Bernie Madoff, The Wizard of Lies

by Diana B. Henriques

What they don’t know is that Madoff has grown larger than any of them can imagine. If his hedge fund clients stick with him, he doesn’t need the genial guests who gathered tonight for Carl Shapiro’s celebration. And if the hedge funds desert him, there is little that even Shapiro can do to save him, no matter how willing and trusting he may be.

  THURSDAY, FEBRUARY 21, 2008

  Bernie Madoff welcomes a British bank executive into his office on the nineteenth floor. The banker works in London for HSBC, which handles the administrative paperwork for a growing roster of global hedge funds, including several that do business with Madoff.

  This is not a social call. Some HSBC units have been recommending various Madoff feeder funds to their clients for years, starting with the Fairfield Sentry fund in 1999. A number of the bank’s offshore hedge fund clients are invested with Madoff and are trusting his firm to hold their assets for safekeeping. Legally, that makes Madoff the “sub-custodian” of the funds, since HSBC is accepting fees to serve as their official custodian. As much as everyone trusts Madoff’s reputation, this is an unusual arrangement, especially with the world in such a skittish mood.

  The banker needs to answer a simple question: Are the securities that the hedge funds have left in Madoff’s custody actually there?

  They aren’t, of course. Madoff knows this—and by now there is enough quiet gossip about him in the hedge fund community to suggest that what he already knows others are starting to suspect.

  Even within HSBC there have been sceptics. As early as 2001 a few bank executives were expressing doubt about Madoff. In September 2005 the bank asked a major accounting firm, KPMG, to review the “operational risks” of Madoff’s business. When the report came back in early 2006, it included a chilling list of what could go wrong, from misdirected trades to outright fraud. But despite warnings and some internal doubts, the bank apparently felt that Madoff’s stainless reputation and his standing with market regulators made such nightmare possibilities sound outlandish.

  Still, next month, the bank will ask KPMG to do yet another assessment of the risks of doing business with Madoff. Perhaps this is what the banker has come to say. Or perhaps that examination will be ordered as a result of his visit today.

  Despite that renewed scrutiny, HSBC will continue to provide administrative and custodial services to the funds that deal with Madoff for almost ten more months.

  FRIDAY, MARCH 14, 2008

  After the stock market lurches to its sweaty close today, coworkers see Marcia Beth Cohn climb the oval staircase to the nineteenth floor and slump into the secretary’s chair near Bernie Madoff’s glass-walled office. She is a wiry, athletic woman with very short dark auburn hair. She swivels towards Madoff, standing nearby, and asks with a shaky smile:

  “O, wise man, what is going to happen to us?”

  Earlier today, the Federal Reserve extended an emergency line of credit to the Bear Stearns brokerage house, which was caught in an old-fashioned “run on the bank”. It is the first time in history that the Fed, a bank regulator, had stepped in to rescue a brokerage firm. Rumours of unrecognized mortgage losses are shaking people’s faith in other giant Wall Street firms, too—the shares of Morgan Stanley and Lehman Brothers were swept into the downdraft that cut Bear’s stock price in half today. The Dow closed down nearly two hundred points.

  There is probably no brokerage house on Wall Street with closer ties to Madoff’s firm than Bear Stearns. It has been a client of Madoff’s trading desk for years. Bernie and Ruth Madoff have good friends among senior Bear Stearns executives. When the Wall Street division of the American Jewish Committee honoured Madoff at a fund-raising event at the Harmonie Club in 1999, the reception was hosted by Bear Stearns chairman Alan C. Greenberg.

  For Marcia Beth Cohn, though, the threat is more than academic. She is president of Cohmad Securities, the tiny brokerage firm that shares office space with Madoff’s firm but clears its small volume of stock trades through Bear Stearns. Despite her wry tone, she seems genuinely frightened. What if some of her customer orders get caught in Bear Stearns’s collapse?

  It is a day to frighten anyone, but Madoff is characteristically calm. He gives the small group around her a quiet but reassuring lecture on the safety net that protects customer accounts on Wall Street. He is confident that Bear Stearns will find its footings once today’s panic ebbs.

  But federal regulators are already scrambling to find a buyer for Bear Stearns before the Asian markets open on Sunday evening. At the last moment, JPMorgan Chase will agree to buy the firm, after being promised substantial loan guarantees from the Fed. But it will offer only $2 a share—for Bear Stearns stock that closed today at $30 a share.

  The bank will ultimately raise its bid, but the damage will have been done. Investors will bail out of the financial sector, fearing that failures once considered unthinkable no longer are. From this weekend on, pension funds and other institutional investors will demand more information about the banks and brokers they deal with. There will be more questions put to Madoff, more answers demanded, and more nervous withdrawals.

  It is an anxious, faintly terrifying day, but this is nowhere near as bad as it will get. Indeed, this is all just prologue.

  FRIDAY, APRIL 25, 2008

  A partner at the Fairfield Greenwich Group, one of Madoff’s earliest and biggest hedge fund investors, is studying the rate at which cash is pouring out of its flagship product, the Fairfield Sentry fund, whose $7 billion in assets are entirely invested with Madoff. The Fairfield Greenwich firm has quietly put itself up for sale, and the partner knows that any well-heeled buyer will scrutinize these numbers to calculate the firm’s potential value.

  An explanation will definitely be required, based on the numbers the partner shares today in an e-mail to some of his colleagues. Redemption rates are high—twice the hedge fund industry average. The partner can explain this: “With monthly [redemptions allowed] on 15 days notice many investors use Sentry like a checking [current] account,” he notes. This contributes to the Sentry fund’s appeal—and to its vulnerability.

  On the plus side, Madoff has capped how much money he will take from Fairfield Greenwich, so redemptions allow them to satisfy investors who were shut out in the past. On the negative side, the redemption rate could dash the firm’s hopes of finding a buyer.

  In a more private e-mail a few minutes earlier, the partner had been more candid. The downside risk of not replacing the withdrawn cash “is very significant,” he wrote. It would reduce the firm’s revenue from management fees and, thus, its value to a prospective buyer.

  “And unfortunately,” he continued, “the upside is capped by capacity at Madoff so the risk/reward is disproportionate—a less obvious risk with Madoff than the risk that he ‘blows up’ but a real one nevertheless.”

  Other hedge funds, private bankers, and wealthy individuals scattered around the world have invested billions of dollars in the Fairfield Sentry fund. If one of the risks these investors are taking is that Madoff will blow up, it clearly is not obvious to them.

  WEDNESDAY, MAY 14, 2008

  Bernie Madoff looks quizzically at the two men who have been waiting in his nineteenth-floor conference room since 11:00 AM, and gestures them into his adjacent office.

  “I don’t know why I agreed to see you,” he says. He doesn’t sound rude, just a little confused.

  Madoff moves to his seat behind the desk as the visitors, a retired New Jersey businessman and his accountant, settle into the chairs across from him.

  The businessman mentions the name of the wealthy Madoff investor who had made the introduction. Madoff looks blank, as if he does not recognize the name. He has thousands of investors—but his visitors do not know that. They still think Bernie Madoff is an exclusive, highly selective investment adviser. After all, the businessman made at least a half-dozen calls before finally getting this spot on Madoff’s calendar.

  “All right, as long as you’re here . . . ,” Madoff says, as he seems to
relax slightly, his cherubic face taking on a kindly smile. He does not have a lot of time to spare, he adds—he will be leaving the next day for the south of France. They trade some pleasantries about his vacation plans. He seems in no hurry to make a sales pitch; he shows no sign of wanting the businessman’s money.

  Suddenly the businessman asks, “You didn’t grow up wealthy, did you?”

  Madoff smiles. He begins to recount his humble beginnings, the classic biography of the self-made man, something he has in common with his visitor.

  Finally they get down to the details.

  What is his fee? There is no fee.

  What is the minimum investment? Five million dollars.

  “I’m not really prepared to put in that much at first,” the businessman says. Typically he starts small with a new money manager, waiting for good results before committing as much as Madoff requires.

  Madoff shrugs. “Well, you can put in two million now, but by the end of the year you have to put in the rest.”

  At that, the businessman’s accountant knows this discussion is going nowhere and he turns his attention to his surroundings. There is not a single item on Madoff’s desk—not even a pencil. He notices the array of costly Roy Lichtenstein prints on the wall, all variations on the figure of a bull, Madoff’s icon. He takes in Madoff’s expensively cut dress shirt and handsome tie, his silver hair curling stylishly over his collar. Madoff truly seems indifferent to the outcome of the meeting.

  The businessman continues to quiz him—that’s his style, as his accountant can attest. He pokes and prods until he gets answers.

  Abruptly, Madoff becomes firmer. “Listen,” he says, “you ask a lot of questions. I just want to make one thing clear: With all due respect, once you invest, you can’t call me. You’ll deal with someone else.”

  The businessman smiles—his accountant knows the comment has shut the door on any possibility of a deal. Perhaps that’s what Madoff intended. As much as he needs this man’s cash, he cannot afford this relentless curiosity. After a few more pleasantries, they rise, exchange handshakes, and walk towards the double glass doors leading to the lifts.

  FRIDAY, JUNE 6, 2008

  Today the Madoff firm sends a cheque for just over $6 million to lawyers handling Mark and Stephanie Madoff’s purchase of a new grey-shingled house on the beach in Nantucket, Massachusetts.

  It is a beautiful property, larger and better situated than their former vacation home there, which they’ve just sold for $2.3 million. Located on the exclusive island’s south shore, it has five bedrooms and baths, a gracious guest cottage, a swimming pool and hot tub, and a 180-degree view of salt grass, sand, and ocean from its deep wraparound porch.

  There is room for their two-year-old daughter to play and for Mark’s two older children, from his previous marriage, to come for summer visits full of bike rides, fishing trips, and games.

  Perhaps it isn’t wise for Madoff to let Mark borrow so much cash right now. The trends are getting more worrisome. Some of Madoff’s important feeder funds are withdrawing more than they’re bringing in. Even the vast Fairfield Sentry hedge fund, that $7 billion behemoth, is losing cash.

  But to refuse Mark would be almost impossible. How would he explain it, after all these years of being the family’s bank? His two sons live the way the heirs of any successful hedge fund manager would expect to live. Operating at the level Madoff pretends he has reached—with many billions in assets supposedly invested with him, with a net worth in the hundreds of millions, with three vacation homes of his own—how could he explain that it simply wasn’t a good time for him to part with a mere $6 million?

  The younger Madoffs will close on the home on Monday, just in time for the sweet summer months on Nantucket.

  FRIDAY, JUNE 13, 2008

  It’s not really his job, but the financial consultant in Boulder, Colorado, feels he must warn the Fairfield Greenwich Group about the options trading Madoff did for the Fairfield Sentry fund last month. For one thing, it violated the rules that Madoff is supposed to be following when he does trades for the fund. Stock options are to be used only to hedge existing stock positions, not to generate profits independently. But this is exactly what Madoff reported doing last month: he bought twice as many options contracts as his stock positions required. In fact, his excessive options trading accounted for $95 million of the fund’s monthly earnings.

  Something just doesn’t add up. This isn’t the first time the consultant has noticed that Madoff was “over-hedging”, but it is the most extreme example.

  In an e-mail this morning to the fund’s chief risk officer, the consultant concedes that he may be a bit out of bounds, since he was hired merely to summarize the trading activity “without providing editorial commentary.” However, he continues, “I must mention to you that I find the May options trading activity to be unusual and difficult to explain, and would encourage you to investigate it further.”

  The risk officer replies a bit later that he, too, “found the activity somewhat abnormal.” But he has two weeks of travel ahead, so they agree to discuss the trades in a phone call later in the month.

  During that call, the consultant will share his fundamental fear. Even as skilful a trader as Madoff cannot wind up on the winning side of every single options trade, so there is the risk that he is backdating his trades to fake his profits. Someone needs to find out who is trading with him. More urgently, someone needs to verify that Madoff actually is holding all the assets he supposedly has purchased for the Fairfield Greenwich funds.

  There probably is a simple explanation for these options trades; most likely they were the only fictional trades Madoff could concoct that would explain how he made money when the entire market was down. But it was clumsy—and too obvious. Perhaps he wonders why nobody at Fairfield Greenwich has called him on it, but no one ever has.

  And, despite the consultant’s urgent warnings today, no one ever will.

  TUESDAY, JULY 15, 2008

  Bernie Madoff is meeting with four visitors from Florida—and he knows this meeting could cost him as much as $33 million.

  Three of the visitors are associated with the MorseLife Foundation in West Palm Beach, which operates one of the premier senior care facilities on Florida’s golden East Coast. The fourth is a financial planner in Merrill Lynch’s West Palm Beach office, who has recently expressed a few mild doubts to the foundation’s board about its Madoff investment. His specific concern is that the foundation is putting too many of its eggs in Bernie’s basket. In the spring, he recommended pulling out some of the Madoff money and investing it elsewhere.

  The MorseLife Foundation, whose board is dominated by the same sort of wealthy Jewish philanthropists Madoff has cultivated everywhere, opened an account with him in 1995. Since then, the foundation has invested more than $11 million and has never made a withdrawal. On this hot summer day, these visitors believe that MorseLife has about $33 million in that account, representing almost 60 percent of its total endowment.

  There is nothing in the account, of course. It is just another small pipeline into Madoff’s huge criminal enterprise. But if MorseLife asks for some of that money back, Madoff will have to write a cheque—further reducing the pool of cash that is keeping his fraud alive.

  He is caught in an increasingly dangerous market environment. This week, the stock of the once-impregnable US mortgage giant Fannie Mae is in freefall. Madoff knows some of his big, nervous hedge fund clients could soon demand their billions back. But steady long-term endowments such as that of MorseLife have been his bread and butter for years. It will greatly magnify his worries if they start pulling money out, too.

  No doubt he is determined to charm the man from Merrill Lynch.

  Madoff is relaxed and calm, as always, and he clearly succeeds in reassuring his visitors about his hedged, conservative “split-strike conversion” strategy. Shortly after this meeting, the Merrill executive will reverse his position and accept the foundation’s continuing i
nvestment with Madoff.

  Still, it is an ominous victory. Not long ago, the question of whether the foundation should stay would never have come up at all, much less have made its way into Bernie Madoff’s appointment book.

  WEDNESDAY, AUGUST 20, 2008

  There is a strong whiff of worry in the e-mail traffic today at Fairfield Greenwich Group. Nervous investors and prospective clients are pressing for answers about Madoff—indeed, one client is pulling $74.5 million out of the Sentry fund specifically because of its concerns about Madoff. And staffers at HSBC are asking questions as part of an operational due-diligence analysis of the Sentry fund.

  Even after years of due diligence, Fairfield Greenwich’s chief risk officer, Amit Vijayvergiya, conceded in an e-mail yesterday that “there are certain aspects of BLM’s operations that remain unclear” to him and his colleagues. They are trying to respond to the questions from HSBC, which is still focused laser-like on Madoff.

  The root of all these worries is counterparty risk. Even institutions confident about their own health know they can be brought down by the failure of an institution on the other side of a trade or on the receiving end of a loan. There are frightened whispers all over Wall Street about Lehman Brothers and Morgan Stanley. Those worries could become self-fulfilling prophecies—if counterparties are afraid that Lehman or Morgan won’t survive, they may refuse to trade with them or lend to them, thereby ensuring the very failure they fear.

  Trust—it all comes down to trust.

  In one of his shorthand messages today, Vijayvergiya reminds the firm’s Risk Assessment Committee that “the biggest single counterparty exposure risk we have at FGG” is Bernard L. Madoff. “I think the larger question is if the Risk Group is comfortable with BLM counterparty risk.”

  It used to be. Is it still?

  SUNDAY, SEPTEMBER 7, 2008