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S3: Conversation with Harry Markopolos, Managing Member, Forensic Decisions PR LLC — Transcript

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0:00[Music]
0:05welcome to educational Alpha I'm Bill
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1:00in this episode Bill welcomes Harry
1:02maropoulos the renowned financial fraud
1:04investigator and whistleblower best
1:06known for uncovering the Bernie madeof
1:07Ponzi scheme Harry shares his journey
1:10from portfolio management to forensic
1:12Finance detailing his Relentless pursuit
1:14of exposing fraudulent Financial schemes
1:16the conversation covers the challenges
1:18he faced in getting the SEC to act on
1:20the madeof case the inner workings of
1:22Ponzi schemes and how Financial
1:24professionals failed to conduct proper
1:26due diligence Harry also discusses the
1:28systemic weaknesses in Financial
1:30regulation the rise of new Financial
1:32frauds and the ongoing battle against
1:34deceptive investment
1:38practices Harry maropis welcome to
1:41educational Alpha it's about time we
1:43finally got together we've been planning
1:45this for a few years so it's great to
1:47finally be here and see it happening
1:49live you know my pleasure and I think
1:51the last time I did see you in person I
1:53believe was down in the Cayman Islands
1:56probably preco you were speaking at a
1:58CFA event in your very kind to talk
2:01about some of your varied experiences at
2:04a lot of events particularly in
2:06associations like K like the CFA and I
2:08think we can learn a lot and have
2:10learned a lot from you so I appreciate
2:11that giving back and that might have
2:13been the last time I saw you but
2:15Boston's a small City we're going to get
2:16into some of that as we get through the
2:18conversation today but many of the
2:20listeners will know you and if they
2:23don't they'll quickly realize they do
2:25but maybe a little bit in your
2:26background we're going to walk a little
2:28bit through maid off which I think is a
2:29sign post to show maybe we don't learn
2:32anything from these very painful lessons
2:34but maybe we'll start with your
2:35background first Harry undergrad
2:38business administration major Loyola
2:40College
2:41Maryland Jesuit school graduate school
2:44Boston College another Jesuit school
2:46Master science and finance chartered
2:49financial analyst earned that in 1996
2:52then started teaching derivatives the
2:53following year for the Boston security
2:55analyst Society now the CFA Society of
2:58Boston became vice president of
3:01education for two years and then became
3:04the chairman of the society from 2002 to
3:082003 I started in Boston as a portfolio
3:11manager for Equity derivatives for
3:13Rampart investment management was
3:15managing several billion dollars in
3:16equity derivatives overlay portfolios
3:19later became Chief investment officer
3:22ran across Bernie maid off he was
3:24competing in my space and I knew he was
3:28nothing but a fraud I tried to prove
3:30that case time and time again with the
3:32SEC and of course they didn't listen
3:34because Bernie was so well respected on
3:36Wall Street he was one of five
3:38co-founders of NASDAQ the electronic
3:42computerized trading market for the 21st
3:44century he was chairman of NASDAQ for
3:46two years his brother Peter was vice
3:49chairman and they just didn't believe me
3:53because Bernie was advising the SEC he
3:56was sitting on their advisory boards he
3:58knew the commissioner person at the SEC
4:01and everybody on Wall Street knew Uncle
4:04Bernie he was trading 5 to 10% of the
4:06daily stock exchange volume in the US so
4:09everybody assumed that he was too
4:10wealthy to steal but that's never the
4:12case there's never enough for a
4:14fraudster and I ran across him in late
4:1699 early 2000 turning him into the SEC
4:20but I came in with math proofs and
4:23accounting proofs and what do we know
4:24about the SEC they're not very good at
4:26accounting and they're not very good at
4:28Finance because they're over over
4:29lawyered and the place is owned and
4:32operated by lawyers and so they have no
4:35diversity of thought and if you are a
4:37finance person or a CFA or a CPA you
4:40don't really have a voice in that type
4:42of
4:42organization and when the Commissioners
4:44are all Securities lawyers all five
4:46Commissioners that's a problem I mean
4:49those dogs just don't know how to hunt
4:51on Wall Street and me I could spot a FR
4:54from across the room so can you so can
4:56anybody with years of experience in
4:58finance but that's not who they are and
5:01so that case failed spectacularly and
5:04led the SEC into a total
5:07reorganization because that was a fiasco
5:09and it was coincided with the global
5:11financial crisis in 2008 and so
5:15everybody had a place the brain
5:16somewhere and it was on our banking
5:18regulators and our Securities Regulators
5:20that were totally asleep and just to
5:22orient the listeners you were The
5:24Whistleblower in this case and if memory
5:27serves me correctly and I looked so this
5:30up in advance of this conversation to
5:31remind me Harry mid off was arrested in
5:35December 2008 it was a $65 billion Ponzi
5:40scheme was then and you can tell me if
5:42it still is the largest but his sons
5:43turned him in so that was 17 years ago
5:46but you went to the SEC 25 years ago for
5:50the first time in 2001 and 2005 and you
5:54were met with maybe not resistance but
5:56you were speaking to them in Latin and
5:57they only know Italian so I think that
5:59there was a failure to communicate but
6:02what did you see and I know you traveled
6:04overseas and who had access but was it
6:06so obvious when you looked at it I know
6:08there's a competitive bent to it too so
6:10maybe spend a little bit of time on that
6:13backstory oh the SEC assumed it couldn't
6:15be real because I was a disgruntled
6:17competitor who wasn't as successful as
6:19made off because I was actually running
6:20portfolios and he was just pretending to
6:23run them and they didn't know they
6:25lawyers what do they know about
6:26derivatives they went to law school for
6:28a reason because they can't do math just
6:30like I wouldn't go to law school for a
6:32reason because I don't think with their
6:34side of the brain I'm Ill suited to
6:36become an attorney I just don't have
6:38what it takes to be an attorney just
6:40like they couldn't do finance and so I
6:42respect them for who they are I just
6:45don't think an agency should be full of
6:46lawyers running the show to to police
6:49Finance lawyers can't catch Finance
6:52people they just don't have the
6:53background and training for it and so
6:55there's a total mismatch inabilities and
6:57motivation and I think that was a
7:00problem for them for the people on my
7:02team tracking ma off it was so obvious
7:05when we first started tracking made off
7:07he had three to seven billion we thought
7:09assets under management and we found
7:11that out through conferences so Neil
7:13cello also a Ted financial analyst and
7:16aaya Frank Casey marketing guy and Mike
7:20O who was the managing editor for the
7:24largest hedge fund publication M hedge
7:27in the world and had all the connections
7:30we'd go to the conferences and you say
7:32who has MA off or you didn't even have
7:34to use the last name you just say who
7:35has Bernie and you would just total up
7:37the A and we did that throughout North
7:39America and Europe and it was clear to
7:41us that Bernie was way bigger in Europe
7:43than he was in North America and when
7:46you meet the people that had made off
7:48you could tell that they hadn't done any
7:49due diligence because Bernie never
7:51allowed due diligence he would allow
7:54social meetings you could have breakfast
7:56lunch or dinner with him you could golf
7:57with them but you couldn't ask any
7:59questions because his formulas and his
8:02trading strategy were so-called
8:04proprietary and he wasn't going to
8:06educate you so that other people could
8:08copy his patented or not patented but
8:11his proprietary trading strategy
8:13duplicate his returns and Arbitrage them
8:15down to nothing and so he had good
8:19excuses and people said they had due
8:21diligence they had done due diligence
8:22they had a big checklist but they didn't
8:25have anything filled out in those
8:26checklists they just pretended to do due
8:28diligence because it was a closed loop
8:31mid off wouldn't tell you what he was
8:32doing it was take it or leave it and I
8:34can tell you that people in Boston who
8:37knew made off was a fraud because I
8:39showed them the math and they said Yep
8:41this is a fraud people would come in
8:43prospective large clients on the high
8:46netw worth spectrum and they'd say this
8:47is our portfolio and my friends
8:50including my wife would say we don't
8:52take made off portfolios here and
8:55without exception that prospective High
8:58net worth client would say you guys are
9:00Crooks you're scammers maid off's the
9:03best portfolio manager I have he's the
9:05best investor and you don't have him you
9:07guys aren't worth listening to they'd
9:09get up and leave and they'd walk out of
9:11the room thank God they did because you
9:13could imagine the lawsuits after made
9:15off turned himself in and that was a
9:17very common theme in Boston that my
9:19friends knew and wouldn't take made off
9:21portfolios and unfortunately the
9:23investors they don't know and the people
9:25that did have made off they didn't do
9:28due diligence they're check list were
9:30blank and it's interesting Harry without
9:32even getting into maybe the more complex
9:35arithmetic behind some of these trades
9:38where I think somebody of your ilk and
9:40others would argue or see very clearly
9:42it could not happen but where in the
9:44world can you find a product with very
9:46low V little to no draw down and pretty
9:50steady High singled digigit returns it
9:52does not exist so that right away should
9:56have been a flag well maybe it does
9:58exist I've seen people in private credit
10:01saying they can get over 10% with low
10:03Vol they can have sharp ratios of 10
10:05I've seen them advertise that how is
10:07that possible they're better than Bernie
10:10you always see that you don't think you
10:12will I did a case in
10:142016 eight years after mid off turned
10:16himself in and it was Platinum Partners
10:20and I got it two ways and it's really
10:22interesting story one was I looked at
10:25this inside cover maybe two second or
10:28third page of Baron
10:29and it had the top 10 hedge fund
10:32managers and platinum was number one so
10:35they were they had a 10-year track
10:36record 18% annualized returns one down
10:40month better than made off way better
10:42and then coincidentally I get a Linked
10:45In message from some guy I never heard
10:47of Nathan Anderson chartered financial
10:50analyst yeah just retired yes he did he
10:53called me so he contacts me and says
10:55Harry I got this Ponzi scheme I read
10:57about him in Bloomberg and he said
10:59something more red flags than a Spanish
11:02bull fight something like that and I
11:04think he copied something from my book I
11:06think I wrote that in my book anyway he
11:09contacts me and he says you know I
11:10turned this case in so I called him up
11:12and I said what' you turn in he goes ah
11:14a couple pages did you write it in
11:16finance he said of course I'm a finance
11:19guy I said send me what you got I looked
11:21at it I said see you made the same
11:23mistake I made in made off it you rate
11:25Finance lawyers don't understand Finance
11:27we got to simplify this and put it like
11:29cartoon format and so him and another
11:32portfolio manager he's a hedge fund
11:35manager I'm not going to tell you who he
11:36is he's a hedge fund manager in special
11:39situations by day and Ponzi Hunter by
11:42night just putting people in jail left
11:45and right for many years and he's still
11:47in the closet he hasn't come out of the
11:49closet and admitted he's a Ponzi Hunter
11:51he's really good at it and so we keep
11:53him undercover because sometimes we need
11:56access to information and he's good at
11:58getting it because he has a lot of a and
12:01people won't turn him away and so the
12:04three of us go after that case and this
12:07was I think I spoke to Nate in February
12:09of
12:102016 we file in mid April just a few
12:14months later and we turned it into the
12:16SEC unfortunately I knew the head of
12:18white collar for the FBI field office in
12:20New York David shops who's actually a
12:22massachusett native from the Plymouth
12:25County area he understood this case and
12:28he did not know that Platinum Partners
12:30was a Ponzi case because they knew it
12:32was a public corruption case and they
12:34were getting ready to arrest the
12:36co-founder of Platinum Partners Murray
12:39hufeld for bribing the head of the
12:42Corrections Officers Union in New York
12:44Norman sebr with an $800,000 bribe in a
12:47Ferragamo Italian leather bag and cook
12:52put 20 million of the Corrections
12:55Officers $100 million pension fund into
12:58the pond sche he's serving a long prison
13:01term how do you think the prison guards
13:03are treating him you think he might be
13:05getting special treatment like every
13:07night I think so you screw the union you
13:09screw the Corrections Officers I think
13:11they would have long memories and so he
13:14gets arrested in early June and I come
13:17in in mid April and Dave says you got to
13:19come down here right away and a couple
13:21days later we're in New York they badge
13:24us through 26 Federal Plaza the federal
13:26building where the FBI headquarters is
13:28in New York and we go up and clear AF
13:30FBI security and we're just ghost as we
13:34go in there and we go into the
13:36conference room it's super crowded
13:37there's agents everywhere they're
13:39sitting against the wall big long
13:41conference table that's full of agents
13:43and I couldn't figure out what's going
13:44on I thought maybe they wanted us to
13:46train them on ponies because I'd done
13:47the made off case well that wasn't it it
13:49was because there was two squads in that
13:51room one was the white color squad one
13:54of their white collar squads I should
13:55say and the other was a public
13:58corruption Squad
13:59and so they're listening for public
14:01corruption which that wasn't part of our
14:03case we just knew the $1.6 billion Ponzi
14:07so they arrest marur hu failed in the
14:09first week in June of 2016 two weeks
14:12later they go back in for our case the
14:14Ponzi with the postal inspectors and the
14:17FBI and they raid the offices take out
14:19the computers and all the documents and
14:22a week before Christmas in 2016 they're
14:24arresting everybody seven people get
14:26arrested six go to jail one dies soon
14:29after getting arrested and the rest is
14:32history a$ 1.6 billion Ponzi scheme with
14:34better numbers than maid off amazing so
14:37as you reflect on that story and made
14:40off as well Harry and we talked a little
14:43bit about Ed Manion before we came on
14:45he's a portfolio manager that I had
14:46worked with but he was somebody at the
14:48SEC that probably was not a lawyer and
14:50maybe was maybe the closest thing to
14:51somebody that was going to understand
14:54what you put together advocate for you
14:56but at the endend after made off
14:59arrested who goes to prison does anybody
15:01from the SEC ring you up and say thank
15:03you Harry we must do better the next
15:05time around
15:07officially no unofficially all the time
15:11and I've gone to book signings given
15:14speeches people come up from the SEC
15:17asking me to sign the book and apologize
15:20many many times I've had senior people
15:22at the secc mainly from the inspector
15:24General's office thanking me for the
15:26cooperation I had to give testimony and
15:29it was interesting to give testimony to
15:31the SEC because the day before I had to
15:34testify against them for the house
15:37Financial Services Capital markets
15:40subcommittee and the night before my
15:42testimony I got called into chairman of
15:45the committee Paul korski tough old
15:47Democrat from Scranton Pennsylvania and
15:50I grew up in Pennsylvania and they're
15:52very matter of fact those folks and he's
15:55tough he's Pennsylvania tough and he
15:57says I'm I want you coming in here
15:59tomorrow and I want to tell you
16:01somebody's coming in not to testify and
16:03not to tell the truth well I knew I was
16:06coming in to testify and tell the truth
16:09and I knew who I was sitting with I was
16:10sitting with five staff directors from
16:12the SEC so I knew it had to be them and
16:15he says I don't want you pulling any
16:17punches young man I want you to be
16:20hard-hitting I want you to hold their
16:22feet to the fire and hold them
16:23accountable and I don't want any maybe
16:27this that one on one hand or on the
16:29other hand I want you to be FAL and
16:30direct and I want you to give it to him
16:32with both barrels while I grew up
16:34hunting in Pennsylvania and I knew that
16:37he was referring to both barrels from a
16:39shotgun and he wanted me to be shooting
16:41and not stop and he said you know would
16:44you like to see the sec's testimony
16:46tomorrow and I said sure he says here's
16:49some copies and he handed them out to my
16:51legal team and I was in that room with
16:54two attorneys one was civil one was
16:56criminal former Federal prosecutor
16:59and so we took those copies with us and
17:01it was late at night and I had to be up
17:02there early in the morning to testify so
17:05we went to a restaurant and we opened up
17:07the testimony of the SEC and I realized
17:10it I recognized every word they' taken
17:13their website for their staff directors
17:15and printed out their mission statement
17:18and handed that in as their testimony
17:20and and that was going to be their
17:22testimony so when he said they were
17:23coming in not to testify I realized he
17:26was right and so we had two testimonies
17:29prepared for the next day one was
17:31written by my civil attorney and it was
17:33very mey mouthed in indirect and wordy
17:38and then I had mine that I wrote myself
17:40and it was just I take the knife I stick
17:42it in your gut and I got you and then I
17:45put you on the ground and I stomp on
17:47your throat and then I start pulling out
17:49your gold fillings I mean I was not
17:50going to have any Mercy In My Testimony
17:52I called for Mary Shapiro the incoming
17:54SEC chair to clean house and sweep the
17:58place clean with a wide broom and I told
18:00it like it was and I told them exactly
18:03the treatment I received at the hands of
18:05the SEC in New York my treatment at the
18:08hands of the Boston SEC was much better
18:11I got to work with Ed Manion who was a
18:13chartered financial analyst had 25 years
18:15of Industry experience he understood the
18:18case backwards and forwards and I went
18:21in but unfortunately the director of
18:23enforcement didn't understand the case
18:26and I got turned down at the SEC my
18:29first couple of times there and it
18:31wasn't until I went back in 2005 Ed
18:33Manion kept inviting me back he knew it
18:35was a serious case and so I went in in
18:382005 and I got to meet Mike gity who's
18:41since retired and Mike was a former
18:43journalist so he sort of knew how to
18:45investigate he was a lawyer but he knew
18:46how to investigate and I met with him
18:49and he understood the case and he had me
18:51go up and draw things to simplify it so
18:54we were using colored markers and I was
18:56drawing out the madeof strategy and why
18:58it couldn't work and how mathematically
18:59there weren't enough options in
19:01existence for the strategy to exist and
19:04he understood that and so as I leave he
19:07says this is a very serious case if this
19:10was in Boston we would be in there
19:12tomorrow with two teams not one team
19:14we'd have an exam team and an
19:17enforcement team we would double up the
19:19teams but unfortunately this case is in
19:22New York so I'll promise you I'll get
19:25back to you as soon as I can with some
19:27information because I have to go to New
19:30York with this and so Boston was
19:31pressing this case on New York and New
19:34York was thinking there's no way Boston
19:37our fiercest rival would give us a great
19:40case like this it has to be a crappy
19:42case before they would give it to us and
19:44the and Boston was just following
19:46procedures their jurisdiction was New
19:48England their jurisdiction extended as
19:50far as Greenwich Connecticut once you
19:52cross the New York border into
19:54Portchester New York it was the New York
19:56City Regional Office of surf and and
19:58unfortunately the New York SEC they read
20:02my report the 30 red flags most of them
20:05were mathematical and I said highly
20:08likely to be a Ponzi highly unlikely to
20:11be front
20:12running because front running does
20:14things that you don't want a scam to do
20:17the bigger you get in our front running
20:19scheme the lower your returns yet and
20:22the higher your odds are getting caught
20:25and so it would be unlikely to be front
20:27running so what did the SEC do they sent
20:30in their broker dealer team to
20:32investigate for front running on the
20:3319th Floor there was no front running it
20:37was all taking place on the hidden 17th
20:39Floor hedge fund down below and it was a
20:41Ponzi scheme just like I told him it was
20:44but they never went there and so that
20:46case was a true disaster I can't tell
20:49you how many supposedly professional
20:52Highly Educated Finance people with mbas
20:56cfas missed this they were mark in this
20:59case they no one did due diligence
21:01especially the Europeans they fell like
21:03moths to a flame the kill ratio over
21:06there for funa funds was very high you
21:09had a lot of family offices blow
21:11themselves up a lot of funa funds blew
21:13themselves up a lot of people lost their
21:16life savings there was a lot of suicides
21:19it had a horrible horrible ending and we
21:21spent a lot of time in Europe and they
21:23had well over 200 beer funds in the made
21:26off in the US we only had like 78
21:29because they're a lot less sophisticated
21:30in Europe than they are in the US and
21:33Bernie was just getting started in Asia
21:36and if the Europeans are poorly educated
21:40on finance it's even worse when you get
21:42to Asia and so if he would have gotten
21:45into the Asian market he would have
21:46gotten a lot bigger but eventually he'd
21:48run out of clients because he pretty
21:51much saturated the US and Europe and so
21:54the final frontier for him was going to
21:56be Asia and eventually he would have
21:58gotten stopped
21:59yeah it becomes so big you can't feed
22:01the beast so one last fun fact before we
22:04lead this and I want to talk about the
22:05future of Fraud and unfortunately looks
22:07very bright but there was a Netflix
22:09series out there Harry and I looked up
22:11to say who's playing Harry maropis and I
22:14recognize the actor Frank Wally he was
22:17in Pulp Fiction so he sounds like a
22:19tough guy and maybe like you but were
22:22you hoping for Leonardo DiCaprio are you
22:25happy with Frank I was really hoping for
22:28p Herman but he was
22:30unavailable did you participate in the
22:33making of that because the more that
22:34resembles reality and not just Hollywood
22:38with whatever spin they want to put on
22:40it the better were you able to actively
22:41participate in the production I think
22:43there was a movie as well I've not seen
22:44the Netflix series just curious as your
22:46involvement there I didn't on that one
22:49we would split those up so there'd be
22:51American Greed there'd be this show that
22:53show and that one they never really
22:55contacted us I did help with made off
22:58the monster Wall Street a couple years
23:00ago I think that came out on Netflix in
23:02January of 2023 it was really highly
23:05rated got a lot of views that one I
23:08worked extensively with the director and
23:11the producer on factchecking and giving
23:15them people to talk to because I knew
23:17the people in the case so I knew the FBI
23:19agents that were leading the task force
23:22I knew the people at the SEC that would
23:25talk and those people did appear on the
23:27air I knew people that would be willing
23:29to talk about this case and those people
23:31did very very good job and they put a
23:33lot of money into that was a high value
23:35production they took a warehouse in
23:37Jersey City and they recreated the
23:40trading floor and the hidden hedge fund
23:43on the 17th floor and they did it with
23:44FBI cooperation the FBI press office
23:48gave 100% cooperation and made the
23:50agents who work that case both retired
23:52and those still on active duty available
23:55as technical experts and two of them did
23:58appear the task force leader Keith Kelly
24:01who was a CPA and Steve garfinkle his
24:05Deputy they both appeared on the program
24:07and there were other agents that were
24:08helping in the background and they
24:10opened up their archives to well most of
24:13the archives there was some things in
24:14that case have never been made public
24:16the FBI knows them my team knows them
24:19and we just don't talk about certain
24:20aspects of that case but I think the
24:22public has a pretty good flavor for what
24:24really did happen on that case but
24:25there's some things that are still
24:26hidden from View that was pretty Eerie
24:29to be in those type of environments you
24:31would look out the windows and you would
24:33see Manhattan that's how much money they
24:35spent on it they had a set that was
24:39perfect to every detail wow amazing so
24:43moving on and we may come back to it in
24:46bits and pieces but moving on from ma
24:48off what lessons did we learn and I
24:51would like to think that this would
24:53never happen again and that's foolish
24:55thinking obviously this is a seminal
24:57case we cover the kayak curriculum Harry
24:59as you know so we have it there
25:01ingrained on people's minds and I know
25:03you don't cover the crypto space but Sam
25:05bankman freed and FTX was a classic case
25:08of well I thought you did the due
25:09diligence I thought you did and
25:10everybody trusted him so time and time
25:13again is alive and well and I was just
25:15saying to you somewhat in just but maybe
25:17meant in Earnest when I looked at your
25:19business model I think you're a bit of a
25:21free agent and I want to talk about what
25:23the job description of a whistleblower
25:25specialist looks like but your typical
25:27cases are $1 billion dollar or more
25:30where the CEO and the CFO are involved
25:33and I would say well Harry must never
25:35have to work but in fact you are quite
25:37busy so it is amazing frauds of this
25:40size are still out there in the
25:42marketplace on a semi-regular basis how
25:46big is this industry can you put a size
25:48on it and it is an industry unto itself
25:51peral bull market it's fantastic Fraud's
25:54taking off because it doesn't get
25:56punished it doesn't get caught it rarely
25:58gets prosecuted the big guys always go
26:01free and that would be the banks and the
26:03accounting firms and the major
26:05corporations they never get punished and
26:07little guys like SPF they go to jail for
26:0930 years as a poor woman she sells a
26:12company with a fake Client List to JP
26:15Morgan for $173 million and JP Morgan
26:19has the Jews to get her prosecuted in
26:21Manhattan by the federal prosecutors
26:24well they shouldn't I mean they missed
26:26on due diligence they Wast $173 million
26:30they should have fired everybody who did
26:31the due diligence who was part of that
26:34transaction and they shouldn't be in the
26:35criminal courts because this is a
26:37company that was responsible for
26:39trillions in fraud in the mortgage back
26:41Securities crisis and not one person at
26:43JP Morgan went to prison so they
26:45shouldn't have access to the judicial
26:47system like that they should be suing
26:48her civy in civil court and get their
26:51money back that way so she's certainly
26:53less of a criminal than the people at JP
26:55Morgan that were involved in mortgage
26:57back security so I I think there's a lot
26:58of unfairness out there but as far as
27:00due diligence it's pretty much fake I
27:03think it's more marketing than reality
27:05for instance I always challenge people
27:08when I meet with industry professionals
27:09I say how many of you on your income
27:12statement have a line item for due
27:14diligence as an expense and no one's
27:17ever raised their hand yet well it was
27:19important you'd be measuring it right so
27:21where is it covered under unfortunately
27:23it's covered under marketing and so
27:25people think due diligence is let's go
27:27into the conf room meet the portfolio
27:29manager the chief investment officer and
27:31maybe the CEO of the firm in the
27:34conference room that's not due diligence
27:36and you're going over their presentation
27:37materials and their track record and
27:40you're getting a dog and pony show with
27:42smok and mirrors included and that's not
27:44the way to conduct due diligence is it
27:46I'll give you some examples one ivy
27:49league endowment headquartered in Boston
27:52in the financial district but we're not
27:53going to name names invested in property
27:57trees in a Latin American country that
28:00they didn't exist I mean how does that
28:02happen if you're going to spend I don't
28:05know let's say if you're going to spend
28:06$200 million $500 million what's the
28:09proper amount to spend on due diligence
28:11is it 20 basis points is it in dollars
28:15you measure it what did you do how do
28:18you end up buying trees that maybe they
28:20exist but are not owned by you it's a
28:22scam that the manager doesn't have title
28:24to them there's a mutual fund in Boston
28:27that bought a fake gold mine in Canada
28:29remember Brix they were salting the gold
28:31mine with gold shavings person ended up
28:34getting who did do diligence apparently
28:36got tossed out of a helicopter in the
28:37Philippines on that one so I had a buddy
28:40classmate of mine at Boston College at
28:42grad school and he ends up getting a job
28:45because of Brix because the Canadian Oil
28:49and minerals analyst gets fired after
28:51Brix and that analyst wore a suit and
28:54tie for it and my buddy he wore jeans
28:58and hip boots and heavy winter coat and
29:02mittens and he didn't go to work by
29:04Subway he didn't go to work by car he
29:06went to work by helicopter he had to fly
29:09to every mining site every oil well he
29:12had to check to see if there was oil he
29:14had to go down in the mine with a
29:15headlamp and make sure there were miners
29:17down there because that firm didn't want
29:20to get fooled again I would say that
29:22that firm learned how to do due
29:24diligence and it took painful experience
29:26to learn how to do due diligence for
29:27that firm it's embarrassing when you buy
29:29into a fake gold mine and so the stories
29:32bound just in Boston much less the rest
29:34of the world and I have read your
29:35materials on Kaa from the madeof case
29:37because my wife is a Kaa and as she's
29:39reading through her materials studying
29:41for the exam she says Hey read this
29:43section so I did so that was well done
29:45well hopefully we did a thorough job but
29:47you know it's interesting as you say
29:48this Harry I'm thinking back in the
29:50course of my career I'm a CPA from way
29:53back when I'm not active anymore but
29:55they used to send out the brand new
29:57Stafford account out to the Hinterlands
30:00to count the inventory and if there's
30:02going to be a fraud perpetuated a
30:03company usually it starts on the balance
30:06sheet and inventory is a perfect place
30:09to do it and I think they diminish maybe
30:12some of the most obvious signs to the
30:14least common denominator because you
30:16know how bad could it be but then I
30:18think your other point about the
30:21punishment not fitting the crime it's
30:24almost becomes more of a cost of doing
30:26business and I'm not saying that every
30:28Fortune 500 CEO is Criminal quite the
30:31opposite I think there is a latitude of
30:33a gray area where you can push very very
30:37far and if somebody says well you
30:39stepped over the line you pay a fine and
30:42you don't admit or deny any guilt and
30:46you move on nobody's in a helicopter
30:48nobody's being pushed out nobody's going
30:50to prison and I just don't know is it
30:53that the Rules of Engagement and the
30:55punishments are just not where they need
30:57to be yes accounting fraud now has a 99
31:00to 98% profit margin and no one goes to
31:03jail no one adits guilt the audit
31:05committee gets to keep their job the
31:06ceas weak is to keep their job you're
31:09earning a higher profit margin than the
31:10Latin American drug cartels with no risk
31:13the SEC is actually fostering and
31:15encouraging more accounting fraud just
31:18by not punishing correctly they should
31:19go in and clean house everybody involv
31:22should take a lifetime ban from the
31:23industry never to be an officer director
31:26again the accountants the engagement
31:28partner and the quality assurance
31:29partner should be gone from the
31:30accounting field we don't need bad
31:32accountants we have plenty of those it
31:34should be next person up fill those
31:36slots with people that know how to do
31:37the job and so we're not punishing fraud
31:40we're not catching fraud and we haven't
31:42done meaningful accounting fraud
31:44prosecutions in over two decades they
31:47haven't been any since 2004 when you had
31:49Adelia Worldcom Tao Enron hell South I
31:53was a victim there on that one you want
31:54me to hear that story yeah go ahead oh
31:56God it's embarrassing but I'll tell it
31:58the best stories are the ones that are
31:59painful so we had a Quant strategy so my
32:03portfolio manager had devised it it was
32:05pretty good I helped them but it was a
32:07good strategy it was volatility based
32:09we'd take 50 stocks equal weighted by a
32:122% position and it was working we were
32:15outperforming by about
32:18225 to 250 basis points over the S&P 500
32:23so we take the 50 names in the S&P and
32:27we hell South gets crushed one day it
32:31goes way down looks like a screaming buy
32:34looks like a good buy well goodbye yes
32:37as a g d
32:40b not buy at the end so we buy at six
32:46because our model told us to and we got
32:48out at nine unfortunately we bought at
32:51$6 and got out at nine
32:54cents wow painful lesson was 2% position
32:57it was a 2% position and I said to the
33:00portfolio Manor said Neil the only way
33:02we can lose money on this trade is if
33:04it's an accounting fraud well true words
33:06were never spoken because it was in fact
33:10the company had no cash because it was
33:12paying taxes income corporate income
33:14taxes on income it never had and it was
33:17paying property personal property taxes
33:19on inventory it didn't hold and so they
33:22had no cash wow wow it's interesting
33:25maybe these are Lessons Learned as you
33:27grow through your financial career but
33:29you mentioned Nate Anderson and I try to
33:31get in touch with him I'd love to have
33:32him on but I did notice Hindenburg very
33:35recently announced they're shutting down
33:37and he's had a very successful run and
33:40usually the short houses it can be a
33:43very painful end because you could be
33:45very very right but the market doesn't
33:47believe it so it's a lonely business I'm
33:49not suggesting you have to get into your
33:51business model if you don't want to get
33:52into the specifics and I don't think
33:53you're the same as Hindenburg but if you
33:55see this fraud you know it's there and
33:57you're taking a short position if the
33:59market doesn't see it it can be very
34:01very expensive Hindenburg had an awesome
34:03run but many of these short firms don't
34:06but it can be a lonely business you saw
34:08it in maid off we see it time and time
34:10again where nobody wants to listen
34:13nobody wants to believe it if this guy
34:15is in it how bad could it be so it's got
34:18to have its moments where you look into
34:19the mirror and say yeah Harry why am I
34:22banging my head against the window like
34:24this I think truth matters and with
34:27without truth without accountability
34:30capitalism's days are numbered and we
34:33may be approaching those days as fraud
34:35is running out of control and when good
34:37people like Nate Anderson pack it up and
34:40he didn't pack it up for being wrong he
34:43packed it up because he was too busy he
34:45had too many cases and he was burning
34:47out you know he's doing 15 to 18 cases a
34:49year and it's always a constant battle
34:52and the company saying that you're lying
34:54when the ones lying are man of company
34:57management and the frauds were so
35:00obvious that he was working on take a
35:01look at Tingo it had a market
35:03capitalization very high market
35:05capitalization it was out of Nigeria
35:07should have been a highrisk factor and
35:09it reported hundreds of millions in cash
35:12and it had a big four auditor and if you
35:14looked at the cash at the bank statement
35:17it said that it had hundreds of millions
35:19but if you looked at the line you'd see
35:20that they used white out and they used a
35:24different font to type in the cash
35:26number and was slanted it wasn't even
35:29how do you get more obvious than that
35:31instead of having hundreds of millions
35:32in the bank account they had $9 and that
35:35was a big four audit and that's the
35:37quality of the audit when most of the
35:39audit hours are performed by somebody
35:41between the ages of 22 and 27 years old
35:44I would say that's an upside down
35:46profession what do those kids know
35:48they're not getting trained they're
35:49working terrible hours 7even days a week
35:52they're burned out they're using Auto
35:54procedures that are carefully designed
35:56never to catch fraud my my sons are both
35:58fourthe accounting majors in Boston and
36:02at one of my son's schools Bentley the
36:04kids were interviewing were actually
36:06interning last summer at a big four firm
36:08in Boston and they were told whatever
36:11you do if you see fraud don't say
36:13anything is that a way to train your
36:15interns at a big four firm is that what
36:18it's come down to right so maybe Harry
36:21Before I Let You Go one other area I do
36:23want to cover in the business of Fraud
36:25and I have a fear that it's going to
36:27accelerate it more than slow it down but
36:29gen of AI has been on the tips of
36:32everybody's tongue and now deep seek has
36:35come out and it briefly brought Nvidia
36:37down I think they lost close to 600
36:39billion in one trading session maybe
36:41just a week or so ago in in late January
36:43but we're just amping up and I think in
36:45an investment process perhaps it could
36:48help to some degree but I also wonder
36:52about deep fakes and AI in the hands of
36:56frosters particularly in ccial Services
36:59where you've got this great transfer of
37:01wealth less sophisticated people
37:03inheriting money I think the situation
37:05is very very ripe and I do fear that
37:08there might be some useful benefits to
37:10AI but it might be maybe bending the Arc
37:13of opportunity more toward the person
37:15looking to commit the fraud than adding
37:17value to the client's portfolio I'm a
37:20long time Quant and we were looking at
37:23AI type models years ago and the problem
37:28that you run into there was a lot of
37:30factor modeling on Wall Street and you
37:31remember in the in the 90s quants were
37:34doing quite well and they would mine
37:36those databases to the nth degree and
37:39the problem became that as more people
37:41got into it and discovered the same
37:43factors the alpha was arbitraged away
37:47and I think what AI what they're going
37:49to run into is how much of the financial
37:52research even though it's peer reviewed
37:55was actually accurate and it's not a
37:57high percentage is it and how much fraud
37:59is there in academic research turns out
38:01that there's a lot and we just
38:03discovered that in Boston recently at
38:04several of our universities didn't we
38:06more on the scientific journal side and
38:09the medical side and so if the data is
38:11wrong and if everybody's using the same
38:13databases like crisp and fax set and
38:17Bloomberg what's the source data look
38:19like and what if it's wrong and
38:21misreported and then let's think about
38:23the data that does get reported when the
38:26government reports economic figures
38:29early in the mornings usually how many
38:31revisions are there if it's GDP there's
38:33going to be the initial revised and then
38:36a final you're going to get three
38:37different numbers well what does the
38:39market trade on it trades on the first
38:41number doesn't it the initial it doesn't
38:43trade on the actual because that's going
38:44to come a couple months later isn't it
38:46and so a lot of people don't even know
38:47where the data comes from and is AI
38:50going to know because it's programmed by
38:52it guys and it has always promised you
38:56the moon and and delivered a lot less
38:58than a moon and they've done that a lot
39:01a lot over the decades because they have
39:04stock options they're incentivized to
39:06sell you a bill Goods how many of you
39:09have upgraded your phones recently and
39:11AI is on your phone I discovered it the
39:14other day it's been sending out texts to
39:16Buddies of mine that I never wrote and
39:19so I had to kill that as soon as I could
39:22and so we're going to have problems with
39:24AI and AI generated fraud and fakes I
39:28guarantee you the scammers are evolving
39:31the dollars are getting bigger the
39:33incentives are high especially for
39:35foreign-based
39:37broaders in countries without
39:39extradition to the United States
39:40especially Russia North Korea China
39:44Eastern Europe yeah those def fakes are
39:46coming there's going to be a lot of
39:47people losing a lot of money and due
39:50diligence you got to go boots on the
39:52ground you got to actually be there if
39:55people are going to invest in forests
39:57they better go to the forest and make
39:59sure they're not buying trees that
40:00somebody else already bought because
40:02those things don't have serial numbers
40:03on them do they you better check the
40:05property title records I actually did a
40:08case where somebody was selling trees
40:10more than once and it was an ESG scam a
40:13lot of ESG is fake on those carbon
40:15credits that's a horribly policed Market
40:18there is no police force there the
40:20standards they just don't exist the
40:22accounting standards don't exist for ESG
40:25it's too early to invest in ESG
40:27everybody's saying they're ESG and
40:29they're greenwashing I don't do those
40:31cases but I did attempt one and I'm
40:34waiting for it to get bigger the case
40:36was too small for me to take but I was
40:38seeing people selling the trees more
40:40than once the same carbon credits crazy
40:43and no one checks anything and the
40:45reason is you got to go to some third
40:47world country it's really hard to get to
40:50and you got to put boots on the ground
40:51and you got to hire an interpreter that
40:53speaks the native language and how many
40:55people are doing due diligence like that
40:56and turns out
40:57no one the agency risk is very high we
41:00don't have time to get into this area
41:02but it is interesting if I look at this
41:03next turn where democratization of
41:06Alternatives is alive and well and the
41:10nature of getting access to Alternatives
41:12should be a pure play diversification
41:15trying to get a risk exposure you cannot
41:17get in the public markets that can
41:20happen and diversification still a free
41:22lunch but one of my favorite taglines is
41:25it's got a cover charge and the cover
41:27charge is called due diligence and you
41:30think about agency risks just in a local
41:32environment versus trying to handle that
41:35and manage that in farflung places that
41:38you can't even find in the globe much
41:40less visit and you are taking a lot of
41:42risk and the Art of investing is all
41:45about taking risk and understanding how
41:48you're being compensated for that it's
41:50no more complicated than that but it
41:52seems like that very basic lesson gets
41:54thrown out the window time and time
41:56again
41:57I think Charlie Ellis said it best it's
42:00a losers game just try not to lose don't
42:03make a footfall and he uses the tennis
42:06analogy you got to be smart about things
42:09and you can't afford to have blowups in
42:11your portfolio like
42:13Toronto obvious fraud no one to due
42:16diligence there except for the people
42:18working there with the whistleblowers
42:20the board was out to lunch it was a
42:22great board on paper but nothing but
42:24empty suits and empty dresses on that
42:28board even Walgreens CEO who lost his
42:30job over that they put aund million
42:32dollar into putting those thonus
42:35machines to test blood in their stores
42:37and cause patient harm and it was so
42:41obvious to do due diligence you go to a
42:43blood lab like Quest Diagnostics you get
42:45the test run you get a test strip run
42:48you go in with the results then you go
42:49to the thonos machine and get their
42:51results and you stay there and watch the
42:53machine perform and of course it
42:55couldn't if you had done that that CEO
42:58at Walgreens might still be there and
43:00they wouldn't have lost over hund
43:01million doar on it and how many people
43:04lost billions of dollars investing in
43:05that crappy product that didn't exist
43:08and it was too many and it was some of
43:10the top VC firms in America that were
43:14taken and so it's easy to get fooled if
43:16you don't show up with the right kind of
43:18test you have to think before you invest
43:21what's my due diligence going to consist
43:23of what kind of tests would no one think
43:26to ask come up with those tests and go
43:28in there and ask those tests and run
43:30those tests and if they don't respond or
43:33say it's privileged information walk out
43:35the door because it's a scam no one does
43:37those type of things that's how you
43:39avoid the losers game read Charlie
43:42Ellis's book yeah no I think it's a
43:43great Point Harry and something you
43:45mentioned earlier that if you cannot see
43:47due diligence as a line item on that
43:50manager's p&l you should run in the
43:53opposite direction if it is part of
43:54marketing or just part of the IR team
43:57coming in there that didn't work 15 to
44:0020 years ago it will never work into the
44:02future unfortunately it sounds like
44:04you're quite busy which I guess is maybe
44:06good for the maropis family less good
44:09for the industry as a whole but I very
44:11much appreciate the great work you're
44:13doing and even more so your ability to
44:16give back and talking at the CFA Boston
44:19in terms of teaching some of this next
44:20Generation we can all benefit a lot so
44:23great discussion Harry and I'll probably
44:25have you back it's just a very fast
44:27ining story and made off but there are
44:28going to be more Tales from the Crypt
44:30and I just love to hear them we should
44:31talk about the currency frauds that I
44:33did with the custody Banks were
44:35backdating Forex screwing all the hedge
44:37funds all the mutual funds all the
44:40Pension funds for decades never got
44:43caught until I came along started asking
44:46questions and recruiting people from
44:47inside to turn whistleblower and we
44:51should talk about American depository
44:52receipts hundreds of billions of dollars
44:54or adrs were sold by over 30 Banks and
44:57investment Banks they never bought the
44:59shares they never put them into the
45:01trust they'd run that scam for decades I
45:05helped a buddy of mine get that case
45:06taken by the SEC they turned it down the
45:08first time and John German Ariel
45:11American hero I'd like to come back and
45:13tell you about that man and what he did
45:15and how he suffered to do that case to
45:18bring truth and honesty to the American
45:20depository receipts Market how many
45:22times do the banks have to cheat before
45:25you stop trusting them and talk about
45:27due diligence so if you want me to come
45:29back I have a big case coming this year
45:31and if you want me to come back I have
45:33some other fascinating cases that we can
45:34cover that the public probably knows a
45:36lot less about than made off and I can
45:38give you guys a lot more due diligence
45:40tips I hope to be teaching in some of
45:42the universities next fall hopefully I
45:43can do that in Boston too where my sons
45:46go to university they're both accounting
45:47majors and they got another year and a
45:49half left so I'd like to do some
45:51teaching in the universities as well on
45:53due diligence so thank you love to come
45:55back yeah outstanding on all friends
45:57Harry and I live in Newton just outside
45:58of Boston I'm active in the group out of
46:01Boston the local chapter there and we do
46:03a lot with the local CFA societies to so
46:05perhaps we can have you speak at one of
46:06those events this episode's going to be
46:08the opening for season 3 of educational
46:11Alpha and I think your day job and the
46:13title of the series fits so well
46:15together and I'd love to have you back
46:17throughout the course of this season and
46:19maybe see you at a local Kai event as
46:21well great love to speak to the CFA
46:23Society of Austin and of Austin chapter
46:25of Kaa love to do that as well so thank
46:27you hopefully we'll get together soon in
46:29Newton or downtown Boston excellent
46:31thanks
46:32Harry thank you for listening to
46:34educational Alpha I'm your host Bill
46:37Kelly learn more about the Kaya
46:39Association And subscribe to the show at
46:41ca.org that's
46:44c.org see you next time

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