The litigation filed later against the two accountants in bankruptcy court, however, laid out a very different scenario, one in which the two men allegedly kept silent about Madoff’s obviously fraudulent activity, helped recruit new players to step into their shoes as introducers, and encouraged their former clients to invest directly with Madoff. In return, the lawsuit claimed, the two men demanded that Madoff pay them guaranteed profits of 17 percent a year on their own new Madoff accounts, along with secret commissions of 2 percent a year on the money their former investors handed back to him.
In Frank DiPascali’s world, these payments allegedly came to be known as the “schupt” payments—the bankruptcy trustee would later theorize that the term was a phonetic garble of the word schtup, a crude Yiddish verb whose rough Anglo-Saxon equivalent is screw.
The SEC investigation in 1992, incomplete though it was, had significant consequences for Bernie Madoff’s expanding fraud.
First, it forced Madoff to apply to his Ponzi scheme some of the computer technology he was already using in his legitimate business. It was simply impossible for Frank DiPascali to concoct manually the trading records and monthly statements for the thousands of new accounts Madoff had suddenly inherited from Avellino & Bienes. Madoff needed to automate the Ponzi process somehow, and he turned to DiPascali for help.
DiPascali, in turn, allegedly relied on two computer programmers who had joined the firm a few years earlier and who were later accused of designing software for one of the firm’s new IBM AS/400 computers that simplified the process of generating the fictional account statements. DiPascali and some of his staff allegedly researched the necessary trades from the historic record, and then the customized Ponzi software would allocate those trades, in perfect proportions, among the various customer accounts using a simple “mail merge” computer function.
Besides reducing the manual labour involved, this automation provided new opportunities for deception. It was around this time that Madoff leased separate space on the seventeenth floor of the Lipstick Building—ostensibly for his new IBM computers but actually to create a more secure environment for his increasingly elaborate fraud. As he later recalled, he set up the separate suite because “I could not have operated in view of the other people on the 18th floor.” The nondescript warren of offices and cubicles on the seventeenth floor became Frank DiPascali’s domain, a private laboratory for his creative deceptions.
As DiPascali perfected his craft, he branched out. He devised fake clearinghouse forms that showed up on computer screens—perfect replicas, regularly updated. On Madoff’s orders, he kept a supply of old letterhead stationery and used it when backdated paperwork was needed for files that regulators wanted to see. In time, he even ordered the creation of a software program that made it look to an observer as if a trader at one computer terminal were buying or selling for an investor’s account, when in fact the “trader” was merely exchanging keystrokes with another staff member at a computer hidden in a room down the hall.
This Potemkin village paper trail became so convincing that Madoff was able to fool dozens of insufficiently sceptical regulators and inadequately observant lawyers and accountants for years.
Another consequence of the SEC’s breakup of the casual “friends and family” network run by Avellino & Bienes was that Madoff came to rely far more on those larger, more professionally marketed sources of cash known as hedge funds.
Hedge funds had been around since 1949, but until the late 1960s they were largely invisible; they just quietly produced remarkable profits for their wealthy and intensely private investors while avoiding regulatory and, for the most part, media attention. The theory behind hedge funds was that inherently risky strategies—buying stocks with borrowed money or selling stocks short—could be combined in a single fund in ways that would actually reduce overall risk and produce profits in good markets and bad. The goal was never to have a losing year, whether the market was up or down—the Holy Grail for investors throughout time, the siren song that would bring so many of them to Madoff’s door.
The hedge fund was pioneered by a sociologist and financial journalist named Alfred W. Jones, who, by the early 1960s, was providing his investors with stunning annual average returns of 65 percent. But the 1969 bear market brought a lot of these new funds down to earth; even the fabled Jones fund incurred losses of up to 40 percent in the first nine months of the year.
Many hedge funds failed in the rough market of the 1970s, but the mystique proved to be utterly resistant to bad news. The idea took hold in the 1980s that hedge funds were superior to the regulated mutual funds used by middle-income investors, and wealthy, sophisticated investors flocked to them.
What persisted in every incarnation of hedge funds was the remarkable fee structure: the manager received 20 percent of the profits he made with his investors’ money. As years passed, an annual management fee of 1 percent of a fund’s assets was added to the typical hedge fund manager’s pay cheque. The fees dwarfed those charged by regulated mutual funds, but men of wealth and wisdom were willing to pay them—that’s just what it cost to have a wizard handling your portfolio. One scholar referred to the performance fees as the “rent” investors paid to get a genius to manage their money.
There seemed to be little brilliance behind the Fairfield Greenwich Group, the family of funds run by Jeffrey Tucker and Walter Noel Jr that sponsored the largest of all the giant funds caught in the Madoff scandal. Madoff himself would later observe that its partners “aren’t rocket scientists.” And “genius” was not a term usually applied to the firm’s amiable chairman and cofounder Walter Noel, although he was much cleverer than he was given credit for.
It is hard to imagine two men less likely to forge a durable, multibillion-dollar relationship. If Bernie Madoff was a villain created by Horatio Alger from a draft by Anthony Trollope, then Walter Noel was a minor character dashed off by F. Scott Fitzgerald: a study in prep school style and social striving.
Born in Nashville and educated at Vanderbilt University, Noel was handsome—tall and lean with chiselled features, thick dark hair, and exuberantly bushy eyebrows—and genial enough to win office in some modest campus organizations. Despite later impressions, he was clever enough to make Phi Beta Kappa honours at Vanderbilt and earn both a master’s degree in economics and a law degree from Harvard, in 1953 and 1959 respectively. Between his two stints at Harvard, he served in the US Army. His engagement announcement in 1962 said he had worked as “a Russian linguist for three years.” At the time, he was working as a consultant for Arthur D. Little Inc in Lagos, Nigeria. He later helped develop an international private banking operation for Chemical Bank and in 1983 set off on his own to advise private international clients.
While Madoff married the pretty teenager he courted on the bus to Far Rockaway High School, Walter Noel’s bride was the lovely Monica Haegler, whose wealthy and cosmopolitan parents split their time between Zurich and Rio de Janeiro and sent her to elite private schools in Brazil and Switzerland.
While Madoff’s two handsome sons would graduate in the 1980s from good universities, Michigan and Penn, Walter Noel’s five beautiful daughters would graduate from very good universities—Harvard, Yale, Brown, and Georgetown—and four of them would marry into influential European and Latin American families. Monica Noel had her own wealthy family connections. A cousin was a rich Brazilian financier and industrialist, and a brother, at one point, was the Brazilian representative for Credit Suisse. Portuguese, Spanish, Italian, and English were interchangeably used around the Noel family table.
By the time Avellino & Bienes was forced to close its doors, Walter Noel had been in business with the former SEC lawyer Jeffrey Tucker for a half-dozen years and had been investing with Madoff most of that time. From the beginning, Noel left the legal scrutiny and structural details of the funds to Tucker, whose father-in-law first made the introduction to Madoff in 1989. With his grounding in securities law, Tucker was the one who went out
and supposedly kicked the tyres in the due-diligence examinations that Fairfield Greenwich Group conducted. By contrast, Noel was the easygoing salesman, explaining the new funds to existing clients, courting new clients at the private banks and foreign institutions he knew from his earlier career, and spreading the word among the wealthy families with whom he and Monica socialized on their home turf in Greenwich, Connecticut, or at privileged enclaves such as the Hamptons and Palm Beach.
It was during these early days of cultivating Fairfield Greenwich—which almost certainly coincided with the early days of the Ponzi scheme—that Madoff and DiPascali perfected the talking points for their “split-strike conversion” investment strategy and tried them out on Tucker and Noel. It worked like a charm.
Of course, there was nothing illicit about the strategy itself; it was familiar to any equity options trader at the time. In 1989, Tucker and Noel could not have known that Madoff’s alleged execution of that strategy over the years would produce profits more consistent and substantial than the strategy itself ought to have produced. They could not know that the amount of money Madoff would ultimately claim to be deploying would have moved through the stock and options markets like a battleship in a bath if he’d actually been making trades. At the beginning, it made sense—and it made money, especially for them. After all, as the fund managers, they pocketed 20 percent of the net profits Madoff produced for their private investors.
By 1990 they had invested about $4 million with Madoff through their Fairfield Sentry fund, incorporated in the British Virgin Islands to serve foreign investors. In 1993 they created a version of the fund for domestic clients and called it the Greenwich Sentry fund.
Fairfield Sentry’s steady profits made it attractive, but its returns were unspectacular compared with other hedge funds being hawked in this very elite bazaar. From 1990 until 1994, the fund merely kept pace with the overall market, as measured by the S&P 500 index. Even some public mutual funds, such as Fidelity’s popular Contrafund and its legendary Magellan fund, were producing better returns and charging fees that were microscopic compared with those Fairfield Sentry’s investors had to pay. And it got worse: from late 1996 until the end of the decade, Fairfield Sentry actually lagged behind the S&P 500.
Clearly, the Fairfield Sentry fund and its offshoots would not sell themselves. They likely would not sell at all unless their demerits were burnished into virtues. Walter Noel was good at that; an innately conservative investor himself, he made the Sentry fund sound like a carefully crafted, rigorously monitored investment for cautious people who were willing to trade some upside profits for stability and safety in the long run.
The pitch worked, and the firm grew. Its marketing materials soon began to take on the sheen of polished professionalism. Young accountants and MBA graduates were hired. They set up elaborate charts that assessed fund performance against various benchmarks. They developed a formal checklist of questions to ask about a money manager’s operations—questions they put to Bernie Madoff when they tagged along on Tucker’s visits. Madoff or DiPascali would answer some of the questions, show them the fake records, perhaps even do a little phoney computerized trading in their account as they watched, and then show them the bogus clearinghouse statements that backed up what they had been told.
Some questions Madoff simply refused to answer. In hindsight, his intransigence may seem like a blatant red flag, but at the time, given Madoff’s status in the financial industry and apparent success on Wall Street, it was all too convincing. The young due-diligence staffers apparently did not raise any concerns with the partners. Or, if they did, they were ignored.
The faith that the Fairfield Greenwich Group partners had in Bernie Madoff’s integrity may have been affirmed in the mid-1990s, when more than two dozen market-making firms were accused of fixing prices on the NASDAQ stocks they traded. The scam had been going on for years, undetected or at least uncorrected. Some of the biggest firms on Wall Street had acquiesced in the bullying cartel, and their industry-financed regulators at the NASD had failed for years to catch them.
It was the worst scandal the over-the-counter market had faced in Madoff’s tenure on the board—but his hands were squeaky clean. The private lawyer who led the earliest investigations confirmed that his team never saw any indication that Madoff’s firm was involved in the bid-rigging. In a letter from prison, Madoff said his firm was “not a party” to the scandal because “it was our belief that [the] NASDAQ market’s credibility depended on creating a more competitive transparent efficient marketplace.” And by that point his firm was more focused on the profits to be made trading Big Board stocks in the “third market” and was indifferent to the games others were playing with the over-the-counter stocks. It is also possible that Madoff had warned his traders against participating in the scheme because he was trying to avoid any actions that might bring his Ponzi scheme under scrutiny.
Given his firm’s size and prominence in the NASDAQ market, however, Madoff was conspicuous by his absence from that scandal. For Walter Noel, Jeffrey Tucker, and their due-diligence teams, the notion that they were dealing with one of the few exonerated market makers on NASDAQ may have been comforting, especially if they were growing a little frustrated at his eccentric way of doing business and his unwavering refusal to tell them everything they wanted to know.
As Fairfield Greenwich expanded and raised money to invest elsewhere besides with Madoff, its people reviewed audits and asked careful questions of those other money managers. Like Madoff, the other managers were successful, and the other small funds prospered. Unlike Madoff, those other managers actually answered questions fully and provided the documentation requested. In time, Fairfield Greenwich began to take pride in the quality of its due-diligence work and describe it in glowing terms in its marketing materials, to distinguish itself from the other hedge funds popping up and offering oddly similar returns.
By the mid-1990s a growing share of the Sentry-selling work was being done by a team assembled by Andrés Piedrahita, the Colombian-born husband of Walter Noel’s eldest daughter, Corina. Piedrahita’s prior career on Wall Street had been routine: a half-dozen years as a “financial consultant” at Prudential Bache, followed by three years as a vice president at Shearson Lehman Hutton. In 1991, less than two years after his marriage, Piedrahita set out on his own, forming a hedge fund marketing business called Littlestone Associates. (His surname means “little stone” in Spanish.) In 1997, Piedrahita’s company and its international sales staff merged with his father-in-law’s partnership, and he became a “founding partner” of the new Fairfield Greenwich. One of his first chores in the new regime was to open a London office for the firm.
The same year, Walter Noel’s daughter Alix married Philip J. Toub, a trader at another hedge fund, in a romantic ceremony that was held at white hillside home there in 1995, while the Madoffs were settling into a $3.8 million resort home in Palm Beach. “Mustique is the antithesis of Palm Beach,” Monica told a writer from Town & Country magazine a few years later. “It’s still rustic, you see. It’s also very international. And there are no Hermès bags.”) After his marriage, Toub also joined the Fairfield Greenwich sales force and became one of its most successful members, drawing on his business connections in Brazil and the Middle East.
In 1999 another of Noel’s sons-in-law, Yanko Della Schiava, came aboard, marketing the firm’s funds in southern Europe from his home in Lugano, Switzerland. In 2005, a fourth son-in-law, Matthew C. Brown, a Californian, would also join the Noel family firm.
Madoff could not have had a more polished and cosmopolitan sales force—nor, it seemed, a more effective one. By the end of 1999 the little hedge fund that had entrusted $4 million to him in 1990 had an almost staggering $3 billion in its Madoff accounts, and its assets were growing more than 30 percent a year, through new deposits and putative earnings. Hundreds of millions of dollars had come into Fairfield Greenwich’s Madoff-related funds from other hedge funds in Europe and the Car
ibbean. As its assets grew, so did the firm’s management fees—and, consequently, the size of the fortunes financing the lifestyles of its lucky partners.
The Noels, with their island luxuries, and the Tuckers, who took region, lived very well. It is not clear exactly how much Tucker and the extended Noel clan collected in fees in the 1990s, but it probably totalled more than $45 million in 1998, a year when there were only a handful of partners sharing in the tiny firm’s revenues. (Records filed in later lawsuits would show that the firm would collect nearly $920 million between 2002 and 2008.)
And, while the Noels and Tuckers may have lived no better than their extravagant peers in the hedge fund world, they did live more publicly, with splashy magazine photo spreads of their exotic homes and society page appearances by the Noels’ glamorous daughters. The proud old money of Greenwich, Saratoga, and the Hamptons might have sneered, but the socially ambitious new money of the hedge fund world probably up thoroughbred breeding in upstate New York State ’s posh Saratoga the Grenadine Islands. (Monica and Walter Noel had purchased a sugar-the open-air Bamboo Church on the exclusive island of Mustique, in thought the beautiful Noel family and the sporty Tuckers had hit the jackpot of life.
And they owed it all to Bernie Madoff.
The cash from offshore hedge funds, rich European families, and private boutique banks—all the sources of wealth familiar to the partners at Fairfield Greenwich—were critical in allowing Madoff to expand the pool of money available to his Ponzi scheme in the 1990s. Another increasingly important spigot was connected to the nonprofit world, whose endowments, educational institutions, foundations, and investment committees came to trust Madoff with more and more of their wealth.
What Walter Noel was to the jet-setting, sophisticated world of international wealth, J. Ezra Merkin was to the intimate, fraternal world of Jewish philanthropy. Unlike Noel, though, who had climbed his way into cosmopolitan society, Merkin was born into the financially generous and deeply religious community that became the core clientele of his hedge fund career—and a significant target of Madoff’s devastating fraud.
Bernie Madoff, The Wizard of Lies Page 15