The Wizard of Lies: Bernie Madoff and the Death of Trust (12 page)

That impossible dream was exactly what some lucky people said they got, year in and year out, from Frank Avellino and Michael Bienes: real, steady interest payments, zero volatility. Because Madoff’s returns, like those of a lot of arbitrage traders of that era, were always within a narrow range, the payment of interest to their clients made sense to them. It meant that for some quarterly payments, they’d pay out a little more than they received from Madoff, and for others they’d pay out less than they received, but in the end it would all even out. And if most clients left the interest in their accounts to grow, the rough edges would become all but invisible over time. Avellino & Bienes seemed to have turned the speculative and risky practice of investing in the stock market into a smooth and predictable revenue stream—like interest on a high-grade corporate bond, without the erosion of capital. Bernie Madoff’s steady returns made this possible.

In an inflation-obsessed environment, the change that Avellino and Bienes made in how they handled the investors first recruited by Saul Alpern—“let’s pay them interest”—put Alpern’s little business serving a cluster of “friends and family” into overdrive.

Madoff would later insist that he recovered from his missteps in 1962 and went on to make real money for these early clients—and given the hot market environment in the 1960s and the strategies he claimed to be using, he might have been telling the truth. In his first decade in business, the over-the-counter market was racking up annual gains many times greater than his investors were supposedly getting in those days. Even in the 1970s, Madoff could have been making more money as an institutional investor than Avellino and Bienes were paying out to their retail investors. Indeed, a few faint recollections among investors suggest he may actually have used the money from some early investors as working capital for his young firm, producing enough profits to easily cover the promised returns.

That still would have broken the rules, of course—had they known about it, regulators could have accused Madoff of misappropriating client funds. But it was at least statistically possible that he was successfully investing the limited amount of money that Saul Alpern was bringing in from family and friends.

Word spread, and the word was that the Avellino & Bienes firm was the only way to invest with the remarkable Bernie Madoff, who would not accept individual customer accounts.

That so many of the firm’s accounting clients invested through the firm may simply reflect the role that accountants played in an era before “private bankers” and “investment advisers” were widely available to the moderately affluent people who ran small businesses. For them, their company’s accounting firm was as close to a financial adviser as they could get—and who had time for anything more elaborate, even if you could find someone more qualified? They were running a business, after all.

So the number of Avellino & Bienes investors grew exponentially, and the amount of money involved grew right along with it. By the end of the 1970s the Madoff investment operation made up more than a third of the accounting firm’s business. Four people in the firm’s New York office handled calls and applications and mailed out the checks and statements: two data entry clerks, a receptionist, and an office manager who dealt with inquiries through the mail and over the phone.

And the firm always paid; no one ever complained or expressed doubts about their operation. No wonder the checks poured in and the referrals were incessant.

Bienes insisted later that he and Avellino “never advertised, we never promoted, we never sent out a Christmas card—and the money came in.” When they had collected a substantial sum, they would send it to Madoff. At the end of each quarter, they would draw money from the firm’s Madoff account and deposit it to cover the individual interest checks they mailed out.

Apart from the money, the amount of trust that customers invested in this back-of-the-envelope arrangement was remarkable. No one on Wall Street or in regulatory agencies in Washington had ever heard of Avellino or Bienes. There were no brochures, no fact sheets, no paperwork at all—and the two accountants made it emphatically clear that there never would be, so don’t ask. All you could expect was a simple receipt stating the amount you’d invested and the promised interest rate. “That’s all we’d say. We were very tough,” Bienes recalled later. Those were the rules: put nothing in writing.

Meanwhile, they were also handling their firm’s accounting work. “We had medium-sized, small clients, individual clients,” Bienes later recalled. “A lot of them were oddballs, I gotta tell you. But then again, as Saul Alpern always said, the normal person does not go into business for himself—he goes and gets a job.”

Bienes and Avellino were oddballs themselves, a pair of Damon Runyon characters set in real life. Frank Avellino had the curious habit of referring to himself in conversation in the third person, by his full name. Asked in subsequent testimony about any bank loans the partnership had obtained, Avellino said, “All I could say to you is, at one point in time, Michael Bienes and Frank Avellino borrowed millions of dollars from Chemical Bank, unsecured, period…. We voluntarily turned in our loan to the bank. They hated us for it.”

Avellino did it, he explained, because “I don’t like to give out financial statements, I don’t like them to know—I’m a very private guy, by the way, as is Michael—it’s none of their goddamn business, in plain English, and I think we could afford not to borrow.”

Avellino and Bienes referred to the people who sent them money as “lenders,” not investors. They repeatedly explained that their clients were lending them money to finance the accounting firm’s investment activities. They were promising to pay those individual lenders a stated interest rate, which they paid with the profits they earned by investing with Madoff. Their persistence in this description suggests that they thought they could fit this lucrative business into a legal loophole for “demand notes,” which did not have to be publicly filed with securities regulators.

Later, in response to a question about how the partnership made sure it could pay its promised interest rates to this expanding universe of “lenders,” Avellino answered, “Michael Bienes and Frank Avellino…have their own assets, which we always know can be called upon because we are personally liable on those loans.”

Despite these highly unorthodox arrangements, a host of investors came to believe that this, at last, was a legitimate solution to their gnawing investment dilemma. Traveling far beyond regulated Wall Street, they set up camp in a murky land with no written rules and no adult supervision. They nevertheless thought they had found a safe haven: they were getting the security of consistent returns without sacrificing the higher inflation-beating profits of more volatile, riskier investments. Wildly underestimating the risks they were taking, they felt lucky to have been allowed to invest money with—that is, to
lend
money to—Avellino & Bienes.

For so many smart but credulous investors, the road to Madoff led through a regulatory no-man’s-land. And for many of them, that road was paved, wittingly or not, by their trusted business accountants. Frank Avellino and Michael Bienes were merely the first.

The computer technology that took root on Wall Street in the 1970s allowed the world to take a closer look at the stock-picking, market-timing wizards who seized the public’s attention in the previous decade. Unfortunately for the wizard fraternity, analysts found that a portfolio carefully chosen by some lionized genius typically did no better than a portfolio of stocks chosen utterly at random.

The fatally seductive idea that there was a genius who could be relied upon to pick the right stocks at the right moment and beat the market by double or triple digits, year in and year out, without fail—well, that notion is a phoenix, a feather-headed concept that rises, more or less intact, from the ashes of every market meltdown.

Its indestructible appeal to a wealthy investor named Stanley Chais had enormous consequences for Bernie Madoff, who seemed to be exactly the kind of genius Chais and everyone else were looking for.

Chais was a courtly gentleman who, by the late 1960s, had sold and retired from his family’s East Coast knitwear manufacturing business. Before moving to the Los Angeles area sometime around 1970, he lived in Sands Point, on Long Island, with his attractive wife, Pamela—one
New York Times
article from the era took note of her “peaches-and-cream complexion” and “tidily coiffed” blond hair—and their three children. Pamela Chais was the daughter of a Broadway playwright and was a promising playwright herself by the time the family moved west.

Before the family relocated, Chais met Bernie Madoff through Marty Joel, the freewheeling broker who had shared office space with Madoff at 39 Broadway and was a client of Saul Alpern’s accounting firm. Chais and Joel had been classmates at Syracuse University and had remained friends. The Madoffs socialized with the Joels, so it was natural they would meet the Chaises. Chais was impressed by the money Madoff was making with arbitrage trading and decided to invest some of his own money in arbitrage. Soon he was making money, too.

Stan Chais and Bernie Madoff would remain connected for nearly forty years. The trust funds for the three Chais children and other family members were invested with Madoff. In time, Chais would have more than four dozen Madoff accounts, including those set up for his charitable foundation. Based on a few documentary traces, it seems possible that Chais also became acquainted with others in Madoff’s immediate circle, including his father-in-law, Saul Alpern.

Chais was not just an individual Madoff investor; nor was he someone who simply set up a Madoff account and put other people’s money into it, as Avellino & Bienes did. Starting in 1970, Chais set up three formal partnerships that raised money from other people and invested it with Madoff. This made Chais the forerunner of the hundreds of entrepreneurs who would create and peddle private funds designed solely to carry other people’s money to Madoff’s door.

Chais set up the first formal “feeder fund.” A feeder fund is simply a fund that raises money from investors and puts it into one or more other funds. Feeder funds raising cash to invest with Madoff would proliferate like oversexed rabbits after 1990. But it all began here, with Chais’s first partnership.

It was called the Lambeth Company, and it opened for business in 1970. The Brighton Company followed in 1973, and the Popham Company in 1975. Chais collected fees from his investors for running these three early funds, which looked very much like informal mutual funds, although he never registered them with the SEC. He did not believe he needed to because he had only a few dozen direct investors, according to people who knew him well. For similar reasons, he did not think he needed to be registered with the SEC to act as an informal investment adviser, they said.

Most of his clients found their way to him through word of mouth, either within the creative Hollywood circles frequented by his wife or through an accounting firm he used. And although he and his investment accounts were unregistered and unregulated, Chais and his many clients apparently felt confident that nothing would go wrong.

Each of Chais’s three partnerships took in money from additional “sub-funds,” other formal but unregistered partnerships that collected money and paid fees to their separate general partners. All the money, whether gathered directly through his own companies or indirectly through the sub-funds, was invested with Madoff.

The early paperwork for the three Chais feeder funds indicated that they were being formed to pursue arbitrage strategies—which matches the memories of a few early Madoff investors and other sources familiar with the accounts, and the version of events offered by Madoff himself.

A younger member of one family of very early investors—devastated by their later losses—said that his father was told by Madoff directly, at some point in the late 1970s, that he was using arbitrage as his money-making strategy. “He supposedly had come up with this computerized system for identifying opportunities to purchase preferred stock and short the common stock,” he recalled.

So it seemed possible—perhaps Stanley Chais persuaded himself it was even plausible—that Bernie Madoff could have used legitimate arbitrage strategies to generate steady, reliable profits on the money Chais collected for the Lambeth, Brighton, and Popham accounts at Madoff’s firm in the 1970s.

The strategy would begin to seem a little less plausible as the amount of money entrusted to Madoff grew with each passing year. Most arbitrage opportunities disappeared quickly if too much money was thrown at them too fast. And by the early 1980s, Madoff would be taking in a lot of money. Moreover, big institutional investors started to become more interested in convertible securities—the basic elements of these arbitrage strategies—in the late 1970s, and they would have been competing with Madoff for the best profit opportunities.

As far as Chais knew, however, Madoff had only a few clients and took in new ones only as a favor to a few close friends. Perhaps, in these early days, this was true. Madoff was already cultivating an air of quiet exclusivity. He expected his lucky clients to keep quiet about being in his elite club—talking about it would cause more people to pester him to get in and he didn’t want that, he said.

This attitude not only lent cachet to his growing business, but it apparently also kept each cash source in the dark about the existence of the others. Over the years, it would be difficult for anyone to mark the point when Madoff’s arbitrage-based investment business grew too large to be plausible.

Memories are fuzzy about exactly what kind of profits the Chais partnerships produced during the 1970s. Could Madoff have been producing steady arbitrage profits of 10 to 14 percent, year in and year out, as some people recall? Maybe. A lot of smart people allowed themselves to believe that’s how he did it. And perhaps, in those early days of the first true feeder funds, they were right.

The accounts Chais set up with Madoff for his own family were not arbitrage accounts; those accounts allegedly bought stock in strong, promising companies and then held on to it for years, or even decades. When Madoff’s account records were examined after his arrest, these Chais family “buy-and-hold” accounts were found to have performed far better than the formal arbitrage partnerships Chais set up for outside investors.

Lawsuits would later assert that by 2008 there were a number of odd errors in many Chais accounts. Stocks had been bought or sold on dates when the markets were closed, or at prices that were outside the stocks’ range on those dates. There would also be accusations, denied by Chais, that he directed Madoff to backdate trades and guarantee there would be no losses in his accounts, or to fabricate trades to produce specific tax gains or losses.

The wealth that accumulated in Chais’s own Madoff accounts, some of it fueled by the fees he collected from his outside investors, allowed Chais to become a devoted and consistent benefactor to economic and charitable institutions in Israel. He was also generous to Jewish charities in the United States and was widely respected and admired.

Family lawyers said later that Stanley Chais was utterly blindsided by Madoff’s betrayal and had never suspected a thing. He believed that Madoff was one of those rare market geniuses—like Warren Buffett or George Soros or the Magellan fund’s Peter Lynch—who have an instinct for consistently making a lot of money, no matter the market conditions. If he had had any idea Madoff was a crook, they said, surely he would not have left most of his family’s wealth, his income from fees, and his illusory investment profits in Bernie’s hands.

Stanley Chais was one of a quartet of very wealthy Jewish entrepreneurs who had set up accounts with Bernie Madoff by the end of the 1970s. The others in this elite club were Carl Shapiro, a legendary success in the garment industry; Norman F. Levy, a giant in the New York real estate business; and Jeffry M. Picower, the youngest of the four, who would start out peddling tax shelters and emerge by the end of the next decade as a man for whom the term
wheeler-dealer
might have been invented.

Unlike Chais, the other members of this core clientele did not form feeder funds or actively recruit streams of other investors for Madoff. But like Chais, they would stay with him for at least four decades, reaping astonishing profits and underwriting his credibility among other rich investors from Park Avenue to Palm Beach to Beverly Hills.

Their affinity for him seemed at least partly rooted in their status as self-made men who had great confidence in their own well-tuned bullshit detectors. Yet those detectors never seemed to buzz around Bernie Madoff. Young as he was—he would not turn forty until 1978—Madoff already had an air of calm mastery, free of any razzle-dazzle or phony showmanship. He didn’t seem greedy for their patronage. He never tried to entertain them with jokes or personal stories; rather, he listened appreciatively to their jokes and their personal stories. He never seemed to be trying to impress them—and, perversely, that impressed them.

He first impressed Carl Shapiro in the early 1960s by delivering better service than Shapiro was getting from a bigger Wall Street firm. Shapiro, born in 1913, was raised in an affluent Boston suburb and graduated from Boston University. In 1939 he and his father formed Kay Windsor Inc., which colonized a low-class niche in the garment industry—cheap cotton dresses—and utterly transformed it.

“When Kay Windsor was formed, cotton dresses and inexpensive housedresses were synonymous,” a reporter for the
New York Times
noted in 1957. “And retailers would quickly dispense with the services of any buyer foolish enough to suggest that cotton dresses be sold throughout the year.”

Kay Windsor helped change that, producing stylish year-round cotton dresses that became a wardrobe staple for the “working girls” and suburban housewives of the early postwar boom. A gifted salesman and hard-driving manager, Shapiro had taken the reins himself in the early 1950s, when his father retired. By the end of that decade, Kay Windsor was one of the largest dressmakers in the business, and Carl Shapiro was a very wealthy man. He became even richer when he sold Kay Windsor to a larger clothing company in 1970.

By then, he was already doing at least a little business with Madoff. According to Madoff, the connection was made through Madoff’s high school friend and fellow broker Michael Lieberbaum, whose family was woven into the small patch of Wall Street that Madoff occupied in those days. Mike Lieberbaum’s brother, Sheldon, worked for a larger brokerage firm, and Carl Shapiro was one of its clients, Madoff said in his first prison interview.

Shapiro “was interested in doing arbitrage, and they had a difficult time doing it” at Sheldon Lieberbaum’s firm, Madoff recalled. Plagued by the paperwork delays that would soon engulf all of Wall Street, that firm was taking too long to convert convertible bonds into common stock, a basic step in many arbitrage strategies, Madoff explained. “I did it faster,” he said.

After Madoff’s arrest, Shapiro told a roughly similar version of the story. “In those days, it took three weeks to complete a sale,” Shapiro said. “This kid stood in front of me and said, ‘I can do it in three days.’ And he did.” By some accounts, he gave the young broker $100,000 to conduct arbitrage trades for him and was pleased with the results. The bond between them grew stronger.

When Shapiro ultimately retired from the garment industry, he devoted himself to philanthropy in Boston and entrusted even more of his assets to Madoff. Many people would later say he trusted Madoff “like a son,” but their initial bond was clearly all business—he staked Bernie Madoff at the arbitrage table, and Madoff used that money to make more money. For the hugely successful Shapiro, it apparently was a simple equation: he trusted Madoff because Madoff delivered.

Norman F. Levy came into Madoff’s orbit later and through a more convoluted path, but he ultimately became one of Madoff’s closest friends and most faithful admirers. A year older than Shapiro, Levy graduated from DeWitt Clinton High School in the Bronx in 1931, just in time to see the New York economy plunge into the Great Depression. By 1934, after working as a clerk and door-to-door salesman, he landed at Cross & Brown, one of the largest real estate brokerage firms in the country. A close family friend said Levy joked that he was “the first Jew” ever hired by the venerable firm, whose roots went back to 1910. According to one account, he was hired on a two-week trial. If so, he clearly passed: within two years, he had scraped together enough to pay $700 for a Midtown building that he sold seven years later for a $15,000 profit. By 1967 he was president of the firm and well on his way to becoming an extremely wealthy man.