The Wizard of Lies: Bernie Madoff and the Death of Trust (28 page)

Lamore did note that his team had not approached any of Madoff’s hedge fund clients, so the new team decided to cover that base at least. It sent a letter to the Fairfield Greenwich Group, asking for crates of documents relating to its dealings with Madoff. The plan apparently was to check whether Fairfield’s account statements (which DiPascali had fabricated) matched up with the account statements Madoff had given Lamore’s team (which DiPascali had also fabricated). If Madoff was operating a Ponzi scheme, this was a useless exercise.

But it got Madoff’s attention. There he was with his cash balance hovering close to zero and suddenly his biggest, most reliable source of cash was receiving letters about him from the SEC.

The danger to his fraud increased on December 13, when the junior member of the New York SEC team discovered an “odd discrepancy” between Fairfield’s documents and the previous team’s notes on its interview with Madoff in May. In the spring, Madoff had claimed that he hadn’t used options as part of his strategy for about a year. But the current Fairfield account statements still showed options trades. There did not seem to be any explanation, other than that Madoff was lying to someone. Since Madoff’s feeder funds all believed he was still buying options for them, it would be devastating if the SEC started suggesting that he wasn’t.

Still, even the discrepancy over his use of options did not suggest to the SEC team that relying on Madoff as a source of truthful information was a bad idea. He remained an extremely reputable figure on Wall Street, as far as they knew. Reflecting on the case later, one investigator wrote a colleague that there wasn’t “any
real
reason to suspect some kind of wrongdoing.”

In December 2005 the chief risk officer at Fairfield Greenwich confirmed in an SEC interview—conducted after the SEC gave him permission to consult with Madoff before testifying—that options remained part of the Madoff strategy. The investigative team decided it would be a good idea to track down some of the counterparties to these mysterious options trades before questioning Madoff about it. It would have been an excellent idea—indeed, if it had been diligently pursued, it would certainly have exposed Madoff’s crime. But this didn’t happen.

Bernie Madoff and Frank DiPascali spent January 2006 producing documents in response to the SEC’s new demands—although the huge stacks of paper did not include any OTC options contracts. On January 26, DiPascali went downtown to the SEC’s offices to answer questions about the counterparties supposedly on the other side of Madoff’s trades, and his lies were sufficiently convincing to keep the investigators off-track for a while longer.

Regulators and prosecutors later accused Dan Bonventre of spending this perilous January dealing with the Ponzi scheme’s worsening cash crisis, using another $54 million in government bonds from Carl Shapiro’s account as collateral for a $50 million bank loan in mid-January. The loan proceeds were put into the Ponzi scheme account to cover continuing withdrawals. On at least four occasions, money from the legitimate firm’s bank accounts had to be tapped to cover giant withdrawals from the Ponzi scheme. It was not clear how long this could go on before the legitimate firm started suffering a cash squeeze as well—or someone working there picked up gossip about the curious transfers and loans.

Meanwhile, SEC investigators continued to poke around at the feeder funds that Madoff relied on for the fresh cash he desperately needed. On January 30, 2006, they interviewed Jeffrey Tucker from Fairfield Greenwich. Two days later they sent a letter to Tremont Partners demanding the same list of documents they had sought from Fairfield in December.

Then, in mid-February, the team asked Madoff for a piece of paper that he knew could send him to prison. They wanted a list of all the accounts through which he executed, cleared, or settled any trades, including the disputed options trades—trades they still believed he was making, despite his earlier testimony. Of course, he was not executing, clearing, or settling any trades at all, but he could not refuse the request without setting off all kinds of tripwires at the SEC. So, on February 23, Madoff gambled big and produced a six-page list of the financial entities through which he was allegedly conducting trades for his hedge fund clients, along with his account number at the DTCC clearinghouse.

Then he waited for the sky to fall.

It is hard to fathom how Bernie Madoff managed to handle the protracted liquidity crisis and SEC investigation of late 2005 and early 2006. Even on paper, the magnitude of the cash drain was shocking. Between April 2005 and June 2006, investors withdrew roughly $975 million from the Fairfield Sentry fund alone, nearly 20 percent of its assets. The situation looked so dire that it is hardly surprising that Dan Bonventre and two computer programmers who worked with Frank DiPascali on the seventeenth floor emptied their Madoff accounts in the spring of 2006 and moved the assets elsewhere—although all three have denied that they knew anything about the fraud or its teetering finances. Madoff could scarcely refuse to let them pull the money out. Even if they were not helping his Ponzi scheme stay afloat, and they flatly denied that they were, it would have raised alarms if they had not been able to make the withdrawals. On April 13, Madoff arranged to tap his brokerage firm’s operating account once again to cover another $120 million redemption request from the Sentry fund, which had withdrawn $150 million just a month earlier.

Despite the peril facing his Ponzi scheme, Bernie Madoff apparently did not put any restrictions on his family’s access to cash. The overall stock markets were strong; the global hedge fund business seemed to be healthy. Anyone who believed that Madoff was running an extremely successful hedge fund business would necessarily have believed that he had money to burn. Every other successful hedge fund manager did.

If his family members knew that his secret Ponzi scheme was in the grip of a potentially fatal cash crunch, they certainly were doing nothing to make it easier for him, and their redemptions were certainly ones he could have refused without question if they had been his accomplices. In December 2005, Madoff loaned each of his sons $5 million. Between September and April, he allowed his brother to withdraw $3.2 million from the accounts Bernie managed for him. No one in his family hurried to close out their accounts during this crisis and move their assets to safer havens. They left the great bulk of their wealth—their pensions, their deferred compensation, their children’s trust funds—in Bernie’s hands.

In retrospect, the fact that the family continued to withdraw cash but did not empty their accounts suggests that they were unaware of both the fraud and its imminent peril in the fall of 2005. They simply continued to tap Bernie’s piggybank, as they had always done, as if everything at the firm were running as smoothly as it always had.

Madoff’s unstinting largess may also have reflected the reality that life beyond the business was far from smooth for the Madoff family. Peter’s son, Roger, was losing his long battle with leukemia and had been slipping toward death all through the winter, attended by his young wife and his heartbroken family. On April 15, 2006, he died at age thirty-two. Bernie’s secretary, Eleanor Squillari, would later say that the Peter she had known for so many years died that day, too.

It was during these months of private anguish, in this secretly precarious season of SEC scrutiny and frantic loans and cash transfers, that Madoff nearly lost his battle to keep his Ponzi scheme alive. By April 2006, he had transferred more than $260 million from the brokerage firm’s accounts into the Ponzi scheme’s slush fund to cover withdrawals and keep the fraud afloat—and it still wasn’t enough.

The tide began to turn on April 18, when Madoff’s problematic investor Jeffry Picower deposited $125 million into one of his Madoff accounts—no doubt a very welcome infusion of cash, since it was made just five days after Fairfield Greenwich pulled out $120 million. It is one of the bits of evidence that suggests that Picower was better informed about Madoff’s continuing crime than even Madoff suspected—or at least than either man ever admitted.

After its timely arrival in his Madoff account, Picower’s fortuitous deposit underwent a remarkable transformation. Within two weeks, it had grown on paper to $164 million, thanks to big gains on some stocks supposedly purchased with the money. According to Picower’s account statements, however, the lucrative stock purchase was made three months earlier, ten weeks before the $125 million check actually arrived in his account to pay for the stock. And in September 2006, after Madoff’s cash crisis had eased and new money was pouring in daily, Picower withdrew his $125 million, leaving paper profits of $80 million in the account after just five months. It is possible that Picower thought he had bought the shares months before on margin and paid for them after the fact. But the bankruptcy trustee would later interpret the transaction as circumstantial evidence that Picower helped bail out Madoff and was rewarded with fabricated profits generated through backdated trades. It is almost inconceivable that Madoff could have cooked up such blatantly fictional trades in the account of an investor as sophisticated as Picower without him noticing.

The welcome and mutually rewarding Picower check and, at last, an ebb in withdrawals weren’t enough, though, to save the corrupt scheme in that season of crisis. Madoff still had to get the SEC off his back. Fortunately for him, the agency’s investigators were hampered by their refusal to trust Harry Markopolos and his analysis. They failed to do the tough homework of studying the files of previously bungled investigations. They knew little about Ponzi schemes and the people who built them. But with all their shortcomings, Madoff’s regulators got tantalizingly close to exposing him in the spring of 2006.

Sometime in May, the SEC investigative team drafted letters to send to Barclays Bank and the Bank of New York, asking them to confirm Madoff’s trading activity. Responses to those letters would have put him at risk because they would have revealed that there simply wasn’t any trading activity going on. For some reason, however, Meaghan Cheung and her colleague Simona Suh decided to delay sending the letters until Madoff himself was interviewed later that month. Ultimately, the letters were never sent—later, no one could recall why.

Then, in mid-May, the SEC team asked a staff member at FINRA, the Financial Industry Regulatory Authority, to check on Madoff’s options trading on a particular date. The FINRA staffer reported that Madoff had done no options trading at all on that date. Still, the team simply chewed over the bizarre report and dismissed it, persuading themselves that Madoff either was failing to disclose his trades or was making them overseas. Despite all his obvious lies, they never suspected he was not making any trades at all. By then, after so many years of caution and bureaucratic inertia at the SEC, that lie apparently was simply too large to fit into the agency’s limited imagination.

The entire investigation, eventually, came down to Madoff himself.

A little before 10:00
AM
on Friday, May 19, 2006, Bernie Madoff arrived at the SEC’s New York office in the American Express tower, adjacent to the huge empty footprint of the World Trade Center. He came alone, without a lawyer. Across the table were five SEC staff members, including Meaghan Cheung, Simona Suh, and Peter Lamore.

Madoff seemed relaxed and cordial. He grew expansive when he talked about the art of trading stocks and the science of computers, which he conceded was not his strong suit. “If I was talking to a brain surgeon and they started talking about the terminology—
that
I wouldn’t know. But if they said, ‘see this scalpel, stick it in there,’ now I understand,” he said.

Everybody had different computer algorithms to guide their trading, he went on. “People design their systems to say ‘I don’t care about this, I care about that.’” But he didn’t attach much importance to the widely available information that flows into the marketplace. “People are always trying to ask me ‘what makes a good trade?’ Or ‘why can you trade better than other people,’ and so on. It’s the same thing—we are proprietary traders and market-makers. Some guys have more guts than others. Some of them are just stupid—they don’t get frightened when they should be getting frightened. Some people just feel the market. Some people just understand how to analyze the numbers that they are looking at.”

The explanation for his success was that simple, he suggested without quite saying so: he was one of those people who “just feel the market.”

He was asked why he didn’t do his options trading on one of the public exchanges instead of in the opaque over-the-counter market. “Everybody goes to the over-the-counter market on options. That’s the way the market is,” he said. Listed options could be traded only “during the U.S. hours, which you don’t want to do.” Besides, he added, “there’s really not the liquidity in the options market. It’s improving, but it’s not where you would want to go.”

He seemed confident, knowledgeable, relaxed—there was no sign that he had almost run out of cash. There was no indication that, after handing over that list of fictional counterparties in February, he feared he had already run out of time. Every day for the last three months he had expected to hear that the SEC had called some of the names on the list and found out he was lying. So far they hadn’t—indeed, they never would—but suddenly that potentially fatal list was there in front of Madoff, on the table in the SEC’s conference room.

“I’d like to go over this list and have you explain in a little more detail the function of each account,” Simona Suh said. “The account, Depository Trust Clearing Corporation, what is the function of this account?”

Madoff answered truthfully, “That’s the general clearance account for the firm, that handles all the settlements of transactions for the firm.”

Did the clearinghouse set up separate accounts for the different institutional customers?

Yes, Madoff said. Well, there was one big account, but different codes for whether the securities belonged to the brokerage firm or to an institutional customer.

“You know what those codes are?”

“No,” Madoff said.

“But DTC would know?”

“Yes,” he said.

Well, that was probably the final, fatal step—the moment when his time ran out. “I thought it was the end, game over. Monday morning, they’ll call the DTC and this will be over,” he recalled later. “And it never happened.”

That “astonished” him, he said, because “if you’re looking at a Ponzi scheme, it’s the first thing you do.”

If the investigative team had checked Madoff’s clearinghouse account that day or on the following Monday, they would have found that it held less than $24 million in blue-chip stocks, at a time when it should have held either billions of dollars’ worth of stock or an equal amount in Treasury bonds, based on the account statements they had seen.

But the investigators misunderstood how the clearinghouse worked and wrongly assumed that it would be hugely laborious to sift out the hedge fund transactions from the firm’s normal high-volume trading business. So they didn’t follow up on the DTCC account.

By this point in the Madoff interview, Peter Lamore was beside himself. Madoff had been sitting there for hours, bold as brass, describing his options trades—almost exactly a year after telling Lamore he wasn’t using options as part of his investment strategy anymore. Simona Suh confronted Madoff with the discrepancy.

“Do you recall telling Peter that, as of January 1, 2004, you no longer incorporated options into the strategy for the institutional trading business?”

“I said they’re not part of the model,” Madoff lied smoothly. “The options are not deemed to be part of the model. I did not say—my recollection certainly is not that I said that the accounts don’t use options anymore to trade. I said the options—that the options were taken out of the model, and they’re not part of the model any longer.”

Suh followed up: “So what change were you referring to in that statement?”

“Well, they used to be part of the model,” Madoff explained. They had been taken out, he continued, because they weakened his intellectual property claims to the software that guided his investment strategy. “We consider the model our intellectual property. It states so, I believe, in the trading authorization directive,” he said. But there simply wasn’t “enough meat” on the options portion of the model. “So we took it, basically, out of the model and treated them separately,” he said.

Hadn’t he told Lamore that, as of January 1, 2004, the clients could hedge the strategy by buying their own options?

“No,” Madoff answered.

“You do not recall making that statement?”

“I recall saying what I just said, that they were [originally] part of the model, that they were no longer part of the model, but that—I remember specifically saying that the options are still used to hedge the transactions.”

Lamore was furious. “I just remember sitting there in the testimony saying, he’s lying,” he recalled years later. “It was just remarkable to me.”

Like so many others, Lamore did not contemplate that a man who would tell such a brazen lie might also commit a brazen fraud. “I mean, ‘lying or misleading’ to ‘fraud, Ponzi scheme’ to me was a huge step—a huge leap.”

It was a leap Bernie Madoff took every day, but the SEC failed to understand this. When its team officially closed this flawed investigation on January 3, 2008, after a long period of inactivity, it would conclude that, despite all the lies they had discovered, there was no evidence of fraud.