Bernie Madoff, The Wizard of Lies

by Diana B. Henriques

  Ezra Merkin grew up in the shadow of his wealthy and fiercely intelligent father, Hermann Merkin, a firmly observant Orthodox Jew who fled Nazi Germany and later did intelligence work for the US Army. After the war, Hermann Merkin built his fortune in New York, the bulk of which came from his stake in a fleet of oil tankers. He also started a small investment banking company; his constant pursuit of new ideas and stock tips led him to cultivate a number of talented young traders on Wall Street. One of them recalled the ritual of lunching with Hermann Merkin in those postwar years. The elderly gentleman was always accompanied by a silent, well-dressed lieutenant who kept a small notebook tucked into his suit pocket. If the trader mentioned a stock he liked—perhaps a promising new technology company such as IBM—Merkin would flip a heavily accented question to his companion. “Do I have any IBM?” The companion would quickly consult his notebook. If the answer was no, Merkin would tell the trader: “I’ll take a thousand shares.” Then they’d turn back to their lunch. This former trader thought it likely that the young Bernie Madoff was among those whom the elder Merkin cultivated over lunch.

  But Wall Street wasn’t the only thread that tied Bernie Madoff to the Merkin family. In 1955, Hermann Merkin left his home synagogue and helped to establish the new Fifth Avenue Synagogue. During the years that he served as its president and then its chairman, the synagogue became the spiritual home of a number of wealthy congregants who, in turn, became generous supporters of important Jewish causes and institutions—and, ultimately, important investors with Madoff.

  As his wealth grew, Hermann Merkin became an increasingly generous donor himself, especially to Yeshiva University, in New York City. He served on Yeshiva’s board of trustees for nearly forty years, and he was vice chairman in 1996, when Madoff was invited to join the board.

  Jacob Ezra Merkin, one of six children, was a worthy successor to the family’s scholarly Orthodox traditions. He attended prep school at Ramaz, one of the premier private Jewish academies on Manhattan’s Upper East Side. He studied English at Columbia University, graduating with Phi Beta Kappa and magna cum laude honours in 1976. He received his law degree with honours from Harvard in 1979 and spent time studying in Israel. One friend recalled him as “a voracious reader,” and another described him as “pious, prayerful and profound.” Close friends saw his self-deprecating sense of humour but also his sometimes harsh dismissal of those he considered his intellectual inferiors.

  After briefly practicing law at an elite New York firm, he followed his father to Wall Street. He worked for a well-established hedge fund, and then set out on his own, forming what became Gabriel Capital Corporation. In 1988 he created a pair of hedge funds that came to be known as the Gabriel fund and the Ariel fund. He was a deft salesman for his funds but was far less involved in actually managing the money in them; he quietly outsourced that task.

  From the beginning, the investment decisions for the Ariel and Gabriel funds were being made almost exclusively by a young man named Victor Teicher, an intuitive investor with an irrepressible personality who had been sharing office space with Ezra Merkin for several years. That fact was not disclosed to the investors, so there was no public embarrassment when Teicher was convicted in 1990 on insider trading charges unrelated to his work on Merkin’s funds. (According to Teicher, he continued to advise the two Merkin funds after his conviction and, by phone, during a thirteen-month incarceration that began in 1993, a claim disputed by Merkin.)

  In 1989, beset by poor performance following the 1987 crash, Merkin started thinking about putting a portion of the Ariel and Gabriel money into the hands of another hot money manager: Bernie Madoff. At some point around 1990, Merkin paid a visit to the exclusive, intensely private market wizard in the Lipstick Building.

  Anyone glancing into Madoff’s fishbowl office or listening at the door that day would have been struck by the contrast between the man behind the desk and his visitor, settled ponderously into one of the office chairs. Merkin was a grizzled, bespectacled man in his mid-thirties, already a little jowly on his way to becoming portly. Madoff, just past fifty, had not slipped far from his lifeguard’s physique and wore his tailored clothes with grace. Merkin was erudite, prone to showing off with literary allusions and philosophical musings. He seemed to be an essentially honest man who was inclined to embroider the facts a little to enhance a story or avoid an awkward truth. Madoff spoke like a down-to-earth guy with no intellectual pretensions, but he actually was a consummate con artist who was certainly on the brink of running a Ponzi scheme, if not already doing so.

  Despite their differences in age and temperament, the two men hit it off. Merkin seemed to enjoy their initial conversation—his sister later speculated that he saw Madoff as “a kind, haimish sort of guy compared to my father.”

  Merkin listened as Madoff described the investment strategy he credited with producing his steady, utterly reliable returns—the same “split-strike conversion” talking points that had been so successful with the Fairfield Greenwich founders. One of Merkin’s associates would later theorize that Merkin thought of Madoff as a skilled mechanic, not a gifted theorist—as if Merkin were an architect condescending to discuss design with the general contractor. But this contractor seemed to be getting the job done, and Merkin ultimately decided to place some of the money in his two hedge funds with Madoff.

  As with Teicher, Madoff’s role as one of the managers of those funds was not officially disclosed, although Merkin would later argue in court that many investors were aware of the Madoff relationship and, indeed, eagerly sought it out.

  According to Merkin, his father first introduced him to Madoff in the late 1980s. Hermann Merkin was known for being exceedingly stingy with his praise, so it apparently carried great weight with his eldest son that he spoke well of Madoff.

  It must have, because other people on Wall Street whom Merkin knew and respected did not share his father’s good opinion of Madoff. Victor Teicher was instinctively dubious about the lack of volatility in Madoff’s returns, even in rocky markets. Merkin had “described Madoff in terms of what he was doing, in the consistency of the returns, and I felt that that was just not possible,” Teicher said later. “I’ve never seen anyone, I mean, have such consistent returns . . . it just didn’t seem like it was possible.” He would remain suspicious of Madoff for years.

  Merkin got similar warnings from John Nash, a legendary investor and cofounder of the Odyssey Partners hedge fund. Nash and his son had made a small personal investment with Madoff and did not trust his results. They withdrew their money and shared their doubts privately with Merkin.

  But Merkin’s faith in Madoff—or, perhaps, his faith in his father’s opinion of Madoff—carried the day. In 1992, the year of the Avellino & Bienes investigation and the year Madoff later identified as the launch date for his Ponzi scheme, Merkin formed a new hedge fund called Ascot Partners to invest exclusively with Madoff.

  Because Madoff was paid only through commissions on the trades he was supposedly making for Ascot, the plump management fees generated by the new hedge fund flowed entirely to Merkin. Later lawsuits would calculate that Merkin collected nearly $170 million in management fees from the Ascot fund alone between 1995 and 2007, and more than $500 million in fees from the two other funds that were partly invested with Madoff. Like Walter Noel and Jeffrey Tucker, Ezra Merkin was on the road to enormous wealth, thanks to Bernie Madoff.

  Ezra Merkin would be as generous with his wealth as his father had been, but he would also be more willing to spend it on comforts and luxuries for himself and his family. Around 1994 he paid $11 million to move his family into an eighteen-room apartment in one of Manhattan’s fabled buildings, 740 Park Avenue. He purchased tens of millions of dollars of museum-quality art, specializing in works by the twentieth-century artist Mark Rothko, whose enormous colour-washed canvases would come to dominate the apartment’s decor.

  Throughout the 1990s Merkin balanced such conspicuous consumption with sizeable gi
fts to his synagogue and to institutions such as Yeshiva University and his prep school alma mater, Ramaz. Philanthropies embraced him. He chaired the investment committee at the UJA-Federation of New York for ten years and ultimately served on the boards of Yeshiva University, Carnegie Hall, and several other nonprofit organizations. His reputation opened doors for him at other nonprofit endow-ments—at Bard College, Tufts University, New York University, and New York Law School. In time, nearly three dozen nonprofit groups would entrust their money to Merkin—and thus to Madoff.

  In a letter from prison, Madoff expressed great regard for Merkin: “Ezra Merkin is one of the brightest and [most] wonderful people I have ever known. He is an honorable man.” Bernie and Ruth would occasionally have dinner with Merkin and his wife at their luxurious apartment and mingle with their prominent friends from Jewish charities and educational institutions at other private dinners and charity events.

  The Nobel laureate and Holocaust survivor Elie Wiesel later recalled one such dinner with the Madoffs. “We did not speak about markets,” he said. “We spoke about ethics. . . . He presented himself as a philanthropist.” He remembered Madoff trying to lure him to Queens College, Ruth’s alma mater, by offering to endow a chair for him there.

  However heady such encounters were for Ruth and Bernie Madoff, his relationship with Merkin helped to cement Madoff’s reputation among Jewish philanthropists. The allure was poignantly simple: his investment skill would amplify their generous impulses. As Wiesel put it, in explaining why he decided to invest his entire endowment with this modest, magnetic man from Queens: “Everybody we knew told us we could do so much more if we could make more money with Madoff.”

  In these circles, Madoff’s reputation for generosity was enhanced after he and Ruth purchased a handsome home in Palm Beach in 1994 and, in 1996, were accepted as members of the Palm Beach Country Club, a haven of predominantly Jewish wealth since its founding in the 1950s. It was widely known that prospective members had to demonstrate that they regularly made annual charitable donations that were at least equal to the club’s hefty initiation fee, which likely was between $150,000 and $200,000 at the time.

  The Ascot Partners paperwork gave Merkin latitude to place his investors’ money with other managers. But, given what he was actually doing, it is difficult to read the documents as anything but misleading. They gave the impression that Merkin was the primary manager of the fund, and they indicated clearly that, if he chose other managers, he would diversify the assets among them. In fact, from the beginning he had intended to invest the Ascot fund exclusively with Madoff, and that is what he did—a fact he never disclosed in the formal documents that were provided to new investors.

  Instead, he told them that the fund “will engage primarily in risk arbitrage investments in private debt claims and publicly traded securities of bankrupt and distressed companies.” It might also make indirect investments in “mutual funds, private investment partnerships, closed-end funds, and other pooled investment vehicles which engaged in similar investment strategies,” the documents said.

  Even if Madoff had honestly been pursuing his “split-strike conversion” investment strategy on Merkin’s behalf—and he was doing no such thing—it would not have remotely matched those parameters.

  7

  WARNING SIGNS

  As the world celebrated the advent of a new century, Bernie Madoff was riding high. The 1990s had seen an extraordinary surge on Wall Street, including a red-hot rally in Internet technology stocks trading on NASDAQ. The automated OTC system Madoff had helped establish was now the hottest market on the planet. The electronic trading of stocks, which Madoff pioneered in the 1970s, had emerged as a powerful tool for individual investors, who increasingly relied on the financial markets for their retirement security. Legions of “day traders” began playing the market from their home computers, buying and selling stocks and learning that fortunes could be made through puts, calls, shorts, and other gambits once available only to established traders such as Madoff himself.

  The democratization of the markets did not lessen the appeal of Bernie Madoff’s investing genius. Yes, fortunes could be made, but they could also be lost, and investors persisted in believing there was a way to lock in high returns without exposing themselves to high risk. When the tech-stock bubble burst in the opening months of 2000, it served to affirm Madoff’s reputation as a safe haven in turbulent times. By now he had established himself as one of the most exclusive, most successful money managers in the business. For some time he had cultivated the impression that new investors simply couldn’t get in—he had all the money he wanted; he wouldn’t even discuss the business with would-be clients. It was akin to winning the lottery if he agreed to add your hedge fund to his coterie of institutional clients. This approach was masterful, of course. It proved that Groucho Marx’s famous rule also worked in reverse: everyone wanted to join the club that wouldn’t let them in.

  And the lucky ones who had already gotten in—Avellino & Bienes, Fairfield Greenwich, Cohmad Securities, Stanley Chais, Ezra Merkin, a host of charities and private foundations, an army of offshore hedge funds—did not want to annoy the fussy goose laying all those golden eggs. They had staked their reputations, their money, and their clients’ money on the premise that they could trust Bernie Madoff. They simply ignored or dismissed the quiet cautions and caveats that were starting to seep through the hedge fund community that Madoff’s returns were too consistently good to be credible.

  Then, those whispered suspicions became public.

  The May 2001 issue of a widely followed hedge fund industry publication called MARHedge carried a lengthy article by writer Michael Ocrant disclosing the stunning scale of Madoff’s extremely private money-managing business. Ocrant estimated that Madoff managed more than $6 billion. This actually was far less than he was pretending to manage, but even that sum would have made Madoff one of the largest individual investment advisers in the world, even though the money was ostensibly flowing in through hundreds of other investment advisers.

  Ocrant wrote that more than a dozen credible people in the hedge fund world—none identified by name—were mystified by Madoff’s performance. They didn’t doubt the annual returns, but Ocrant observed that such results were “considered somewhat high for the strategy” Madoff claimed to be using. Ocrant reminded readers about Gateway, the small public mutual fund that had pursued a similar “split-strike” strategy since 1978 but “experienced far greater volatility and lower returns during the same period.”

  The experts Ocrant consulted “asked why no one has been able to duplicate similar returns using the strategy and why other firms on Wall Street haven’t become aware of the fund and its strategy and traded against it, as has happened so often in other cases.” The article also questioned why Madoff agreed to take only the trading commissions the funds generated, allowing the fund managers to keep the lion’s share of the very hefty fees. His role, his fee structure, his secrecy—it all ran counter to the rules of the hedge fund game as they knew it.

  Ocrant acknowledged that “four or five professionals” he interviewed understood the strategy and did not dispute its reported returns—further evidence that Madoff had at least selected a plausible cover story for his fraud. But even those professionals doubted that Madoff could be pursuing the strategy the way he claimed, using S&P 100 stocks and options, especially with $6 billion under his management.

  In a spontaneous, apparently relaxed after-hours interview with Ocrant at the Lipstick Building offices in Manhattan, Madoff dismissed those doubts, saying that the private funds were a little more volatile than they looked in the monthly and annual returns and that his deep experience and his firm’s trading strength and sophistication fully explained the results.

  His trading strength had been affirmed barely a year earlier by some of the biggest names on Wall Street. As computer-driven trading networks multiplied across Wall Street, regulators pushed to eliminate the Big Board’s res
trictions on where its members could trade its listed stocks. In anticipation of that liberated future, five brokerage houses banded together in 2000 to invest in a new trading system called Primex. The five were Goldman Sachs, Merrill Lynch, Morgan Stanley, Salomon Smith Barney, and Bernard L. Madoff Investment Securities, which was actually developing the new network. “Never in my wildest dreams did I think I would have partners like these,” Madoff told reporters when the consortium was announced.

  Madoff was not arrogant or dismissive with Ocrant. Rather, he was charming and bemused. He took his time, showing Ocrant around the trading floor, easily and confidently discussing his disputed investment strategy, and casually offering plausible-sounding explanations for his success.

  “Market timing and stock picking are both important for the strategy to work,” Ocrant wrote, “and to those who express astonishment at the firm’s ability in those areas, Madoff points to long experience, excellent technology that provides superb and low-cost execution capabilities, good proprietary stock and options pricing models, well-established infrastructure, market-making ability and market intelligence derived from the massive amount of order flow it handles every day.” All of this was certainly true—it was what gave Madoff such credibility on the Street; it just had nothing to do with his investment returns.

  Madoff explained that he hadn’t set up his own hedge fund or demanded hedge fund fees because he believed his firm should stick to its “core strengths.” This explanation did not satisfy the “expert sceptics” Ocrant consulted. “Most continued to express bewilderment,” he wrote, “and indicated they were still grappling to understand how such results have been achieved for so long.”