It was claimed by Madoff that he didn’t operate a hedge fund; however Madoff had the only entrance through an approved feeder fund. Into his operation, Madoff paid the funds for order flow. The performance of Madoff was doubted by others in the industry but just like Markopoulos very few studied about the same. Like Barron’s articles were written in respected publications and Madoff’s investment strategy was started to call into question. Markopoulos believed that given the fact that there was very little to no volatility of principle there were unrealistic returns and as the strategy claimed it promised to give excess returns. The options strategy claimed to be employed by Madoff was known as the split-strike conversion. This strategy was supposed to provide limited rewards and had limited risks. A long position in the basket of about 30-35 large capitalization stocks was required in this strategy which was highly correlated to the broader market(Rhee 2009). This also included a long position on out-of-the-money index put options and a short position of out-of-the-money index call money. However, there was no correlation amongst the strategy and the Madoff’s performance numbers. The claim made by Madoff was a return of 16% or more year after year which by a wide margin always resulted in beating the market.
The questions raised by Markopoulos regarding the business model of Bernie made some sense. Full service brokerage wasn’t provided to the clients of the Madoff securities. By applying a technologically enhanced approach to a traditional strategy known as split strike forward conversion, the strategy rendered execution only services to selected clients. As Madoff passed up standard hedge fund fee to feeder fund managers, this made no sense to anyone; while at the same time he was earning just the execution commissions on the proprietary trading strategy. The doubt which was raised that why would he accept execution commissions when with the performance history of Madoff a earning of 16% or more could have been earned. Moreover, by running a hedge fund also he could have earned 20% of the profits and return of 1%.