There were several things in this report that surprised me, especially the fact that the SEC’s director of risk assessment, Jonathan Sokobin, had never received my last-ditch attempt to expose Madoff—because I’d mistakenly sent a copy of my 2005 submission to the wrong e-mail address.
Among several things in this report that we didn’t know was the fact that the SEC had received other warnings about Madoff and had ignored them, too. In 2003, for example, an unidentified fund of hedge funds manager alerted the SEC as to his suspicions about Madoff, explaining during a conference call that “he couldn’t understand how [Madoff was maintaining his performance” and “he couldn’t figure out how he was ... earning returns.” This manager’s firm had responsibly conducted due diligence on two Madoff feeder funds—apparently using Mike Ocrant’s MARHedge article as at least a partial blueprint—and submitted its own list of red flags that, in many cases, pointed out many of the same problems we had tried to warn the SEC about. The SEC branch chief who handled this complaint pointed out that MARHedge was a respected industry publication, but “not one that she believed the Commission usually received.” And just like all of our submissions, this was lost in the bureaucracy.
The fact that Madoff’s scam was widely known in the industry and easy to rip apart was proved in 2004 by an SEC compliance examiner. As Kotz reported, while conducting a routine examination of Renaissance Technologies LLC, this investigator discovered e-mails between executives of that fund that professionally analyzed Madoff’s strategy and returns and concluded there was no way to explain Madoff’s activities. As one of those executives told Kotz, “This is not rocket science.” The reason they had not notified the SEC was that all the information they relied on to reach these conclusions was readily available to the SEC. “It’s not like we needed a PhD in mathematics to do the ... study on the OEX.”
In 2005 the SEC received an anonymous tip from a former investor who had taken his $5 million out of Madoff. The informant claimed he was “deeply concerned that Madoff is running a very sophisticated fraudulent pyramid scheme,” adding, “I know that Madoff [sic] company is very secretive about their operations and they refuse to disclose anything. If my suspicions are true, then they are running a highly sophisticated scheme on a massive scale. And they have been doing it for a long time.” The SEC has no record of ever investigating this claim.
Reading this, it almost makes me wonder why the SEC believed Bernie Madoff when he claimed to be the mastermind of a $50 billion Ponzi scheme. If they had needed any more clues, they received an anonymous letter in March 2008, apparently mailed from the New York Public Library, which concluded, “It may be of interest to you that Mr. Bernard Madoff keeps two (2) sets of records. The most interesting of which is on his computer which is always on his person.”
There is no stronger evidence of financial fraud than a second set of books. Nobody keeps a second set books for fun. But rather than investigating this detailed claim, which seemed to me to indicate some insider knowledge, Simona Suh responded, “[B]ecause the letter is anonymous and lacks detail, we will not be pursuing the allegations in it.”
Kotz’s conclusion was obvious: The SEC never took “the basic and necessary steps to determine if Madoff was operating a Ponzi scheme,” and if it had it could have uncovered the scheme “well before Madoff confessed.” Personally, after reading all 457 pages of this report I have great admiration for David Kotz. He took on his own agency and shredded it with the truth. As I said later, Kotz and his team reaffirmed my faith in government. That’s how strongly I supported his report.
A lot of people disagreed with me—they were very disappointed with the report because it didn’t assess blame. They wanted to see the people responsible for this debacle named and punished. And like Frank, they found it very difficult to believe that the failure of the SEC was due to inexperience and stupidity, rather than collusion or even corruption. But I was at the center of the storm, and I never caught even a whiff of corruption, only incompetence and arrogance.
David Kotz investigated what went wrong at the SEC and why, and the evidence he presented makes it obvious who should be blamed. It also wasn’t his job to determine how Madoff actually was able to pull off this scam for decades. In our investigation we didn’t go after that, either. I don’t even remember discussing it. Who knew?
My team didn’t even attempt to find evidence that anyone else, including his wife, his two sons, his brother, his friends, his landscaper, or any of the employees of his money management firm knew about the mechanics of his scheme and helped him pull it off. But I believe it was impossible for him to have done it without considerable help. My family couldn’t even operate one Arthur Treacher’s Fish & Chips franchise without assistance. This was a $65 billion international scam that operated successfully for decades. Madoff’s Ponzi scheme was too large an operation for one person to have done it by himself—unless you’re talking about Superman, of course. And truthfully, Bernie really wasn’t that smart. He wasn’t particularly sophisticated with the numbers. For example, the reports provided to investors every month had to be prepared, and whoever did that had to know that the numbers were based on fairy dust. There was no mathematical basis for them. But who knew and when they knew it may well take years to be settled.
One member of my team did hear a story from a potential Madoff investor who had met with Bernie only two months before his surrender. This man was a fund executive who was interested in making a substantial investment, but insisted on meeting Madoff personally. Madoff agreed, and spent more than an hour with this executive in his office, answering every question and carefully explaining his strategy. It was, according to this man, an impressive performance. But at the end of the meeting the man asked politely, “You know, Mr. Madoff, this all sounds good, but the fact is you’re getting older—and what’s going to happen to the company when you’re no longer able to manage it?”
Bernie apparently waved his hands in the universal “no problem” gesture. “There’s nothing to worry about,” he explained. “I’ve been grooming my two sons to take over their whole life. If anything happens to me, they know what to do.”
Who knows if that was true? But the executive shook hands with Bernie, promised to think about it, and left. As he got on the elevator, two other men joined just as the doors were closing. As the elevator started going down, they began making some small talk. One of them asked the other, “So how’s business going?”
The other young man nodded, saying, “I got to tell you, even with everything that’s going on, we’re doing great. It’s really amazing.”
The curious executive couldn’t help himself, and he asked, “Do either of you know Bernie Madoff?”
They both turned to look at him, and one of them responded, smiling, “Yes, he’s my dad.” They said a few more words before the doors opened. Later, when the executive thought about it, he believed this apparently chance meeting in the elevator seemed much too coincidental. He was supposed to overhear this conversation. The whole thing appeared to be orchestrated in an attempt to sway his decision. As a result, he decided not to invest in Madoff.
Among the people Kotz interviewed while preparing this report was Bernie Madoff himself. Kotz spent three hours in prison with him. It’s impossible to know how much of what Bernie told Kotz that day is true. Bernie Madoff’s entire life had been a complete lie for decades. Imagine that. We never stopped during our investigation to wonder what kind of human being Bernie Madoff actually was, what kind of insanity it must have taken to get through every day. In all that time there wasn’t one day, one conversation, in which he could tell the truth. Every single word he said carried with it the risk of exposure. Every time he went to a synagogue or had dinner with friends or attended an affair, he had to look people whose money he was stealing right in their eyes and smile and humbly accept their gratitude—and all the while he was probably thinking, You suckers. And if you choose to believe Bernie, those people he was lying to al
so included his wife, his sons, his sister, and other members of his family. For Bernie, lying became his natural way of life. So when he told Kotz he sometimes wished he had been caught sooner because the stress was incredible, only he knows if he is telling the truth.
Unfortunately, the government wasn’t quite done with me. I’d told my story and made my recommendations, and I had a tremendous amount of work to do in my False Claims Act cases. My whistleblowers were depending on me to get this work done. The anger I’d felt was gone; it was up to the proper authorities to make sure the SEC followed through on its promises and that legal action be taken against those people who deserved it. But after Kotz’s report was issued, I was invited to appear in front of the Senate Banking, Housing, and Urban Affairs Committee to comment on the report. I knew I owed it to David Kotz to do that.
So when I was invited to support Kotz’s report I agreed, and on September 10, 2009, I appeared before what was supposed to be the Senate Banking Committee. The stated purpose of this hearing was to examine the information contained in the inspector general’s report. It was a strange hearing. David Kotz testified first, and the committee asked him a lot of very good questions. But after a period of time the committee adjourned temporarily to allow the senators to vote on the floor. Only Senators Chuck Schumer, who had made a phone call to the SEC, and Jeff Merkley, a Democrat from Oregon, returned. Schumer took over the questioning.
During the recess, Gaytri, Pat Burns, and I had gone for a walk. When we returned, the whole feeling in the hearing room had changed. The SEC had reserved all the seats in the room. With the exception of two senior officials from the Association of Certified Fraud Examiners who had come to Washington from Texas for this hearing, the entire room was filled with SEC staffers. Gaytri took one look around and whispered to me, “The fix is in.” We were hoping the room would be full of victims, an audience we considered among our biggest supporters; but the victims had been shunted to a hearing room on the floor below us to watch the proceedings on closed-circuit television. We couldn’t have picked a more adverse audience.
I was joined on the panel by Robert Khuzami, the new director of the SEC’s Enforcement Division, and John Walsh, the SEC’s acting director of Compliance, Inspections and Examinations. In my opening statement I praised David Kotz, explaining that if my three sons grew up to be men like him I would be very proud. As for the SEC, in my prepared submission for the official record I wrote, “Even a great fiction-writer like Stephen King couldn’t have made up the nightmare that the SEC was pre-December 11 th, 2008. The SEC’s actions and inactions during the Madoff investigation were a comedy of horrors.” But in my oral testimony I was a little more succinct, telling Senator Schumer, “In a nutshell, the SEC staff was not capable of finding ice cream in a Dairy Queen.”
I was surprised that I was asked so few questions in this hearing. Senator Schumer seemed to focus on the other members of the panel. In fact, throughout the panel questioning Gaytri was handing me index cards with suggestions, but I really got very little opportunity to speak. Finally she started handing me cards urging me, “Jump in whenever you can.”
The whole situation was unusual. The other senators had left after the first session and Schumer carefully controlled this panel. I’m sure he had his reasons. One question Senator Schumer did ask me was what my two strongest recommendations would be for the improvement of the SEC.
After explaining that in our investigation we saw only incompetence and no evidence of corruption, I replied, “The best tool that the SEC could use, in my opinion, is the pink slip. It’s a piece of paper that every employee could understand. There need to be a number of them; I suspect about half the staff, perhaps more. The pink slip is when you get called into account and when you get fired for doing a bad job or not being competent on the job. I think many of these examiners and many of these enforcement attorneys lack competence at the basic skill level. There needs to be a skill inventory, a reduction of the staff. They need to take multiple-choice exams, and those who don’t cut the mustard—let them go. Everybody’s performance needs to be closely reviewed, and they basically need to start weeding out staff.”
There. That seemed to me to be a pretty strong recommendation. Fire half the staff, more than 1,700 people. And if that didn’t make the SEC a more effective force, there was still another half left to replace. Naturally the two SEC representatives appearing next to me disagreed. Naturally.
I actually had fun in the remaining few minutes of this hearing. Trying to make a long point in a brief statement, I resorted to the use of very descriptive metaphors, which everybody not working for the SEC seemed to enjoy. In response to the director’s defense of the agency and its employees, for example, I pointed out, “It’s very hard to soar like an eagle when you’re surrounded by turkeys, and there’re a lot of turkeys that need to be let go.” When Schumer asked me to elaborate, I added, “Most of these attorneys at the SEC—I don’t think they could find steak in an Outback.”
As I left the hearing that day, all in all I thought it was probably a good thing that at that moment I was not going over to the SEC Building.
Officially, at least, that was it for me and Bernie. Madoff was in jail for the next 150 years, with good behavior perhaps 140 years; Thierry was dead; and the tens of thousands of people who had lost their savings will recover only a portion of it at best. The Madoff story was far from done, though, as a large posse of lawyers had ridden into town, armed with loaded briefcases. The litigation has barely even started as those lawyers try to figure out which people and what organizations may bear some responsibility for these losses. There certainly will be more civil cases filed, more criminal indictments, and even more deaths like that of Thierry de la Villehuchet and that of Jeffrey Picower, who had received $7 billion from Madoff and was found on the bottom of his swimming pool in late October 2009. The SEC already has made substantial changes in the way it does business, and there will be many more changes to come if it intends to survive as an independent agency. The federal government will also be instituting new regulations and procedures for overseeing government financial institutions. Some of those industries—unregulated hedge funds, for example—undoubtedly will be trying to police themselves in an effort to keep the government out. And Gaytri has become very active in helping establish the first international financial court through the Global Alliance to deal with cross-border financial claims.
And unfortunately, other financial frauds will be uncovered. Soon after the story of our investigation became public, each member of the team began receiving letters and tips offering evidence of other financial frauds, including several Ponzi schemes. I’ve gotten a large pile of them that allege frauds in a variety of industries. Unfortunately, I’m so busy with active cases that I don’t have time to even look at the mail that comes my way.
What has become apparent to me and to Frank and Neil and Mike and Gaytri is that there is an overwhelming desire among the majority of people in the financial industry to clean up the mess. Most people who work in the industry actually are proud to be part of it, and a scandal like this one taints all of them. While a few people make money, scandals make the business harder for everyone else. So there is widespread support for these suggested changes. For Neil’s efficient markets theory to function, it is essential.
On October 20, 2009, five years after I became a full-time fraud investigator, the very first whistleblower case that I developed became the first of my cases to be unsealed. California’s attorney general, Jerry Brown, charged the State Street Corporation with a $56.6 million fraud against the state’s two largest pension funds, announcing that he hoped to receive $200 million in overcharges and penalties. Brown said, “State Street bankers committed unconscionable fraud by misappropriating millions of dollars that rightfully belonged to California’s public pension funds.”
This amount was only the tip of what my team and I believe was nothing more than a fraudulent iceberg. Basically, our complaint
alleged that the bank has executed more than $35 billion in currency trades for the pension systems since 2001, and what foreign exchange traders were doing was falsely claiming that buy trade orders were made at or near the highest exchange rates of that particular day while sell orders were executed at or near the lowest exchange rates of the day, allowing the bank to pocket the difference. It remains to be seen whether the bank will choose to go to a jury trial to prove its innocence or will settle the matter before it goes to trial.
Two days after Brown unsealed the lawsuit, the bank’s chairman and CEO, Ron Logue, announced he would retire the following March. There was no mention of the lawsuit in this announcement, and if anybody had asked about the odd timing, certainly the answer would have been that there was no link between the two events. And clearly that is possible. But it is quite a coincidence.
I have many other cases in the pipeline. There will be a lot more announcements and lawsuits just like this one to come in the future. In fact, I intend to be in this business until I can’t find anymore financial or Medicare frauds—which makes me think I’m going to be in the whistleblower business for a long, long time.
Epilogue
Mr. Pinkslip Goes to Washington
I’ve seen the failures of the Securities and Exchange Commission (SEC) from both inside and outside the industry. I know how the agency was supposed to function, and by this time I certainly knew how it actually worked—or, more accurately, didn’t work. So when I was asked numerous times to suggest ways in which the SEC could improve, I was able to offer a long and fairly detailed list of ideas.
No One Would Listen: A True Financial Thriller Page 33