Bernie's Little Helper Gets Nailed

Eliana Aponte, Pool / AP Photo Ezra Merkin, sued yesterday for sending millions of clients' money to Madoff, was in an even better position to uncover the scheme than the feds. So why didn't he?

What did you need to mark Bernie Madoff? Well, you needed access to Madoff, to his performance numbers, the inclination to know what the hell was going on, and, of course, some time. Feeder-fund manager Ezra Merkin had the first two, but, apparently lacking the requisite curiosity and time, he never uncovered this largest Ponzi scheme in U.S. history.

Ah, the tragedy. Mind you, it helps make the letter from Merkin’s lawyer yesterday more entertaining. In a statement after New York Attorney General Andrew Cuomo brought a civil complaint against Merkin, the latter’s lawyer said the following: “Mr. Merkin performed extensive due diligence on Madoff and his trading strategy… Unfortunately, Mr. Merkin’s due diligence, just like the detailed investigations performed by countless others, including regulators, was thwarted by the intricate, fraudulent scheme perpetrated by Madoff.”

Too many smart investors who invested with Madoff couldn’t have really and truly believed Madoff was doing just what he said he was.

Oh, so close! Mind you, Bernie Madoff’s straight outta Austin Powers scam (vintage computers, doddering help, and icky gray carpets) was not intricate, unless by that you mean muddying things with intermittently absurd and incorrect claims to people who should have known what he was saying made little sense. Because Madoff’s “split-strike conversion” strategy didn't produce the results he claimed for it when it was reproduced by others; his trading results were more spooky-stable than the Sargasso Sea; and the things Madoff said he was doing couldn’t be done at the size at which he claimed to be doing them in the markets in which he said he was doing them. It is only a slight exaggeration to say it was as if Madoff was wearing an “I’m the Ponzi guy” T-shirt and ringing a bell.

But Mr. Merkin’s lawyer says his client missed it, as, he rightly points out, did the SEC. Good company, right? Well, not to take anything away from crack SEC investigators, but Merkin had an investigatory edge: He had more than a decade of close exposure to Bernie’s implausible trading results, as well as to his get-out-of-scrutiny-free gambits. (My favorite Bernie dodge: At the end of each quarter, just when he was supposed to report his holdings, he would claim he sold everything and went to cash. In your best Church Lady voice say, “How con-ven-ient!”) And let’s not forget that, according to the Cuomo complaint, some Merkin clients allegedly began telling him of the problems with Madoff’s claimed strategy and performance as far back as the 1990s. The SEC had to wait a few more years for Harry Markopolos to show up and tip them off in detailed fashion to the Ponzi scheme, so they could cheerfully ignore him. Unfair!

So, do we know that Merkin knew more than he says? Of course not. It’s possible that his lawyer is right, and that Merkin tried but never uncovered anything anomalous in Madoff’s numbers. Hey, maybe Merkin himself came within inches of breaking the story. Maybe.

But let’s get past Ezra Merkin. The point, as I said months ago when the Madoff story broke, is that too many smart investors who invested with Madoff or brought people to Madoff couldn’t have really and truly believed Madoff was doing just what he said he was. They traded those markets; they knew Madoff’s strategies and results didn’t make sense. But they invested with him anyway,

Why? Greed and cynicism. They liked the profits, and they probably assumed Madoff was doing something straightforward, like front-running orders at his market-making subsidiary, or something similar. Who could have known the crazy bastard was running a multibillion-dollar Ponzi! Yeesh! So long as no one ever did something dumb like ask Madoff what he was really doing, they could collect the checks as they came rolling in. Sure, now and then some investigators came along asking irritating questions, but they would just repeat Bernie’s “split-strike conversion” mantra, and then stifle the giggle and hide the eye roll. Because it’s just amazing the things you can not know when you’re intent on not knowing them.

Paul Kedrosky is the editor of the business blog Infectious Greed. He's a senior fellow at the Kauffman Foundation, where he is focused on entrepreneurship, innovation, and the future of risk capital. He is also a strategist with Ten Asset Management, a Southern California institutional-money-management firm.