Page 47 - Malcolm Gladwell - Talking to Strangers

CHAPTER FOUR

The Holy Fool

1.

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: