The Madoff case also would drive home the fact that SIPC provided a far less extensive safety net than the deposit insurance programmes created for banks and savings and loans after the Great Depression. (It would have been strange if the Congress, in 1970, had intended to make investing in stocks as safe as putting money in the bank. Stocks paid higher returns than banks precisely because they involved greater risk.) Despite the comments of a few legislators at the time, few people in Washington considered SIPC as “insurance” against wall-to-wall fraud inside a brokerage house—until Madoff’s victims came along.
By 2008, SIPC had been shaped by its own courtroom history in ways that would compound its difficulties in handling the Madoff mess. If a brokerage firm failed for financial reasons, everyone agreed that SIPC’s role was to oversee the transfer of customer accounts to a healthier brokerage firm. If assets were stolen from customers by some rogue broker, clearly the customer’s first line of defence was always the broker’s employer.
But what if the brokerage firm failed because of a systemic fraud—for example, a Ponzi scheme such as Madoff’s? Unfortunately, SIPC’s court battles in fraud cases over the years had left a trail of limited and occasionally inconsistent decisions that would become a churned-up battlefield before the Madoff case was over. Most, if not all, of those court challenges arose from the liquidation of two-bit brokerage firms selling penny stocks—firms whose customers either had relatively small claims or, in some cases, were not entirely innocent bystanders. That experience, too, was going to be singularly unhelpful in preparing SIPC to deal with the Madoff liquidation.
Then there was SIPC’s reputation for customer service, which was spotty, to say the least. As early as 1992, the US General Accounting Office urged the agency to explain more clearly to investors what it did and did not cover. A dozen years later, the GAO was still critical of how SIPC handled its public relations duties. SIPC did not even have an office of public affairs to ensure that the public got accurate, timely information about what was going on in high-profile cases. Instead, it left most of the public relations chores to whichever lawyer it hired to handle each case—a witless approach, since lawyers were typically trained not to talk at all about their cases outside the courtroom or the judge’s chambers.
Fundamentally, SIPC—like so many people in Washington, on Wall Street, and along all the Main Streets across America—had simply scaled back its vision of what could go wrong in the financial markets. As firms became more professional and better capitalized, the risk of a huge failure began to seem remote. By 1996, SIPC’s emergency fund to cover cash advances to defrauded customers had grown to more than $1 billion—far more than the organization ever expected to need, given that it was handling only a few small cases a year. So that year, it cut its member assessment from a percentage of each firm’s revenues to a flat fee of $150 a year.
As early as 1992, the GAO warned that SIPC was not really prepared for a titanic failure. But the warning was not taken seriously by the Congress, Wall Street, the SEC, the investing public, or SIPC itself.
Despite its flaws, SIPC attracted little public or congressional attention after the 1970s simply because it became increasingly marginal to the world of Wall Street. Strong markets and targeted regulations sharply reduced the number of brokerage firm failures. In its first four years of existence in the early 1970s, SIPC liquidated 109 firms, some of them well known. Since then, its busiest year had been 1992, when it had thirteen open cases. In the four years before 2008, there were just five; there were none at all in 2007. Three small firms failed early in 2008, but they certainly did not put SIPC on the public’s radar.
This changed a bit on September 15, when Lehman Brothers filed for bankruptcy, the largest brokerage firm failure in history. But with Lehman’s customer service and accounting infrastructure still in place, things went smoothly. More than 135,000 customer accounts with more than $140 billion in assets were seamlessly moved into the hands of two other brokerage firms within weeks. While the legal battles among Lehman’s giant Wall Street counterparties would continue for years, Lehman’s retail customers were barely inconvenienced by the massive bankruptcy.
Then came the Madoff case. Bernard L. Madoff Investment Securities had been a charter member of SIPC, but this did not automatically mean that the Madoff fraud was a SIPC case or that its victims would be eligible for the limited cash advances the organization offered.
The victims clearly were not the kind of customers served by Madoff’s legitimate wholesale brokerage business. The customers of that business were the likes of Fidelity and Merrill Lynch, whose traders made their own decisions about what and when to buy and sell.
Moreover, Madoff had been registered with the Securities and Exchange Commission as an investment adviser since 2006. Although his customers opened their accounts with standard brokerage firm paperwork, they clearly had relied entirely on Madoff to pursue his own investment strategy on their behalf. This was one reason the SEC had forced him to register as an investment adviser in the first place.
And if one thing was crystal clear in the murky law governing brokerage bankruptcies, it was that SIPC did not cover a member’s investment advisory business.
In the days since Madoff’s arrest, the small SIPC staff in Washington had been wrestling with its responsibilities. Before anyone knew what had actually happened, a decision had to be made. The SIPC board and staff apparently concluded quickly that refusing to take responsibility for the Madoff fraud claims, while possibly defensible in a court of law, would be politically suicidal.
The only formal business Madoff had was his SIPC-protected brokerage firm. Even after he registered as an investment adviser, he did not incorporate a separate unit for his advisory clients. All the customer account statements were on the brokerage firm’s letterhead. And there on that letterhead, tiny as a ladybird, was the logo announcing that Madoff’s firm was a member of SIPC.
With the firestorm brewing in the weeks after Madoff’s arrest, it was simply impossible for this Wall Street–financed organization to walk away from this gigantic Wall Street swindle. So the SIPC board and staff stretched their definitions a little and took on the Madoff fraud claims.
They then stretched a little further and decided to make every valid claim eligible for the largest cash advance SIPC offered. By law, victims with claims for cash were limited to a $100,000 advance; those with claims for securities could get up to $500,000. Although SIPC did not know what was supposed to have been in those Madoff accounts or what might still be there, the agency decided that every Madoff claim would be treated as a claim for securities, not for cash.
So before most of Madoff’s devastated victims had even heard of SIPC, the agency made two decisions that would benefit many of them greatly at its own expense. Those steps would not earn it any high ground in the battles to come; SIPC would be confronting the most formidable legal challenges in its history, and angry Madoff investors would be demanding that it be completely overhauled.
But those battles were still in the future on the afternoon of Monday, December 15, when Picard and Sheehan bundled up for the subway ride downtown for a hearing before Judge Louis L. Stanton on the twenty-first floor of the federal courthouse just off Foley Square. They were accompanied on the trip by a senior lawyer for SIPC and were joined by SEC attorneys just before the hearing. Judge Stanton knew the issues; he had signed an emergency after-hours court order the evening of Madoff’s arrest authorizing Lee Richards to take immediate control of the Madoff operations in New York and London.
At the hearing, the SEC proposed that SIPC be allowed to put the domestic brokerage firm into bankruptcy, with Picard as the SIPC trustee and Baker & Hostetler—in reality, an army of lawyers led by David J. Sheehan—as the trustee’s counsel.
A little after 4:00 PM, Judge Stanton signed the order granting the SEC’s request, after directing Picard to post a $250,000 bond.
Richards would remain in control of the London operat
ion for a few more days, until it was put into bankruptcy in the British courts. He was still operating out of the Lipstick Building on Monday evening when Picard and Sheehan arrived, after a briefing by federal prosecutors at the US Attorney’s Office.
Leaving his “war room” in the nineteenth-floor conference room, Richards gave the two lawyers a tour—through the impressive black-and-grey trading room at the opposite end of that floor, then down the oval staircase to the more congested administrative offices on the eighteenth floor, and finally to the heart of the mystery: the seventeenth floor. The office suite on that floor was nondescript and strangely banal, considering the financial damage and emotional pain that had rippled out from those rooms over the previous five days. Just some cheap-looking desks, some computers, and some filing cabinets—but no people. As they returned upstairs, Richards recalled with a laugh that Frank DiPascali had been there last week but “went out for a cup of coffee and didn’t come back.” Richards then headed to the airport and his flight to London, as Sheehan and Picard got to work.
For that pair of old friends, the Madoff liquidation would be the opportunity of a lifetime, the capstone to their long careers—and the most difficult case they had ever handled.
They had encountered fraud cases, even Ponzi schemes, before. But they had never faced anything on this scale. The tally of customer losses was staggering, and the victims were spread around the globe. The firm itself was a crime scene, with FBI agents and federal prosecutors in charge. Employees on whom they would typically have relied for information were hiring lawyers and clamming up. They couldn’t find the kind of records they expected to find; instead, they found millions of pages of puzzling documentation stuffed into thousands of boxes at three locations around the city, much of it on old-fashioned microfiche.
There were more than a hundred employees, heaven knew how many general creditors, and at least four thousand active customer accounts, each one representing a person, a family, a partnership, the beneficiaries of a pension plan, a gigantic hedge fund with thousands of clients of its own, or a government agency investing money for an entire nation. Some of the firm’s customers were clearly innocent and almost destitute, but others were fabulously wealthy and possibly accomplices—and on the day Picard and Sheehan were appointed, they had no idea how to tell them apart.
On paper, the job assigned to them was simple: gather as much of the dissipated money as possible and divide it among the eligible claimants under the supervision of the bankruptcy court. But the journey Picard and Sheehan would have to take to reach that goal put them on a collision course with more than half of the Madoff victims.
The next day, Tuesday, December 16, a different legal drama was playing out. A crowded room in the offices of the US attorney in Manhattan was the setting chosen by the harried prosecutors for their first confidential meeting with Bernie Madoff and his lawyers. To some former prosecutors in the room, it was a curious setting for the delicate ritual known as “the proffer”.
The proffer is the occasion when a defence lawyer brings his client in to answer questions and provide information under a limited grant of immunity covering the day’s conversation. If the defendant’s information is good and his desire to cooperate is persuasive, the proffer can give him a shot at a plea bargain—a deal of some kind—and give prosecutors a road map for future cases against others who may be implicated in the crime.
As in any emotionally charged interview, ambience matters. An astute prosecutor will want the defendant to feel at ease, relaxed, almost intimate with the people questioning him. But there was no hope for that at this proffer. There were nearly a dozen people in the room, some at the long central table and others in chairs against the walls, and Madoff hadn’t even shown up yet.
The prosecutor, Marc Litt, and his boss, Bill Johnson, sat at the centre of one side of the table. Around them were two FBI agents, several lawyers from the SEC, and a few people from SIPC.
Then, at around 11:00 AM, Madoff walked in, accompanied by his lawyers Ike Sorkin, Dan Horwitz, and Nicole De Bello. They took their seats at the table, directly across from Litt and Johnson.
After the formalities—chiefly, the clarification of the limited immunity agreement—Litt and Johnson began questioning Madoff, drawing him out.
Madoff recounted how he got started in his business, how he wanted to establish himself with the well-to-do Jewish businessmen he cultivated; he wanted to impress them. He got in some trouble back in 1962, had to borrow money from his father-in-law to cover some customer losses. He was doing all sorts of complicated trading, which he struggled to explain. He got in trouble again, started to cheat a little. Then he slipped into the full-scale Ponzi scheme. He expected to get out again quickly, but he never could. It got too big.
He insisted that he had run the elaborate Ponzi scheme himself. No one helped.
What about when you took holidays? Would you communicate through Frank DiPascali?
Madoff shrugged. No, he said, he was just careful; no one else was involved.
No one in the room believed him.
After several hours, the group broke for lunch. Madoff and his lawyers brought paper-wrapped delicatessen sandwiches back to the table.
The proffer session resumed. By now questions started popping from around the room, and some of them misfired, interrupting Madoff’s answers and derailing another questioner’s train of thought.
Somewhere in all this intellectual disorder, Madoff was asked how and when his crime began—and no one would agree later about what they heard, perhaps because no one specified “which crime?” Some people heard him date his Ponzi scheme to the 1960s, when he lost money for his clients and had to borrow from Saul Alpern to make them whole. When he lost more money later on—no one later recalled if he said when this was—he said he couldn’t go back to Alpern to be bailed out again. So he started to steal from one client to pay another.
Others would later insist that the early fraud that Madoff described was not the Ponzi scheme, which he would claim began in the early 1990s, but rather, the faked investment returns he reported to his clients back in the 1960s.
Which was it? As always with Bernie Madoff, the truth was a slippery creature. It wriggled out of this crowded room before anyone could catch it and lock it up.
But if the truth could not be locked up, this didn’t mean Madoff himself could roam free. At his initial hearing before Judge Douglas Eaton the previous Thursday, Madoff’s lawyers had agreed with prosecutors on a recognizance bond of $10 million, to be cosigned by four “financially responsible people”. Now, nearly a week later, Madoff could not get four people to sign a surety bond to secure his bail; only his wife and brother were willing.
His sons would not consider it. Even if they had not been silenced by their fury and grief, their lawyer would not let them speak to their parents, determined to protect them from any suspicion that they might be colluding with their father after the fact.
Madoff could not turn to his closest friends, either; they were also his victims. Even if their lawyers would let them take the call, it would be fatal to their credibility in the courtroom battles ahead to be seen helping the man who had stolen so much from so many.
So, on Wednesday, December 17, Litt agreed to accept a compromise. In lieu of more signatures, Madoff would have to submit to home detention with electronic monitoring and would pledge the homes in Montauk and Palm Beach, which were in Ruth’s name. In addition, Ruth would surrender her own passport, as Madoff had. Magistrate judge Gabriel W. Gorenstein approved the new arrangement without a hearing.
That afternoon, casually dressed in a navy canvas baseball cap and a black quilted Barbour jacket, Madoff returned to his apartment on East Sixty-fourth Street after being fitted with his electronic monitoring device. There had not been time for his lawyers to arrange security for the trip home, so Madoff was alone when he approached the gauntlet of cameras and microphones on the pavement outside his apartment.
The me
dia crowd scurried to keep him on camera as he moved steadily towards the door, his face a mask, his mouth a thin, tight line. Someone blocked his way as questions were shouted at him. Someone else shoved him on the left shoulder; he tried to ward off the shove, pushing back and moving forward. Shaken, he finally reached the lobby and disappeared into the building. The recorded scene would be played repeatedly on television over the coming days.
If prosecutors, blindsided by the furious public reaction to Madoff’s release on bail, were looking for an opportunity to reopen the issue, the shoving match provided one. By Thursday morning, they started questioning Madoff’s lawyers about whether it would be safe for him to remain free.
His lawyers scrambled in an effort to preserve his freedom without burning up assets the government would need to claim for his victims. They managed to arrange a twenty-four-hour security detail headed by a former New York City police detective, Nick Casale, and staffed largely by retired NYPD officers.
With that in place, the prosecutors agreed that Madoff would be confined to his apartment around the clock, leaving only for court dates or medical emergencies.
The talk show comics immediately called it “penthouse arrest”.
For the people at the SEC, especially in the New York office, Madoff’s arrest was a stomach-sinking moment.
Bernie Madoff, The Wizard of Lies Page 29