The Wizard of Lies: Bernie Madoff and the Death of Trust (18 page)

Roughly a thousand people had about $400 million tied up in this little firm that operated out of the Wall Street equivalent of a broom closet. According to Avellino, all that cash—plus a “cushion” of cash that brought the total to roughly $440 million—was invested in securities held in various partnership accounts with a Wall Street broker named Bernard L. Madoff.

The SEC lawyer did not seem to recognize the name.

When the accounts were finally analyzed, it turned out that a “very private group” of more than 3,200 people were listed as lenders to Avellino & Bienes, receiving interest payments ranging from 13.5 to 20 percent.

Two days later, a team from the SEC showed up at the Avellino & Bienes offices on the eighth floor of the soaring new Heron Tower on East Fifty-fifth Street. (Apparently concerned about rumors, Sorkin asked the investigators not to “badge” the building’s reception desk in the lobby—just to give their names, without showing their government credentials or disclosing their employer.) They gathered records and started piecing together the universe of creditors.

One of those creditors was Telfran Associates, whose founding partners included the father of Avellino’s friend Richard Glantz. Regulators told Avellino & Bienes and Telfran to stop accepting fresh “loans” and began to frame a civil lawsuit accusing them of selling unregistered securities through what amounted to an illicit mutual fund. Regulators anxiously sought assurances that the money was all still there, safely invested with Bernie Madoff.

Was it?

Madoff would insist later that he had not yet begun his Ponzi scheme when the SEC came after Avellino & Bienes—that the money was all there, all invested in arbitrage trading—but that simply is not credible. Even his faithful lieutenant Frank DiPascali acknowledged as much in an off-the-cuff remark to a federal judge years later, saying that he first realized he was engaged in a fraud “in the late ’80s or early ’90s.”

A civil lawsuit in the Madoff bankruptcy case would later assert that Avellino and Bienes had lied to the SEC about how much money was supposed to be in their Madoff accounts. According to that lawsuit, the balance actually shown on their account statements did not include the promised “cushion” of cash; rather, it was almost $30 million short of the total the two accountants owed their investors.

The lawsuit claimed that this shortfall was a result of the fraudulent use of the investors’ money for the accountants’ own benefit—an allegation their lawyers denied—and that Madoff covered for them. He did this, the lawsuit contended, by creating a phony account on June 23, 1992, and falsifying enough backdated trading profits in the new account to magically close the gap and forestall regulatory suspicion.

The entire episode was a grueling test for Madoff. A subsequent lawsuit would claim that the ordeal wound up costing him nearly $60 million in elaborately concealed hush money in the years to come. It also bore down on Frank DiPascali, the high school graduate who had made himself useful in so many ways since he was hired in 1975. He had been generating the account statements that were sent out regularly to customers, assisted by other close associates on the small staff devoted to Madoff’s investment clients. Even after Madoff launched his fraud, these statements continued to look sufficiently convincing to deflect any skeptical inquiry from investors, largely thanks to DiPascali.

But constructing those records was kindergarten fraud compared with the task posed by the SEC investigation in the summer of 1992. If the Ponzi scheme was already up and running, as seems likely, Madoff had to produce trading records for seven Avellino & Bienes accounts that would show the necessary volume of consistently profitable trades, going back at least several years. These records had to be convincing enough for federal regulators, not just for customers and private accountants. And they were needed immediately—before the SEC showed up to look at the documents on file at the accounting firm.

DiPascali, a small terrier-like man with the unpolished speech of his native Queens, came through for Madoff. Using self-taught computer skills and the historical stock and options prices available to any brokerage firm, he created a convincing paper trail covering several years of complex trading activity that almost certainly had never occurred. Based on those phony records, an SEC lawyer later reported that his staff had “analyzed” the Avellino & Bienes trading accounts at the Madoff firm, “verifying the equity value in these accounts.” A footnote showed that Madoff had fluently explained it all to them, as he would for years to come, with calm confidence and trading terminology that was most likely over their heads.

Still, DiPascali’s fabricated records and Madoff’s deft conversations with regulators unschooled in current trading jargon were just delaying tactics—necessary but nowhere near sufficient to keep the trap from snapping shut. Within months, the SEC would get a court order requiring Madoff to return the $400 million to Avellino & Bienes’s customers by the end of November 1992.

Madoff later acknowledged that this cash demand posed difficulties for him, although he denied it was because he was already running a Ponzi scheme. Rather, he claimed it was because the “bona fide arbitrage” positions in the Avellino & Bienes accounts, like the arcane “synthetic” trades in the accounts of his other big clients, could not be easily or rapidly liquidated. “I was actually doing the trades,” he insisted. But almost certainly this was not true; most likely, there were no convertible bonds or preferred stocks in the Avellino & Bienes accounts at all.

Still, even Madoff conceded that he urgently needed about $400 million, and there were a limited number of ways he could get it. According to him, he raised the cash from three of his biggest clients: Carl Shapiro, Jeffry Picower, and Norman Levy. The three men simply agreed to “take over the positions” in the Avellino & Bienes accounts and put in fresh cash to do so, Madoff claimed. “Shapiro, Picower, and Levy all sent in actual money, new money,” he said.

Records unearthed in subsequent investigations confirm that Madoff got a lot of the cash he needed from the accounts of Norman Levy. They do not show if he did so with Levy’s permission, or even his knowledge.

It is possible that Levy really did think he was “taking over” the investments that supposedly had been in the Avellino & Bienes accounts, without knowing they were fictional. Or it is possible that Madoff, who had discretion over Levy’s accounts, simply moved the fake positions into his account to explain where the money had gone. After all, DiPascali could doctor the account statements as necessary.

What seems hugely unlikely to everyone who knew Norman Levy is that he knowingly helped Bernie Madoff preserve his Ponzi scheme. After all, Levy later named Madoff as an executor of his estate and let his two children entrust their foundation endowments and some of their personal wealth to him, an inexplicable expression of faith if he knew Madoff to be a crook.

Whatever stratagem Madoff used to get cash from Levy would have worked just as well with Picower and Shapiro. By late November, Madoff had scraped together the money he needed to placate the SEC regulators, who did not inquire where he got it or pursue any of the intriguing loose ends that dangled around the case.

In the meantime, Frank Avellino, a millionaire many times over, haggled for months over the $429,000 in fees charged by the auditor the SEC had forced him to hire. “I am not a cash cow and I will not be milked,” he said in a memorable affidavit filed in that dispute. “I personally oversaw Avellino & Bienes’ books and records,” he told the court. “In all the years that we ran our business prior to the intervention of the Securities and Exchange Commission, we did not receive any unresolved complaints from our lenders. We were never sued by a lender. We did not miss our interest payments.”

The problem, he said, was that the accountants were demanding all sorts of sophisticated records that simply did not exist, that had never existed. All the firm had was a few sheets of paper for each lender, so that was all it could turn over to the accountants.

By the time the dispute dragged to a close in the spring of 1993, not even the federal judge handling the case had much faith in Frank Avellino. “I don’t believe your client,” the judge bluntly told Ike Sorkin in court. “I heard his testimony, I saw his demeanor, I heard his inconsistencies…. I don’t believe him. So to the extent there are credibility issues to resolve, I resolve them against your client.”

The case, which began and ended with doubts about Frank Avellino’s honesty, was a parade of red flags. And the
Wall Street Journal
hung some of those flags out in the open with a modest article on December 17, 1992, detailing the SEC’s investigation of a money trail that ended at Madoff’s door. But the warnings were not pursued, to Madoff’s intense relief; paradoxically, some investors were actually reassured by the
Journal
article about Madoff. It accused him of nothing, after all.

The SEC lawyers breathed a sigh of relief, too, thinking they had returned $400 million to thousands of investors who had innocently wandered into a flimsy, unregistered, and unregulated mutual fund. On top of the disputed audit expenses, the $350,000 fine imposed on Avellino & Bienes was large by the standards of the day. The unregistered investment operation and its Telfran subsidiary were shut down.

The SEC was satisfied and moved on to other issues. One of the sad quirks of the Madoff case is that, of his thousands of investors, the only ones who could have recovered all the fictional wealth shown on their account statements and kept any money they had withdrawn in the past were those clients of Avellino & Bienes who took the money the SEC returned to them in 1992 and walked away.

Most of them didn’t do that. They didn’t realize that they had been rescued. They thought instead that they had been banished from Eden, shut out of a wonderful low-risk investment that still paid good interest rates. So they were delighted when Madoff invited them all to open new accounts directly with him, even if the rates were lower than they had been getting from Avellino & Bienes. Most of the money Madoff had paid out was put right back into his hands.

What role did Avellino and Bienes play in restoring that cash to Madoff’s Ponzi scheme? They denied that they were involved at all, with Bienes publicly insisting they were both just glad to get out of their inadvertent SEC difficulties and walk away from their Madoff business relatively unscathed.

The litigation filed later against the two accountants in bankruptcy court, however, laid out a very different scenario, one in which the two men allegedly kept silent about Madoff’s obviously fraudulent activity, helped recruit new players to step into their shoes as introducers, and encouraged their former clients to invest directly with Madoff. In return, the lawsuit claimed, the two men demanded that Madoff pay them guaranteed profits of 17 percent a year on their own new Madoff accounts, along with secret commissions of 2 percent a year on the money their former investors handed back to him.

In Frank DiPascali’s world, these payments allegedly came to be known as the “schupt” payments—the bankruptcy trustee would later theorize that the term was a phonetic garble of the word
schtup
, a crude Yiddish verb whose rough Anglo-Saxon equivalent is
screw
.

The SEC investigation in 1992, incomplete though it was, had significant consequences for Bernie Madoff’s expanding fraud.

First, it forced Madoff to apply to his Ponzi scheme some of the computer technology he was already using in his legitimate business. It was simply impossible for Frank DiPascali to concoct manually the trading records and monthly statements for the thousands of new accounts Madoff had suddenly inherited from Avellino & Bienes. Madoff needed to automate the Ponzi process somehow, and he turned to DiPascali for help.

DiPascali, in turn, allegedly relied on two computer programmers who had joined the firm a few years earlier and who were later accused of designing software for one of the firm’s new IBM AS/400 computers that simplified the process of generating the fictional account statements. DiPascali and some of his staff allegedly researched the necessary trades from the historic record, and then the customized Ponzi software would allocate those trades, in perfect proportions, among the various customer accounts using a simple “mail merge” computer function.

Besides reducing the manual labor involved, this automation provided new opportunities for deception. It was around this time that Madoff leased separate space on the seventeenth floor of the Lipstick Building—ostensibly for his new IBM computers but actually to create a more secure environment for his increasingly elaborate fraud. As he later recalled, he set up the separate suite because “I could not have operated in view of the other people on the 18th floor.” The nondescript warren of offices and cubicles on the seventeenth floor became Frank DiPascali’s domain, a private laboratory for his creative deceptions.

As DiPascali perfected his craft, he branched out. He devised fake clearinghouse forms that showed up on computer screens—perfect replicas, regularly updated. On Madoff’s orders, he kept a supply of old letterhead stationery and used it when backdated paperwork was needed for files that regulators wanted to see. In time, he even ordered the creation of a software program that made it look to an observer as if a trader at one computer terminal were buying or selling for an investor’s account, when in fact the “trader” was merely exchanging keystrokes with another staff member at a computer hidden in a room down the hall.

This Potemkin village paper trail became so convincing that Madoff was able to fool dozens of insufficiently skeptical regulators and inadequately observant lawyers and accountants for years.