Harry Markopolos submitted a document to the SEC in November 2005 titled The World's Largest Hedge Fund is a Fraud. It runs to twenty-one pages and lists twenty-nine red flags.
It is, incidentally, the best investment fraud detection protocol ever written, and it is publicly available.
Its central argument is arithmetic rather than moral. Madoff's reported returns — around one to two percent a month, with almost no losing months, sustained for years — described a performance curve that no strategy produces. Markopolos's specific point was that the claimed split-strike conversion strategy could not generate those returns given the size of the fund relative to the options market it would have had to trade in. The options volume did not exist.
The structural flags are the transferable part, and they can be checked by anyone.
Custody. Madoff's firm held the assets, executed the trades, and produced the statements. There was no independent custodian, which means every number an investor saw was generated by the party being evaluated. This is the single most important check in the list.
The auditor. Madoff's accounts were audited by a three-person firm in a strip mall in New City, New York, with one active accountant, for a fund reporting tens of billions.
Volatility. Real returns have variance. A smooth line is not evidence of skill; it is evidence that the numbers are not coming from a market.
Secrecy about strategy, justified as proprietary.
And the redemption test, which is the cheapest and most informative action available: ask for your money back. A functioning fund returns it. A Ponzi scheme meets redemptions from deposits and becomes evasive when they cluster, which is what ended Madoff in December 2008.
The SEC's Office of Inspector General report, OIG-509, documents what happened to Markopolos's submissions. There were multiple credible complaints over nearly a decade. Examinations were opened and closed. The report's conclusion is that the failure was not a lack of information.
The behavioral finding to carry from chapter 124: investors read the smoothness as safety. Prospect theory's value function prefers a stream of small gains with no losses above almost anything, so the impossibility registered as reassurance.
The counter-response is procedural: independent custody, an auditor you can look up, published volatility, and a small test redemption before a large commitment.
This counters Law 26.
Counters Law 26, Appear Not to Need It