Hedge fund managers that generate exceptional returns over time are often held in high esteem by investors. Moreover, the few that possess charisma or are staunchly outspoken even become household names. Society puts a great value on these people because few possess their highly sought money making skills. This begs the question: “Do we have our priorities in proper order?” There is no doubt that hedge fund managers are true entrepreneurs that risk their wealth especially when a leveraged strategy goes against them. This is a risk that they are willing to assume in exchange for the potential for significant gains that can be achieved through their highly scalable business models.
Identifying the Cheat
Which brings me to Phocion’s good friend, Frank Casey, who incurred a very different, much less attractive payoff profile during his pursuit of Bernard Madoff. In the Spring of 1999 Frank had brought Madoff’s investment strategy to his then colleague, Harry Markopolos, requesting that he reverse-engineer the strategy so that they too could provide clients with steady annual returns with very little volatility. Soon after, both Frank and Harry became convinced that Madoff’s investment strategy was shrouded in what would become known as the largest Ponzi scheme ever consummated. From 1999 until Madoff’s self-outing in December 2008, both Frank and Harry never wavered in their decision to gather and analyze as much information as possible with the goal of bringing down Madoff’s false empire whom they identified as being an unwelcome cheat to the ultra-competitive hedge fund landscape. Frank worked covertly accumulating data that he passed on to Harry who would then overtly presented his case on several occasions to the SEC. Incredibly, despite his compelling evidence his voice went unheard.
Frank and Harry’s Payoff
In terms of payoff, neither Frank nor Harry would benefit in a monetary fashion for their tireless efforts primarily because at the time the SEC’s Office of the Whistleblower did not exist. Rather, the only risk premium they would capture was from a sense of self-fulfillment achieved by doing the right thing to protect the integrity of the financial markets. The risk that they were exposed was very real and could have even resulted in the loss of their lives. What was the motivating factor in Frank and Harry assuming such an unattractive payoff? In both cases it was their military training that instilled in each a core sense of placing country before oneself. The fact that the SEC at the time was inept only emboldened them. In essence, they recognized that they had become the only line of defense in the Madoff Ponzi scheme. Though at the time rumours existed that Madoff’s operations may not be on the up and up, only Frank, Harry and a few trusted lieutenants were willing to assume the risk.
Society for the most part places celebrities on pedestals and many of us forget to pay proper tribute to the fallen many that gave their lives to ensure that we and our kids live in freedom. Within the same spirit, investment participants continue to fail to properly acknowledge and pay proper tribute to both Frank Casey and Harry Markopolos. The fact of the matter is that both of these men are proven heroes. Some strides have taken place in last ten years to enhance operations while at the same time markets have been rising to record levels. In too many instances participants have either chosen not to address operational deficiencies or have not been active in the markets for a long enough period of time to fully comprehend what needs to be done. Going forward each market participant must examine what they are doing to make their industry operations better. The SEC is much better than they were ten years ago at identifying and prosecuting malfeasance. Nevertheless, in order to really achieve improvement each industry participant must do his part.
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