up. Otherwise I think my uncle would’ve been a dead man.
The standard immigrant-entrepreneur story is about the redemptive power of grit and ingenuity. To hear Markopolos tell it, his early experiences in the family business taught him instead how dark and dangerous the world was:
I saw a lot of theft in the Arthur Treacher’s. And so I became fraud-aware at a formative age, in my teens and early twenties. And I saw what people are capable of doing, because when you run a business, five to six percent of your revenues are going to be lost to theft. That’s the Association of Certified Fraud Examiners’ statistics. I didn’t know the statistics when I was a young ’un. That organization didn’t exist. But I saw it. I saw our chicken and shrimp sprout legs and walk out the back door on a regular basis. They would throw cases of that stuff in the back of their cars. That was the employees.
When Harry Markopolos was in business school, one of his professors gave him an A. But Markopolos double-checked the formula the professor used to calculate grades and realized that there had been a mistake. He had actually earned an A-minus. He went to the professor and complained. In his first job out of business school, he worked for a brokerage selling over-the-counter stocks, and one of the rules of that marketplace is that the broker must report any trade within ninety seconds. Markopolos discovered that his new employer was waiting longer than ninety seconds. He reported his own bosses to the regulators. Nobody likes a tattletale, we learn as children, understanding that sometimes pursuing what seems fair and moral comes with an unacceptable social cost. If Markopolos was ever told that as a child, he certainly didn’t listen.
Markopolos first heard about Madoff in the late 1980s. The hedge fund he worked for had noticed Madoff’s spectacular returns, and they wanted Markopolos to copy Madoff’s strategy. Markopolos tried. But he couldn’t figure out what Madoff’s strategy was. Madoff claimed to be making his money based on heavy trading of a financial instrument known as a derivative. But there was simply no trace of Madoff in those markets.
“I was trading huge amounts of derivatives every year, and so I had relationships with the largest investment banks that traded derivatives,” Markopolos remembers.
So I called the people that I knew on the trading desks: “Are you trading with Madoff?” They all said no. Well, if you are trading derivatives, you pretty much have to go to the largest five banks to trade the size that he was trading. If the largest five banks don’t know your trades and are not seeing your business, then you have to be a Ponzi scheme. It’s that easy. It was not a hard case. All I had to do was pick up the phone, really.
At that point, Markopolos was precisely where the people at Renaissance would be several years later. He had done the math, and he had doubts. Madoff’s business didn’t make sense.
The difference between Markopolos and Renaissance, however, is that Renaissance trusted the system. Madoff was part of one of the most heavily regulated sectors in the entire financial market. If he was really just making things up, wouldn’t one of the many government watchdogs have caught him already? As Nat Simons, the Renaissance executive, said later, “You just assume that someone was paying attention.”
Renaissance Technologies, it should be pointed out, was founded in the 1980s by a group of mathematicians and code-breakers. Over its history, it has probably made more money than any other hedge fund in history. Laufer, the Renaissance executive to whom Simons turned for advice, has a PhD in mathematics from Princeton University and has written books and articles with titles such as Normal Two-Dimensional Singularities and “On Minimally Elliptic Singularities.” The people at Renaissance are brilliant. Yet in one crucial respect, they were exactly like the students in Levine’s experiment who watched the instructor leave, spotted the envelope with the answers lying conspicuously on the desk, but couldn’t quite make the leap to believe that it was all a setup.
But not Markopolos. He was armed with all the same facts but none of the faith in the system. To him, dishonesty and stupidity are everywhere. “People have too much faith in large organizations,” he said. “They trust the accounting firms, which you should never trust because they’re incompetent. On a best day they’re incompetent, on a bad day they’re crooked, and aiding