The Red Flags In the Madoff Fund's Past

Eighteen months ago a firm that does due diligence on investment advisers warned clients not to do business with Bernard Madoff's investment fund.

The firm, named Aksia and run by Jim Vos and Jake Waltour, based its warning on several red flags it discovered during an investigation. Those included ....

1. The Madoff investment strategy, called "split-strike conversion," is known to be very volatile; it involves trading huge positions around options expirations. Despite that volatility, its returns over the past decade were an amazingly stable 8-10 percent.

2. Aksia discovered a 2005 letter to the Securities and Exchange Commission from a financial advisor who supposedly studied Madoff's operations. That letter asserted Madoff was running a Ponzi scheme. There was also a Wall Street Journal story at the time about one of the Madoff's associated "feeder funds" getting shut down in 1992.

3. Madoff's strategy was bizarre: He said he would move $13 billion in various trades at once, yet Aksia couldn't find traders who saw his trades. There were also no regulatory filings. And family members were running the firm.

4. The comptroller of the firm was based in Bermuda. Most mainstream hedge fund investment advisers have their comptroller in-house. Madoff's so-called feeder funds, meanwhile, were audited by respectable auditors. That gave the impression that Madoff had a professional operation. But the central investment action wasn't with the feeder funds, but in Madoff's New York City headquarters. And those activities were audited by a smaller, lesser known firm.

5. Madoff sent out accounting statements by mail. Most hedge funds email statements and allowed them to be downloaded via computer for easier analysis by investors. Learn more in the accompanying video.

6. Aksia wasn't the first firm to check out Madoff's activities. A two-man shop (not counting the secretary) which operated out of a small office in Muncie, N.Y., was also looking into Madoff's activities.

Wooing European Clients on the Slopes

Sources told CNBC that Madoff was able to sell himself to European investors by indulging his favorite hobby: snow skiing.

Twice, the Frankfurt Stock Exchange held an "interbourse" ski competitions in Europe. Various stock exchanges around the world hold such competitions annually, and Madoff, a minority owner of the Cincinnati exchange, attended.

Madoff used the event the ski events to meet and greet major European business people, bankers and exchange heads. "He was like a rock star," said one person who attended a competition with Madoff.

• Slideshow: Crime on the High Seas