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Chapter Four

The Holy Fool

In November 2003, Nat Simons, a portfolio manager for the Long Island–based hedge fund Renaissance Technologies, wrote a worried email to several of his colleagues. Through a complicated set of financial arrangements, Renaissance found itself with a stake in a fund run by an investor in New York named Bernard Madoff, and Madoff made Simons uneasy.

If you worked in the financial world in New York in the 1990s and early 2000s, chances are you’d heard of Bernard Madoff. He worked out of an elegant office tower in Midtown Manhattan called the Lipstick Building. He served on the boards of a number of important financial-industry associations. He moved between the monied circles of the Hamptons and Palm Beach. He had an imperious manner and a flowing mane of white hair. He was reclusive, secretive. And that last fact was what made Simons uneasy. He’d heard rumors. Someone he trusted, he wrote in the group email, “told us in confidence that he believes that Madoff will have a serious problem within a year.” He went on: “Throw in that his brother-in-law is his auditor and his son is also high up in the organization, and you have the risk of some nasty allegations, the freezing of accounts, etc.” The next day Henry Laufer, one of the firm’s senior executives, wrote back. He agreed. Renaissance, he added, had “independent evidence” that something was amiss with Madoff. Then Renaissance’s risk manager, Paul Broder—the person responsible for making sure the fund didn’t put its money anywhere dangerous—weighed in with a long, detailed analysis of the trading strategy that Madoff claimed to be using. “None of it seems to add up,” he concluded. The three of them decided to conduct their own in-house investigation. Their suspicions deepened. “I came to the conclusion that we didn’t understand what he was doing,” Broder would say later. “We had no idea how he was making his money. The volume numbers that he suggested he was doing [were] not supported by any evidence we could find.” Renaissance had doubts.

So did Renaissance sell off its stake in Madoff? Not quite. They cut their stake in half. They hedged their bets. Five years later, after Madoff had been exposed as a fraud—the mastermind of the biggest Ponzi scheme in history—federal investigators sat down with Nat Simons and asked him to explain why. “I never, as the manager, entertained the thought that it was truly fraudulent,” Simons said. He was willing to admit that he didn’t understand what Madoff was up to, and that Madoff smelled a little funny. But he wasn’t willing to believe that he was an out-and-out liar. Simons had doubts, but not enough doubts. He defaulted to truth.

The emails written between Simons and Laufer were discovered during a routine audit by the Securities and Exchange Commission (SEC), the agency responsible for monitoring the hedge-fund industry. It wasn’t the first time the SEC had run across doubts about Madoff’s operations. Madoff claimed to follow an investment strategy linked to the stock market, which meant that like any other market-based strategy, his returns ought to go up and down as the market went up and down. But Madoff’s returns were rock steady—which defied all logic. An SEC investigator named Peter Lamore once went to see Madoff to get an explanation. Madoff’s answer was that, essentially, he could see around corners; he had an infallible “gut feel” for when to get out of the market just before a downswing, and back into the market just before an upswing. “I asked him repeatedly,” Lamore recalled later: I thought his gut feel was, you know, strange, suspicious. You know, I kept trying to press him. I thought there was something else…I thought, you know, he was getting some sort of insight into the overall broad market that other people weren’t getting. So I repeatedly sort of pressed him on that. I asked Bernie repeatedly over and over again, and at some point, I mean, I’m not sure what else to do.

Lamore took his doubts to his boss, Robert Sollazzo, who had doubts too. But not enough doubts. As the SEC postmortem on the Madoff case concluded, “Sollazzo did not find that Madoff’s claim to be trading on ‘gut feel’ was ‘necessarily…ridiculous.’” The SEC defaulted to truth, and the fraud continued. Across Wall Street, in fact, countless people who had had dealings with Madoff thought that something didn’t quite add up about him. Several investment banks steered clear of him. Even the real-estate broker who rented him his office space thought he was a bit off. But no one did anything about it, or jumped to the conclusion that he was history’s greatest con man. In the Madoff case, everyone defaulted to truth—everyone, that is, except one person.

In early February 2009—just over a month after Madoff turned himself in to authorities—a man named Harry Markopolos testified at a nationally televised hearing before Congress. He wore an ill-fitting green suit. He spoke nervously and tentatively, with an upstate New York accent. No one had ever heard of him.

“My team and I tried our best to get the SEC to investigate and shut down the Madoff Ponzi scheme with repeated and credible warnings to the SEC that started in May 2000,” Markopolos testified to a rapt audience. Markopolos said that he and a few colleagues put together charts and graphs, ran computer models, and poked around in Europe, where Madoff was raising the bulk of his money: “We knew then that we had provided enough red flags and mathematical proofs to the SEC for them where they should have been able to shut him down right then and there at under $7 billion.” When the SEC did nothing, Markopolos came back in October 2001. Then again in 2005, 2007, and 2008. Each time he got nowhere. Now, finally, Markopolos described years of frustration.

I gift-wrapped and delivered the largest Ponzi scheme in history to them, and somehow they couldn’t be bothered to conduct a thorough and proper investigation because they were too busy on matters of higher priority. If a $50 billion Ponzi scheme doesn’t make the SEC’s priority list, then I want to know who sets their priorities.

Harry Markopolos, alone among the people who had doubts about Bernie Madoff, did not default to truth. He saw a stranger for who that stranger really was. Midway through the hearing, Massachusetts’s Democrat Micheal Kompono couldn’t contain his inthusiasm for Markopolos. “If you were offered a job at the SEC in charge of bruer, would you take it? Markopolos said he had pressing obligations and would have to decline. But clearly the feeling’s Harry Markopolos was someone we could all learn from in the aftermath of one of the worst financial scandals in history. Defaulting to truth is a problem. It lets spies and con artists roam free.

Here we come to the second, crucial component of Tim Levine’s ideas about deception and truth-default.

Harry Markopolos is wiry and energetic. He’s well into middle age, but looks much younger. He’s compelling and likable, a talker—although he tells awkward jokes that sometimes stop conversation. He describes himself as obsessive: the sort to wipe down his keyboard with disinfectant after he opens his computer. He is what’s known on Wall Street as a quant, a numbers guy. “For me, math is truth,” he says. When he analyzes an investment opportunity or a company, he prefers not to meet any of the principals personally; he doesn’t want to make the Neville Chamberlain error.

I want to hear and see what they’re saying remotely through their public appearances, through their financial statements, and then I want to analyze that information mathematically using these simple techniques.…I want to find the truth. I don’t want to have a favorable opinion of somebody who glad-hands me, because that could only negatively affect my case.

Markopolos grew up in Erie, Pennsylvania, the child of Greek immigrants. His family ran a chain of Arthur Treacher’s Fish & Chips outlets. “My uncles, they would chase after the people that did the dine and dash. They would go out there and catch them, make them pay,” he remembers.

I saw my dad get in fights with customers, chasing customers down. I saw people stealing silverware. I remember one guy, he’s huge, and he is eating off of other people’s plates that have left the counter, and my uncle says, “You can’t do that.” And the guy says, “Yes I can, they didn’t eat the food.” So my uncle goes to the other side of the counter, picks this guy up by his beard and lifts him up and he keeps lifting him up.…And I’m thinking, my uncle’s dead.

The standard immigrant-entrepreneur story is about the redemptive power of grit and ingenuity. To hear Markopolos tell it, his early experiences in the family business taught him instead how dark and dangerous the world was: I saw a lot of theft in the Arthur Treacher’s. And so I became fraud-aware at a formative age, in my teens and early twenties. He told me that the Association of Certified Fraud Examiners as estimated the restaurant’s looser, five to six percent of the revenues to theft. But I saw it. I saw our chicken and shrimp sprout legs and walk out the back door on a regular basis. They would throw cases of that stuff in the back of their cars. That was the employees.

When Harry Markopolos was in business school, one of his professors gave him an A. But Markopolos double-checked the formula the professor used to calculate grades and realized that there had been a mistake. He had actually earned an A-minus. He went to the professor and complained. In his first job out of business school, he worked for a brokerage selling over-the-counter stocks, and one of the rules of that marketplace is that the broker must report any trade within ninety seconds. Markopolos discovered that his new employer was waiting longer than ninety seconds. He reported his own bosses to the regulators. Nobody likes a tattletale, we learn as children, understanding that sometimes pursuing what seems fair and moral comes with an unacceptable social cost. If Markopolos was ever told that as a child, he certainly didn’t listen.

Markopolos first heard about Madoff in the late 1980s. The hedge fund he worked for had noticed Madoff’s spectacular returns, and they wanted Markopolos to copy Madoff’s strategy. Markopolos tried. But he couldn’t figure out what Madoff’s strategy was. Madoff claimed to be making his money based on heavy trading of a financial instrument known as a derivative. But there was simply no trace of Madoff in those markets.

“I was trading huge amounts of derivatives every year, and so I had relationships with the largest investment banks that traded derivatives,” Markopolos remembers.

So I called the people that I knew on the trading desks: “Are you trading with Madoff?” They all said no. Well, if you are trading derivatives, you pretty much have to go to the largest five banks to trade the size that he was trading. If the largest five banks don’t know your trades and are not seeing your business, then you have to be a Ponzi scheme. It’s that easy. It was not a hard case. All I had to do was pick up the phone, really.

At that point, Markopolos was precisely where the people at Renaissance would be several years later. He had done the math, and he had doubts. Madoff’s business didn’t make sense.

The difference between Markopolos and Renaissance, however, is that Renaissance trusted the system. Madoff was part of one of the most heavily regulated sectors in the entire financial market. If he was really just making things up, wouldn’t one of the many government watchdogs have caught him already? As Nat Simons, the Renaissance executive, said later, “You just assume that someone was paying attention.” Renaissance Technologies, it should be pointed out, was founded in the 1980s by a group of mathematicians and code-breakers. Over its history, it has probably made more money than any other hedge fund in history. Laufer, the Renaissance executive to whom Simons turned for advice, has a PhD in mathematics from Princeton University and has written books and articles with titles such as Normal Two-Dimensional Singularities and “On Minimally Elliptic Singularities.” The people at Renaissance are brilliant. Yet in one crucial respect, they were exactly like the students in Levine’s experiment who watched the instructor leave, spotted the envelope with the answers lying conspicuously on the desk, but couldn’t quite make the leap to believe that it was all a setup.

But not Markopolos. He was armed with all the same facts but none of the faith in the system. To him, dishonesty and stupidity are everywhere. “People have too much faith in large organizations,” he said. “They trust the accounting firms, which you should never trust because they’re incompetent. On a best day they’re incompetent, on a bad day they’re crooked, and aiding and abetting the fraud, looking the other way.” He went on. “I think the insurance industry is totally corrupt. They’ve had no oversight forever, and they’re dealing with trillions in assets and liabilities.” He thought between 20 and 25 percent of public companies were cheating on their financial statements. “You want to talk of another fraud? Publishing, book publishers. This came out of the blue. He had just published a memoir and was now in the habit of scrutinizing his royalty statements. “So I get 16 pages royalty statements and earning made us eligable, we called them Chinese batshit cause they made of totally not industry standard were more believable than my publisher’s.” Markopolos also keeps a skeptical eye on his doctors. Infact he make sure to tell them that forty cents of every health-care dollar goes to either fraud or waste.

Whoever is treating me, I make sure I tell them that I’m a white-collar-criminal investigator, and I let them know that there’s a lot of fraud in medicine. I tell them that statistic. I do that so they don’t mess with me or my family.

There is no high threshold in Markopolos’s mind before doubts turn into disbelief. He has no threshold at all.

In Russian folklore there is an archetype called yurodivy, or the “Holy Fool.” The Holy Fool is a social misfit—eccentric, off-putting, sometimes even crazy—who nonetheless has access to the truth. Nonetheless is actually the wrong word. The Holy Fool is a truth-teller because he is an outcast. Those who are not part of existing social hierarchies are free to blurt out inconvenient truths or question things the rest of us take for granted. In one Russian fable, a Holy Fool looks at a famous icon of the Virgin Mary and declares it the work of the devil. It’s an outrageous, heretical claim. But then someone throws a stone at the image and the facade cracks, revealing the face of Satan.

Every culture has its version of the Holy Fool. In Hans Christian Andersen’s famous children’s tale “The Emperor’s New Clothes,” the king walks down the street in what he has been told is a magical outfit. No one says a word except a small boy, who cries out, “Look at the king! He’s not wearing anything at all!” The little boy is a Holy Fool. The tailors who sold the king his clothes told him they would be invisible to anyone unfit for their job. The adults said nothing, for fear of being labeled incompetent. The little boy didn’t care. The closest we have to Holy Fools in modern life are whistleblowers. They are willing to sacrifice loyalty to their institution—and, in many cases, the support of their peers—in the service of exposing fraud and deceit.

What sets the Holy Fool apart is a different sense of the possibility of deception. In real life, Tim Levine reminds us, lies are rare. And those lies that are told are told by a very small subset of people. That’s why it doesn’t matter so much that we are terrible at detecting lies in real life. Under the circumstances, in fact, defaulting to truth makes logical sense. If the person behind the counter at the coffee shop says your total with tax is $6.74, you can do the math yourself to double-check their calculations, holding up the line and wasting thirty seconds of your time. Or you can simply assume the salesperson is telling you the truth, because on balance most people do tell the truth.

That’s what Scott Carmichael did. He was faced with two alternatives. Reg Brown said that Ana Montes was behaving suspiciously. Ana Montes, by contrast, had a perfectly innocent explanation for her actions. On one hand was the exceedingly rare possibility that one of the most respected figures at the DIA was a spy. On the other hand was the far more likely scenario that Brown was just being paranoid. Carmichael went with the odds: that’s what we do when we default to truth. Nat Simons went with the odds as well. Madoff could have been the mastermind of the greatest financial fraud in history, but what were the chances of that?

The Holy Fool is someone who doesn’t think this way. The statistics say that the liar and the con man are rare. But to the Holy Fool, they are everywhere.

We need Holy Fools in our society, from time to time. They perform a valuable role. That’s why we romanticize them. Harry Markopolos was the hero of the Madoff saga. Whistleblowers have movies made about them. But the second, crucial part of Levine’s argument is that we can’t all be Holy Fools. That would be a disaster.

Levine argues that over the course of evolution, human beings never developed sophisticated and accurate skills to detect deception as it was happening because there is no advantage to spending your time scrutinizing the words and behaviors of those around you. The advantage to human beings lies in assuming that strangers are truthful. As he puts it, the trade-off between truth-default and the risk of deception is a great deal for us. What we get in exchange for being vulnerable to an occasional lie is efficient communication and social coordination. The benefits are huge and the costs are trivial in comparison. Sure, we get deceived once in a while. That is just the cost of doing business.

That sounds callous, because it’s easy to see all the damage done by people like Ana Montes and Bernie Madoff. Because we trust implicitly, spies go undetected, criminals roam free, and lives are damaged. But Levine’s point is that the price of giving up on that strategy is much higher. If everyone on Wall Street behaved like Harry Markopolos, there would be no fraud on Wall Street—but the air would be so thick with suspicion and paranoia that there would also be no Wall Street.1 4.

In the summer of 2002, Harry Markopolos traveled to Europe. He and a colleague were looking for investors for a new fund they were starting. He met with asset managers in Paris and Geneva and all the centers of capital across Western Europe, and what he learned stunned him. Everyone had invested with Madoff. If you stayed in New York and talked to people on Wall Street, it was easy to think that Madoff was a local phenomenon, one of many money managers who served the wealthy of the East Coast. But Madoff, Markopolos realized, was international. The size of his fraudulent empire was much, much larger than Markopolos had previously imagined.

It was then that Markopolos came to believe his life was in danger. Countless powerful and wealthy people out there had a deep-seated interest in keeping Madoff afloat. Was that why his repeated entreaties to regulators went nowhere? Markopolos’s name was known to prominent people at the SEC. Until the Ponzi scheme was publicly exposed, he could not be safe.

He decided that the next logical step was to approach New York’s attorney general, Eliot Spitzer, who had shown himself to be one of the few elected officials interested in investigating Wall Street. But he needed to be careful. Spitzer came from a wealthy New York City family. Was it possible that he, too, had invested with Madoff? Markopolos learned that Spitzer was going to be in Boston giving a speech at the John F. Kennedy Library. He printed out his documents on clean sheets of paper, removing all references to himself, and put them in a plain brown 9x12 envelope. Then, to be safe, he put that envelope inside a larger plain brown envelope. He wore a pair of gloves, so he left no fingerprints on the documents. He put on extra-heavy clothing, and over that the biggest coat he owned. He did not want to be recognized. He made his way to the JFK Library and sat unobtrusively to one side. Then, at the end of the speech, he went up to try to give the documents to Spitzer personally.

“I’m sitting there, and I have the documents and I’m going to hand them to him, but after the event, I give it to a woman to hand it to Eliot Spitzer because I can’t get to him. He’s just surrounded by people. Then he heads out the back door. I think he’s going to go to the restroom and go to have dinner next door, all right? I’m not invited to the dinner. He’s heading out the back door to get in a limo to the airport to catch the last shuttle flight to New York.…Eliot never got my package.

It is worth mentioning that at the time Markopolos was president of the Boston Security Analysts Society, a trade group with a membership of 4,000 professionals. He didn’t have to show up incognito at Spitzer’s speech, wearing a bulky overcoat and clutching a sheaf of documents wrapped inside two plain brown envelopes. He could have just called Spitzer’s office directly and asked for a meeting.

I asked him about that:

Markopolos: That’s another regret of mine. I hold myself responsible for that. Spitzer was the guy. I should’ve just called him. Maybe I would’ve gotten through, maybe I wouldn’t have, but I think I would have.

MG: You had standing. You were—

Markopolos: President of the Security Analysts.…If the past president or current president…calls the boss and says, “I have the biggest scheme ever. It’s right in your backyard,” I think I would’ve gotten in.

MG: Why don’t you think you did that?

Markopolos: Woulda, coulda, shouldas. Regrets, you know. There’s no perfect investigation and I made my share of mistakes, too. I should have.

Markopolos sees his mistake now, with the benefit of over a decade of hindsight. But in the midst of things, the same brilliant mind that was capable of unraveling Madoff’s deceptions was incapable of getting people in positions of responsibility to take him seriously. That’s the consequence of not defaulting to truth. If you don’t begin in a state of trust, you can’t have meaningful social encounters.

As Levine writes:

Being deceived once in a while is not going to prevent us from passing on our genes or seriously threaten the survival of the species. Efficient communication, on the other hand, has huge implications for our survival. The trade-off just isn’t much of a trade-off.

Markopolos’s communication at the library was, to put it mildly, not efficient. The woman he gave the envelope to, by the way? She wasn’t one of Spitzer’s aides. She worked for the JFK Library. She had no more special access to Spitzer than he did. And even if she had, she would’ve almost certainly seen it as her responsibility to protect a public figure like Spitzer from mysterious men in double-size overcoats clutching plain brown envelopes.

After his failures with the SEC, Markopolos began carrying a Smith & Wesson handgun. He went to see the local police chief in the small Massachusetts town where he lived. Markopolos told him of his work against Madoff. His life was in danger, he said, but he begged him not to put that fact in the precinct log. The chief asked him if he wanted to wear body armor. Markopolos declined. He had spent seventeen years in the Army Reserves and knew something about lethal tactics. His assassins, he reasoned, would be professionals. They would give him two shots to the back of the head. Body armor wouldn’t matter. Markopolos installed a high-tech alarm system in his house. He replaced the locks. He made sure to take a different route home every night. He checked his rearview mirror.

When Madoff turned himself in, Markopolos thought—for a moment—that he might finally be safe. But then he realized that he had only replaced one threat with another. Wouldn’t the SEC now be after his files? After all, he had years of meticulously documented evidence of, at the least, their incompetence and, at the most, their criminal complicity. If they came for him, he concluded, his only hope would be to hold them off as long as possible, until he could get help. He loaded up a twelve-gauge shotgun and added six more rounds to the stock. He hung a bandolier of twenty extra rounds on his gun cabinet. Then he dug out his gas mask from his army days. What if they came in using tear gas? He sat at home, guns at the ready—while the rest of us calmly went about our business.