It was. In October 2003, Neil accepted the job and moved to Tacoma, Washington. A super-smart guy named Stu Rosenthal took his seat across the desks from me. In his new position Neil was responsible for interviewing potential hedge fund managers to be included in the Benchmark Plus portfolios and doling out funds for them to manage. It put him a position to meet even more people. So rather than our investigation being sidetracked, as we physically moved further apart, the pursuit of Bernie Madoff became the glue that held the team together.
Chapter 5
The Goddess of Justice Wears a Blindfold
If I needed a reminder of how potentially dangerous an investigation of the financial industry can be to a whistleblower, I got it in February 2003. An honest man named Peter Scannell was working in Putnam Investments’ Quincy, Massachusetts, call center, basically taking customer buy and sell orders. Eventually he realized that some of his customers were market-timing; at the end of the trading day, if the American stock market had gone up they bought mutual funds loaded with foreign stocks, figuring those stocks would rise when trading began in the foreign markets the next day. Many of those trades were being done by members of the Boilermakers Union. Although technically it’s not illegal, it’s a violation of the National Association of Securities Dealers regulations because it penalizes long-term investors, and most funds won’t accept trades from market timers. But when Scannell informed Putnam’s management, they reportedly ignored him. Although he was not supported by management, Scannell finally began refusing orders from the Boilermakers.
On a cold, snowy February night a few days later he was sitting in his car drinking a cup of coffee. He was parked in a dark church parking lot less than a dozen miles from my home. According to Scannell, a heavyset man dressed in a gray sweatshirt with “Boilermakers Local 5” emblazoned on it suddenly attacked him, hitting him in the head over and over with a brick, screaming that he’d better “shut the fuck up.” Scannell was left to die in that parking lot. Fortunately, a police officer found him lying there. At first he thought Scannell was drunk—it was only when he went to wake him that he saw the blood and rushed him to the hospital. Scannell barely survived. But I got the message: If a member of a local union had tried to kill Scannell over millions, it was not hard for me to imagine what organized crime would do for billions.
Ironically, this assault on Scannell changed my life, too. Scannell eventually brought his complaint about the market timers to the Boston office of the Securities and Exchange Commission (SEC). After waiting five months without any response, he finally went to Massachusetts Secretary of the Commonwealth William Galvin, who initiated an investigation that led to fraud charges being filed against Putnam, the resignation of its CEO, and the withdrawal of tens of billions of dollars by its clients. It also caused the head of the SEC’s Boston office, Juan Marcelino, to resign in November, several days after it was reported that the SEC had paid no attention to Scannell’s complaint. On September 9, 2003, New York State Attorney General Eliot Spitzer and Secretary of the Commonwealth of Massachusetts Galvin announced indictments against a number of hedge funds in New York and Putnam Investments in Boston for allowing market timers to steal returns from long-term fund shareholders.
The SEC’s Boston office was publicly humiliated and set out to rectify that by finding and prosecuting market-timing cases. And the SEC was willing to pay a reward for information. Ed Manion called me to ask if I knew about people market-timing in Boston, telling me, “If you have any cases for us, we do have this bounty program. We can pay you up to 10 percent and triple damages.”
I had known a little about the bounty program. I knew, for example, that Madoff wasn’t front-running, so it didn’t apply to him; but Ed described it in detail. “This definitely applies,” he said. “There’s money in this one. Bring us a big case and you can make millions of dollars.”
Over the next few days I started thinking about that. Millions of dollars? I now had a wife and two children, and I was bogged down in a job that was no longer very interesting to me. Millions of dollars? Maybe this is something I’d really enjoy doing, I thought. I began learning a lot more about the world of whistleblowers. I ordered several books about whistleblowers and fraud investigation from Amazon and quickly read through them. I was right—I was fascinated by these stories. Then I ordered several more books and raced through them. I can do this, I thought, and it would be a hell of a lot more interesting than what I’m doing right now.
Market timing is not at all unusual. The world markets are open 24 hours a day. The trading day begins in Asia, moves through Europe, and ends in the United States at the close of business. The European and Asian markets generally follow the U.S. markets; if we go up in the afternoon, then generally those markets will rise the next day. But the prices of stocks on those markets do not reflect the results of the U.S. trading day, which leaves four hours to arbitrage. Market timers buy international mutual funds, take out their gains right away and leave long-term mutual fund holders saddled with all the trading costs. Basically, market timers are picking the pockets of long-term investors. What was illegal about it was that the mutual funds claimed they did not allow it, when in fact they did allow certain large, favored customers to market-time their funds at will. They allowed their high-dollar clients to participate while they were telling their smaller investors it wasn’t going on. They were committing fraud against their fund shareholders.
As past president of the Boston Security Analysts Society, I knew people in the industry throughout the country who would be in a position to know about market timing. I’d met most of them at Chartered Financial Analyst conferences. I began making phone calls at night, just dipping my toes in the investigative waters. I told those people that the SEC was desperate for market-timing cases and had a bounty program that would pay up to 30 percent of the ill-gotten gains or losses avoided. “It’s a ticket out of the industry,” I said flatly, offering, “If we do a case together I’ll split it with you.” Over months I began building an investigative organization. I found a legal team that would handle the cases on a contingency basis and I learned how to protect the identity of anyone working with me. Investigating market-timing cases became my second job. I’d come home at night and practically rush up to my attic office to go to work. Doing this work excited the hell out of me. These companies were cheating their clients, and I was helping to catch them—and maybe I was going to make a few million bucks doing it. I worked endless hours, nights and through the weekends, completely erasing any boundaries between my work and my personal life. I had to find cases of fraud, recruit my whistleblowers, and document those cases so my legal team could prepare a submission. I had to teach my whistleblowers what to look for and what the legal boundaries were, as well as continually providing the emotional reinforcement they required.
Being a whistleblower is an extraordinarily lonely existence. You’re putting your livelihood at risk, maybe your life, and you can’t tell anyone about it. You have to go through every workday as if everything is normal, when in fact you’ve made a conscious decision to expose illegal actions your company is taking, and you’re doing it with the knowledge that the people you work with are going to suffer because of that, and some of them may even go to jail. It’s incredibly tough. So I became an adviser and a confessor to many of my people.
And the only person who knew I was doing this was my wife, Faith.
I had to teach myself an entirely new business. After I had found several strong cases, I called the smartest securities lawyer I knew and told him what I had. His firm couldn’t handle those cases, he explained. It was a defense firm; it represented the companies the SEC would be suing, large corporations that paid his firm by the hour. I needed a plaintiffs’ firm, which are generally smaller firms that file these cases and work on a contingency basis, meaning they take their fees from the proceeds—if they win. “It’s in our interest that plaintiffs’ firms file these cases—so we can defend them,” he explained,
just before giving me the phone numbers of several good plaintiffs’ firms.
Which is how I found a legal firm to work with me.
Over an extended period I was able to identify 20 cases of market timing in which investors had been defrauded out of at least $20 billion. The companies participating in this included some very large mutual funds and foundations. Twenty billion dollars. Finding them was not especially difficult, although obviously you never see a CEO admit in his annual report to investors, “Fraud was up 25 percent this year. We had a great year in fraud; it’s our highest-margin product. My expectation for fraud is that we intend to grow it 25 percent a year to infinity. I have a really good fraud team; we believe we have the best crooks in the business.” In fact, most of my cases began when I examined companies’ publicly reported numbers. The clues were always in their annual reports, income statements, balance sheets, and footnotes—if you knew what to look for. And knowing that required having experience in the financial industry and great math skills. To me, some of these numbers popped out like a glowing neon sign flashing in red letters, “We are a fraud. Our numbers are too good to be true.” I found these cases by analyzing the numbers, convincing some employees to speak to me, and getting information from them that gave me insight into the way their company did business. Recruiting those employees proved to be the most difficult task. Eventually I would file all 20 of those cases with the SEC, confident that in every one of those cases I had established beyond any doubt that these companies were defrauding their investors by market timing.
On paper, I was a rich man.
Early in 2004 I began to consider leaving Rampart. Not because I was rich on paper, but rather because when I woke up in the morning the thought of another day in the industry depressed me. On some level I had never felt like I belonged in the finance industry. I knew there were at least 100 people in equity derivatives who were better than me. Everybody in finance was smart, but the only way to get that edge was to be superbrilliant. I knew some of those superbrilliant people quite well, and I knew I wasn’t one of them. I wasn’t in the top 1 percent. It had been at least five years since I’d seen any exciting new math. It was just the same old repackaged stuff in a different form. I just didn’t feel the industry was providing products that people should be buying. Basically, I was getting really bored.
Investigating Bernie Madoff, as well as the work I had started doing on the market-timing cases, convinced me I could be successful at fraud investigation. And I was enjoying it. When I had started looking at Wall Street through my fraud lens, I realized how much of the business was based on deception and outright fraud. Those people who work in the industry know it is not pretty. There were times I would watch the television commercials for some of the large funds and just sit there shaking my head in disbelief. The fantasy they were selling had absolutely nothing to do with reality as I knew it to be. It isn’t every person or every firm, but the dishonesty is widespread and there is little the honest majority in the industry can do about the corrupt minority without the assistance of local, state, and federal agencies. And that support just doesn’t exist.
I was confident I knew how to weed out those frauds. My derivatives background gave me the math skills to look closely at pitch books, annual reports, and other public documents and pick them out. And I also knew there was enough fraud ingrained in the business practices of the finance industry that I wanted to be on the other side.
I discussed this at length with Faith. While the thought of losing the security of my paycheck made her very nervous, she told me simply and directly, “If you’re not happy doing what you’re doing, you shouldn’t be doing it.” We both knew that if I did this we would have to live on the money I’d managed to save, but we’d be depending mostly on her paycheck until I was able to settle some cases. I was confident that would happen pretty quickly, but there were no guarantees. Fortunately, Faith was doing very well in her career, working as a senior analyst at a very large Boston-based mutual fund company. Leaving Rampart meant we would have to survive for at least a little while on one Wall Street salary, but we finally decided it was time. Fortunately for us, we had always lived well below our means, had bought an affordable home with only a small mortgage payment, owned both of our cars, and had no debt otherwise to worry about. Thanks to our years of living frugally and wise investing, financially we could afford for me to start a new career.
When I had first casually examined Madoff’s split-strike strategy five years earlier, there was no way I could have imagined the twists it would take—or that it would lead directly to the end of my career as a derivatives portfolio manager.
In May 2004, I gave notice at Rampart and offered to stay until the end of October, giving the firm ample time to find and train a suitable replacement. I felt great loyalty to that company. I’d been there almost 13 years, and I appreciated everything my employer had done for me. I explained that I had been investigating fraud cases for some time, although I certainly never mentioned Madoff. I’d discovered there were a lot of frauds being perpetrated on investors, and thanks to my years at Rampart I had the tools, the experience, and the knowledge to stop them. At least some of them. They were gracious about it. I recommended my successor, a really smart guy named Nick Penna, and in mid-August they hired him. And two weeks later, on the last day of August, they surprised me by informing me that it was my last day.
But I’d prepared for that months earlier, gradually taking home anything personal that I would need. What was left was already stored and ready to be moved. Truthfully, like any good geek I am a little germ phobic. I’m not obsessive, just aware. At Rampart I always kept a bottle of rubbing alcohol and cotton swabs in my desk, and occasionally I’d wipe down my keyboard, mouse, and phone. George Devoe, our late senior investment officer, used to get colds, and he’d sneeze or cough without covering his mouth or nose. The last thing I did on my last day was take out my rubbing alcohol and carefully swab down my keyboard, mouse, and phone. Then I walked out the door into my new life.
I wasn’t the only member of our team looking for new challenges in 2004. Frank Casey’s job with Parkway Capital had prevented him from sailing, the passion that had been the bond between him and Thierry de la Villehuchet. During the week, he and his wife Judy lived in Freehold, New Jersey, returning to Boston each weekend. So when a close friend, Kevin Leary, invited him to sail from Boston to Bermuda on the 38-foot Sennen, he happily accepted. The third member of the crew was a bulky Russian woman who had responded to Kevin’s Internet ad for a cook/crew member, claiming to be a medical doctor with considerable ocean sailing experience.
The Sennen sailed out of Boston Harbor on July 31. As they left, for the first time in their 24 years together, Frank’s wife Judy cried—and asked where the insurance policies were kept. That seemed odd. Kevin and Frank had responsibly checked all the weather patterns before departing and saw nothing to raise any concern. But as they sailed through calm waters the first few days, Frank began having doubts about the cook, who didn’t seem to know how to correctly set the sails and wasn’t familiar with certain medical terms. It didn’t seem to matter too much, though; for a six-day sail it shouldn’t cause any problems.
On the third day out, a weather fax reported that a tropical storm had formed off the coast of Florida and was moving northeast up the coast. They decided to continue toward Bermuda, sailing across the Gulf Stream and using it as a warm-water shield to shelter them from the storm. But it was vital to get across it before the storm hit. As Frank knew, “Strong winds blowing against this vast current of water produce tremendous waves with flat sides like a barn wall.... Picture a bowling alley with the storm being the ball; you do not want to be the pins. Sailors know they might survive a hurricane in open ocean, but would likely die if caught by one in the Gulf Stream.”
Late in the afternoon of the third day, they learned that the tropical storm had grown into the first hurricane of the season, Hurricane Alex, and was moving northeas
t much faster than initial estimates. It was moving directly toward their position. To survive, they were going to have to race through the night, away from Bermuda, toward Africa.
By this point it was obvious the Russian cook had little sailing experience. She was told to stay below and secure the cabin to prevent projectiles from flying if they were hit by a wave. Frank and Kevin spent the night in the cockpit, handing off the tiller every 15 minutes, “being beaten to death in a wild mouse ride in storm-tossed seas.... Any slip of concentration could mean disaster.” By the afternoon they had put 200 miles between their position and Hurricane Alex’s track. They were going to be three or four days late to Bermuda, but they had successfully skirted the hurricane. For the first time in two days, they breathed easily.
As the captain’s log reads: “Later that evening, around 9 P.M. Boston, Sennen was knocked over by one enormous rogue wave.... Seawater gushed past the closed but submerged companionway hatch. This seawater immediately ruined much of the boat’s electrical system, including all three radios, navigational computer, electrical monitor and inverter, and the GPS. The rogue wave also crushed the fiberglass dingy and disabled both the monitor and auto-helm steering devices. In addition, the wave forced seawater into the fuel tanks ... making the engine inoperative.”
No One Would Listen: A True Financial Thriller Page 16