Sunday, March 21, 2010

Book Review: The Trouble with Harry


Harry Markopolos has an important story to tell in No One Would Listen: A True Financial Thriller (John Wiley & Sons, Inc.)

Markopolos, if you don’t recall the name or where you’ve heard it already, happens to be the guy who figured out—early enough in the process to mean something—that Bernard Madoff was conducting a classic Ponzi scheme, an in-one-door-out-the-other redistribution of his investors’ cash, under the guise of operating a sophisticated stock trading operation.

Now, Harry was not actually the only guy to figure it out—as it turns out, a lot of investment professionals knew, or presumed, that what Madoff was doing was not what he said he was doing and what his deluded investors assumed he was doing.

Also, Harry had several other professionals working with him, formally and informally, as part of a loosely unified “team” to decode what Madoff was really doing with the cash.

Still, Harry seems to be the one guy who actually felt strongly enough about the whole charade to try to stop it. He alone contacted the SEC and described in some detail what was probably going on behind the scenes on the 17th floor of the famous “Lipstick Building” in New York City where Madoff carried out his remarkably simple, but convincing, fraud.

And he did so not once, but five times.

So what did the SEC do?

Well, knowing the high stakes involved and the fact that billions of innocent investment dollars were at risk, the SEC immediately moved to investigate Madoff and swiftly shut down the fraud before many billions of dollars could be lost.

No—sorry! We’re making that up.

The SEC did nothing—almost literally nothing, it appears, if Markopolos’ account is to be believed.

And therein resides the problem—the only problem—with this book: it is so full of Harry writing about himself that the reader gets a little jaded. The trouble with Harry is he really seems to need the attention.

Now, if you’d been working on unmasking a financial fraud for ten years—going so far as to contact the SEC yourself, on your own time and your own dime, to walk them through chapter and verse of what would turn out to be the biggest financial fraud in history—you’d want some attention too.

But it would have been far better, I think, for someone else to have told this story.

(Of course, I could be wrong, but having written a book of which at least one published book review was written by a reviewer who never actually read the book, I think all book reviewers should a) have written and published a book themselves, and b) actually read the entire book he or she is reviewing, and c) say something constructive along with any critique.)

Structured as it must be in a first-person narrative, this book finds Harry awkwardly quoting himself in highly self-conscious fashion, as when he proudly recounts telling Congress, “The SEC roars like a mouse and bites like a flea.”

Muhammad Ali he is not.

But he is the guy who tried to tell the SEC that Madoff was very probably a scam. And a great—heartbreaking, but great—story it makes.

So pertinent and astonishing a story it is, in fact, that we here at NotMakingThisUp think this book should be read by every employee at the SEC; by anybody taking a course in securities analysis; and by anybody who puts their money in the stock market.

The history of the SEC’s failure with Madoff (SEC: total budget for Fiscal Year 2009, $913 million; or just about one billion with a “B”) needs to be told and retold.

While Markopolos is, unfortunately for the flow of the narrative, not above retelling things every chance he gets, it is highly fortunate that his entire story has seen the light of day.

Even the most jaded market observor with decades of experience will feel something like nausea while reading how the SEC’s Boston office was handed Madoff’s head on a metaphorical platter, and merely glanced briefly at it before sliding it into a deep freezer.

For Markopolos did not merely email somebody a brief complaint about Madoff’s suspicious-looking “45-degree” investment returns (so-called because that’s how his steady monthly increases appeared in chart form). Rather, Harry put together a serious analysis and, thanks to a contact within the Boston office, walked through the analysis with a regional director of enforcement he describes as “coldly polite.”

That was in May, 2000. Madoff wouldn’t give himself up for another eight years.

Still, Markopolos and his pals kept at it—the “it” being trying to figure out exactly how Madoff reported such steady, consistent gains.

The fact that Madoff couldn’t be doing what he claimed to be doing (using options to protect his downside while capturing modest upside in the underlying stocks) was easy enough for most professionals to grasp.

After all, anybody who knew anything about the options markets knew there simply weren’t enough options trading in Madoff’s stocks to accommodate his stated goal of providing constistent monthly gains on multiple billions of dollars under management.

But Markopolos & Company dug deeper: they proved, by a lot of hard work, that the so-called hedges wouldn’t work as advertised even if Madoff could do them in size.


So how is it, you may wonder, that so many professionals—even those who knew Madoff’s numbers didn’t make sense—never suspected the Ponzi scheme nature of Madoff’s operation?

As it turns out, Madoff had a built-in “cover” in the structure of his business: he operated a legitimate market-making firm in the two floors above his money management scheme.

Thus, the professionals who snorted that Madoff’s better-than-Buffett returns were impossible to be accomplished by a legitimate investing method simply assumed he was doing it illegitimately. They guessed he was front-running the clients of his market-making operatings.

And that was the beauty of Madoff’s scam: there was an explanation that made sense even to the most cynical professionals.

Except Harry Markopolos and his pals. They persisted, and this book tells the worthwhile story of that persistence.

Yet it is not always flattering to the author. He describes in gory detail his own motives (more on that later), which were not, in the beginning, as high-minded as you might think. Worse, he takes readers on strange side-trips, such as the nearly fatal but completely unrelated sailboat expedition of one of his compatriots, as well as the creepy negotiation he held with his wife-to-be (in a humorous vein, I think) about buying her an engagement ring: he offered to spend the money on breast implants instead, saying, “That way it’s something we both can enjoy.”

Yes, he quotes himself saying that to his wife.

Harry also becomes paranoid—almost comically so.

(I say ‘almost comically,’ for having shorted stocks professionally as part of my own investment methodology for decades, I know it is not easy going up against a sociopath with the resources of a large company behind him—and most effective scam-artists fit the classic profile of a sociopath.)

For example, in the most inadvertently amusing passage, Harry has decided that if the SEC will do nothing (two years have elapsed since his first attempt), then by gosh he’ll present his case to a Wall Street scourge, then-Governor Eliot Spitzer (still in his prime, before his highly public involvement on the consumer end of the flesh trade brought him down).

Spitzer was coming to Boston for a speech at the J.F.K. Library.

Harry writes:

The safest thing to do, I decided, was to get this information to him anonymously. I had identical twin sons due to be born…and those boys were going to need a father….

I started by printing out my entire submission on clean sheets of paper, taking out my name or any information that could identify me. I made certain I didn’t leave any fingerprints on the pages. I put on a pair of gloves and slipped the submission into a 9 x 12 manila envelope…

Markopolos then describes a scene out of a Ron Howard comedy:

It was cold that December night. I put on extra-heavy clothing and the biggest coat I owned. I was careful to dress down; I didn’t want anyone to notice me. I sat quietly for Spitzer’s speech. When he was done…I put on my coat and my gloves as if I was ready to go out into the cold, then walked to the front of the room. A library staff member was standing a few feet away from Spitzer. I took the 9 x 12 envelope…and handed it to her. “Would you do me a favor, please?” I asked. “Could you please make sure Mr. Spitzer gets this?”

“Of course,” she said.

“It’s important,” I added. Then I turned around and walked out into the blackness of a cold wintry night.

There is no evidence that Eliot Spitzer ever read my submission…

No kidding! Envelopes handed to politicians by strange men in heavy overcoats whispering “It’s important” do not generally go to the top of the inbox.

But Markopolos kept going, despite the inability of the regulators whose job it was (and is) to protect investors to grasp what his beef was.

His second attempt to convince the SEC that something was wrong took place in 2005, and it was much less subtle than the first—the report was titled: “The World’s Largest Hedge Fund Is a Fraud.”

This time, the SEC snapped into action: it raided Madoff’s offices—no, sorry, kidding again!

Inter-office politics caused the ball to be dropped, once more. Nonetheless, Harry persisted again, and again and again, until Madoff himself spared the SEC further aggravation at the hands of this crazy obsessive from Boston, and turned himself in.

Now, a reader might be wondering, “What was in it for Harry?” And it is a good question.

After all, Harry was not a short-seller looking to make money betting against Madoff: Madoff’s firm wasn’t publicly traded.

But he was a competitor.

A Wall Street “quant” by training, Harry was being pressured by his bosses to come up with a computerized trading program that could mimic Madoff’s steady, risk-free returns. They wanted the same dumb Europeans who were pouring money into Madoff’s black hole to leak some cash into Markopolos’s firm. And Harry wanted to get his bosses off his back.

He also—to his credit, and this is a trait shared by every short-seller I know—truly wanted to expose a fraud, to get the bad guy.

And get him he, eventually, indirectly, did.

For the full story, and all the details, read this book. It is an important book because the trouble with Harry—mostly a vainglorious paranoia that informs much of the phraseology in “No One Would Listen”—is not nearly as consequential as the trouble this book reveals among the regulators who should have, and very easily could have, shut down a run-of-the-mill scam before it became an off-the-charts human tragedy.

They only had to listen to Harry, and do something about it.



Jeff Matthews
I Am Not Making This Up

© 2010 NotMakingThisUp, LLC

The content contained in this blog represents only the opinions of Mr. Matthews, who also acts as an advisor: clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.

8 comments:

Anonymous said...

"The history of the SEC’s failure with Madoff (SEC: total budget for Fiscal Year, $913 billion with a “B”) needs to be told and retold—and Markopolos is not above repeating things every chance he gets—most especially, I think, how the SEC’s Boston office was handed Madoff’s head on a metaphorical platter, and merely glanced briefly at it before sliding it into a deep freezer.
"
913 Billion? SEC bigger than the military?
Or was that just made up?

MisterJuggles said...

The SEC budget of $913mm is an amazing amount for an ineffective gov't agency. But it's not as outrageous as the nearly trillion dollar figure that you cite.

Jeff Matthews said...

Crucial typo has been corrected to what was meant to be "one billion with a 'B'"

Thanks!

JM

David Harper said...

a petty review...
I find the book fascinating and i find this critique to be petty: yea, it's autobiographical but certainly not ego maniacal. The guy is writing "his story" so, um, give me a break...
... and the implication of paranoia, well, that's an easy charge to raise. In his shoes, knowing what he knew, i think he was completely justified to fear for his life; grave danger requires far less nefarious circumstances.

so about your review: meh.

american bandersnatch said...

How would you compare Markopoulos' book with Einhorn's "Fooling Some of the People ..."? Einhorn's book left me depressed and angry that so many people in government seem just not to give a crap and I fear Harry's book would just leave the same bad taste.

Jeff Matthews said...

American Bandersnatch asks how I'd compare this book to Einhorn's book. And while AB uses a word we here at NMTU hate (the 'c' word), we'll ignore it and respond since AB has a history of worthwhile comments. Just don't think we've lowered our standards for intelligent disucssion...

I likewise found Einhorn's book to be extremely depressing, because the good guys didn't win.

Here, at least, the bad guy got sort of caught.

Einhorn's book presented an Orwellian view of the people who regulate our securities markets...and Orwellian stuff is no fun to read.

But it was likewise worth reading, to know what we're up against.

And along those lines, I'd recommend Andrew Sorkin's "Too Big To Fail," which a few chapters in focuses much worthy light on Einhorn's correct and prescient analysis of Lehman Brothers.

But I haven't finished it yet...

JM

Ivan said...

I agree with what you said that the book should be read by anyone studying Securities Analysis. There is a lot of info on the industry a student or entry-level professional might learn. And yeah, there is a lot of Harry - but that makes it a much easier read.

American Bandersnatch said...

Jeff:

I deeply regret any distress that my offensive language may have caused you, or your family, and I hereby undertake not to repeat any such boorish commentary at any time in the future.

With that being said, it only took several years, but it appears that the SEC has finally admitted their incompetence vis-a-vis Einhorn and Allied Capital. See the link:

http://www.prnewswire.com/news-releases/greenlight-capital-comments-on-sec-oig-report-regarding-failed-investigation-of-allied-capital-88926837.html