• HIGHLIGHTS
• How they came to realize it was a fraud
• How he tipped reporter Michael Ocrant
• Their SEC contacts: "Nothing happened"
• The day he and Harry heard Madoff confessed

I want to go back to when you're first made aware of Bernie Madoff's operation as an investment adviser. When does he first come on your radar?

I had joined Rampart Investment Management in Boston in May '98, I think it was, and my primary function was business development, raising institutional capital to invest in option-type strategies. ... Harry Markopolos was a portfolio manager at Rampart, and Neil Chelo was his assistant. ...

And Harry said: "You're trying to put these portfolios together, and you have banks guarantee them as to the return of principal. There is a fellow that I know down in New York City that has been investing with some manager he didn't mention the name of, but this fellow's kicking up 1 percent a month."

And he says: "I just can't believe that somebody could do that with that consistency. Why don't you go figure out what the game is? I understand this fellow is in the options business that they're investing with." So I met this individual, and he happened to work for Access International Advisors. ... The principal of the firm, Thierry de la Villehuchet, was invested with Madoff, and so I was introduced to Thierry and began asking him questions about what he was doing.

Back in those days, I understand that Mr. Madoff didn't like his investors mentioning his name, let alone what he was doing. But Thierry, knowing that I was an options fellow, I guess, and the fact that he was a sailor and I was a sailor, established some common ground and trust, I guess. And he mentioned that it was this fellow by the name of Bernie Madoff.

And I said, "Well, what's he doing?" And he said, "Split-strike conversion work." ... You buy the stock at 30, you sell at 35 call, giving away the upside. You buy the 25 put with the premium that you received from the sale of the call [to] protect you from 25 and below. ...

You've given away some of the upside, but you bought protection on the downside?

That's correct. And so if the stock market were to fall -- and this stock is correlated highly with the stock market, let's say -- and the stock market goes down 10 percent over the next 90 days, that stock would have fallen from 30 to 27.5.

But it's a good strategy in a bull market?

You've got it. Now, if somebody is telling me that they're doing split-strike conversion and puts out a profit every month, and the market sometimes goes down during the month or two months back to back, how is it, with this strategy, that they're making positive money in a negative environment?

And that's what Harry was wondering when he told you to go down to New York and meet with the folks at Access?

Exactly. When I looked at the return streams very quickly, he [de la Villehuchet] told me basically he was making 12 to 15 percent per year on this, net, for his clients. I didn't say much about that, but I thought, well, wait a minute. ... It is predominantly a bull market strategy, and how can you make money in bear markets or down markets? So something's amiss.

Thierry said: "Well, I've been doing this due diligence on this fellow. ... I get reports every day of which positions are bought, which are sold, and which options are purchased and which are sold." And he had, I remember, two or three clerks logging everything into a computer, all the confirmations that he was receiving from Madoff Securities. ...

I said: "Why are you bothering logging in all these pieces of paper? He can make that up. There's no check and balance here." I was joking with him. I said: "I wouldn't even bother having two or three clerks log this thing in. I would just have one guy, once a week, sit down, look over the trades at the end of the week and see if any of them were trading outside of the day's range."

But de la Villehuchet thought this was a kind of due diligence?

It was due diligence to him. ... So I brought the return stream, the track record, back to Harry, and I said, "Harry, if you can do this for me, we can make a lot of money." ... Harry started engineering, looking at it and dissecting the returns. And after four hours of work or so, came up and said, "Frank, this is a Ponzi scheme." This is late '98, early '99. I said, "Harry, that's a strong word." ...

We both agree that he's probably not doing what he says he's doing; he's using split-strike conversion as a jargon cover for what he's really doing. ... He's got information flow that no one else has, because he's executing these big blocs of business for major mutual funds. And so he knows there might be an element of timing in there, and he doesn't want to tell anybody what he's doing.

So you suspect he's front-running?

Well, there's several forms of front-running. First of all, I thought, no, maybe he has some timing information flow. And Harry says: "It's impossible. You can't time every turn of every market. Look at this. The market goes down, he's not hurt at all; he produces 1 percent. Market goes up, he produces 1 percent."

To be fair, he did report a few bad months here and there -- very few, but he did report a few bad months.

Sure. Harry looked at that later on over the years and told me that basically a baseball player would have to be hitting .925 straight for 10 years in a row. Would you want to bet on a player like that, that he wasn't doing something illegal? I would doubt that most people would believe a professional athlete could do a .925 every year. That's the perspective that we have to judge Bernie from at this point.

We have to state that we were not any archangels of financial justice here. We were competitors. We were looking for an angle to basically figure out what this man was doing. And then we figured out he's not doing what he says he's doing. So that's fraudulent, first of all. ... What the degree of fraud was, I didn't know at this point.

Did you know how big Bernie Madoff was at that point?

Not in late '98, early '99. ... What's important, I think to me anyhow, at that stage was not who was investing [but] who was not investing. The people that were not investing were your big international banks, your big brokers, your big asset managers.

Like Goldman Sachs, Morgan Stanley?

They have proprietary traders. They had desks of people as smart as Madoff. They have order flow, because they're executing orders; they're dealing for Fidelity and so forth. These people have the best intellect that you can finance on the street, and they can't figure out what this Madoff guy is doing.

So they're not investing?

They're not investing.

But the Europeans were? And even some banks in Europe were investing?

Yeah. It seemed that the people that we were hearing were investing were the uberwealthy superrich that were basically going through their private banker.

But BNP Paribas, [Banco] Santander, some big, established banks in Europe?

Later on we find that out. And some of these large firms perhaps were initially responding to client demands for structured notes with Bernie in the center of the note, writing principal guarantees, providing leveraging facilities. ...

But they have a responsibility to those clients to do due diligence?

I believe so. Now, that's a sin, as far as I'm concerned, ... not doing due diligence there. The bigger sin are people that were dressed in the clothing of a diversified asset manager, a fund of hedge funds -- sort of a mutual fund, but instead of buying stock, you invest in hedge funds -- those people, who were purporting that they had conducted due diligence, this is not complacency; this is complicity. ...

I think that people that have a professional designation as an analyst, ... they had a responsibility, just as you might have if your name was titled with "Dr.," right? Professional or medical, you have a responsibility to your trade. I think that these organizations ought to hold boards and call some of these analysts up to task and to explain how was it that they believed that a man could produce 12 percent a year net every year, month by month, 1 percent, right, in a strategy that everyone knew had a correlation with the markets? How could you accept that? They ought to be defrocked of their titles, I think, some of these people. ...

... So [at some point] you went to a conference in Barcelona?

Yes, I did.

And you met [journalist] Michael Ocrant?

Yes, we shared a cab on the way in. ... Michael says, "I'm with Managed Account Reports [MARHedge]" -- that's a trade publication. ... "I have uncovered a couple of the big scams around." And he says, "And I know everyone in the hedge fund industry."

I said, "Well, that's good, Michael." I said, "I'll make you a dinner bet that you don't know the biggest hedge fund in the world." And he says, "Impossible." ... So anyhow, I mention Madoff Securities, right? And Mike says, "I've heard of Madoff Securities, but they don't run a hedge fund." So he ends up buying my wife and I dinner in Barcelona.

I said: "You really ought to write a report on this; you ought to do some investigation. Something's not right here, Michael." And so he begins, when we get back, calling us and educating himself on options. And every time he'd run into a blind alley, he'd pick up the phone and call us. And we had Harry and Neil and myself kind of give him some guidance.

Well, Bernie Madoff gets wind of the fact that Michael Ocrant is sniffing around, and he calls him up, and as the story is told to me by Michael, Bernie says, "If you're going to write a story about me, you'd better come on down here and speak to me, because you'd better get it right." ...

He ends up down in the inner sanctum apparently, somewhere in Madoff Securities. And he comes out of this meeting, and he calls me, and he says, "Frank, I don't know." He says: "This guy is unflappable. He can't be guilty of anything. I've never seen anybody so cool and collected. I mean, he's telling me he's got the secret sauce, and he doesn't want to tell anybody what the ingredients are, and [we're] just competitively jealous," and all of these other things. He says, "Maybe he's not a fraud."

I said: "Go back to the basic square one, Michael. Answer me this: If any broker-dealer that has a very risk-controlled strategy could go to any international bank and borrow $7 for every dollar that they have in their own equity in this firm, ... why would he pay these investors $12? And he's not charging fees on it." No one has ever been able to answer that simple question, and to me that's one of the biggest red flags ever.

So ... if he could make this 12 to 15 percent, why should he not just borrow money from banks himself and run the strategy and take it all? Why take other people's money?

And if he was going to take other people's money for any reason at all, he could have charged them a 2 percent fee on assets, plus 20 percent of the profits. He could have made himself anywhere around 4 to 5 percent, let's just call it, on $10 billion. Plus, he could have borrowed the money and leveraged his own balance sheet and made the difference between the 5 percent cost of funds and 12 to 15 percent profit. Why wouldn't he make the 10 percent? ...

... So you go back to de la Villehuchet and you put this to him?

Well, actually I go back to de la Villehuchet ... to make a proposal that we run some money at Rampart; that we can come up with something that helps him diversify his risk. ... I said to Thierry one day down there, "But what happens if you've got all your eggs with Bernie and he is a fraud?" And Thierry says: "He can't be. I've got all my money with him. I've got most of my family's money with him. Almost every royal family that I know has got money with him."

In Europe?

And he says, "Almost every professional associate that's running private banks that I've dealt with all my life are invested in him." So he says: "We really have done our work, Frank. You just don't have all the facts."

"You don't get it"?

"You don't get it." And you know what? When a man says that, you back off. Don't forget, he's a potential customer of mine. ... And besides that, who am I? Who are we? ... There's always that potential, that one little potential that you've got a rocket scientist, an Einstein here, and he's found some piece of information that's flowing to him proprietarily because of the nature of this business of executing big trades. ...

So there's a part of you ... that has some doubts?

Harry never had it. ... I knew that he wasn't doing what he said he was doing, but I didn't know what he was doing to generate the returns.

And you thought ... it might have been illegal, but at least the money was there?

That's what I said. I never believed it was a Ponzi scheme. ... Harry had no doubt in his mind, because he said: "Frank, he wouldn't be able to swim in this pond. It's too small for him. He's running 10 billion."

He can't run that many option trades?

He can't run that amount of options the way he says. So what's his answer to that? He tells Ocrant, ... "I use over-the-counter options," which means, "I trade with banks on private swap contracts."

What about that argument?

It's bull, because the banks have to lay off the risk somewhere, ... unless your bank is willing to take $10 billion of counterparty risk with one guy. And I'll lay you odds the big banks wouldn't do that, and he said he was only dealing with two or three of the biggest. ...

... And [at some point] you begin to take the warnings to the SEC [Securities and Exchange Commission]?

Harry does. He had a friend there, an acquaintance who was an investigator there at the SEC in Boston; Ed Manion, I think it was. And so he goes to Ed, and he says, "Listen, we've uncovered what we think is a fraud." And Ed looks at it and says, "Let me get back to you on this."

And he does some investigative work, and he comes back, and he says: "I think you might have something here. There's a bunch of unanswered questions and red flags that are popping up here. So why don't we have you write it up and submit it to the SEC in New York, because Madoff Securities is New York-based, so it's their territory."

Now this was 2000, early 2000, I believe. Nothing happens. ...

What does Harry write up at that point?

Well, I didn't actually see that first piece, but he writes up this -- who he is, his credentials, this is the thought process, this is the fraud, we think it's happening and so forth. And at the time, he may have been looking for, if there was a reward for uncovering this thing, he wanted to get paid for his work.

And so now Mike Ocrant from MARHedge, in May 1, '01, writes the article (PDF). And we expect -- it's in a trade publication, but the SEC's bound to see it; they're going to swoop in. Nothing happens. Six days later, Barron's picks it up and writes a big piece on it. Barron's -- we're all sitting around, calling each other up and e-mailing each other: "It's going to happen soon. Boy, the SEC is on it." Nothing happens. ...

You had faith in the SEC?

We had faith. And then this thing goes on from early '01, through October or so and November '01. The SEC in Boston calls Harry, I understand, and says: "Where are they on the investigation? Who contacted you from the SEC in New York?" He says, "No one." He said: "Maybe they didn't get the message. Come on in, let's write it up again."

Maybe they missed their issue of Barron's?

That may be. So nothing happens in '01. Then Harry -- this thing keeps growing, and then we're feeding information to Harry. I had left Rampart in the end of '01, October '01, matter of fact, to help build a fund-of-funds business out in Tacoma, Wash. and Freehold N.J. I had moved to New Jersey. ... Harry left Rampart I think in the end of '04, somewhere around '04.

But during this period of time, he continues to send messages --

Oh, we continue, yeah. He's talking to the SEC in Boston, and I don't know how many official communiqués he had with New York SEC, but I'm sure he had follow-up calls: "Where are you on this thing?" and so forth. In '05, he gets really frustrated that nothing's happened by now.

Can I ask you a question? Did anyone ever from the SEC really come from New York and sit down with him?

Never. ... Matter of fact, he was stonewalled every time he called them. And he was really treated, as he says, like an intellectual doormat. It was, "Well, we got your stuff; we're investigating; we'll call you if we need you." ... The arrogance just fried Harry. And so then he writes this letter in '05 (PDF) with the 28, 29 red flags on it. ... When he wrote that letter and I read it, I said: "Oh my God, they're going to be on this. You're giving it to them. You're giving them everything." And nothing happens. And now Harry is very suspicious and frustrated and angry, and it builds and builds and builds. And I think he wrote one more letter, I think in '07.

Did you ever suggest to him that he had to let this go?

No, actually we always believed, naively so, that somebody there would figure it out. If we kept gathering information -- and it wasn't our full-time jobs; don't get us wrong. I mean, we were out at a conference, and somebody mentioned that they had this great strategy, and we said: "Oh, let me guess: It's Bernie Madoff. How much money do you have with them?"

I was meeting people that basically led me to believe that this guy was up around $20, $25 billion in '05 and '06. Mike Ocrant went to a conference in '01, '02, and he said, "Frank, he admitted to me he's running $7 billion" -- we thought maybe it was $10 billion. He said, "I asked people at my dinner table how many people were invested with Madoff." And he says: "The show of hands was amazing. It's the majority." And then he said, "I asked them how much money they had," and he says, "And I could count almost $10 billion there at the table."

That was just one dinner party?

One dinner party. These are all feeder funds, professional organizations that basically were raising capital around the world to invest in Madoff. So we knew this thing was big; we just didn't know what to do about it. And we kept going to our chain of command. You go to the people that regulate you; that's where you go. ...

What about going to Fairfield Greenwich [Group] or Tremont [Group Holdings] or any of these other big feeder funds and giving them the letter?

That's like, what, am I going to show them there's a fox in a henhouse? I mean, they know what they're doing. They can't be that stupid. There's no one in the trades that could be that naive and raise billions of dollars for a guy without doing analytical work. I mean, you know, you just don't do that.

If I'm running your money, I might have 20 or 30 people in a portfolio that are running money for you in hedge fund disciplines. I'm surely not putting it all with one guy. But that's what they were doing. So these weren't our peers; these were marketing outlets that were raising money around the world, claiming to do due diligence.

But there's been people that have criticized Harry for not taking his warnings to the feeder funds.

No. Neil Chelo one time actually had a solicitation from a feeder fund. The fellow must have been very naive to call our firm, which was a fund of funds, and suggest that we look at this manager called Madoff. And so Neil played along, and he had a phone call with these people, I guess. And he's talking to the risk manager at I think it was Fairfield Sentry fund, Greenwich Sentry fund, one of the biggest feeders into Bernie, and the guy couldn't answer basic questions.

So we knew no one has done due diligence there. I mean, I shouldn't say no one at that firm has done due diligence. Maybe they did, but they sure didn't pick up on any fraud. I don't mean to single them out, because there were a lot of people that invested that were supposedly doing due diligence, which was a disgrace for the industry. ...

... Dec. 11, [2008,] comes around. Tell me how you got the news. ...

I guess I was leaving my office in Boston there, and my phone rang. I can't remember what time; I think it was close to 5:00 or so. And it was Harry, and Harry was excited: "The guy just blew up. I knew it was a fraud the whole time. He admitted it was a Ponzi scheme. Amazing." And so I'm talking to him on one cell phone. My other cell phone rings, and it's Mike Ocrant. ...

And then my house phone rings, and it was some fellow that I have to leave unnamed that was from a wealthy family that I had just met 45 days earlier. ... This fellow wanted to warn his family of a potential fraud, so he asked me for some proof. I gave him 20 flags out of 29 ... and all the disclaimers that you would want to normally put on something like this to protect yourself. Didn't hear from him again.

The night that Bernie blew, he called me. He says: "First of all, Frank, I want to say thank you for trying to help. Second of all, I took it to my family. They said: 'This is incredulous [sic]; we can't believe it. Matter of fact, we don't believe it. We've known Bernie all our life. Bernie wouldn't do that to us.'"

What kind of man could do that to his best friends? I don't know. But this guy, this younger man, he just saw his family's fortune go out the window, and I really felt for him. It was the only victim that I have gotten to know, but just the devastation that this man has wrought on trusting people. I said early in the game, we looked at who wasn't investing, and it was all the smart analysts who weren't investing. The people that were investing were the naive people that trusted advisers and bankers. And those bankers weren't doing their job.

You say naive, but Banco Santander; BNP Paribas; Ezra Merkin, [a former] GMAC chairman -- I mean, not exactly dumb money.

Really? I don't know. Henry Ford used to say, "I may not be the smartest guy in the world, but I have 12 buttons on my desk, and I can push any one of them and get the smartest guy in here." So when you're a powerful guy running a finance company, you have buttons, and they're tied to analysts -- quantitative, qualitative analysts.

If you were opening a car wash, and you came to me looking for money as your partner, what would I want? I'd want to see your bank statement. ... I'd want to see how the business is run. Competitively, where does it stand? All the checks and balances, none of them were there -- none of them. This guy was vertically integrated. He was his own banker, custodian, administrator.

Had a small accounting firm.

A man and a dog in upstate New York. I mean, this is ludicrous. How do you run a business like this? With no checks and balances? Why didn't anybody question it? We just don't understand it.

So you go from talking with Harry and then Michael, somewhat satisfied that you guys were right all along, to this very crushing phone call you get from this fellow who's wiped out?

He basically brings it home to what is really in your soul, right? We were always fearful that people would get hurt, and we were also worried about ourselves in the industry, because if this nuclear bomb goes off, it could have a devastating effect to the industry, what I call financial nuclear winter.

Because the trust is just blown?

The trust is blown, yeah. I don't know if I have my numbers exactly right, but the financial companies in the United States, ... as a percentage of the total capitalization of the U.S. stock market, used to run at around 10 percent back around the '80s. And it had moved up to 40 percent. ...

Now, you have to also believe that a good percentage of that money is now owned by foreigners who own our debt and the U.S. Treasury because we've been spending so much. So now we are an asset management center to the world, not just us, and everybody trusts us. ...

We've always built ... criteria for good business practices in asset management and brokering. Then we would audit our members through the SEC, the NFA [National Futures Association], FINRA [Financial Industry Regulatory Authority], and then we would investigate when things fell through the crack.

Well, that compliance mission now has to be one-half of the mission, not the sole mission. The other half has to be ... fraud investigation and prevention, and that means you have to have senior people -- as Harry said in front of Congress (PDF) with no hair or gray hair -- men and women that are willing to use what they've learned, that have capital markets knowledge.

... Can you get somebody that smart to work for the SEC, for substandard [pay] compared to what he's going to get with that kind of knowledge on the street?

No. That's why Harry brings up a good point in the congressional testimony. I don't know this for a fact, but I believe that if the SEC levels a fine, ... that fine is paid, and it goes into the general tax coffers of the United States. Why? If we catch a drug dealer and he's got an illegal car or a boat, we keep it for drug enforcement. ... You want a group of individuals that are bounty hunters.

And they're well paid?

Well paid. You have to pay them $180,[000,] $220,000 base salary, and then you pay them a bonus based upon success. ... It kind of reminds me of the old Western movies: They hire the marshal to clean up the town. They pay them good money because nobody else would tote the gun. Somebody has to tote the gun.

[Tell me about when] you get the news about what happens to Thierry de la Villehuchet.

Yeah. I was crushed, really crushed. Thierry was not only a French nobleman, he was a noble man. And the reason I was touched was that he really believed what he was doing. He thought he had engineered -- and I read this after the fact -- ... that Thierry has figured out through his machinations of due diligence that Bernie Madoff had always predicted each turn in the market by at least two or three hours. ...

Thierry was a sailor, and he was a hunter, ... and he could've taken himself out any way he wanted to if he wanted to just remove himself from the pressure. The man chose the method he did, in my mind only, as a act of atonement.

Slitting his wrists?

Watch himself bleed to death slowly. It's a horrible way to go, I would imagine. ... To me, it was the old way that perhaps the royals did it when they were in Rome. If they were caught [in the] wrong, they atoned. And so maybe there was some sense of this.

I'll ask you one last question: [Harry Markopolos took a] significant amount of risk. He was going after a guy who a lot of people believed in, and he took the risk of being wrong.

Oh, absolutely. The professional risk is big, right? I mean, he had a reputation of being a forensic analyst, a mathematician, a digger -- a guy who was a seeker of the truth.

So he staked it all on a bet against Bernie Madoff?

He stakes it all on a bet, betting that the SEC was going to do something about it. He even offered to go undercover for the SEC. I mean, he was an intellectual purist attempting to right a wrong and help the victims out and get their money back, and no one was listening to him. He was akin to a preacher crying in the desert, and no one heard the sermon, and no one was saved. Sad.