Octopus

by Guy Lawson

  “At the time Butch was looking to get funding for a record label,” Sam recalled. “A mutual friend got us together. We met at a steak house for lunch. It was supposed to be a one-hour meeting, but we went from 1:00 PM to 1:00 AM. We just couldn’t stop talking, like brothers split at birth. Butch gave me my "rst set of really good drums. I started practicing all the time. It was a way for me to relax. Late at night in my basement I’d play for hours. After that Butch arranged for me to have backstage tickets at the Beacon Theater in New York whenever I wanted. I played with the Allmans a lot. I played with B.B. King, the Neville Brothers, Dr. John. When the Allmans were in town, I was up on stage with them.”

  Trucks was promoting a business he called Moogus, which was how his toddler son pronounced “music.” The idea was to set up a virtual blues club online so fans could watch live acts at di!erent clubs around the country on their computers. Israel invested $150,000 of Bayou’s money up front, followed by sums that amounted to $790,000.

  Whatever the merits, the project never materialized into a meaningful business.

  Word of Sam’s success traveled along Buckout Road and through the town of Harrison. Sam was the subject of admiration and wonder. Friends, neighbors, perfect strangers knocked on the front door of the Israel house and asked for investment advice.

  “People started to turn up with bags of cash,” Sam said. “There would be "ve, ten thousand in cash in the bag. They wanted me to trade it for them. They said their son needed a new car, so they wanted me to turn it into twenty thousand. They wanted me to make them enough money to pay for their kid to go college. It was incredible—fucking incredible. I was the moneymaker.”

  But Sam’s marriage was in trouble. His erratic behavior and appetite for illegal substances disturbed his wife. To Sam’s dismay, Janice joined a women’s support group.

  Sam argued that a group gripe about the various failings of their husbands would only undermine their marriage. Janice insisted. So at the suggestion of his psychiatrist, and as a retort to Janice, Sam joined a men’s support group. Sam’s men’s group convened every Monday night. The men were Sam’s peers—wealthy businessmen, white-shoe lawyers, surgeons, venture capitalists.

  “The guys were all smart,” Israel recalled. “I was okay rich, but some of those guys were really rich—like $150 million rich. The ones who were the biggest geniuses had the biggest problems. There was a doctor named Jack who’d prescribe himself fun stu!

  on the weekends, like Valium or liquid heroin. He had family money. When we met at his place, we played on his basketball court. The games would get serious sometimes—dishing out elbows, shouting. But mostly it was middle-aged white guys letting o!

  steam.

  “The group wasn’t elitist. For dinner we’d order pizza. Some of the guys thought they were fancy, but the group would knock the fancy out of them. I enjoyed it. Men opened up with each other in a way they usually wouldn’t. Men don’t want to be vulnerable or to cry in front of other men. Of course I couldn’t talk about what was really bothering me. But I talked about my back pain and how I had horrible issues with painkillers. I said I was having a hard time at work, controlling the sta!. By then Bayou had a dozen employees or so. A guy with an Internet company who had one hundred employees gave me management tips. He was trying to figure out what to do with all the money he was making—up to a billion. It was all beyond his wildest dreams. Every time his stock went up one hundred points, he’d do something stupid, like kill a bottle of vodka and crash a car—which didn’t matter because he’d just leave it there and get a new one.

  “The men were the American establishment. They were supposed to be living the American dream. But guys would talk about how they hit their wives, how they went over the edge and didn’t come home for two weeks because they were holed up in a hotel with a hooker and a handful of eight balls. Most of us were divorced or separated.

  One blond guy, maybe thirty, was a trader who came home to his wife every night and shot heroin and then got back up o! the canvas in the morning and went to work. I knew from my own experience there were a lot of functional alcoholics and junkies who went to work, who were legitimate people, who were truly fucked up.

  “For me, no matter how much medication I took I couldn’t get my back to stop hurting. Eventually that creates a wound in your brain. But there was no way I could share with anybody what was really going on with me. There was no way I was going to say that I was committing a felony. It would destroy my reputation. It would destroy my life. Who are you going to tell that to?”

  In the fall, Sam’s neurologist injected dye into his spine and saw that he had a severe disc bulge. Bedridden, Israel was occasionally able to trade from home by calling in his orders to the office. But his control over events at Bayou was slipping. So was his ability to pretend that he was achieving the results necessary to keep the scam going. Then Dan Marino told him about a computer trading system that yielded 100 percent annual returns. Marino said he’d seen the system work. It was foolproof.

  Sam should have been the "rst to doubt such a claim. But he was desperate and incapacitated. Marino traveled to L.A. to meet the trader who ran the program. Basil—he gave only his "rst name—was an exile from Iran. When Marino asked how the program worked, Basil refused to explain. Even so, Marino put $5 million into an account for Basil to trade. In a matter of weeks, Basil lost $4.1 million—further deepening the hole.

  “I told Dan the trade was ridiculous,” Israel recalled. “But I wasn’t trading well and we were in a big hole.”

  Sam decided he needed to quit drugs cold turkey if he was ever going to regain control of himself. He checked into a Hilton hotel to detox. At marriage counseling the next day, Janice was alarmed by Israel’s physical state. Stopping all his meds at once had turned Sam into a mumbling mess. After the session, Janice followed him to the hotel and urged him to get medical help. Sam’s doctor said he could have a heart attack if he suddenly stopped taking his drugs. Sam was trapped in a vicious cycle: The meds were driving him mad, but the meds were the only thing that made life tolerable. The hole yawning at his feet, threatening to suck him into the abyss, was all he could stare at. But no one else could see it.

  “There was a black hole in my heart,” Israel said. “Every day I was in the hole. I had one hundred million to trade with. I was telling people I was beating the market. So I would trade and trade and trade and I would do okay. I would make some money, say 3

  percent. But I was still seven million down because I had to show a 10 percent gain.

  The actual losses weren’t that big most of the time. But the disparity between the real money and the performance was killing me. I was actually making money—just not enough. It weighed on me all the time—on my shoulders, my heart, my mind. I was always surrounded by blackness.”

  CHAPTER EIGHT

  The Trump House

  In January of 2003, Sam had back surgery—in fact a series of life-threatening surgeries. The !rst procedure involved decompressing his lumbar spine and fusing screws to his vertebrae. After a week in hospital, Sam was "ipped over and another procedure was performed to address nerve damage. The next day yet another surgery was done to remove bone fragments—this time accessing the surgical area through Sam’s chest. The prospect of Israel’s death terri!ed Marino—but Sam viewed the possibility as a way to be released from his torment.

  Bayou’s results for the previous year were catastrophic—yet again. The fund had managed to lose another $27.7 million. But the audited statement that Marino prepared painted a di#erent picture. Richmond-Fair!eld stated that Bayou now had nearly $150

  million in assets. The fund had attracted $55 million in new investment. The “Due from Brokers” line in the !nancial statement had exploded to $103,923,506. But as in the past no one asked what was behind the number or what it was supposed to mean.

  As far as Marino was concerned, the “plan” was working. Bayou was now a sustainable business, Marino believed. The key
was cash. In a conventional Ponzi scheme, new money was used to pay old investors o#. But Bayou didn’t have to pay o#

  old investors. Only $11 million had been redeemed in 2002, none of it because of displeasure with Bayou’s performance. Investors were delighted to keep their money in the fund and watch it increase with every quarterly net asset value report.

  Marino had unearthed one of the deepest—and most disturbing—truths about modern !nance. All that was required to keep a con going was cash "ow. It seemed to Marino that the entire system could be like Bayou. The implications were incredible. If Israel and Marino had seen how to maintain a facade like their hedge fund, who else had !gured it out? How many other funds were doing the same thing? Dozens, hundreds, thousands?

  The fraud could be expanded exponentially in size, Marino believed. So long as Bayou had enough cash and was able to maintain the appearance of a busy and prosperous trading desk, the ledger legerdemain functioned properly. Once Bayou’s capital base reached $300 million, Bayou would legitimately throw o# more than $20

  million in pure pro!t a year, Marino reasoned, and that was before the 20 percent incentive fee on the (invented) performance of the hedge fund, which would be millions more. Marino’s reasoning didn’t make sense—but neither did much of the !nancial system in the bubble economy.

  AS ISRAEL CONVALESCED from back surgery, Marino took advantage of the lull in activity to restructure the fund. Because of !nancial laws, the maximum number of investors Bayou could have was ninety-nine. But as with most things hedge fund related, getting around the rule was laughably easy. All Bayou had to do was open another hedge fund. The new fund could follow the exact same trading system as Bayou, using the same sta# and o$ce space. The new fund would be just as unregulated and inscrutable as the original Bayou.

  To increase the amount of money the fund could attract, Marino decided to split Bayou into four di#erent funds. For the scheme to be discovered, four funds would have to be cross-referenced and their returns integrated. It made the fraud harder to detect.

  But there was risk in making any changes. Marino was most worried about providing the supporting documents to the clearinghouse SLK. In the past, SLK had been incredibly lax. But the company had recently been acquired by Goldman Sachs for $6.5

  billion, causing Israel and Marino to fear that higher diligence standards might be applied. They needn’t have worried. When Bayou started to open the new accounts, SLK

  requested the o#ering documents that were going out to investors. But providing them would have been suicidal. The performance numbers Bayou claimed were wildly di#erent from the sums in SLK’s accounts. Even the lowliest clerk would notice the disparity. Marino played for time.

  “I was able to see patterns in how people behaved,” Marino said.

  “I saw how people followed routines and how those routines were !lled with "aws. I knew from my own experience that when I received a FedEx package on a Friday afternoon I’d often toss it on a pile for Monday morning, and then when I got in on Monday I’d be busy getting the week started. Often I wouldn’t get to the package until a week later. When I was an accountant I saw how often this happened when I sent out !nancials or tax returns. It was almost comical how predictable it was. So when SLK

  called to ask for Bayou’s !nancials, as they were required to do, I told them that I would mail it to them. Of course I didn’t. When they called a week later to ask again, I told them I’d mailed it. The process went on for a month and a half. Finally I’d sent it FedEx to arrive late on Friday afternoon. I knew that it would be put in a pile and not looked at until the next week, and that it would only get a cursory look.”

  As predicted, the false !nancials were glanced at and !led. Even the mighty Goldman Sachs, imagined to be omniscient by many, was fooled by Bayou—or allowed itself to be fooled. While one branch of Goldman (SLK) failed to perform even perfunctory due diligence, another branch of the !rm (Pedigree) began to consider Bayou as a potential fund to promote to its clients. Normally, getting Goldman’s attention was a coup. But Marino didn’t want anything to do with them, no matter how much money they had.

  “I knew at some point Goldman would want some detailed information that I wouldn’t be able to give to them,” Marino said. “So when they called, I didn’t call them back. When they persisted, I answered questions only if they were directly asked. I was very slow in responding to requests for documents and setting up meetings with their clients. Everyone was confused by what I was doing, including Bayou’s salespeople and advisors. They couldn’t understand why we weren’t pursuing the leads with Goldman.

  But I knew we couldn’t deal with them.”

  On the rare occasions when securities regulators asked questions about the hedge fund, Marino and Israel "im"ammed, using lingo about puts and swaps and derivatives.

  Regulators didn’t understand how the market was supposed to work, let alone the reality. Nor were the regulators able to admit their ignorance. Sam was acutely aware of these truths. It provided him some comfort when !nancial regulators in Boston required that Bayou provide records related to the broker-dealer side of the business.

  Sam knew the SEC was checking to ensure that Bayou Securities wasn’t overcharging Bayou Funds to bilk the hedge fund investors. If the real numbers were sent, no overcharging would be found. But the documents would also show Bayou had lost massive amounts of money—if the record was examined properly. Marino wanted to falsify the numbers. Israel said there was no need to take the risk. Leave the numbers as they are, Sam said. The SEC will never notice.

  “I called the regulators up in Boston and asked if they were sure they wanted all the documents,” Israel said. “I said it was going to be a lot of boxes. Dan was freaking out, but I told him to calm down. We shipped all the trading records up. They had no clue how to look at the numbers. Because they were looking for that one thing, I knew they wouldn’t see anything else. The numbers showed that the amount of money in the fund didn’t match the amount that was supposed to be there. All they had to do was look.

  But they didn’t know how to look. Even if they did !nd something wrong, they would think they had made the mistake—not Bayou. They wouldn’t say anything because they didn’t want to look like fools—like they didn’t understand what was going on. So I just hid in plain sight. There was no reason to do it any other way.”

  THE SANGFROID AT WORK wasn’t matched by Israel’s shambolic personal life. Now addicted to new powerful painkillers from another failed back surgery, Sam !nally agreed to go to rehab. The Retreat was a deluxe facility set in the leafy grounds of a large hospital campus. There were only !ve rooms, each set up like a luxury hotel suite, with a concierge and gourmet room service. It was the perfect hideaway for a hedge fund trader like Israel to quietly slay his inner demons—and not be discovered by his investors.

  Israel lasted twenty days. After checking out voluntarily, he immediately relapsed.

  Cocaine and codeine and marijuana were found in the urine tests he’d agreed to take. It happened that the Israels had tickets to see the Allman Brothers. On the night of the concert, Sam walked into the master bedroom to ask Janice if she was coming. She told Sam she didn’t want to go; she didn’t like the Allman Brothers. She asked if he’d gone for his urine test that day. “You want urine?” Sam asked. He undid his zipper and proceeded to take a leak on the bathroom floor.

  The situation was hopeless. Janice demanded he leave the house. Sam didn’t want to go. Janice insisted. He !nally agreed to move out, though with the express agreement that they would try to reconcile. Seeking a temporary place to stay, Sam checked into the Doral Arrowwood Hotel in White Plains. He took a penthouse suite with sweeping views of the Hudson River.

  “I’d been with Janice since high school,” Sam said. “Now I wanted to meet as many women as I could get. I tipped the bartenders and bellhops really good. I told them to be on the lookout for pretty girls, to talk me up, to say I was a big-time hedge fund trader. They lov
ed doing it for me.”

  Janice went with Sam to see his psychiatrist. She wanted a safe environment to tell Sam that she was going to seek a protective order to keep him away from her and the house. When Janice was done, Sam exploded, just as his father had done when he was a boy. “I took you out of the gutter,” Sam screamed. “I made you and now I will break you. I’m going to send your ass back to Yonkersville.”

  Thanksgiving was a disaster for the Israel family in 2003. Hoping for a reconciliation, Sam and Janice hosted a gathering. Wasted, Sam passed out while trying to eat his turkey. Janice took the children to her sister’s house. Sam’s conduct had become completely unacceptable. Sam was still trading from an office in his basement when one day two policemen came to the house to see him. The o$cers were fathers of kids he’d coached in soccer. Sam greeted them in a friendly fashion, but their mood was somber.

  They asked Sam to take a seat and remain calm. For a second, Sam had a pang of fear: Was he about to be arrested? Had the Bayou fraud been discovered? The police said they had bad news. A protective order had been issued. Sam had to leave the house immediately. Sam had twenty minutes to pack his things. Israel refused to submit to the demeaning ritual of !lling suitcases with his belongings. He had money. He would buy himself a new wardrobe—sneakers, sweatpants, baseball caps.

  “My marriage didn’t fall apart, it got cut o#,” Sam said. “Janice had looked up to me.

  I was the father !gure, the rainmaker. But she lost faith in me. She saw me in!rm. I was high on opiate doses because of my back pain and the surgeries. I fell o# the pedestal. Instead of doing things that she thought were funny, now I was being an asshole. She saw fault in everything I did.”