The Wizard of Lies: Bernie Madoff and the Death of Trust (17 page)

When Squadron’s firm landed Rupert Murdoch’s News Corporation as a client, Howard Squadron became very rich. He would invest a good deal of his wealth with Bernie Madoff and would introduce clients and friends to him as well.

Lawyers at several New York City firms set up formal partnerships so their clients could invest with Madoff. The same pattern developed at prominent accounting firms, such as Konigsberg Wolf and Stanley Chais’s accountants, Halpern & Mantovani in Los Angeles, both of which formed conduit accounts through which their clients could invest indirectly with Madoff. Even Friehling & Horowitz, the small accounting firm that handled Madoff’s brokerage firm audits, became a portal for others to invest with him.

It was in these bull market days of the 1980s that a former SEC lawyer named Jeffrey Tucker decided to leave the law firm he’d formed and set up an options trading fund with one of his clients. That client shared Midtown office space with a handsome former banker named Walter Noel Jr., who was trying to build his own money management business by relying on his affluent connections and those of his Brazilian wife. Noel thought Tucker’s new fund might have promise for his foreign investors. “Walter was very impressed with their trading—not just the strategies but the returns,” a contemporary recalled.

Sometime in 1989, Tucker parted company with his former client and began working exclusively with Noel to put the finishing touches on a new fund to be called Fairfield Greenwich. At about this time, Tucker’s father-in-law, a retired knitwear manufacturer, suggested that Tucker and Noel check out a brilliant money manager he knew: Bernie Madoff.

What was it about Madoff that made all these smart, analytical people trust him so much, so easily, for so long? Impressions gathered from personal experience with Madoff and from interviews with dozens of people who knew him provide a few clues. Unlike so many successful con artists, Madoff was never showy or brash, never overtly “charismatic.” Instead, without saying a word, he seemed to create a quiet but intense magnetic field that drew people to him, as if he were true north, or the calm eye of the storm. One associate called it “an aura.” Like a gifted actor, he drew one’s attention simply by stepping onstage, by entering a room.

He wore his expertise casually—“he had the decoder ring,” one former regulator recalled—and he seemed seductively unflappable in times that felt messy, chaotic, and scary to everyone else. He inspired confidence and made people feel safe. Another close associate recalled Madoff’s cool smile during the almost weekly bomb scares at the Lipstick Building that followed the terrorist attacks in 2001; he was always the last one out of the office, ushering his nervous charges down the stairways. Like the calm-voiced pilot in the cockpit or the nightmare-soothing father at the bedside, he simply made it seem as if everything were under control, that everything would be fine. Those close to him knew he could be angry, pushy, controlling, cutting, and rude, but even then he conveyed the reassuring toughness of a no-nonsense drill sergeant who never panicked or lost his grip, who drove his men hard but brought them all back alive.

Whatever the formula for Madoff’s fatal charm, his meeting with Tucker and Noel must have been encouraging. In the middle of the summer of 1989, they invested $1.5 million with him, money they’d raised through a vehicle they later called the Fairfield International fund. Six months later, they put another $1 million into Madoff’s hands. By November 1990, they were ready to market their new $4 million Fairfield Sentry fund and let the world in on their success with Madoff—almost literally “the world,” as it turned out.

This is the period that generates the sharpest questions about the origins of Madoff’s crime. Clearly his financial circumstances underwent a sharp change in the aftermath of the 1987 crash, pressuring him in ways that may have pushed him from the gray areas of tax games and currency flight into a full-scale Ponzi scheme. Absolute certainty is impossible—unless and until he and his accomplices come clean or new documentary evidence can be dug out of the rubble of his business records or those of the people who dealt with him. But reasonable conjecture is possible, and it ultimately focuses on these pivotal years in the last half of the gilded 1980s.

The conditions for a Ponzi scheme were all in place. Besides his new connection with Tucker and Noel, Madoff had caught the attention of a few other young offshore hedge funds. Riding the first wave of widening interest in hedge funds, these funds all started sending him large and increasing amounts of cash. The business taken over by Avellino & Bienes—which probably had only a few dozen customers in the 1960s and which Madoff said was still “not much of a business” by the late 1970s—hit an enormous growth spurt after 1983, driving more cash into his hands. At the same time, the cash demands from some of his biggest clients after the 1987 market crash put a great strain on his liquidity.

Those big clients “were very instrumental in creating my problems” because they “failed to honor their agreements,” he wrote in an e-mail from prison. He continued, “I’m sure you wonder how I could be so gullible. I guess I couldn’t face the fact that as close friends, I couldn’t trust them.”

He obviously saw how ironic it was for him, of all people, to complain about being betrayed by close friends. “I’m sure some of my other friends wonder how I did what I did to them,” he went on. “There was no justification for this. The difference I guess is that I thought I would get out of my problem and I had made so much money for them in the past with legitimate trading.”

He added, “None of this changes the timing I claim the bogus trading started.”

By his own admission, however, Madoff was facing big and unwelcome cash demands at just the moment when the cash spigot was turning on in force. It was a tempting bit of timing, and one that supports the conclusion that, at the latest, his Ponzi scheme started in the years right after the 1987 crash, using the money from his new investors to finance the withdrawals by his older ones.

He insisted later that this was not true, that these rivers of new cash did not tempt him to cheat—at least, not until a few years later.

As the 1990s began, Bernie Madoff was running a legitimate and apparently successful brokerage firm, with 120 employees and profits approaching $100 million a year. His firm was responsible for a remarkable 10 percent of the total daily trading volume in Big Board stocks and was handling 385,000 trades a month for larger Wall Street retail brokerage firms and giant mutual funds. As much as his rivals at the stock exchanges hated his practice of paying firms a small rebate for sending him their customer orders, academic studies showed that he still executed those orders at least as fast as anyone, and at prices that were as good as or better than customers could have found elsewhere. His “order execution” prowess impressed regulators and enhanced his firm’s reputation. His sons were developing a small propriety trading operation that made investments for his firm’s own account, and his firm’s software systems were considered among the best on the Street.

Behind closed doors, however, he was also running an immensely larger money management business, one that regulators knew nothing about. This hidden investment advisory operation was supposedly generating commission income for his firm and steady returns for investors whose accounts now totaled at least $8 billion. These included private investors such as Norman Levy, Jeffry Picower, and Carl Shapiro; feeder funds such as those run by Stanley Chais and Walter Noel; “introducers” such as Mike Engler and the brokers at Cohmad; and, of course, the legions of small investors whose money resided in a few large accounts labeled “Avellino & Bienes.”

Madoff grew increasingly careful about concealing how wide and deep the river of cash flowing into his investment advisory business had become. He admonished his feeder fund sponsors to keep quiet about who actually managed their money; he cautioned private clients not to talk about how much business they did with him—or even that they did business with him at all. His caution reflected the fact that his “split-strike conversion” strategy, like the arbitrage strategy it replaced, faced inflexible size constraints. Only so many shares of the blue-chip stocks supposedly in his portfolio were traded at one time, and the number of shares traded was reported every day. Only so many options were traded on the public exchanges in Chicago, and the volume of those trades was reported daily, too.

So a legitimate “split-strike conversion” strategy could not grow endlessly large. The bigger Madoff got, the harder it would be for savvy investors to believe that he was producing an honest profit. At some point, there simply wouldn’t be enough options trading in the public or private markets to hedge the amount of stock he would have been buying, and there would have been little chance he could really buy and sell stocks on the scale required without shoving the markets up and down in very visible ways.

Still, his whole aura of success as an investment manager was that he never failed to deliver the returns his investors expected. He had brought them profitably through all the bad times—the market’s tumble in 1962, the doldrums of the 1970s, even the 1987 crash and its rocky aftermath. No one knew that he had borrowed money from Saul Alpern to replenish his customers’ accounts in his early years, and no one knew that he had been squeezed by a rash of withdrawals in the late 1980s. All his clients knew was that he offered steady returns even in volatile times—and they all wanted to invest more money with him.

It was in this setting, he says, that his Ponzi scheme began. As long as most of his clients left their balances intact, “rolling over” their reported profits and making few if any withdrawals, he could pay out the occasional disbursement from the flood of new money coming in.

It is the classic genesis of a Ponzi scheme on Wall Street. A money manager falls short of cash to cover some expense or placate some customer or deliver on some promise, and he steals a little money from client accounts. The rationale is always that he will be able to pay off his theft before it is detected. Perhaps this occasionally happens—those are the Ponzi schemes we never learn about. More typically, the sum of stolen money grows much faster than the honest profits do, and the Ponzi scheme rolls on toward certain destruction.

According to Madoff, this is what happened to him, although he disputes the timing. He got into a hole—possibly before 1980, more likely by the mid-1980s, but certainly by 1992—and he just couldn’t get out again. His investment advisory business became a vast game of musical chairs. The only way he could hide the fact that there weren’t enough chairs left for all his clients was to keep the music going for as long as he could.

The music almost stopped in the summer of 1992. In early June, a pair of skeptical investors had sent two documents to the New York office of the Securities and Exchange Commission describing an attractive investment scheme that made them uneasy. One was a fact sheet about the “King Arthur Account.” The two-page document certainly made the investment sound appealing. “This is a safe fund with no risk of capital paying high income,” it said. The account yielded 13.5 percent a year, paid quarterly—14 percent for investments of $2 million or more.

It’s no wonder the two prospective investors were skeptical: those rates were more than three times the interest rates available in safe “no-risk” certificates of deposit at their banks. And they were notably higher than the gains produced by the much riskier S&P 500 stock index over the previous year—which were about 8 percent without counting reinvested dividends, about 11 percent with dividends included. According to the fact sheet, these remarkable returns were generated through “riskless trading” in arbitrage accounts that the sponsors, Avellino & Bienes, maintained with a “wholesale dealer” in New York who traded in high-volume Big Board stocks. (The reference to arbitrage is curious; Madoff was already telling other investors he was using the “split-strike conversion” strategy—and, indeed, the small Gateway fund had been producing legitimate gains from that strategy in recent years that matched or exceeded the King Arthur fund’s promises. But no one could honestly have called it a “no risk” investment.) The fact sheet was on the letterhead of a financial adviser in San Francisco and was probably written around 1989.

The second item supplied to the SEC was a brief no-nonsense letter that Lola Kurland, the office manager at Avellino & Bienes, had sent out in response to an investor’s query in August 1991. It stated that the firm provided financial services only to “relatives, friends and former clients…a very private group.” The letter’s arch style was pure Avellino. “We do not encourage new accounts and therefore we do not solicit same,” it said. “Summarily, this is a very private group and no financial statements, prospectuses or brochures have been printed or are available.”

Both documents made it clear that the participants’ money would be treated as a loan to the firm, which would use it to invest in its own accounts with the unidentified New York broker.

The documents also made it clear—at least to the lawyers in the SEC’s New York office—that there was something very fishy about the King Arthur Account.

One of those lawyers got in touch with Frank Avellino.

Avellino could not have been shocked to hear from the SEC. A short time earlier, he had received a call from his friend Richard Glantz, an attorney in California. Glantz’s father had been an officemate at the old Alpern firm and was one of the earliest subcontractors to raise money for the Madoff accounts. The younger Glantz had shared in that business and steered others to it.

Avellino bantered a bit and then listened in growing horror as Glantz explained why he had called. He said that an investment adviser he introduced to Avellino in 1989 had just gotten a letter from the SEC with a warning about the King Arthur fact sheet that the adviser had been distributing. Avellino might hear from the regulators himself, Glantz said.

Then the predicted call from the SEC came in. Avellino promptly phoned Michael Bienes, who recalled the conversation years later: “I gotta tell you something. We got a call from the SEC, and they’re asking questions,” Avellino said.

The questions were about “some guy out in California” who was funneling money to Avellino & Bienes through Glantz. This California guy “was printing up brochures with our name on it,” Avellino continued. Of course, this violated the pair’s long-standing prohibition on providing any written sales material to customers.

“Oh my God, no. What is he, insane? He knows the rule,” Bienes responded. “Anyone who deals with us knows the rules. What happened?”

“Well, they’re coming over to see us.”

Avellino clearly took the lead in dealing with the SEC’s interest in the firm. So, most likely, he was the one who called and broke the news to Bernie Madoff.

Madoff did two things. First, he called his friend and longtime investor Howard Squadron and asked if his law firm would take on the case. Squadron steered the call to his partner Ira Lee “Ike” Sorkin, a stocky man with an expressive face and thick graying hair who had joined the firm in 1976 after three years as a staff attorney in the SEC’s New York office and a busy five-year stint as a federal prosecutor.

In 1992, Ike Sorkin knew Bernie Madoff only slightly—a few quick chats at benefit dinners for the Jewish philanthropies they both supported, nothing more. But he knew almost every A-list securities defense lawyer in Manhattan and had worked with or tried cases against many of them. He spoke the SEC’s language fluently. In 1984 he had briefly left the Squadron firm to return to the SEC, whose New York office was in disarray as the agency wrestled with the changes John Shad was implementing. For the next two years, he ran the New York office as its administrator; then he happily returned to the Squadron firm.

After lining up an effective lawyer for the two accountants, Madoff also began a frantic effort to create phony records that would back up their claims about how much money was in their Madoff accounts. The effort left a paper trail that would be reconstructed by the bankruptcy trustee more than fifteen years later—a trail that provides some of the most persuasive evidence available that Madoff’s fraud was up and running well before this encounter with the SEC.

When the SEC staffers first contacted Frank Avellino in June 1992, the conversation only increased their suspicions. One of them noted in a subsequent memo: “When asked what he does with the money borrowed, Avellino stated that he invests money in real estate and ‘some securities.’”

But Kurland’s August 1991 letter had been emphatic: “We do not deal in real estate or anything other than securities.” And the fact sheet from the California investment adviser did not mention real estate.

Avellino’s credibility was already crumbling.

Shortly thereafter, someone from the SEC team got a call from Ike Sorkin saying he represented the partners at Avellino & Bienes. He assured the investigators that “nothing inappropriate” was going on and offered to bring in the two men to talk voluntarily, without a subpoena. His clients’ story was that they borrowed money through a word-of-mouth network and made interest payments to the lenders from the profits they made by investing the borrowed money. Whatever profits were left over, they kept.

At 1:30
PM
on July 7, 1992, Frank Avellino and Michael Bienes arrived at the SEC’s downtown offices at 75 Park Place, an undistinguished building two blocks west of the famous Woolworth Building. With them were Sorkin, one of his partners, and a summer intern from the firm. Flushed from the July heat, they were shown to a fourteenth-floor conference room, where three SEC lawyers and another summer intern were seated across the table. For the next four hours, Sorkin would do his job, sparring repeatedly with the SEC lawyers. They listened patiently and directed more questions at Frank Avellino, who responded alternately with windy lectures or terse roadblocks.

“Mr. Avellino,” one of the SEC lawyers asked, “what type of business is Avellino & Bienes in?”

“Private investing,” Avellino responded.

“Could you elaborate on that?”

“Yes. Michael Bienes and Frank Avellino have private investments,” Avellino answered, falling into his habit of avoiding the pronoun “I.”

Eventually, he explained how the “very private group” served by his partnership had grown by word of mouth, without the partners soliciting any business.

“If Lola Kurland gets a call—it’s usually my Uncle Lou who would call up Lola, because he’s been there since Day One with me—he would say that Joe, John, Tom, ‘will be calling you and he is somebody related to me, so if they call, you can accept the call,’” Avellino said.

And just how many people had loaned money to Avellino & Bienes through this folksy tag-team process?

“Approximate guess?” Avellino asked.

“Yes,” the government lawyer answered.

“About a thousand.”

It’s not clear if the SEC staff already knew how big this case was. If not, this must have been a heavy moment.

And how much did Avellino & Bienes owe to those one thousand lenders?

Sorkin broke in to quibble about how much money had flowed in and when it had come, but Avellino’s answer made it into the transcript: “$400 million.”