- Editorial Commentary -

August 18, 2009 (FinancialWire via Investrend Weblogs) — Editor’s note: In November of 2005, Harry Markopolos sent a 17-page letter to the SEC citing two possible scenarios in which Bernard Lawrence “Bernie” Madoff   – the admitted operator of the largest investor fraud ever committed by a single person — might be committing financial fraud. The “unlikely” scenario: Madoff, acting as a broker as well as an investor, was “front-running” his brokerage customers, meaning, for example: a customer might submit an order to Madoff Securities to buy shares in International Business Machines Corp. (NYSE: IBM) at a certain price, and Madoff Securities instantly would buy IBM shares for its own portfolio ahead of the customer order. If IBM’s shares rose, Madoff kept them. If they fell, he dumped them off on his customers. Markopolos’ “highly likely” scenario version — which we now know, nearly four years later, to be the case — was that “Madoff Securities (was) the world’s largest Ponzi Scheme.”

Looking back, the curious thing about the Madoff scandal is how little interest anyone inside the financial system had in exposing it. It wasn’t just Markopolos who smelled a rat. Markopolos’ letter also noted that Goldman Sachs Group Inc. (NYSE: GS) was refusing to do business with Madoff, and that many others doubted Madoff’s profits (or assumed he was front-running his customers and steered clear of him). And, between the lines, Markopolos hinted that even some of Madoff’s investors might be suspecting that they were benefitting a scam. After all, it wasn’t all that hard to see that the profits were too good to be true.

Turning our attention to the present time, Bud Burrell (courtesy if Investrend Weblogs (http://www.investrendweblogs.net), has a few thoughts on the subject, relating to Markopolos’ recent testimony:

Harry Markopolos made his second major appearance before Congress a few days ago, this time in front of the Senate Banking Committee along with two SEC lawyers, who clearly were not up to his professional and intellectual standards. Harry talked about his aborted attempts over a ten year period to get the SEC to listen to the fact that it had taken him about five minutes to figure out Bernie Madoff was a stone fraud. He then described his impressions of the lack of professional attributes of SEC staffers to recognize fraud at even an elementary level, much less a career examiner’s level.

He pulled no punches, saying at one point that the SEC “couldn’t find ice cream in a Dairy Queen”, to they “couldn’t find a steak in an Outback (Steakhouse)”. Since his interview will be available electronically soon, there is no need to recite his many statements challenging the conduct and skills of the SEC staff. Suffice it to say that he told the Senate Banking Committee that they should start by firing half the staff, and replace excess lawyers with smart trading and accounting people who should be paid bonuses for finding and busting crooks and frauds.

What many can’t begin to understand is the skill set required for someone to be a really outstanding forensic fraud examiner. This is not just the math and language skills, but the capacity for rigorous pattern recognition, and a detailed knowledge of the path that truly objective research has to take to be both valid and reliable.

“Valid” and “reliable” are two words which dictate the ultimate test of research methodology. In the case of the word: valid, it means has the examiner used a research approach that produces accurate assessments of what has happened. It must be neutral and testable. In the case of the word: reliable, it means in very simple terms that a new examiner/researcher should be able to use exactly the same methodology independently to produce the same results every time the test is done.

The tests for validity and reliability dictate whether or not research meets minimum professional standards, or not. If the test instruments, criteria and controls are not managed to a literally impeccable standard, then the results obtained are worthless, or reflective of the lack of professional standards or organizational ethics of those involved.

Harry Markopolos did this proper kind of work in his analyses, repeatedly. If you want an embarrassing standard to compare it to, look at the sloppiness and rigged lack of professional research used to study the impact of shorting on stocks by the SEC Economics Staff, a disgrace that didn’t even maintain a control group, a failing that would flunk a first year MBA. The SEC put out a report that gave a predetermined result, already knowing an objective study would not support what the industry wanted. The SEC would repeat this conduct to their everlasting shame with their “Study” of the Tick Test rule.

In order to do the work he did on Madoff, Markopolos had to spend years of study of advanced math, to have an intimate knowledge of the functions of markets and their derivatives, derived from years of actual work doing the analysis of trading, hedge funds and money managers. A gentleman, Mr. Markopolos didn’t say till his conclusions that the current staff of the SEC includes no one with the actual experience of doing such work, making them the proverbial blind man trying to describe an elephant by touch. I will say what he didn’t, to his credit. The SEC staff couldn’t find their behinds with both hands in a lighted room with wall to wall mirrors. The multiple images would confuse them.

The kind of institutional arrogance and condescension shown by the SEC in its own report on the findings on the Madoff matter stunningly found that there was no “Undue Influence” exercised by the SEC Staff in protecting their next potential job on Wall Street or at a major law firm. This is sheer poppycock. Where are their statistics on where their lawyers went for over say, the last 20 years only when Madoff was running and gunning, slicing and dicing $65 Billion of investors’ funds up like a demented pitchman from TV, a financial hawker. How did $50 Billion become $65 Billion, and why should we trust that even that number? How is it possible that the only money recovered from Madoff has been the $1 Billion brought in by Madoff himself?

The SEC’s bolt is shot, shot and re-shot. They cannot be trusted, not about anything. It is time to break up this ill-conceived, quasi-autistic love child of Joe Kennedy Sr. and his fellow thieves and put it down the same toilet it came from. It is not just that they are no longer trusted, rather they are feared by the very same people they were created to protect, the individual investor. Nearly 20 years of systematically conflicted behavior favoring major vested financial interests first has made this organization an irreparable institutional Humpty Dumpty of the child’s story, but not a child’s story by any stretch of the imagination.

I hope that when the constituent parts of the SEC are split up in a kind of diaspora, that the incoming missiles launched into other organizations are neutered at entry.  There is no logic in spreading their poison. If that is to be the case, better it should be liquidated and the staff fired wholesale. They have certainly cost millions of jobs in this country, and it couldn’t hurt for them to learn they weren’t to the manor born, nor was their silver spoon to be shoved in the wrong place.

The SEC has become a cancer on the soul of America. It needs the appropriate institutional chemo and radiation doses to insure it doesn’t become metastatic. No securities lawyer should ever again dare to look down on a examiner or researcher. Like Pogo in the classic cartoon of the 1950’s, they have seen the enemy and it is them.

Source: Courtesy of Investrend Weblogs (http://www.investrendweblogs.net).

Readers are invited to read previous FinancialWire(tm) commentary by Bud Burrell (via http://www.financialwire.net/?s=bud+burrell).

Bud Burrell’s experience spans a diverse spectrum, including service with the U.S. Military in the Special Forces, as a Finance Officer and as a Project Finance & Accounting Officer. Burrell also pursued studies in fine arts, the Renaissance, Russian history, and Chinese culture. Following years of working on Wall Street, he worked with specialty and derivative money management consulting and research and development in IT and AI.  Since then, Burrell has worked globally with major development stage companies from the IT, energy, alternative energy, bio-pharma, and general technology arenas, as well as on counterfeiting and financial fraud scandals.

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