States, especially Russia, North Korea, China, Eastern Europe. Yeah, those deep fakes are coming. There's going to be a lot of people losing a lot of money and due diligence. You got to go boots on the ground. You got to actually be there. If people are going to invest in forests, they better go to the forest and make sure they're not buying trees that somebody else already bought. Because those things don't have serial numbers on them, do they? You better check the property title records. I actually did a case where somebody was selling trees more than once and it was an ESG scam. A lot of ESG is fake on those carbon credits. That's a horribly police market. There is no police force there. The standards, they just don't exist. The accounting standards don't exist for esg. It's too early to invest in esg. Everybody's saying their ESG and they're greenwashing. I don't do those cases, but I did attempt one and I'm waiting for it to get bigger. The case was too small for me to take, but I was seeing people selling the trees more than once. The same carbon credits. Crazy. And no one checks anything. And the reason is you gotta go to some third world country it's really hard to get to and you gotta put boots on the ground and you gotta hire an interpreter that speaks the native language. And how many people are doing due diligence like that? And turns out no one.
- [40:59]
Bill Kelly
The agency risk is very high. We don't have time to get into this, Harry, but it is interesting if I look at this next turn where democratization of alternatives is alive and well and the nature of getting access to alternatives should be a pure play diversity diversification. Trying to get a risk exposure you cannot get in the public markets. That can happen. And diversification is still a free lunch. But one of my favorite taglines is it's got a cover charge. And the COVID charge is called due diligence. And you think about agency risk just in a local environment versus trying to handle that and manage that in far flung places that you can't even find on the globe, much less visit. And you are taking a lot of risk. And the art of investing is all about taking risk and understanding how you're being compensated for that. It's no more complicated than that. But it seems like that very basic lesson gets thrown out the window time and time again.
- [41:58]
Harry Markopoulos
I think Charlie Ellis said it best. It's a loser's game. Just try not to lose. Don't make a footfall. And he uses the tennis analogy. You gotta be smart about things and you can't afford to have blow ups in your portfolio like Toronto's obvious fraud. No one did due diligence there except for the people working there, the whistleblowers. The board was out to lunch. It was a great board on paper, but nothing but empty suits and empty dresses on that board. Even Walgreens CEO who lost his job over that. They put a hundred million dollars into putting those Theronis machines to test blood in their stores and cause patient harm. And it was so obvious to do due diligence. You go to a blood lab like Quest Diagnostics, you get the test run, you get a test strip run, you go in with the results, then you go to the Theranos machine and get their results and you stay there and watch the machine perform. And of course it couldn't. If you had done that, that CEO at Walgreens might still be there and they wouldn't have lost over $100 million on it. And how many people lost billions of dollars investing in that crappy product that didn't exist? And it was too many. And it was some of the top VC firms in America that were taken. And so it's easy to get fooled if you don't show up with the right kind of tests. You have to think before you invest. What's my due diligence going to consist of? What kind of tests would no one think to ask? Come up with those tests and go in there and ask those tests and run those tests and if they don't respond or say it's privileged information, walk out the door because it's a scam. No one does those type of things. That's how you avoid the loser's game. Read Charlie Ellis book.
- [43:43]
Bill Kelly
Yeah. No, I think it's a great point, Harry. It's something you mentioned earlier, that if you cannot see due diligence as a line item on that manager's P and L, you should run in the opposite direction. If it is part of marketing or just part of the IR team coming in there that didn't work 15 to 20 years ago, it will never work into the future. Unfortunately, it sounds like you're quite busy, which I guess is maybe good for the Markopolis family, less good for the industry as a whole. But I very Much appreciate the great work you're doing and even more so, your ability to give back. And talking at the cfa, Boston, in terms of teaching some of this next generation, we could all benefit a lot. So, great discussion, Harry, and I'll probably have you back. It's just a very fascinating story in Madoff, but there are going to be more tales from the crypto. I just love to hear them.
- [44:31]
Harry Markopoulos
We should talk about the currency frauds that I did, where the custody banks were backdating Forex, screwing all the hedge funds, all the mutual funds, all the pension funds for decades. Never got caught until I came along, started asking questions and recruiting people from inside to turn whistleblower. And we should talk about American Depository Receipts. Hundreds of billions of dollars of ADRs were sold by over 30 banks and investment banks. They never bought the shares. They never put them into the trust. They'd run that scam for decades. I helped a buddy of mine get that case taken by the sec. They turned it down the first time. And John German, Ariel, American hero, I'd like to come back and tell you about that man and what he did and how he suffered to do that case. To bring truth and honesty to the American Depository Receipts market. How many times do the banks have to cheat before you stop trusting them and talk about due diligence? So if you want me to come back, I have a big case coming this year. And if you want me to come back, I have some other fascinating cases that we can cover that the public probably knows a lot less about than Madoff. And I can give you guys a lot more due diligence tips. I hope to be teaching in some of the universities next fall. Hopefully I can do that in Boston, too, where my sons go to university. They're both accounting majors and they got another year and a half left, so I'd like to do some teaching in the universities as well, on due diligence. So thank you. Love to come back.
- [45:56]
Bill Kelly
Yeah. Outstanding on all fronts. Harry and I live in Newton, just outside of Boston. I'm active in the group out of Boston, the local chapter there, and we do a lot with the local CFA societies, too. So perhaps we can have you speak at one of those events. This episode's gonna be the opening for season three of Educational Alpha, and I think your day job and the title of this series fits so well together, and I'd love to have you back throughout the course of this season and maybe see you at a local KAI event as well.
- [46:22]
Harry Markopoulos
Great. Love to speak to the CFA Society of Boston and the Boston chapter of Kaya love to do that as well. So thank you. Hopefully we'll get together soon in Newton or downtown Boston.
- [46:31]
Bill Kelly
Excellent. Thanks, Harry. Thank you for listening to Educational Alpha. I'm your host, Bill Kelly. Learn more about the Chi association and subscribe to to the show at kaya.org that's C-A I A dot org. See you next time.