Epistemically Virtuous Risk Management: Financial Due Diligence and Uncovering the Madoff Fraud

The chapter analyses how Bernard Madoff’s Ponzi scheme was uncovered by Harry Markopolos, an employee of Rampart Investment Management, LLC, and the contribution of so-called epistemic virtues to Markopolos’ success. After Rampart had informed the firm about an allegedly highly successful hedge fund run by Madoff, Markopolos used qualitative and quantitative methods from financial due diligence to examine Madoff’s risks, returns and strategy, ultimately to conclude that Madoff was running a large Ponzi scheme. Other actors in the financial industry may likely have done the same financial due diligence, but when they reached the same perplexing outcomes that Markopolos had found (alpha of 0.009 and beta of 0.06, for instance), they blamed the maths. Madoff’s impeccable reputation at the time was sufficient to make them doubt the maths and cease their financial due diligence. Markopolos, by contrast, exercised epistemic virtues such as openmindedness, epistemic temperance and justice, which led him to continue his financial due diligence and uncover the fraud. Financial due diligence, the chapter ultimately shows, has to be complemented by epistemic virtues if it is to be an effective shield against fraud and financial crime.