Bernie Madoff, The Wizard of Lies

by Diana B. Henriques

  Despite the peril facing his Ponzi scheme, Bernie Madoff apparently did not put any restrictions on his family’s access to cash. The overall stock markets were strong; the global hedge fund business seemed to be healthy. Anyone who believed that Madoff was running an extremely successful hedge fund business would necessarily have believed that he had money to burn. Every other successful hedge fund manager did.

  If his family members knew that his secret Ponzi scheme was in the grip of a potentially fatal cash crunch, they certainly were doing nothing to make it easier for him, and their redemptions were certainly ones he could have refused without question if they had been his accomplices. In December 2005, Madoff loaned each of his sons $5 million. Between September and April, he allowed his brother to withdraw $3.2 million from the accounts Bernie managed for him. No one in his family hurried to close out their accounts during this crisis and move their assets to safer havens. They left the great bulk of their wealth—their pensions, their deferred compensation, their children’s trust funds—in Bernie’s hands.

  In retrospect, the fact that the family continued to withdraw cash but did not empty their accounts suggests that they were unaware of both the fraud and its imminent peril in the autumn of 2005. They simply continued to tap Bernie’s piggybank, as they had always done, as if everything at the firm were running as smoothly as it always had.

  Madoff’s unstinting largess may also have reflected the reality that life beyond the business was far from smooth for the Madoff family. Peter’s son, Roger, was losing his long battle with leukemia and had been slipping towards death all through the winter, attended by his young wife and his heartbroken family. On April 15, 2006, he died at age thirty-two. Bernie’s secretary, Eleanor Squillari, would later say that the Peter she had known for so many years died that day, too.

  It was during these months of private anguish, in this secretly precarious season of SEC scrutiny and frantic loans and cash transfers, that Madoff nearly lost his battle to keep his Ponzi scheme alive. By April 2006, he had transferred more than $260 million from the brokerage firm’s accounts into the Ponzi scheme’s slush fund to cover withdrawals and keep the fraud afloat—and it still wasn’t enough.

  The tide began to turn on April 18, when Madoff’s problematic investor Jeffry Picower deposited $125 million into one of his Madoff accounts—no doubt a very welcome infusion of cash, since it was made just five days after Fairfield Greenwich pulled out $120 million. It is one of the bits of evidence that suggests that Picower was better informed about Madoff’s continuing crime than even Madoff suspected—or at least than either man ever admitted.

  After its timely arrival in his Madoff account, Picower’s fortuitous deposit underwent a remarkable transformation. Within two weeks, it had grown on paper to $164 million, thanks to big gains on some stocks supposedly purchased with the money. According to Picower’s account statements, however, the lucrative stock purchase was made three months earlier, ten weeks before the $125 million cheque actually arrived in his account to pay for the stock. And in September 2006, after Madoff’s cash crisis had eased and new money was pouring in daily, Picower withdrew his $125 million, leaving paper profits of $80 million in the account after just five months. It is possible that Picower thought he had bought the shares months before on margin and paid for them after the fact. But the bankruptcy trustee would later interpret the transaction as circumstantial evidence that Picower helped bail out Madoff and was rewarded with fabricated profits generated through backdated trades. It is almost inconceivable that Madoff could have cooked up such blatantly fictional trades in the account of an investor as sophisticated as Picower without him noticing.

  The welcome and mutually rewarding Picower cheque and, at last, an ebb in withdrawals weren’t enough, though, to save the corrupt scheme in that season of crisis. Madoff still had to get the SEC off his back. Fortunately for him, the agency’s investigators were hampered by their refusal to trust Harry Markopolos and his analysis. They failed to do the tough homework of studying the files of previously bungled investigations. They knew little about Ponzi schemes and the people who built them. But with all their shortcomings, Madoff’s regulators got tantalizingly close to exposing him in the spring of 2006.

  Sometime in May, the SEC investigative team drafted letters to send to Barclays Bank and the Bank of New York, asking them to confirm Madoff’s trading activity. Responses to those letters would have put him at risk because they would have revealed that there simply wasn’t any trading activity going on. For some reason, however, Meaghan Cheung and her colleague Simona Suh decided to delay sending the letters until Madoff himself was interviewed later that month. Ultimately, the letters were never sent—later, no one could recall why.

  Then, in mid-May, the SEC team asked a staff member at FINRA, the Financial Industry Regulatory Authority, to check on Madoff’s options trading on a particular date. The FINRA staffer reported that Madoff had done no options trading at all on that date. Still, the team simply chewed over the bizarre report and dismissed it, persuading themselves that Madoff either was failing to disclose his trades or was making them overseas. Despite all his obvious lies, they never suspected he was not making any trades at all. By then, after so many years of caution and bureaucratic inertia at the SEC, that lie apparently was simply too large to fit into the agency’s limited imagination.

  The entire investigation, eventually, came down to Madoff himself.

  A little before 10:00 AM on Friday, May 19, 2006, Bernie Madoff arrived at the SEC’s New York office in the American Express tower, adjacent to the huge empty footprint of the World Trade Center. He came alone, without a lawyer. Across the table were five SEC staff members, including Meaghan Cheung, Simona Suh, and Peter Lamore.

  Madoff seemed relaxed and cordial. He grew expansive when he talked about the art of trading stocks and the science of computers, which he conceded was not his strong suit. “If I was talking to a brain surgeon and they started talking about the terminology—that I wouldn’t know. But if they said, ‘see this scalpel, stick it in there,’ now I understand,” he said.

  Everybody had different computer algorithms to guide their trading, he went on. “People design their systems to say ‘I don’t care about this, I care about that.’ ” But he didn’t attach much importance to the widely available information that flows into the marketplace. “People are always trying to ask me ‘what makes a good trade?’ Or ‘why can you trade better than other people,’ and so on. It’s the same thing—we are proprietary traders and market-makers. Some guys have more guts than others. Some of them are just stupid—they don’t get frightened when they should be getting frightened. Some people just feel the market. Some people just understand how to analyse the numbers that they are looking at.”

  The explanation for his success was that simple, he suggested without quite saying so: he was one of those people who “just feel the market.”

  He was asked why he didn’t do his options trading on one of the public exchanges instead of in the opaque over-the-counter market. “Everybody goes to the over-the-counter market on options. That’s the way the market is,” he said. Listed options could be traded only “during the US hours, which you don’t want to do.” Besides, he added, “there’s really not the liquidity in the options market. It’s improving, but it’s not where you would want to go.”

  He seemed confident, knowledgeable, relaxed—there was no sign that he had almost run out of cash. There was no indication that, after handing over that list of fictional counterparties in February, he feared he had already run out of time. Every day for the last three months he had expected to hear that the SEC had called some of the names on the list and found out he was lying. So far they hadn’t—indeed, they never would—but suddenly that potentially fatal list was there in front of Madoff, on the table in the SEC’s conference room.

  “I’d like to go over this list and have you explain in a little more detail the function of each account,” Simona
Suh said. “The account, Depository Trust Clearing Corporation, what is the function of this account?”

  Madoff answered truthfully, “That’s the general clearance account for the firm, that handles all the settlements of transactions for the firm.”

  Did the clearinghouse set up separate accounts for the different institutional customers?

  Yes, Madoff said. Well, there was one big account, but different codes for whether the securities belonged to the brokerage firm or to an institutional customer.

  “You know what those codes are?”

  “No,” Madoff said.

  “But DTC would know?”

  “Yes,” he said.

  Well, that was probably the final, fatal step—the moment when his time ran out. “I thought it was the end, game over. Monday morning, they’ll call the DTC and this will be over,” he recalled later. “And it never happened.”

  That “astonished” him, he said, because “if you’re looking at a Ponzi scheme, it’s the first thing you do.”

  If the investigative team had checked Madoff’s clearinghouse account that day or on the following Monday, they would have found that it held less than $24 million in blue-chip stocks, at a time when it should have held either billions of dollars’ worth of stock or an equal amount in US Treasury bonds, based on the account statements they had seen.

  But the investigators misunderstood how the clearinghouse worked and wrongly assumed that it would be hugely laborious to sift out the hedge fund transactions from the firm’s normal high-volume trading business. So they didn’t follow up on the DTCC account.

  By this point in the Madoff interview, Peter Lamore was beside himself. Madoff had been sitting there for hours, bold as brass, describing his options trades—almost exactly a year after telling Lamore he wasn’t using options as part of his investment strategy anymore. Simona Suh confronted Madoff with the discrepancy.

  “Do you recall telling Peter that, as of January 1, 2004, you no longer incorporated options into the strategy for the institutional trading business?”

  “I said they’re not part of the model,” Madoff lied smoothly. “The options are not deemed to be part of the model. I did not say—my recollection certainly is not that I said that the accounts don’t use options anymore to trade. I said the options—that the options were taken out of the model, and they’re not part of the model any longer.”

  Suh followed up: “So what change were you referring to in that statement?”

  “Well, they used to be part of the model,” Madoff explained. They had been taken out, he continued, because they weakened his intellectual property claims to the software that guided his investment strategy. “We consider the model our intellectual property. It states so, I believe, in the trading authorization directive,” he said. But there simply wasn’t “enough meat” on the options portion of the model. “So we took it, basically, out of the model and treated them separately,” he said.

  Hadn’t he told Lamore that, as of January 1, 2004, the clients could hedge the strategy by buying their own options?

  “No,” Madoff answered.

  “You do not recall making that statement?”

  “I recall saying what I just said, that they were [originally] part of the model, that they were no longer part of the model, but that—I remember specifically saying that the options are still used to hedge the transactions.”

  Lamore was furious. “I just remember sitting there in the testimony saying, he’s lying,” he recalled years later. “It was just remarkable to me.”

  Like so many others, Lamore did not contemplate that a man who would tell such a brazen lie might also commit a brazen fraud. “I mean, ‘lying or misleading’ to ‘fraud, Ponzi scheme’ to me was a huge step—a huge leap.”

  It was a leap Bernie Madoff took every day, but the SEC failed to understand this. When its team officially closed this flawed investigation on January 3, 2008, after a long period of inactivity, it would conclude that, despite all the lies they had discovered, there was no evidence of fraud.

  Nine months after Madoff’s nearly ruinous 2005 liquidity crisis erupted, his Ponzi scheme was finally back in the black.

  It had been a big-budget battle. By the time Madoff was sitting down to spin the SEC at the end of May 2006, he had borrowed $342 million under his brokerage firm’s letter of credit to keep his Ponzi scheme alive. But by the end of August 2006, when the SEC finally dropped its thoroughly fumbled investigation—it merely required him to register as an investment adviser—the borrowed money had all been paid back to the brokerage firm’s banks. Even by the end of June, Madoff had been able to start whittling down the debt, arranging to transfer $262 million back into the firm’s operating account by reversing the accounting gimmicks that were used to hide the payments made earlier in the year.

  How did Madoff’s imperilled Ponzi scheme get back on its feet so quickly? With a lot of help from his friends—specifically, some new hedge fund friends.

  It helped enormously that the global appetite for hedge fund investments had quickly shaken off any queasiness left over from the Bayou fund collapse. The turnaround in Europe was nothing short of spectacular. A money manager there who in 2001 had purchased shares in a Kingate fund invested with Madoff decided to cash out in 2005. “I said, ‘I want to sell,’ ” he recalled, “and people were saying, ‘me,’ ‘me,’ ‘me.’ In fifteen minutes I could have my money.” He made 40 percent on that stake but kept watching for an opportunity to invest in Madoff through other funds. He shrugged: “We all thought he was front-running. But so what?”

  Thanks to the continuing sales effort led by Walter Noel’s handsome sons-in-law at Fairfield Greenwich, Madoff was well situated to benefit eventually from this rebound, although Fairfield Greenwich did not start to recover from its 2005 decline until late in the year and saw its biggest gains in 2007.

  The real powerhouse behind Madoff’s fraud-saving success in Europe in 2005 and 2006 was Sonja Kohn, the energetic founder of a boutique bank in Vienna called Bank Medici. Born in 1948 in Vienna, Sonja Blau married Erwin Kohn, a career banker, in 1970 and raised five children. Early in their marriage, they operated an importing business in Milan and Zurich, but in 1983 they moved to New York, and by 1985 she had obtained her broker’s licence. An exuberant and somewhat flamboyant woman who was fluent in at least four languages, she worked briefly in the late 1980s for Merrill Lynch and Oppenheimer. Although some remembered her generating big commissions for the firm in those days, two of her Merrill Lynch customers complained that she had steered them into unsuitable investments, and records show the firm paid more than $125,000 to settle the disputes.

  Publicly, Sonja Kohn recalled that she had been introduced to Madoff in the 1990s, when his “hedge fund” had the endorsement of “people and companies who were the gold standard of the financial community.” In fact, Kohn was introduced to Madoff in the mid-1980s by Madoff’s cheerful Roslyn neighbour and business partner Sonny Cohn.

  When Cohn was mulling over ideas for life after retirement, his accountant at the well-known firm of Oppenheim, Appel, Dixon & Company suggested he talk with a dynamic Austrian woman who supposedly was one of the “biggest producers” at Merrill Lynch. There was a meeting—but apparently no meeting of the minds about any kind of joint venture. Sonja Kohn was very tough-minded and had big ambitions and expansive ideas, while Sonny Cohn was probably looking for a quiet sort of semiretirement. Still, Cohn did introduce Sonja Kohn to Madoff, who was more than a match for her in toughness and ambition.

  In April 1987, Sonja Kohn formed a small company in New York called Erko. A few months later, she formed Windsor IBC, a brokerage firm wholly owned by Erko. Within a few years, she would stand at the centre of a dizzying international complex of corporate shells, holding companies, offshore trusts, and private partnerships, the most prominent of which was her flagship institution, Bank Medici, founded in 1994.

  The first to become publicly known was a small investment firm s
he established in 1990 called Eurovaleur, a hedge fund collective based in New York that worked with some of the top money managers in Europe. When she showed up in Madoff’s appointment book, even two decades later, she was most commonly identified as being from Eurovaleur, not Bank Medici.

  In 1996, a decade after her fruitful association with Madoff began, Kohn set up another small New York company called Infovaleur, later described as a financial research service. One of its most lucrative clients was Bernie Madoff, whose legitimate firm had easy access to any Wall Street research it wished to see. The trustee liquidating Madoff’s firm years later would assert that Infovaleur was “a sham”, one of many shell companies designed simply to receive tens of millions of dollars from Madoff and send the money along to other shell companies controlled by the Kohn family and its associates in Gibraltar, elsewhere in Europe, and Israel. The cash—which allegedly was always handed over face-to-face, never mailed—was Kohn’s compensation for the billions of dollars she helped steer into Madoff’s Ponzi scheme over the years, the trustee claimed.

  Another lawsuit by the trustee would contend that Madoff’s small affiliate in London, Madoff Securities International Ltd, had been a link in this chain of compensation since 1987. That case described meetings at which one of Madoff’s longtime senior executives in London personally delivered Kohn’s quarterly cheque “over tea at the Ritz or Claridge’s in London.” These fees were identified in Madoff’s records as being for research, but the intermediary was “well aware that whatever research Kohn did provide to Madoff was worthless,” the trustee alleged. The London executive did not comment but took steps to dispute the trustee’s allegations in court. Through her lawyers, Kohn insisted that she never had any knowledge of Madoff’s fraud.