SALT LAKE CITY — There is a saying that goes, “If something seems to good to be true, then it probably is.”
Had the people in charge of monitoring the nation’s financial markets heeded that warning, the country might have avoided the disastrous fallout from the worst affinity fraud plan ever perpetrated, according to one of the men responsible for uncovering the multibillion-dollar scam.
About 13 years ago, Frank Casey — along with his then-co-workers at Rampart Investments, Harry Markopolos and Neil Chelo — were the people who figured out that returns reported by then renowned investment manager Bernard Madoff were fraudulent. After carefully reviewing Madoff’s investment models and determining the scam, the trio took their information to the U.S. Securities and Exchange Commission, which Casey said initially ignored the warning signs, allowing Bernie Madoff to spend many years building and operating the largest Ponzi scheme in U.S. history.
In 2009, Madoff pleaded guilty to 11 federal charges and was sentenced to 150 years in prison. He was also ordered to pay $170 billion in restitution. Had the SEC been paying attention to Casey and his colleagues, investigators might have caught on to Madoff’s $65 billion fraud years earlier.
The whistleblower was a featured speaker at the University of Utah's David Eccles School of Business Wednesday. His keynote address was entitled “Lessons From the Madoff Fraud.”
At one point, Madoff was responsible for 5 percent to 7 percent of all stock trading in the U.S. market, Casey explained. He had been the head of the NASDAQ exchange and was one of the main developers of the electronic trading system that is now widely used — making him among the most influential figures in the investment community.
“(Madoff) was a powerful, powerful financial guy,” Casey said.
He noted that one of the reasons Madoff was able to keep his scam under wraps was because his investors were sworn to secrecy and forbidden to reveal that they were investing with his company or risk having their money refunded and their high returns immediately halted. That was how he kept the scheme going for so long, he said.
“He was growing like a cancer,” Casey said. “We thought that if this fraud grew large enough, it would bring down the U.S. financial system and surely the credibility of our regulatory system.”
The more they researched, the more they became convinced that Madoff was running a Ponzi scheme and they made another report to the SEC in the summer of 2002.
He added that because the regulators at the SEC were mostly attorneys, they were not especially well-educated in the complicated world of derivative stock trading, which added to the delay in picking up on Madoff’s fraud.
He said Markopolos made five submissions to the SEC over nearly six years before the agency finally began to see the overwhelming impact of the scam. He added that others in the financial world who might have suspected fraud may also have been complicit in keeping the scam a secret due to sheer greed.
“A lot of people were willfully blind because they were making so much money from this operation of Madoff,” Casey said. “He was the Wizard of Oz, and everybody was basically afraid to lose the business.”
Casey said the Madoff debacle has been very influential in causing investors to be much more diligent today in verifying a financial manager’s credentials and the validity of their investment methods. He has developed a methodology for basic due diligence for investors called T.I.P.S.
The “T” stands for third-party verifications. Who are the auditors? Who are the custodians of the stocks that purportedly are being traded? All generate paper trails and provide checks and balances — except when they are subverted or compromised, he explained.
“I” is for internal controls. Is there a separation between the person who’s making the investment calls and the internal person who is tracking the profit and losses? If not, the fund manager could well manipulate the reporting of profits on his trades, he said.
“P” stands for pedigree. Who are the managers and where did they come from? Generally, verifying this information requires a check from a private investigator, he said.
"Just because someone lists a title on his or her resume doesn’t make it true," Casey said. "They could have inflated their role with former employers or they could have been fired without the reason showing up in the public records."
“S” is for strategy. Does it beat the markets? Are the returns too good to be true? Do they make economic sense?
"Sometimes you need to know a little about the mechanics of the field in which the fraud is being perpetrated to understand what’s plausible and what’s probably fraudulent," he said. "Having knowledge of capital market structures and having knowledge of where the inefficiencies are within those structures and what’s viable as a rate of return would probably be important.”
Besides his role in bringing the Madoff scandal to light, Casey has forged a 35-year investment career, garnering broad capital and derivative markets knowledge from roles through the years at firms like Merrill Lynch, Prudential Securities and Smith Barney, as well as Rampart Investments.
In 2001, Casey left Rampart to help build a successful hedge fund over the course of six years, raising a total of more than $2 billion. During that time, he continued working on the Madoff investigation. The experience in tracking Madoff’s malfeasance made him realize that competition often trumps ethics in the investment business.
“We must raise the ethical bar so experts do not look at their clients as prey,” Casey said.