The Wizard of Lies: Bernie Madoff and the Death of Trust (31 page)

Even Madoff’s own longtime banker, JPMorgan Chase, was growing suspicious—or, at least, some of its high-level executives were. On June 15, 2007, the top risk-management officer at Chase’s investment bank sent a lunchtime e-mail to some colleagues. “For whatever its worth,” he wrote, “I am sitting at lunch with [another senior Chase executive] who just told me there is a well-known cloud over the head of Madoff and that his returns are speculated to be part of a ponzi scheme.” Luckily for the Ponzi scheme, Chase’s retail bankers had not increased either their scrutiny or their skepticism, so Madoff could still move billions of dollars in and out of his Chase accounts, no questions asked. But the whispered doubts about him were getting louder every day.

On the larger stage, the foundation under Wall Street’s house of cards was beginning to shudder. Mortgage defaults were rising, mortgage derivatives were weakening, and Wall Street banks and analysts were worrying about the debts of a host of insurance companies and hedge funds that were heavily invested in those crumbling mortgage-based derivatives.

Even if most civilian stock market investors still saw no cause for alarm, did Bernie Madoff, with his “feel for the market,” sense how fragile the situation had become? Did he catch wind of the increasingly skeptical whispers and suspect that his time was running out?

Perhaps. For whatever reason, 2007 was his year of living extravagantly, his year of living like the feeder fund kings whose lavish lifestyles and big-ticket shopping he had helped make possible. In March he took delivery of a custom Brazilian-made jet, decorated, like his office, in tones of black and gray. The plan was to put the jet up for charter to defray the cost—it had cost him and his co-owner at least $24 million—but it still made family travel luxurious. In June a new $7 million yacht was delivered to a mooring near his town house outside Cap d’Antibes, in the south of France. This gleaming white addition to the Madoff armada was a streamlined eighty-eight-foot Leopard “Superyacht” with three guest staterooms, each with a private bath, and three berths for the crew. In the spring, Madoff attended a series of expensive charity events—at a $50,000 table here and a $25,000 table there, he sat in his English-tailored tuxedo smiling a little and sipping Diet Coke.

He entertained a cosmopolitan parade of visitors at the Lipstick Building: Manuel Echevarria from Banco Santander’s Optimal funds; Patrick Littaye, from Access International; and Carlo Grosso, the Italian based in London who ran the Kingate funds, one of his earliest feeders. Things were still looking good; sales were strong.

In the spring, Madoff attended a Hofstra University benefit honoring Frank G. Zarb, a Wall Street veteran who had been recruited to pull the NASD out of its 1994 price-fixing scandal and who had crossed swords with Madoff a few times in regulatory battles.

Sponsors weren’t sure Madoff would even show up; although he was a Hofstra graduate, he had given very little to the school, focusing his philanthropy elsewhere. But he did attend the benefit and, at some point during the evening, approached Hofstra’s president and chatted about pledging $1 million to the school.

Madoff’s family also enjoyed the surging wealth, of course; why wouldn’t they expect to share in Bernie’s obvious success? Peter Madoff and Madoff’s sons may have known that the market-making business was down to tissue-thin profit margins. The proprietary trading desk’s profits were good but fluctuated with the markets. But, increasingly, those sources of revenue were dwarfed by the money supposedly being generated by Madoff’s hedge fund business. As they all knew, this was true at many Wall Street firms these days.

For years, as Madoff’s hedge fund business had grown, the firm had supported the family’s lifestyle in an ever-grander fashion. In the still-cloudless days of early 2007, it may have looked like it always would.

In 2007, Madoff doubled Frank DiPascali’s annual salary from more than $2 million to just over $4 million, a handsome payday for the helpful high school graduate from Queens. It wasn’t his sole source of income. Since 2002, DiPascali had taken about $5 million directly from the bank account Madoff maintained for the Ponzi scheme, falsifying the paperwork to make it look legitimate. He used some of the money to buy a new sixty-one-foot fishing boat and to fill his suburban New Jersey home with toys, ranging from a pool table to a bright red popcorn cart. DiPascali neglected to share all his good news with the Internal Revenue Service. He did not file his personal income tax returns for 2002 and 2006, perhaps because he was simply too busy with the paperwork for the Ponzi scheme. He wouldn’t file in 2007 either.

DiPascali’s colleague Annette Bongiorno, who had been working largely from Florida for the past decade and had handled administrative chores for Madoff for nearly thirty years, saw her salary and bonus triple in 2007, from $200,200 to $624,000. Prosecutors would later accuse her of playing a longtime role in the fraud, asserting that she handled the creation of phony account statements for Madoff’s largest individual investors. She emphatically denied the charge and was scheduled for trial in 2011.

In mid-May, Bernie and Ruth left for southern France, where they would relax in their small villa for nearly two months. They played golf at various clubs and courses near the Mediterranean, enjoyed exhilarating excursions on the new yacht, and settled into the gracious rhythm of a French summer.

In the fall, Madoff attended his niece Shana’s wedding to Eric Swanson, a former lawyer for the SEC. While Swanson was at the SEC—but before he started dating Madoff’s niece—he supervised one of the bungled Madoff examinations. An investigation later by the SEC’s inspector general concluded that, while the relationship looked like a conflict of interest, there is no evidence it had any impact on the unwise decisions that derailed that exam. For what it’s worth, Madoff would say later that he hadn’t even known Shana was dating an SEC lawyer until shortly before the wedding—Peter had not wanted to tell him, he said.

As always, Madoff was the “bank” for family and staff. He made loans to Shana to invest in an energy company that she and Andrew were putting together. He made loans to his sons and several employees. He agreed to loan his still-grieving brother $9 million and started planning a special gift for him: a vintage Aston-Martin automobile, like the one featured in the early James Bond films, to be delivered in the spring of 2008.

And on October 20, 2007, Madoff did a favor for Frank Levy, the son of the late Norman Levy, by appearing on a panel at the Philoctetes Center, which the younger Levy cofounded in 2003. The topic was “The Future of the Stock Market,” and Madoff gave a bravura performance.

“You have to understand, Wall Street is one big turf war,” Madoff said. “…By benefiting one person you’re disadvantaging another person.”

And don’t forget that it’s a for-profit business—a fact “which sometimes the regulators lose sight of, as do the academics,” he continued. “In every aspect of it, the person that is buying the share of stock is convinced he knows something that the other person, who’s selling it to him, does not know.”

Madoff cogently explained the forces that automation had unleashed on the Street. “Wall Street—just so you understand the scale of it—is one of the few industries where the cost of doing business for the consumer has gone down dramatically, from a commission standpoint. Yet the expense of doing business, from the industry’s perspective, has dramatically increased. The cost of regulation has dramatically increased.”

He laughed and shrugged. “Now, no one is going to run a benefit for Wall Street,” he continued. “So whenever I go down to Washington and meet with the SEC and complain to them that the industry is either over-regulated or the burdens are too great, they all start to roll their eyes—just like all of our children do whenever we talk about the good old days.”

Responding to a question about how firms were surviving, he said, “Today, basically the big money on Wall Street is made by taking risks. Firms were driven into that business, including us, because you couldn’t make money charging commissions.” Trading for their own accounts—“that’s where the money is made.”

He also discussed the question of criminality on Wall Street. “By and large, in today’s regulatory environment, it’s virtually impossible to violate rules,” he said. “This is something that the public really doesn’t understand. If you read things in the newspaper and you see somebody violate a rule, you say, ‘Well, they’re always doing this.’ But it’s impossible for a violation to go undetected, certainly not for a considerable period of time.”

As he spoke, almost exactly two years after his Ponzi scheme had been on the brink of exposure, he was at the apex of one of the most staggering crimes in financial history. By one estimate, more than $12 billion from all over the world had poured into his Ponzi scheme in just the previous twenty-four months—and in the next twelve months, almost all of it would pour out again, finally shattering the façade he had maintained so successfully for so long.

W
EDNESDAY
, D
ECEMBER 12, 2007

Today is the first day of the last year of Bernie Madoff’s epic fraud.

The paperwork has been completed for a $9 million unsecured loan from the company to Peter Madoff, whose titles at the firm now include senior managing director, chief compliance officer, head of the options department, and (since a few years ago) chief compliance officer for the private money management business Bernie runs on the seventeenth floor.

Still, the Madoff firm is casual about titles—Bernie almost seems to make them up as he goes along. Peter’s primary title has always been “Bernie’s brother.” And this latest loan, to finance a real estate investment, reflects this reality. Due in five years, it carries an annual interest rate of 4.13 percent, a very low rate given the uneasiness currently gripping the credit markets.

At most big firms these days, an executive’s request for a $9 million insider loan with a gentle interest rate would be coldly and firmly denied as “inappropriate.” While the stock market seems healthy, the credit markets have been deteriorating since late summer. The housing market is starting to turn sour. Risks ignored just a year ago are starting to loom larger in the market’s mind. Even so, longtime employees of Bernie Madoff’s firm have no trouble borrowing cash when they need it. Bernie rarely says no.

But this loan to Peter—like all the insider loans that have come before and will follow in the months ahead—is sucking out cash that Bernie Madoff will need when the unprecedented turmoil bearing down on Wall Street finally hits.

Tonight is the firm’s office holiday party, and employees are enjoying the margaritas and Mexican beer at Rosa Mexicano, a popular bistro on First Avenue, a few blocks from the office. This is the first time the firm has held its party here. Last year’s site was a trendy young-crowd nightclub called Au Bar, with loud music and dancing. This spot seems more compatible with the firm’s comfortable family-party style.

Ruth Madoff applauds the change in venue. “Book it for next year right now,” she says to one employee with a happy laugh.

The party might almost be a family reunion. Beyond his own family ties, Madoff’s employees work with their fathers, their cousins, their nephews, their stepsons, even their neighbors. Some of them—notably the staff on the seventeenth floor—were hired right out of high school and have never worked anywhere else.

The traders may joke about Madoff’s nearly obsessive demand that they keep their desks clear and tidy, and they may roll their eyes at his crude humor, but the firm still seems like a great place to work. Besides being generous with insider loans, Madoff also manages much of the money his relatives and other senior employees have saved: their deferred compensation and retirement savings. Although he is prickly and secretive about it, everyone knows that giant hedge funds and wealthy individuals are constantly jockeying to get Madoff to manage their money. Employees feel lucky that he is looking out for them, too.

There may be a hint of edginess in the air tonight. Madoff’s traders exchange jokes with the other traders at big Wall Street outfits, and lately, behind the laughter, they all are hearing faint rumbles from the approaching storm.

Perhaps it comforts them to reflect that Bernie Madoff has seen rough weather before—from the shaky markets right after the terrorist attacks in 2001 all the way back to the glut of unfinished paperwork that nearly choked Wall Street in the late 1960s. He’s seen it all and survived it all.

W
EDNESDAY,
J
ANUARY 23, 2008

On Madoff’s calendar, this evening belongs to New York City Center, the innovative cultural institution he and Ruth have supported for years and on whose board he has sat for more than a decade. The center is holding one of its popular “Encores!” performances, a tango tour de force perfectly suited to its distinctive Moorish-style auditorium on West Fifty-fifth Street. The faded facility, built as a Shriners temple in 1923, needs an enormous amount of renovation work, and a major fund-raising campaign is already being planned.

As Ruth and Bernie slip into their seats, Wall Street’s growing anxiety about an approaching recession probably seems like a faint distraction. Madoff has at least $5 billion in the bank to sustain his Ponzi scheme, small bits of it contributed by people seated around him in this auditorium and giant slabs of it deposited by his global collection of hedge fund clients.

In theory, that cushion should see him through even a bad recession. But hedge funds hurtle into a trend, stampede out again, and swerve at unexpected moments like a herd of wild beasts. If they all panic at some clap of economic thunder, Madoff will be lucky to avoid getting trampled.

And if he goes down, many of the rich donors that City Center relies on will go down with him.

T
HURSDAY
, F
EBRUARY 14, 2008

Bernie Madoff catches a night flight to Palm Beach, where hundreds of his investors live. Among them is Carl Shapiro, the retired garment industry entrepreneur who has been a client since the 1960s. Shapiro is celebrating his ninety-fifth birthday with a gala organized by his daughters. The Madoffs are invited.

The party the next evening is a head-turning event, even for Palm Beach. There are armloads of orchids, towers of roses, and caviar and champagne in stunning abundance. The columnist Shannon Donnelly, the leading Palm Beach celebrity watcher, is on duty to collect the details, like the touching moment when Shapiro takes the microphone to serenade his wife of nearly seventy years.

Donnelly notices forty notable society names among the guests, including the owner of the New England Patriots football team and a well-known Chicago financier. She doesn’t mention Bernie and Ruth Madoff—their names are almost entirely absent from the local society archives in Palm Beach, even though they have owned a home on this thin, rich island for almost fifteen years.

Many of the guests who will be mentioned in Donnelly’s column are Madoff’s customers. It isn’t so much that they trust Madoff—if they know him at all, they probably sense the almost obsessive reserve that keeps most people at a distance. But they believe in Carl Shapiro, and Shapiro clearly believes in Madoff. How could you doubt Carl Shapiro’s judgment?

The birthday party is a great success. After some quiet conversation with the Shapiros, Bernie and Ruth Madoff say their farewells and slip into the soft Palm Beach night for the short drive through the Breakers Hotel golf course and along palm-lined Royal Poinciana Way to their home on North Lake Way.

An intricate banyan tree almost obscures the front of the house, throwing night shadows on the drive and scattering leaves on the narrow second-floor balcony. The home is deceptively large, stretching deep behind its modest façade. By local standards, it is not lavish—it certainly is less grand than Peter Madoff’s château-style home nearby, and it can’t hold a candle to the $33 million mansion owned by Bernie’s longtime client Jeffry Picower, on the ocean near the island’s southern tip.

As Palm Beach reckons such things, Bernie and Peter Madoff are newcomers. But Shapiro and his family have vouched for Madoff—Bernie listed Shapiro’s son-in-law Robert Jaffe as a reference on his successful application to the Palm Beach Country Club. Before long, dozens of multimillionaire club members would be fishing for a chance to meet Bernie, to invest with Bernie.

What they don’t know is that Madoff has grown larger than any of them can imagine. If his hedge fund clients stick with him, he doesn’t need the genial guests who gathered tonight for Carl Shapiro’s celebration. And if the hedge funds desert him, there is little that even Shapiro can do to save him, no matter how willing and trusting he may be.

T
HURSDAY,
F
EBRUARY 21, 2008

Bernie Madoff welcomes a British bank executive into his office on the nineteenth floor. The banker works in London for HSBC, which handles the administrative paperwork for a growing roster of global hedge funds, including several that do business with Madoff.

This is not a social call. Some HSBC units have been recommending various Madoff feeder funds to their clients for years, starting with the Fairfield Sentry fund in 1999. A number of the bank’s offshore hedge fund clients are invested with Madoff and are trusting his firm to hold their assets for safekeeping. Legally, that makes Madoff the “sub-custodian” of the funds, since HSBC is accepting fees to serve as their official custodian. As much as everyone trusts Madoff’s reputation, this is an unusual arrangement, especially with the world in such a skittish mood.

The banker needs to answer a simple question: Are the securities that the hedge funds have left in Madoff’s custody actually there?

They aren’t, of course. Madoff knows this—and by now there is enough quiet gossip about him in the hedge fund community to suggest that what he already knows others are starting to suspect.

Even within HSBC there have been skeptics. As early as 2001 a few bank executives were expressing doubt about Madoff. In September 2005 the bank asked a major accounting firm, KPMG, to review the “operational risks” of Madoff’s business. When the report came back in early 2006, it included a chilling list of what could go wrong, from misdirected trades to outright fraud. But despite warnings and some internal doubts, the bank apparently felt that Madoff’s stainless reputation and his standing with market regulators made such nightmare possibilities sound outlandish.

Still, next month, the bank will ask KPMG to do yet another assessment of the risks of doing business with Madoff. Perhaps this is what the banker has come to say. Or perhaps that examination will be ordered as a result of his visit today.

Despite that renewed scrutiny, HSBC will continue to provide administrative and custodial services to the funds that deal with Madoff for almost ten more months.

F
RIDAY,
M
ARCH 14, 2008

After the stock market lurches to its sweaty close today, coworkers see Marcia Beth Cohn climb the oval staircase to the nineteenth floor and slump into the secretary’s chair near Bernie Madoff’s glass-walled office. She is a wiry, athletic woman with very short dark auburn hair. She swivels toward Madoff, standing nearby, and asks with a shaky smile:

“O, wise man, what is going to happen to us?”

Earlier today, the Federal Reserve extended an emergency line of credit to the Bear Stearns brokerage house, which was caught in an old-fashioned “run on the bank.” It is the first time in history that the Fed, a bank regulator, had stepped in to rescue a brokerage firm. Rumors of unrecognized mortgage losses are shaking people’s faith in other giant Wall Street firms, too—the shares of Morgan Stanley and Lehman Brothers were swept into the downdraft that cut Bear’s stock price in half today. The Dow closed down nearly two hundred points.

There is probably no brokerage house on Wall Street with closer ties to Madoff’s firm than Bear Stearns. It has been a client of Madoff’s trading desk for years. Bernie and Ruth Madoff have good friends among senior Bear Stearns executives. When the Wall Street division of the American Jewish Committee honored Madoff at a fund-raising event at the Harmonie Club in 1999, the reception was hosted by Bear Stearns chairman Alan C. Greenberg.

For Marcia Beth Cohn, though, the threat is more than academic. She is president of Cohmad Securities, the tiny brokerage firm that shares office space with Madoff’s firm but clears its small volume of stock trades through Bear Stearns. Despite her wry tone, she seems genuinely frightened. What if some of her customer orders get caught in Bear Stearns’s collapse?

It is a day to frighten anyone, but Madoff is characteristically calm. He gives the small group around her a quiet but reassuring lecture on the safety net that protects customer accounts on Wall Street. He is confident that Bear Stearns will find its footings once today’s panic ebbs.

But federal regulators are already scrambling to find a buyer for Bear Stearns before the Asian markets open on Sunday evening. At the last moment, JPMorgan Chase will agree to buy the firm, after being promised substantial loan guarantees from the Fed. But it will offer only $2 a share—for Bear Stearns stock that closed today at $30 a share.

The bank will ultimately raise its bid, but the damage will have been done. Investors will bail out of the financial sector, fearing that failures once considered unthinkable no longer are. From this weekend on, pension funds and other institutional investors will demand more information about the banks and brokers they deal with. There will be more questions put to Madoff, more answers demanded, and more nervous withdrawals.

It is an anxious, faintly terrifying day, but this is nowhere near as bad as it will get. Indeed, this is all just prologue.

F
RIDAY,
A
PRIL 25, 2008

A partner at the Fairfield Greenwich Group, one of Madoff’s earliest and biggest hedge fund investors, is studying the rate at which cash is pouring out of its flagship product, the Fairfield Sentry fund, whose $7 billion in assets are entirely invested with Madoff. The Fairfield Greenwich firm has quietly put itself up for sale, and the partner knows that any well-heeled buyer will scrutinize these numbers to calculate the firm’s potential value.

An explanation will definitely be required, based on the numbers the partner shares today in an e-mail to some of his colleagues. Redemption rates are high—twice the hedge fund industry average. The partner can explain this: “With monthly [redemptions allowed] on 15 days notice many investors use Sentry like a checking account,” he notes. This contributes to the Sentry fund’s appeal—and to its vulnerability.

On the plus side, Madoff has capped how much money he will take from Fairfield Greenwich, so redemptions allow them to satisfy investors who were shut out in the past. On the negative side, the redemption rate could dash the firm’s hopes of finding a buyer.

In a more private e-mail a few minutes earlier, the partner had been more candid. The downside risk of not replacing the withdrawn cash “is very significant,” he wrote. It would reduce the firm’s revenue from management fees and, thus, its value to a prospective buyer.