No One Would Listen: A True Financial Thriller by Harry Markopolos Read Free Book Online Page B

referred to it as a “collar” or “bull spread.” Basically, it involved buying a basket of stocks, in Madoff’s case 30 to 35 blue-chip stocks that correlated very closely to the Standard & Poor’s (S&P) 100-stock index, and then protecting the stocks with put options. By bracketing an investment with puts and calls, you limit your potential profit if the market rises sharply; but in return you’ve protected yourself against devastating losses should the market drop. The calls created a ceiling on his gains when the market went up; the puts provided a floor to cut his losses when the market went down. As Thierry explained, Madoff had a big advantage: “He determines what stocks to buy or sell based upon his knowledge of the market and his order flow.” In other words, he would use the knowledge gained from his role as the middleman in stock trades, which sounded suspiciously like insider trading. Although this was the first time this possibility was raised, we were to hear variations of that claim numerous times in the following years. It was a convenient way of explaining the inexplicable. But however he was doing it, according to Thierry it worked extremely well: “This guy produces about one percent or more every month with almost no downside.”
     
    Frank shook his head. Almost a quarter century earlier he’d been working with a young math whiz from MIT named Chuck Werner who was creating new option strategies in his living room. Options were a brand-new business, and Werner was using a PDP 11, a computer about the size of a four-drawer filing cabinet, to figure out what could be done with them. One of those strategies turned out to be the split-strike conversion. Although he’d been in that living room, Frank didn’t consider himself an expert on that strategy; but he claimed he knew enough about options to be dangerous. And in all the years since then he’d never heard of anybody consistently producing such substantial returns from a split-strike strategy. The 12 percent annual return was possible in some years; it was the consistent 1 percent a month return—month after month almost without exception, no matter how the market moved—that concerned him. A split-strike strategy certainly wasn’t without risk. There were bound to be times when it lost money, much more than was implied by the results he had seen. How could Madoff possibly still be making a profit whether the market went up or down? But Thierry seemed to have an answer for every question. To prove to Frank that Madoff’s returns were real, Thierry handed him several sheets of paper listing sales confirmations, explaining, “I get reports every day of which positions are bought, which are sold, and which options are purchased and which are sold.” It was all the usual data: On this date he’d bought this many shares of this stock at this price. On that date he’d sold that many shares of that stock at that price. Frank had seen thousands of these confirmations in his career, enough to know that they contained very little real information. It was like opening the hood of a car and looking at the engine. All that confirmed was that there was an engine, but there was no evidence that it ran, or what horsepower it generated, or even if it was powered by seawater. The only thing these papers confirmed was that Madoff was producing paperwork. Frank wondered what Access did with these reports when it received them.
     
    Thierry brought him into another room, where two clerks were busy typing these statements into a computer. “I want to make sure when I get the monthly statement that all of these trades actually show up on that statement,” he said. “I’m also trying to reverse engineer what he’s doing. I want to see where his edge is.”
     
    Frank was incredulous. Access wasn’t receiving any electronic confirmation on execution from Madoff. It was simply getting sheets of paper with numbers on them, typing them into a computer,