History teaches that history teaches us nothing.
-Georg Wilhelm Friedrich Hegel
As defined by the author of the book by the same name, a Black Swan is a highly improbable event with three principle characteristics: It is unpredictable; it carries a massive impact; and, after the fact, we concoct an explanation that makes it appear less random, and more predictable, than it was.
Because of their highly impactful nature, Black Swans elicit strong emotions, whether of despair or inspiration. They come in all forms—from violence to natural disasters to technological advances. Modern day examples of Black Swans: the rise of the internet, the success of Google, the proliferation of mobile phone usage, World War I, and the terrorist attacks of September 11, 2001.
In the past 100 years, for example, computer and communication technologies have been responsible for the largest democratization of information since Johannes Gutenberg invented the printing press in the 1400s. The impact is unmistakable; and the forecasting, impossible. To quote Ev Williams, CEO of Twitter:
“McKinsey did a study for AT&T in the 80’s about cell phones. Prediction: 1M units in US by 2000. Actual: 109M. Forecasting is hard.”
As a Black Swan’s unpredictable and highly impactful qualities are readily identifiable, it is it’s third characteristic—the hindsight bias—that merits a closer look. After the occurrence of a Black Swan, the event is rationalized with hindsight, as if it was expected to happen. Such is the case with what is possibly the most grand fraud in Wall Street history: the asset management arm of Bernard L. Madoff Investment Securities LLC, founded in 1960.
Show Me the Money
There were two main classes of investors in the asset management arm of Madoff Securities. The first class invested for capital gains to fund a generational wealth transfer. This class was focused on compounding wealth as much as possible, re-investing any income or gains back into the funds. As the statement balances compounded over the years, the wealth transfer class grew more and more captivated with the genius of the investment model, having no idea what the actual model was. In the end, this class lost everything. The dreams of a generational wealth transfer carried a shocking conclusion: when they went to the window to withdraw, the fund was closed. The deposits and gains that had existed on paper were gone—redistributed to people and causes that the world may never know.
The second class invested for income. Madoff’s returns were 1% a month, or 12% a year. This class withdrew money on a regular basis to fund retirement, living expenses, or other clandestine operations. This class lost their invested principal, but received regular intervals of income before the shut down. Many names—both known and unknown—were included in this class. Given the level of capital flows from international sources into the fund, it’s easy to deduce that Madoff was managing money for some of the villains which war had been declared upon.
International Fund Flows
Private investigator Harry Marry Markopolos was unable to find former employees to gain information regarding the fraud. Nobody ever left. In response, he tracked the feeder funds—or what he terms “the tentacles” of the fraud. The majority of investors did not invest directly into the funds; they could only gain access with an elite management team that had a “special relationship” with Madoff. As walls were built around entry, the mystique was reinforced. Only the elite, of exceptional privilege, could invest. To have a remote chance of getting in, you had to invest with a fund of funds or so called feeder fund. The feeder funds charged 4% a year to their clients. Contrary to popular belief, the fraud has had a massive international impact. Money flows into the fund came from around the globe. There were 79 feeder funds in the US, 77 in Switzerland, 52 in the UK, 27 in Italy, and so on. Large fund flows came from known tax haven countries. The owners and fund flows from tax havens are exceedingly difficult, if not impossible, to track. To return 12% a year to investors and to pay the managers of feeder funds 4% a year, the model needed to return 16%.
What was started as early as the 1960s had grown to over $10 billion by 2000. As of 2009 estimates, the price tag of the fraud is marked at $65 billion. The word from my sources–the fraud was much larger. The investigation into and details surrounding it are still in their infancy. Markopolos is quoted as saying we are “at the end of the first inning of an extra inning ball game.”
Evidence
In hindsight, there were several glaring clues that pointed to fraud and an investment model incapable of the claimed returns. Consider the following:
The charter of the fund was to replicate the return on the S&P 100 Index (OEX). That said, the correlation coefficient of the fund and the OEX was 6%–far beneath the bounds of rationality for an attempt at replication.
One of the allures of investing with Madoff was the regularity of the (alleged) returns. Madoff returned 1% a month, or 12% a year with striking regularity. The 12% ratio was just enough to enthrall investors, but not too much. Any more would have led to suspicion. If you have traded for any reasonable amount of time, you come to understand that returns are never so smooth. On a graph, the fund’s performance began at the lower left of a chart and ascended to the upper right in a smooth 45 degree angle. 96% of his months were reported as positive. Some track records are just too good to be true. Brokers, dealers and traders who saw the numbers thought it fraud straight away. The problem: Nobody cared.
The fund claimed to own insurance against a severe market dislocation or crash. The insurance was in the form of put buying. Some quick analysis on the size of the fund showed that to insure against a calamitous event would cost +/- 24% a year. Markopolos looked at the number of option contracts traded on the OEX. The numbers showed the entire open interest in the contracts could not insure a fund the (alleged) size of Madoff. In sum, the investment model had to return 40% (12% to investors, 4% to feeder funds and 24% to insurance) to so stay within it’s charter and to break even. This is before any of the employees have been paid. Reportedly only 1% of the funds value was going to the chairman each year. In some circles 1% of $65 billion—$650 million—is a grand sum of money.
The fraud was spotted in 1998 by the aforementioned investigator Harry Markopolos. He submitted the now infamous red flags to law enforcement officials in May of 1999. In 2001, Michael Ocrant rang public alarm bells when he wrote the now infamous commentary Madoff tops charts; investors ask how.
Hindsight
It is important to note that whistle-blower Markopolos does not believe that this was a case of corruption within the legal authorities—neither securities regulators nor criminal investigators. Incompetence, yes; but corruption, no. Consider the whistle-blowers frustration during a conversation with federal authorities.
“We investigate crime after it happens,” the agent defends.
“We’ll I am reporting a crime…it has happened!” He retorts.
“You do not have proof.”
“Yes I do. My proof is as follows…”
“That is not proof.”
With so much evidence and no corruption, how did the fraud persist? With hindsight bias, it is easy to explain away the tragedy of Madoff. Regulators and criminal authorities did not pursue the possibility of fraud even when evidence clearly pointed to it. Necessary scrutiny or reasonable vigilance by management of feeder funds was sorely lacking. Finally—and most compellingly—the model itself was impossible.
Hindsight bias deludes us into thinking we know what we are talking about. Forecasting a Black Swan is impossible—by it’s definition—and we must therefore be careful when tempted to assign blame in their aftermath. This was not the failure of any one person or single agency. Generations of law enforcement and regulators were blind to this now obvious swindle. Many fighters of injustice go unrecognized. They foil iniquity before we must witness and fear it. Harry Markopolos did not investigate Madoff to garner attention. He wishes Madoff would have been stopped sooner. His choice would have been anonymity. The spotlight feels forced.
The Oldest Trick in the Book
History teaches us that history teaches us nothing. While the crime of Madoff persisted, there were plenty of other headlines to deflect us. Now that Madoff is history, we risk the entrenchment of the aftermath—which could deflect us from something larger and far more threatening.
The oldest trick in the book is the infamous tapping on a person’s left shoulder when you’re standing on their right.
And this, Madoff did with perfection.
Saturday, April 4, 2026 
