In today’s regulatory environment, it’s virtually impossible to violate rules … but it’s impossible for a violation to go undetected, certainly not for a considerable period of time. Madoff speaking on a panel called “The Future of the Stock Market” in New York on Oct 20, 2007.
[The fraud] was a nightmare for me. It was only a nightmare for me. It’s horrible. When I say nightmare, imagine carrying this secret. Look, imagine going home every night not being able to tell your wife, living with this ax over your head, not telling your sons, my brother, seeing them every day in the business and not being able to confide in them. An interview to New York Magazine Published Feb 27, 2011
In an era of faceless organisations owned by other equally faceless organisations Bernard L Madoff Investment Securities LLC harks back to an earlier era in the financial world: the owner’s name is on the door. From the company website.
Bernard Lawrence Madoff, 73, is currently serving a 150-year prison sentence for perpetrating the biggest Ponzi scheme in history. Who is this man? And how was he able to fool almost all of the people almost all of the time? It is a gripping story. Some of the financial stuff is complicated and I would be lying if I claimed that I understood it all. But I don’t think it gets in the way of the story. This tale has everything – lies, deception, greed, negligence, incompetence, royalty, Greek tragedy, suicides and betrayal. I hope you find it as riveting as I do.
Madoff was born on April 29th,1938 in Queens,New York. He mother, Sylvia, was a homemaker, while his father Ralph was a plumber and stockbroker. His grandparents had emigrated to the States from Poland, Romania and Austria. He has an elder sister, Sondra and a younger brother, Peter. Curiously, his brother appears to have been part of the scam, while his sister was actually a victim, having apparently lost $3 million. After graduating from high school in 1956, he attended theUniversity of Alabama for one year, before transferring to and graduating from Hofstra University in 1960 with a B.A. in political science. He briefly attended Brooklyn Law School, but in 1960 he left to found the Wall Street firm Bernard L. Madoff Investment Securities LLC, where he remained until his arrest in December 2008. It was a small fish but it used innovative computer information technology to disseminate its quotes. His business grew with the assistance of his father-in-law, accountant Saul Alpern, who put him in touch with a circle of friends and their families. Initially, the firm was involved in market-making. A market maker is a company, or an individual, that quotes both a buy and a sell price in a financial instrument or commodity held in inventory, hoping to make a profit on the bid-offer spread. He also gave investment advice but this was not declared. Madoff helped popularise payment for order flow, in which a dealer pays a broker for the right to execute a customer’s order. Madoff was active in the National Association of Securities Dealers (NASD), a self-regulatory securities industry organization and served as the Chairman of the Board of Directors and on the Board of Governors of the NASD.
Madoff then was a highly respected elder statesman on Wall Street. This was a perfect front to fleece his victims. He had many different victims: the Jewish community, charities, public institutions and many prominent international investors. It was a complicated world of feeder funds, international hedge funds, sub-partnerships and pension funds. Madoff really knew how to ingratiate himself with himself with wealthy, often older people. He was a master of human psychology. He would play hard to get; people begged him to take their money. He would swear his clients to secrecy not allowing them to do the due diligence that they should have done. They were told that if they didn’t like it, they could take their money elsewhere. Few did.
The mechanics of the fraud are just breathtaking. He had fake clearinghouse screens where his head trader, Frank DiPasquale, was apparently trading stocks withEurope. In reality he was just trading keystrokes with an employee who was hidden in a room down the hall. Madoff saved old letterheads and office equipment, so if necessary he could come up with a back-dated document and stick in the files. He knew what regulators were looking for and he really knew how to game the system. It was really brilliant, the way he covered it up. Madoff almost invented a new species of Ponzi scheme. Traditionally these schemes exploit investors’ greed, offering ridiculous amounts. Madoff didn’t do this. Instead, he exploited the investors’ fear of volatility. Madoff did not offer the highest returns, but he did offer an incredible consistency, losing in only four out of 96 months
This is the ultimate delusion. You cannot totally eliminate risk from life. I have recently finished reading No One Would Listen by Harry Markopolos, the Madoff whistleblower. Markopolos was not on the inside – he worked for a rival firm – but he could see that Madoff’s numbers just didn’t add up. It was in 1999 and it took him around five minutes. Madoff had charts showing return streams that went up at a 45-degree angle, which is impossible in finance. His only doubt was whether it was due to a kind of insider trading or a Ponzi scheme. He favoured the latter. Little did he know then that Madoff would go on conning the world for another eight years. It was not for want of trying on the whistleblower’s part. He went to the SEC five times in those years. However this organisation, which is supposed to protect investors’ interests, did nothing. The scheme finally began to unravel in December 2008, when the general market downturn accelerated. The discovery of this gargantuan fraud was not down to the SEC – Madoff turned himself in on Dec. 11, 2008.
The size of the scam is very hard to ascertain. I have heard the figure of $65 billion quoted, but we will probably never know. There were many famous victims: John Malkovich, Pedro Almodovar, Kevin Bacon and Kyra Sedgwick. This famous Hollywood couple discovered that everyone really is connected to Kevin Bacon, especially Bernie Madoff; they lost everything except their current accounts and the land they own. One of his victims, who lost a sizable chunk of his retirement savings, was Stephen Greenspan, a psychologist who specialises in gullibility. He is the author of Annals of Gullibility: Why We Get Duped and How to Avoid It.
Europe lost a lot with Madoff, but very few victims have come forward. The reason for this reticence is that the Europeans were investing mainly through off-shore feeder funds. And when you’re in an off-shore feeder fund, chances are that you want to avoid taxes. These victims probably won’t be filing claims in the U.S.A. because were they to do so, they would be announcing to their host nation tax authorities that they had illegal money on which that they never paid tax. This would probably not be a good idea. And offshore funds tend to attract a high percentage from criminal gangs. Madoff was playing a very dangerous game. Maybe he is better off in prison because if these criminal organisations get hold of him, he may well have a very unhappy demise.
And there were the suicides. Two stick out. René-Thierry Magon de la Villehuchet was a French aristocrat money manager and businessman who helped found Access International Advisors, a research analyst investment agency that specialised in managing hedged and structured investment portfolios. It had connections to some very wealthy and powerful European aristocrats. Villehuchet was not involved in the fraud but he couldn’t live with the shame. Bloomberg News reported on January 2, 2009 that the AIA funds had increased its aggregate exposure to Madoff from 30% to 75% of a total of $3 billion assets in 2008, for a $2.25 billion exposure. And he had all of his personal assets with Mr. Madoff. ON 23 December 2008 the 65-year-old investor locked the door of his office, slashed his wrists and arms with a box cutter and bled to death. He had his feet on his desk and allowed the blood to flow into a rubbish bin under his desk to minimise the mess. Bottles of sleeping pills were found near the body. No suicide note was found but his brother in France received a note shortly after his death in which he expressed remorse and a feeling of responsibility. The second suicide affected Madoff directly. Indeed it was the kind of cosmic retribution that you expect in a Greek tragedy. On the second anniversary of Madoff’s arrest, his son Mark, 46, tried to hang himself with a vacuum-cleaner cord over a pipe on the living-room ceiling of his Soho loft. He didn’t succeed – it broke. He then tried a dog’s leash, and the second time he succeeded. Madoff was shattered by Mark’s death.
It is difficult to find the appropriate vocabulary to describe Madoff. Elie Weisel, who had lost his life savings and most of the assets of his foundation to Bernard Madoff, was asked if he thought Madoff was a psychopath. Psychopath is too nice a word for him, Weisel replied. Mr Madoff has been compared to a serial killer. He certainly wreaked havoc on many lives. Serial killers enjoy having power of life or death over their victims: they are playing God. Madoff was playing financial god, ruining these people and taking their money. Madoff will have none of it. In fact he is in therapy. He asked his therapist if he was a sociopath. She replied that he was not a sociopath, that he had morals and he felt remorse. Diana Henriques, author of The Wizard of Lies: Bernie Madoff and the Death of Trust, argues that he couldn’t admit failure. He insisted to her that he hadn’t really been defeated by the market turmoil of 2008. He believes that he could have kept the fraud going – he claimed that he had plenty of people who were still willing to give him money – but he was tired of having to keep up the fraud.
What conclusions can we draw from all this? This type of scandal will always happen. There’s a basic law of the market. When you get rich, it’s because you’re smart, but when you get poor, it’s because somebody cheated you. I don’t how understand how people could have put all their eggs into one basket. That makes no sense. The role of the SEC was catastrophic. If regulation is done badly, it is actually worse than no regulation at all. Clients were reassured by SEC supervision and audit. It was the official seal of approval. The hedge funds and the banks were basically marketers, skimming off their highly lucrative cut – usually 1% or 2%. This fee was supposed to be for their due diligence. There seems to have been very little of that. Very few people come out of this episode with much credit. All I can say is that when it comes to finance, a healthy dose of scepticism and a little historical perspective are as essential as they have always been. Failure to remember this can seriously damage your wealth.