;;;;;;;;;;;;;;;;;;;;;;;continued
CHART 1
Portfolio Value
Strike Price Call Option Strike Price
Put Option
Put Option
Strike Price
Split-Strike Conversion Strategy
Market Index
CHART 2
Frequency
25
S&P 100
Normal
20
15
10
5
S&P 100 Monthly Return Distribution
December 1990 to April 2007
0
– 7. 5 to
– 6. 5
– 6. 5 to
– 6. 5
– 5. 5 to
– 4. 5
– 4. 5 to
– 3. 5
– 3. 5 to
– 2. 5
– 2. 5 to
– 1. 5
– 1. 5 to
–0.5
–0.5 to
0.5
0.5 to
1. 5
1. 5 to
2. 5
2. 5 to
3. 5
3. 5 to
4. 5
4. 5 to
5. 5
5. 5 to
6. 5
6. 5 to
7. 5
7. 5 to
8. 5
8. 5 to
9. 5
Return (%)
CHART 3
Frequency
60
Madoff Monthly Return Distribution
0
– 4.0 to
– 3. 5
– 3. 5 to
– 3.0
– 3.0 to
– 2. 5
– 2. 5 to
– 2.0
– 2.0 to
– 1. 5
– 1. 5 to
– 1.0
– 1.0 to
–0.5
–0.5 to
0.0
0.0 to
0.5
0.5 to
1.0
1.0 to
1. 5
1. 5 to
2.0
2.0 to
2. 5
2. 5 to
3.0
3.0 to
3. 5
3. 5 to
4.0
Return (%)
50
40
30
20
10
Madoff
Normal
Markopolos acknowledges candidly
that he didn’t succeed in his efforts to
expose Madoff. “I didn’t stop him,” he
told a Boston Globe reporter after Madoff confessed to his fraud last December.
“He stopped himself.”
Markopolos might have made more
headway with regulators had he used
the data at his disposal to develop a visual representation of the distribution of
Madoff’s reported monthly returns and
then compared this distribution against
the S&P 100, the index Madoff claimed
was the basis of his “split-strike conversion” strategy. At this point, Markopolos
had spent years studying Madoff’s purported investment strategy and the
claims around it; he didn’t need a graph
to understand why these returns were
unreasonable. The SEC, on the other
hand, appears to have been unfamiliar
with this strategy and in need of assistance in understanding it.
In 2005, Markopolos had access to
nearly 15 years of monthly performance
data for the hedge fund Fairfield Sentry
Ltd., the largest of the so-called feeder
funds invested entirely with Bernard L.
Madoff Investment Securities LLC. In his
SEC memo, Markopolos expresses amazement that Fairfield Sentry had reported
only seven extremely small losses during
the previous 14½ years, adding, “And these
numbers are too good to be true.”
More precisely, they were too lacking
in downside volatility to be true, based on
the split-strike conversion strategy Madoff said he was using. Markopolos alludes
briefly to this inconsistency when he
notes in his memo that Madoff’s returns
had a Beta (i.e., relative correlation) of
only 6 percent as measured against the
S&P 100. After the Madoff story broke,
Markopolos expanded slightly on this
aspect of Madoff’s track record. In
testimony before the U.S. House of Representatives Committee on Financial
Services last February, Markopolos said
that “[h]aving only a 6 percent resemblance in a situation where … one would
expect a 30 to 60 percent correlation,
was outside the bounds of rationality.”
