By then, Ike Sorkin has landed at LaGuardia Airport and is recharging his phone from the ashtray outlet in his car as it idles in the middle of the huge puddle-filled car park. He calls his office and makes sure all the necessary legal chores have been done, then puts his car in gear and pulls out. When he reaches his Long Island home, he and Horwitz speak at length about the Madoff case. These two tenacious defenders are holding a nearly impossible hand. Madoff has confessed to an FBI agent in his own foyer. Absent proof that he is delusional or otherwise insane, there just isn’t much they can do.
Before midnight, the news that stunned Wall Street in the late afternoon is spreading like wind-driven fire across the country. Bernie Madoff, a pioneer of the modern stock market and a man whom regulators trusted and consulted for decades, has been arrested after confessing to what he himself calls a $50 billion Ponzi scheme.
Even if you’ve never heard of Bernie Madoff, the sheer size of his fraud—fifty billion dollars!—guarantees that you will notice. Even in normal times, it would have been news, and these times are nowhere near normal. The financial system is already reeling with bankruptcies and bailouts. The year 2008 challenges 1929 as the most frightening and frenzied in the long history of Wall Street. The Bear Stearns brokerage house has failed. Fannie Mae and Freddie Mac, two US government-sponsored mortgage giants, have been bailed out; the venerable Lehman Brothers firm wasn’t. Within a day of Lehman’s bankruptcy, the nation’s oldest money market fund was swept away by a tsunami of panicky withdrawals. Before that day ended, regulators were scrambling to rescue the insurance giant AIG, fearing that another titanic failure would shatter whatever trust continued to hold the fragile financial system together.
People are already furious, shaking their fists at the arrogant plutocrats who led them into this mess.
Then, in a camera flash, Bernie Madoff is transformed from someone whom no one but Wall Street insiders and friends would recognize into a man who is headline news around the world. Longtime clients, comfortable people who have lived carefully and who entrusted all their liquid assets to Madoff, will wake up tomorrow nearly destitute.
This is the day the music finally stops for history’s first truly global Ponzi scheme—one that grew bigger, lasted longer, and reached into more corners of the globe than any Ponzi scheme that came before.
FRIDAY, DECEMBER 12, 2008
It’s still the middle of the night in New York City when lawyers in London arrive at the small Mayfair town house occupied by Madoff Securities International Ltd.
The European markets will open soon, and Madoff’s London operation must be locked down and secured before that happens. As the shaken London staff watches, the lawyers take the necessary steps. They arrange for guards to monitor the office around the clock. They secure the bank accounts, locate important business records, take control of the computers, and change the door locks and security codes.
The lawyers are armed with a court order signed last night in New York at the SEC’s request; they work for the receiver the judge appointed to take control of the Madoff firm, a securities lawyer in Manhattan named Lee S. Richards III.
A calm, rumpled man with both the look and the voice of the American humourist Garrison Keillor, Lee Richards is considered one of the top white-collar lawyers in the country. He has handled almost a half-dozen prominent receiverships, and his firm, with offices in New York, Washington, and London, is trained for exactly this kind of emergency.
Yesterday, Richards was getting off his commuter train at Grand Central Terminal when he got a call from the SEC’s Andrew Calamari alerting him to Madoff’s arrest and asking if he could take on the receivership of the firm. Until it is clear that the firm is insolvent and should be put into bankruptcy, a receiver needs to be on site to protect its assets and secure its records, starting immediately.
Murmuring into his mobile phone in the middle of the train station, Richards agreed to take the Madoff case. A few hours later, staff lawyers for the SEC asked US District Court judge Louis L. Stanton to freeze the Madoff firm’s assets and put Richards in charge. Judge Stanton signed the court order at 6:42 PM Thursday evening, and Richards went to work that night, hiring the forensic consultants he would need and mobilizing his London staff.
Around 8:00 AM today, as Madoff’s offices are being secured in London but before the markets open in New York, Richards and several colleagues arrive at Madoff’s Manhattan office. Lawyers and accountants from the SEC have been here most of the night, trying to find the border, if there is one, between the firm’s legitimate business and the massive fraud Madoff says he conducted here.
The regulators are occupying the conference room on the eighteenth floor, where most of the administrative and financial staff and their records are located. Richards goes upstairs and sets up his command post in the large glass-walled conference room that stretches between Madoff’s empty office and the slightly larger office still being used today by Peter Madoff.
Almost every Madoff employee shows up for work today, even Frank DiPascali—although he will leave sometime during the day and not return. By the afternoon, he will be sitting in the office of one of the city’s top criminal defence lawyers, shaking and crying as he describes the work he has done for Madoff for so many years. Madoff, too, will spend this day with his lawyers, trying to understand what happens next.
At the Lipstick Building, Richards asks for the employees’ cooperation and their patience; there is a great deal he simply does not know and cannot tell them.
The members of Richards’s law firm have already curtailed access to the computer systems and confiscated employees’ key cards. His forensic consultants start examining the customer account statements and the firm’s financial records. As in London, security guards are put on twenty-four-hour duty. Richards’s team soon learns that there also are two warehouses in the New York borough of Queens where records are stored and backup computer equipment is maintained; guards are put on duty there, too.
As the news of Madoff’s arrest has spread, the firm’s trading partners have threatened to back out on uncompleted trades. Richards’s staff has to try to unwind or complete the deals with as little loss to the firm as possible. Other lawyers on his team are working to freeze the firm’s bank accounts and its brokerage accounts at other firms.
At about 10:00 AM, two New York City police officers arrive at Richards’s command centre. He needs to come downstairs immediately, they tell him. About three dozen Madoff investors have poured into the lobby, the media is starting to arrive, and the crowd is becoming worrisome to the building’s security staff. Richards quickly heads for the elevators.
The investors gathered in the lobby are anxious, but quiet and well-behaved—remarkably so, given the devastation so many of them are facing. Gathered here in the subdued glow of the holiday decorations, they are the first visible faces of the tens of thousands of people around the world who have been injured by Madoff’s unthinkable fraud. They are proxies for all the trusting widows, all the second-generation investors, all the construction workers, dental office receptionists, retired teachers, restaurant owners, electricians, insurance agents, artists, writers, chefs, models, therapists, small business owners, modestly successful doctors and lawyers who all have suddenly been labelled as “Madoff victims.”
Richards explains to them that it is far too early for him to have any information about their individual accounts—and he can’t predict when he will have that information. There is nothing to be learned here in the lobby, he explains. The crowd gradually disperses as Richards returns upstairs.
2
BECOMING BERNIE
In the late spring of 1962, a twenty-four-year-old Wall Street trader named Bernard Lawrence Madoff was facing almost total ruin.
Madoff started his own brokerage business while he was still a student at Hofstra University, in the winter of 1959/60, just as the stock market was about to embark on a wild decade that would be immortalized later as the “g
o-go years.” The era was overheated, volatile, and peopled with characters who belonged in a Marx Brothers movie. And no corner of Wall Street was wilder or riskier in those days than the one where young Bernie Madoff had put out his shingle: the over-the-counter (OTC) stock market.
The enormous, decentralized, and weakly regulated OTC market of the 1960s may be hard for modern investors to imagine. The New York Stock Exchange, known as the Big Board, had long been dominated by Main Street—or, more accurately, by the people who owned and ran Main Street. Few pension funds or endowments owned common stock, so a large majority of the Big Board’s daily orders were from individual investors, people wealthy enough to feel comfortable in the market despite its turbulent history. They were cosseted by their family stockbrokers. Taking the long view for their children’s trust funds, they bought shares in railroads, utilities, automakers, steel companies, the blue chips they knew and understood—and, in some cases, managed or had founded. Each day, they could check the prices of their shares in the evening newspapers.
In the years after World War II, however, new companies pursuing new technologies were cropping up everywhere, almost overnight. At the same time, family-dominated companies with few public shareholders needed to raise capital to grow. The shares of these unseasoned or thinly traded companies—some of them destined to become household names, such as Anheuser-Busch, Barnes-Hind, Cannon Mills, Tampax, Kaiser Steel, and H.B. Fuller—did not meet the requirements for listing on the prestigious New York Stock Exchange or its smaller sister exchanges around the country. But that didn’t mean their shares didn’t trade. They were the mainstays of the over-the-counter market, where Bernie Madoff planted his flag in the early 1960s—and where he first started to get rich.
Without doubt, there were plenty of people getting rich in those hyperventilating days. The year the Madoff firm opened its doors, 1960, was the next-to-last lap in the longest bull market America had seen to that point—a spectacular climb that began in the summer of 1949 and would continue until New Year’s Eve 1961. Over that time, the prices of blue-chip stocks in the Dow Jones Industrial Average would more than quadruple, with an average gain of nearly 13 percent a year. After the brief bear market in the first half of 1962—the long-forgotten lurch that would nearly destroy Bernie Madoff—the party rolled on into the late 1960s at roughly the same pace.
And those were the returns on conservative blue chips that traded on the Big Board. The gains in riskier OTC stocks during the bull markets of the 1960s were poorly documented, but one study put them perhaps as much as five times higher than the Dow Jones Industrial Average. These are stock price gains reminiscent of the technology stock bubble of the late twentieth century—or the Ponzi schemes of all ages. So Madoff investors who recall early annual returns of 20 percent may not be inflating their memories; such returns would not immediately have raised red flags in an era when the hottest investment funds were sometimes doubling their value in a single year.
The possibilities of the young OTC market in the 1960s were recalled by Michael Steinhardt, who made a fortune on Wall Street and later invested a portion of his charitable foundation with a fund that passed it along to Bernie Madoff. “I thought, when we started up our company, I could compete effectively with older people in the business,” Steinhardt said in one published interview. “Youth believed in such things, because we had grown up in the ’40s, ’50s and ’60s and saw extraordinary technological innovation.” He recalled buying shares in a company whose price increased ninefold in less than a year; he sold it, and within a year, it was bankrupt. “There were plenty of them like that,” he said.
The first home of Bernie Madoff’s one-man brokerage firm in 1960 was a spare desk at his father-in-law’s accounting firm on Forty-second Street in Manhattan. Within a few months he had found two small rooms downtown at 40 Exchange Place—an anteroom for his wife, Ruth, who worked part-time as his office manager, and an inner office where he could work the telephones and try to make trades with other dealers.
Besides a licence, running an OTC trading house in the 1960s required two indispensable tools: a telephone and access to the daily catalogues known as the Pink Sheets, published by the National Quotation Bureau. (The catalogue pages devoted to stocks were printed on pink paper, while the pages listing bonds were printed on yellow paper.) A writer visiting the bureau in the late 1950s thought “the manufacture of The Sheets is perhaps the most amazing operation in the financial market.”
Every weekday, in a stunning feat of manpower and logistics, bureau clerks manually collected price lists for nearly eight thousand stocks submitted by about two thousand over-the-counter dealers. The clerks collated the prices by stock name, entered the data on mimeograph stencils, printed the catalogues, and got them out the door to several thousand firms around the US in a matter of hours. Only dealers with full-service subscriptions, priced at about $460 a year, could submit price quotes.
That was a big expense for Madoff in his first few years in business, so he relied on day-old Pink Sheets collected from another brokerage firm’s offices on the same floor at 40 Exchange Place. After all, Madoff realized, the prices were out of date before the sheets were even printed; all you really needed were the names and telephone numbers of the dealers making markets in the stocks you wanted to trade. And there is no question that Bernie Madoff was trading some stocks in these early days. The share certificates were delivered to Ruth’s desk or picked up there by messengers, and the trades were manually entered into big ledgers maintained at the office. On a miniature level, she was his “back office,” maintaining his trading records for at least the first year he was in business.
As hard as it is for wired-in and instantly connected twenty-first-century investors to accept, there was absolutely no way for the public to independently verify the prices of over-the-counter stocks in the 1960s. A retail customer interested in the price of an OTC stock would have to call a broker, who would likely have to make a half-dozen phone calls to people like Madoff to come up with a slightly reliable answer. The newspapers did not print daily prices for OTC stocks, as they did for exchange-listed stocks. It was an utterly opaque market, a black box for customers and barely more visible to regulators. But armed with broker names and price quotes from the Pink Sheets, an aggressive broker could work the phones looking for business. Madoff would have spent his days calling around to trusted counterparts at other firms to buy shares that he could resell at a higher price to another broker or maybe to a retail customer—at a price that the customer or broker took on faith or walked away from. The whole process was a vast tutorial in how to win and keep the trust of other people. Those who couldn’t do that didn’t survive; Bernie Madoff survived.
There is little documentary evidence of how Bernie Madoff made money in the 1960s, but this is so for most tiny firms of that era. His own version is that he made money primarily by trading, regularly buying OTC stocks at one price and selling them at a much higher price, and then using his profits to finance more trading. The only trace his early business left in the available records is an underwriting deal his firm handled in March 1962 for a little outfit called A.L.S. Steel, based in Queens. According to Madoff, his father was working as a finder for the company and arranged the deal. The underwriter’s markup promised to the firm was handsome, but Madoff said he was not sure the transaction was ever completed.
Years later, the family legend was that he went from success to success in those early days, and this may have been true for the trading desk of his fledgling business. But as an investment manager, it appears he began to bend the rules almost from the beginning, which led him to the brink of failure by mid-1962.
At the time Madoff was managing money for about twenty clients, many of them relatives and most of them small-scale investors who could not afford to take speculative risks. Nevertheless, by his own account, he invested their savings in the famously volatile “new-issues” market of the early 1960s, an early version of the hot stock offer
ings sold during the “tech stock” bubble of the late 1990s. Like the market for those flimsy Internet stocks, the new-issues market in those go-go years was filled with highly speculative shares sold by young, unseasoned companies that occasionally flourished but more often failed. Caught up in the frenzied trend, Madoff violated long-standing market rules and common sense by selling such unsuitable investments to his risk-averse clients.
This lapse didn’t fall into a regulatory grey area. Decades before he set up shop, market regulators had imposed and enforced what came to be known as “the suitability rule.” Brokers were forbidden to sell their clients investments that were too risky for their individual financial circumstances, even if the clients were willing to buy them. Selling those hot new issues to his clients was wrong, and Madoff knew it.
If the new-issue market had continued to rack up the giddy gains of 1961, he might have gotten away with it. But after slumping steadily for weeks, the overall stock market fell sharply in the week of May 21, 1962—its worst weekly loss in more than a decade. Then, on May 28, the market stunned legions of young brokers like Bernie Madoff by plummeting to a daily loss second only to the shuddering one-day drop on October 28, 1929, on the eve of the Great Depression. Trading outpaced the share ticker by several panicky hours. Although the market calmed down a few days later, the boom of the previous year was gone. Worst hit in the “little crash” of 1962, according to one account, were “the hot-issue boys, the penny-stock plungers, the bucket-shop two-week millionaires of 1961.”
Those “hot-issue boys” included Bernie Madoff. When the market for new issues collapsed and the price of those stocks plummeted, his trusting customers faced substantial losses. “I realized I never should have sold them those shares,” he later admitted.
Madoff didn’t just break the cardinal rule of investor protection, the suitability rule, he lied about it, covering it up in ways that preserved his reputation and thus laid the foundation for all that came later in his life of crime. He simply erased those losses from his clients’ accounts by buying the new-issue shares back from them at their original offering price, hiding the fact that his customers’ profits had actually been wiped out by the market’s turmoil. “I felt obligated to buy back my clients’ positions,” he later explained.
Bernie Madoff, The Wizard of Lies Page 5