Would a Fraud Bounty Have Exposed Madoff Years Ago?

Laura Goldman is a money manager who claims to have figured out back in the 1990’s, in the space of about 45 minutes, that Bernie Madoff was a fraud.

In this Fox Business interview, she discusses (very entertainingly) her encounters with Madoff. At the time, Goldman worked for Paine Webber (remember them?):

He was buying stocks and also trading options against the stocks, O.K.? And the thing is, my previous office had been in the Philadelphia Stock Exchange. I’m from Philadelphia, so I knew many of the market players in options in Philly. It’s too hard to track the trading of Microsoft, but it’s much easier for me to track the trading of the options. So I talked to the president of the Philadelphia Stock Exchange at that time, his name was Nick Giordano; I talked to big market makers like Susquehana, and none of them were doing business with Bernie Madoff. So I was a little curious about it. And then Bernie came back and told me that he was trading the options in Europe. Well, that didn’t really make sense to me, because trading in Europe is usually much more expensive than trading in the United States, especially for American stocks. So I said to myself, I don’t need this headache now. It basically took me 45 minutes to figure out something was wrong.

Now Goldman is agitating for regulatory change to lessen the chances of future frauds. “I am working with the S.E.C. to prevent another one,” she says. “One of my ideas is to pay a bounty for those that detect fraud. They already have one for insider trading. People on Wall Street are not Mother Teresas. They are not going to the S.E.C. unless there is something in it for them. Your friend James Altucher even says that in his Tech Ticker interview.”

Goldman is cited in this TIME article about fraud whistleblowing:

Goldman, who blew whistles on such notable investment frauds as First Jersey Securities, Bayou Hedge Fund, and Lydia Capital, among others, now has the full attention of S.E.C. Inspector Kotz‘s office. In all, Goldman says she has alerted the S.E.C. over 30 times and, despite its cold shoulder, through one means or another she has seen 25 of those tips lead to fraud charges being filed.

An S.E.C. whistleblower bounty is hardly a pipe dream; the I.R.S., among others, already pays for good info on frauds.


Note that competitors will turn in suspected frauds because it makes their good numbers look not as good (as Madoff did). The problem in the Madoff case is that people did tell the SEC, which managed to ignore the tips and/or not find anything - at least 4 times! So, paying for tips only works if the SEC will actually do its job. If they will do their job, you likely do not have to pay.
But, I agree that if there is a reward for high stakes and real fraud (not just some minor violation) that actually hurts the investors.
I think there are rewards for whistle blowers within companies that commit fraud in SEC filings, so the model exists.


Nope. The SEC got the information for free and they ignored it. Multiple times. The argument could be made that since the SEC considered such tips "worth-less" (i.e., having no readily ascertainable value), they were justified in ignoring them.

However, offering a bounty would result in the opposite problem: they would be required to scrutinize each tip to find the ones that are "worth-while." And I can think of no better way to tie a regulator up than having them continuously chasing down tips from people with skin in the game.


A fraud bounty exposing the incompetence at the SEC would generate more jobs. At what point does ignorance become criminal?


Hunter makes a good point. If people can get a reward, then a lot of them will just keep turning in all funds at the top of the lists on recent returns (sort of opposite of sleazy lawyers that sue when a stock drops) - basically fishing. Unless you have to pay some money to file these petitions, there is no reason not to if you have a chance at a reward.
I say that instead, you tie complaints to the SEC to intrade. So, you setup bets on whether a particular company is committing fraud (and intrade can set the level of fraud necessary). This would also push the SEC to investigate any where the betting exceeds some threshold.

Neil (SM)

Is that IRS link correct at the end? It goes to the same Time article as the link above it.


#1 PaulK

The trouble with narrowing the "CrimeStoppers" model to only "high stakes and real fraud" in this arena is twofold:

1) It's a disincentive to potential whistleblowers who now have to contend with two sets of people who might think that the reported behavior is "no big deal" - the fraudulent manager and the regulator.

2) The size of the reward for the tip would have to compensate for all the externalities that go along with "high stakes and real fraud." For every Markopoulos who has the guts to speak up for free, there will be ten who won't squeal at any price and twenty who will sing for their supper, retraining for another career and relocation expenses.


Most of the massive fraud recoveries in healthcare are the result of qui tam lawsuits. Anyone can be a qui tam realtor, and the reward is quite substantial.


Instead of blaming the SEC, maybe we should be blaming the Congress that didn't fund the SEC. What good are laws if we don't have the manpower to enforce them.

Joe Smith

It is worth remembering that there were people who thought there was something wrong with Enron and that did not do any good either.


Hunter, if you do not narrow it, then you get too many people that find it too easy to report with little evidence. If the SEC is bogged down on simple and worthless things like slow to log (to miss reporting day), or minor infractions, it does not have the manpower to track serious issues, which take more effort to unwind.
If big frauds meant big rewards, then the perpetrators would be far more worried that someone else "in the know" will turn them in for the money. Most of those con artists fear the greedy whistelblower more than than the honest whistleblower.
If we ever get to where there are no big frauds and only small infractions, the system could be tuned, but I would not hold your breath.

Eric M. Jones

Hold on a minute....If I turn in a fraud to a tax-supported institution tasked with investigating frauds, don't they have a legal obligation to do so? Aren't they complicit in the crime if they just ignore it? Shouldn't somebody go to jail?

Last year I scheduled a business trip to Virginia where it would have been wildly inconvenient to avoid going through Washington D.C. Patriot that I am, I cancelled the trip because I knew I could not go through Washington D.C. without joining up with a radical group in the most audacious civil protest I could find....something involving skunk scent-glands and the justice department perhaps. After endless calls and emails and letters to my clueless representatives, how else can one express oneself when faced with such egregious self-serving criminal activity?

I am still irate.


The only real problem is the SEC.

No matter how sound the logic behind this could be sound but if the SEC gets a tip and then finds that there is no fraud nothing will work.

For Example if this was in place pre-madoff bust: In order to keep people from saying everyone is a fraud there is some penalty set for faulty filing of a fraud tip.

Still people reported the madoff fund as a fraud. However SEC investigates and descovers its not one (like the 4 times) and then penalizes the whistle blowers.

Later it turns out to be a fraud. which leads to a worse situation then we are in now.

Paulk that is very interesting thought about making a fraud-market however it may lead to a practice of buying a lot of your closet competitors and then using it against them.


Is this is a rhetorical question? The answer is obviously "no, a fraud bounty would definitely not exposed Madoff years ago." He had been exposed for free years ago. The SEC failed to take action. There should be a bounty for government incompetence. Harry Markopolos should get $2000 from everyone at the SEC who read his warnings and failed to act.


BONA, betting markets tend to self-correct. Like the sap who was trying to rig the Obama/McCain intrade market by buying a lot of McCain, it did not work because people bought more Obama on those improved odds. So, even if a company is trying to rig a competitors market or their own, the market will likely correct itself as long as enough bettors.


#10 PaulK

I agree with you, I think it illustrates the futility of implementing such a program.

(NERD WARNING) If one were to couch this in information asymmetry terms, a trader who "purchased" (via diligent analysis and possibly personal risk) closely held knowledge for a steep price has a choice: keep quiet and profit (or at least avoid a loss) or open his mouth and guarantee a loss. He can either be an unindicted co-conspirator, a silent bystander, or a whistleblower. Absent significant altruism, profit maximization or loss avoidance will rule the day.

On the other hand, if a low price was paid for the closely held knowledge, a much lower level of altruism is required for the blower to whistle.

So now we create a new, special market for this closely held information. Any monetary incentive will *overinduce* low-value tips, as some level of altruism (or petty vengence) will be enough to report inconsequential infractions. Additionally, it will likely *underinduce* high-value tips, as those who paid dearly to discover the fraud can look at a the dollar amount and make a "rational" (i.e. dollar for dollar) decision on whether it's worth it to sing.

Again, the difference here is that a monetary incentive to the whistleblower substitutes - at least partially - for the altruistic incentive. And while we know that the altruistic incentive works (albeit imperfectly and infrequently), introducing a dollar-figure analysis will certainly overinduce undesirable tips and discourage at least some of the desirable ones.


Gregory Frank

Many posters have pointed out the problem with the whistleblower idea--it still requires that the SEC act competently, which it seldom does.

Economically, a securities fraud whistleblower bounty should be effective because it aligns the economic interest of the whistleblower with society's interest in rooting out fraud.

Thus the more logical thing is to have the whistleblowers report to OTHER private actors, whose interests are already aligned with the public's interest in rooting out fraud--class action lawyers.

Because their own fees are at stake, class action lawyers will never ignore meritorious inside-information. They investigate all potentially viable claims. Because it is extremely difficult to win a class action lawsuit after Sarbanes-Oxley and the Private Securities Litigation Reform Act of 1995, there is little danger the lawyers will be incentivized to bring unmerited lawsuits. Almost all class action lawyers work on contingency and losing a suit is extremely expensive.

Moreover, the fees paid to the whistleblowers would ultimately have to be court-approved in a manner similar to how class-action lawyers' fees are approved. This check would prevent rogue activity and ensure that the whistleblowers are not over or under paid.



Here's a "fraud bounty" for ya: don't invest your money with hedge funds you know (or ought to know) to be fraudulent and you might not lose all of your money.

Larry Eisenberg

Whistle-blower bounty sounds great,
Where would-be-thieves proliferate,
SEC, could be said,
Is in over its head,
Reward those who don't vacillate!


Hunter, there are very few "altruistic" whistle-blowers in my view. Markopoulos reported Madoff because he was being made to look bad by using the stock+options technique and not doing as well as Madoff. Hardly altruistic.
I think most who report do so because of some personal gain or the mitigation of guilt or the prevention of prosecution. All reasonable motivations that any economist can get behind (because it is easy to understand, quantify, and qualify).
In any case, looking at the information asymmetry terms, the likelihood is that the trader will report based on lack of "safe" value in redeeming the information, ability to harm a competitor or someone they do not like, or perceived other value in telling (relative to cost of telling). This may sound cynical, but it is statistically more likely cases to base any policy on. Just because you have information does not mean you can safely use it, no matter how hard to come by.
One factor that has to come into play is cost of whistleblowing. Someone suggested charging for being wrong - talk about putting a chill in people passing on information! But, real whistleblowers face more serious issues in terms of work and even social life, since there are risks in how others around them will react; if they end the "good times" for their friends and bosses, they can assume that there will be repercussions. Most do so out of guilt or fear - guilt being closer to altruism of course.



armchairpunter - "don't invest your money with hedge funds you know (or ought to know) to be fraudulent ". OK, here is one for you: do not buy or own a home when you know or ought to know the housing market will fall dramatically.
The operative phrase is "ought to know". Is this telepathy you are suggesting or perhaps the average investor should spend thousands of hours poring through a funds books and cross checking with other trade desks to see if all legit? Some funds have very validly done very well, even in Bear markets. Doing well is not the proof of fraud. Madoff was careful not to have "gains" that were completely outside the realm of possibility (10% to 13%). The average investor is just not sophisticated enough to tell the difference between a great fund manager and a fraud. This is why we have the SEC and other regulatory bodies by the way.