Frank Avellino and Michael Bienes didn’t worry about this. They had prospered beyond their wildest imagination from their own long association with Madoff. They’d purchased trophy homes, indulged in expensive hobbies such as art collecting, and become coveted patrons among the charities and cultural institutions in their communities.
But they were still remarkably casual about maintaining the paperwork for their enormous investment business. Their four-person staff in New York kept track of accounts—a customer’s file typically consisted of no more than four sheets of paper—and handled queries from the public. The two partners assembled the cheques coming in, sent the money to Madoff, and withdrew money from their account when investors requested disbursements. Every month they received account statements from Madoff’s firm; every quarter they got a computer printout from a data processing company listing all the investors who had contributed to those accounts and how much each was owed.
That was all there was to it. No overhead, no complications, no red tape.
In that, at least, Frank Avellino and Michael Bienes were perfectly in step with the mood of the market and the agenda of regulators in the 1980s.
With the nation feeling bruised and cranky from a decade of plunging stock prices, rocketing petrol prices, manipulated silver prices, rising inflation rates, and lagging employment, President Ronald Reagan came into office in January 1981 with a sunny determination to hack away at what he saw as generations of needless government regulation.
His deregulatory ambitions would firmly push back against a formidable enforcement appetite at the Securities and Exchange Commission. Indeed, the steady advance of that deregulatory philosophy would ultimately combine with weak management and inadequate budgets to leave the once-respected SEC too timid and unimaginative to cope with a widening brushfire of fraud over the next twenty-five years, including the near-fatal firestorm called Bernie Madoff.
After slouching through several decades, the commission had pulled up its socks in the 1970s and gotten serious about tackling the revolutionary changes on its turf, from options trading to insider trading. The Congress, tacitly acknowledging that it had starved the SEC for a decade, began providing an almost adequate budget. By the end of the 1970s the agency had stepped up its supervision of America’s burgeoning mutual fund industry, pushed for tougher industry supervision of brokers, and developed new rules to govern hostile takeovers. Its work was challenging and interesting, and many bright, ambitious lawyers wanted to be part of it.
Some of the brightest and most ambitious wanted to work for the SEC’s fabled Enforcement Division director, Stanley Sporkin, a fiercely committed public servant who had been at the commission for twenty years and had zero interest in using the job as a stepping-stone to a lucrative law firm partnership. Young staff lawyers prayed for a chance to work with him, and blessed their luck if they landed one of the tough, innovative cases that drew his attention.
In 1981, Sporkin was moved out of the SEC by President Reagan, who also tapped John Shad, a lifelong veteran of Wall Street, as the commission’s new chairman. Shad was less hostile to the SEC’s mission than the advocates of deregulation had hoped, balking at the deep budget cuts demanded by the new administration. But although he knew the Street had its black hats, he believed firmly that it “was essentially an honest place,” fully capable of policing itself.
This was transparently not true. The industry-financed watchdogs at the NASD, the first-line regulators responsible for policing brokers such as Bernie Madoff, had an undistinguished record at best. Part of the impetus for the US securities law amendments adopted in 1975 had been a general view in the Congress that the NASD had fallen down on its part of the regulatory job. But the US Congress had no power to increase the NASD’s resources or its appetite for regulation, and it continued to be a weak sister to the SEC.
On balance, Shad’s tenure produced “a competent but cautious commission,” one historian concluded. Those bright and ambitious staff lawyers looking for more than mere competence and caution gradually began to lower their expectations—or simply to leave. Within a decade, Madoff would have his huge Ponzi scheme up and running and would be very grateful for their departure.
In the early Reagan years, Bernie Madoff seemed to be on a roll. The bull market born in August 1982 had sent stock prices soaring, and his firm’s profits were sailing up with them. True, it was an increasingly rocky ride. Wall Street didn’t mind the rising volatility, but many investors did—and more of them fled the volatile market and found their way to the steady returns Madoff offered. While there are no reliable records of those returns in the 1980s, a host of longtime Madoff investors fondly recalled the comforting consistency. They were not making as much money as other investors in that roaring bull market, but they were not riding on a roller coaster either.
As the decade neared its midpoint, Madoff’s brokerage firm had a reported net worth of more than $18 million, up from $5.4 million just two years earlier; its capital reserves had more than doubled in the same period, to $7.5 million, which put it in the top-100 list of the Securities Industry Association in 1985. That same year, Madoff was elected to the first of four consecutive terms on the NASD’s Board of Governors. This was a notable achievement as well. He also joined the board’s international committee; he was one of the few small-firm representatives who had a foreign office. Clearly he relished the prestige; he served five terms on the panel. His opinions were sought on issues usually considered to be the exclusive domain of much larger brokerage houses.
By this time the bull market had cooled a little, but it soon got back on track as the country grew increasingly confident about the tax cuts and deregulatory agenda in Washington. Volume was skyrocketing on the electronic NASDAQ market, where the Madoff firm had become a significant market maker, standing ready to buy or sell hundreds of securities and thereby helping to maintain a liquid market for those shares. The NASDAQ, resisted by so many on Wall Street, had proved itself over the past decade by enlisting an increasing number of active traders and attracting a growing number of company listings and customer orders.
To mark all those achievements, Madoff awarded himself the time-honoured Manhattan trophy: luxury property. In 1984 the Madoffs purchased a two-storey penthouse in a classic prewar apartment building on East Sixty-fourth Street at Lexington Avenue. While not in some historically elite enclave like upper Fifth Avenue or Sutton Place, the Federal-style building had been built in the late 1920s and had a quiet prestige. The unit reportedly had been decorated by Angelo Donghia, a prominent Manhattan interior designer whose clients included newsmakers such as Donald Trump and Ralph Lauren. Ruth Madoff made some minor renovations—chiefly customizing some closets and adding a greenhouse extension to link the spacious kitchen to the broad encircling terrace. It was a tastefully decorated and grandly comfortable apartment, and it marked a significant step up for the Madoffs, formerly of Laurelton, Queens, by way of Roslyn, Long Island.
In a few years, the Madoff firm acquired a ritzier address of its own, with its move in 1987 to the Lipstick Building. That relocation was partly organized by a young employee named Frank DiPascali. The move was the first of a series of ultimately devastating chores he would handle for his boss over the next two decades.
DiPascali had bounced around the Madoff firm for a decade. He had arrived straight from secondary school in the borough of Queens in 1975, at the recommendation of Annette Bongiorno, a woman who was originally hired as a receptionist but who became a mainstay of Madoff’s account administration staff, handling some of his most important client accounts. Bongiorno knew DiPascali from the neighbourhood—like him, she started working for Madoff right out of school—and she passed his name along to Daniel Bonventre, the firm’s director of operations.
DiPascali initially worked as a research clerk for Peter Madoff. He claimed that he worked after that as an options trader, but he did not get his industry licence to trade options until 1986. Mostly he did chores
for Bernie Madoff, whom he increasingly considered his mentor and tutor. Madoff put him in charge of overseeing the installation of the technology platform at the new Lipstick Building offices, and DiPascali apparently handled the job splendidly.
To know exactly what else DiPascali did for Madoff in that transition, we would have to know exactly when the Ponzi scheme began—the middle to end of the 1980s seems like a distinct possibility. But clearly DiPascali forged a bond of unquestioned loyalty to Bernie Madoff and, by his own account, it was boosted by the excitement of being put in charge of the move uptown.
These years also saw Madoff develop connections at a number of large Wall Street houses, mutual fund companies, and other financial institutions. He was handling an increasing share of orders from professional investors, especially for stocks normally traded on the New York Stock Exchange—the so-called “third market” business that Peter had so presciently encouraged him to develop. His firm’s net worth grew from about $18 million in 1985 to nearly $60 million at the end of the decade, and its capital reserves grew from just under $8 million to more than $43 million over the same period. Madoff’s early entry into the London market was paying off, too. Many foreign stock prices were climbing at rates that made the domestic blue chips look anaemic, and Bernie Madoff became a go-to figure for the industry press when international issues arose.
In 1986, Madoff got the sort of accolade everyone on Wall Street noticed: he was included in Financial World magazine’s list of the one hundred highest-paid executives on the Street. According to the magazine, he had earned $6 million the previous year. “Madoff’s sole proprietorship, founded 26 years ago, is involved in brokerage, venture capital and arbitrage,” the magazine reported. “Obscure outside investment banking circles, the 48-year-old Madoff doesn’t seek much publicity.”
Even if the general public still considered Bernie Madoff obscure, his influence in industry circles was beginning to outstrip the relatively modest size of his family firm—even though it seemed to be growing exponentially. Its status as a “family firm” was reinforced when Mark Madoff, Bernie’s older son, who had graduated in 1986 from the University of Michigan with a degree in economics, went to work for his father. By June 1987, Mark was a licenced broker at Bernard L. Madoff Investment Securities, a firm he could reasonably expect to inherit someday. Two years later, his younger brother, Andrew, fresh out of the University of Pennsylvania’s Wharton School for business studies, would also get his licence and come on board.
The year 1987 was quite a time to launch a career in the securities industry, as Mark Madoff soon discovered. When he got his licence in the summer, market makers at the firm were trying to adjust to a jittery new normal. Waves of institutional buying and selling would suddenly hit scores of major Big Board stocks, the ones that Madoff’s third-market traders handled. The orders were generated by computer programs automatically carrying out complex hedging strategies—even more complex than his own “split-strike conversion” strategy. Between January and July 1987, the market climbed almost straight up—the S&P 500 gained more than 30 percent in just seven months. It stumbled in the remaining months of the summer—an overdue correction, analysts said—but it still eked out a gain for the first nine months of the year.
Then came Black Monday, October 19, 1987, when the bottom simply fell out. A record-cracking 600 million shares were traded on the Big Board that day, as the Dow Jones Industrial Average plummeted 508 points—a 22.6 percent fall, more than twice the damage inflicted on the worst day of the historic 1929 crash. The S&P 500 dropped almost as far, just as fast.
The NASDAQ index fell only half as much—because the entire NASDAQ market fell apart instead. There were widespread complaints that OTC brokers were not answering their phones. The OTC market was “in shambles”, according to one account, as countless customer sell orders simply were not being executed. “This added to the confusion and panic in the markets,” the US General Accounting Office later concluded.
Black Monday was the day investors learned that the NASD did not require its “market-making” dealers actually to maintain a continuous market in the over-the-counter stocks they traded, as the traditional stock exchanges did. Many of the smaller market makers were losing ruinous amounts of money and could not keep buying shares that they could sell only at a loss, if they could sell them at all. Instead, they limped to the sidelines. The NASD’s rules allowed them to stop trading. For many, the alternative was bankruptcy.
More troubling, the trading technology that NASDAQ had touted as the face of the future had been utterly unequal to the pressures of this extraordinary day. Traders feared that the bids shown on computer trading screens were unreliable and out of date, and they were right. Even large firms refused to trade blind, and by the next day the over-the-counter market was blasted by the storm that hit the traditional exchanges on Black Monday. The damage prompted a senior NASDAQ staff member to tell the Wall Street Journal, “We’re scared. Of course we’re scared. We’re looking at conditions in the marketplace that are indescribable; gigantic losses, it’s staggering.” It seemed that the much-ballyhooed market of the future—one in which Bernie Madoff had made his reputation—had utterly and unexpectedly failed.
The Madoff firm, dealing as a wholesaler for largely institutional clients, was buffered from the worst of the tsunami of panicky retail orders. With computer networks that could handle large volume at state-of-the-art speed, it made it through the storm. Mike Engler, Madoff’s friend and associate in Minneapolis, would tell his son later that the Madoff firm actually made money for itself and its clients in these bleak days by using options to short the markets. And the Madoff firm was praised by regulators for its solid performance during Black Monday, when so many market makers were falling away.
The reality was different. The market crash had profoundly shaken the confidence of some of Madoff’s largest clients. Men he thought he could count on to keep their portfolios intact and leave their wealth in his hands—men such as Carl Shapiro and Jeffry Picower—suddenly began to cash in their paper profits and withdraw their money. “They were worried all the gains they had would disappear in the years just after 1987,” Madoff said in his first prison interview.
Madoff estimated that his investment accounts totalled about $5 billion at the time of the crash. But he claimed that much of this wealth was tied up in his complex hedging strategies—that he could not fully repay his big American clients without cashing out the French counter-parties, who were expecting to stay invested in US dollars. If he honoured the withdrawal demands, he risked losing his French connections; if he didn’t, he would lose his longtime American investors.
Those longtime investors grew even more nervous after the “mini-crash” that hit almost exactly two years after the 1987 market crisis. Their withdrawal demands increased, and although Madoff acknowledged “there was nothing I could have sued them over,” he was furious.
“Part of the agreement I had with them was that the profits would be reinvested, not withdrawn. And they were the only ones who didn’t abide by that. They changed the deal on me,” he said in the first prison interview. “I was hung out to dry.”
Madoff’s anger strongly suggests that the protracted cash crisis that began after the 1987 crash was real, even if his explanation for it raises more questions than it answers. His strategy involved big blue-chip stocks; even in the rocky post-crash markets he should have been able to liquidate a legitimate blue-chip portfolio, albeit for less than its pre-crash value. The Gateway fund had a losing year after the 1987 crash, too, but it went on to report only seven losing months between October 1988 and the end of 1992—why couldn’t Madoff achieve the same results with the same strategy? Had he lied to his clients about hedging their accounts against losses? Or, as he suggested in a subsequent letter, had he negotiated another investment “deal” with these big clients, one that bore no resemblance to the “split-strike conversion” strategy he was supposedly using?
Madoff acknowledged that he spent much of the 1980s actively arranging a growing volume of complicated “synthetic” trades to help his biggest clients—including Norman Levy and Jeffry Picower—avoid income taxes on their short-term stock profits. He provided few clear details of these transactions, except to say that they were put in place with the expectation that they would be rolled over year after year. These tax-avoidance trades were not prohibited by law until 1997, but they fell close to the line, as Madoff would grudgingly acknowledge later. “I felt they weren’t sham transactions . . .,” he said, “but they became more elaborate in their strategy. At worst, it was a grey area.”
Were these complex tax-avoidance trades harder to unwind without enormous losses? Or did Madoff simply guarantee that these old stalwarts would not incur losses if they stuck with him, assuming he could eventually come out ahead if they maintained their positions and did not withdraw their profits on demand? Madoff may never give a straight answer to these questions, but he is clear about the consequences of this crisis.
“Before I realized it, I was in the hole for a few billion dollars,” he acknowledged in his first prison interview. This didn’t happen overnight—it started happening at least by 1988, and it must have involved enormous sums to have reached that level by 1992.
Clearly the complex portfolios and cash pressures that would mark his Ponzi scheme were starting to take shape, even though Madoff insisted his Ponzi scheme had not yet begun and there is evidence that at least a few trades took place in the accounts of some favoured long-term clients during these years.
Bernie Madoff, The Wizard of Lies Page 12