It made no difference. Armchair analysts without access to any of the evidence available to Picard still assumed that all the family defendants, including Peter, had been Bernie’s accomplices, and they regularly predicted their arrest. Some victims publicly referred to the Madoffs as an organized-crime family.
Picard’s lawsuit sought the roughly $200 million that had been withdrawn from Madoff family accounts, as well as unspecified damages and the rejection of any claims the family might have for SIPC relief.
At the same time, all over the world, the giant feeder funds were being sued by their own investors—although Picard insisted he had first claim on any of those funds’ assets. The same was true for the minor feeder funds, smaller pension advisory firms, and individual investment managers, who were being sued across the US, in Europe, and in the Caribbean. As the stack of lawsuits mounted, the allegation was always the same: “You knew, or you should have known, that Madoff was a fraud.”
These lawsuits cited Harry Markopolos’s red flags and the early warnings that a few alert bankers and hedge fund consultants had shared with their clients. They cited the 2001 article in Barron’s, the occasional errors in the account statements, the impossibly consistent returns. Given all those warning signals, how could any financially sophisticated person have failed to suspect Madoff’s fraud?
But the line dividing those who should have been suspicious from those who couldn’t have been expected to detect Madoff’s fraud was extremely difficult to draw. It became a bitter joke on Wall Street that the Madoff case proved there was no such thing as a “sophisticated investor”. Even financially astute people could look at worrisome facts and draw reassuring conclusions, and even a worrisome conclusion could be explained as sloppy paperwork or obsessive privacy. It did not automatically point to a massive fraud. Apparently, trust in Bernie Madoff could blind a hedge fund manager as easily as it could blind a retired retailer’s widow.
Without doubt, there were signs that should have made even unsophisticated investors pause before investing with Madoff. The firm’s Web site did not mention his advisory services, his “hedge fund”, or his customer accounts. As the years went by, his account statements remained primitive, printed and posted, while customers at Fidelity or Merrill Lynch could check their accounts online. Some were warned by Madoff not to talk about being his investors. For most of his career, he was not registered with the SEC as an investment adviser, surely something a small pension plan trustee or IRA investor would have noticed. True, he paid relatively modest returns—roughly equal to an S&P 500 index mutual fund—but his results were far less volatile and, hence, much safer than an index fund. How was that possible? If he was a lot safer than an index fund, shouldn’t his returns have been a lot lower?
As Madoff’s victims sought redress, the question of who should have known would split the world cleanly into two groups. One group looked at Madoff’s stature in the industry, his long track record with his investors, his obvious wealth, and his phoney but immensely convincing paper trail—voluminous account statements, simulated DTCC screens, bogus trading terminals for conducting fake trades—and asked, “How could his victims have ever figured it out?” The other group looked at the red flags—the anomalies, the impossible scale, the implausible consistency, the secrecy, the whispered warnings on Wall Street—and asked, “How could his victims not have known?”
In truth, the answer to whether you should have known depended on who you were, what your personal circumstances were, how much you trusted Wall Street—indeed, how much you trusted life in general. The world wanted a single answer; in fact, there were thousands, each different, each debatable, and each utterly academic in the aftermath.
It was indisputable that the SEC should have caught Madoff, and would have, except for its woefully inadequate investigative skills. But it is equally true that all his middle-income victims could have protected themselves from ruin simply by sticking with familiar heavily regulated investments, such as mutual funds and bank CDs, and avoiding the less regulated hedge fund environment—not to mention the totally undocumented promises of casual feeder funds such as Avellino & Bienes.
Still, all investors who are honest with themselves will realize that Madoff’s less sophisticated middle-class victims probably were no less diligent in doing their financial homework, or any more trusting in picking their investments, than most investors were in those galloping, giddy days before the 2008 crisis. So many people were trying to manage their retirement savings in their spare moments, with too little training and too many other things to do. So they substituted trust and gut instincts for the fine print and legalese that regulators expected them to study. Some trusted Vanguard and Citibank, and others trusted Madoff—but it was a leap of faith for everybody.
That should have worried everyone much more than it apparently did.
At 2:45 PM on Tuesday, August 11, 2009, Frank DiPascali entered a federal courtroom in downtown Manhattan. Smiling and seeming relaxed, he embraced members of his legal team, led by Marc Mukasey, and shared a few wisecracks with one of the attorneys.
At 3:05 PM, Judge Richard J. Sullivan strode to his high-backed black leather chair on the bench. Tall and attractive, Sullivan had a deep, mellow voice that must have mesmerized juries when he was a federal prosecutor. In simple terms, he explained the purpose of the hearing to the two dozen Madoff victims in the courtroom.
“On Friday, I received notice that Mr DiPascali was waiving indictment,” he said. The defendant had agreed to plead guilty to ten separate criminal counts, including conspiracy to commit securities fraud and tax evasion.
The judge walked DiPascali through the litany of questions designed to show that he understood what he was doing. He did; his mind was “crystal clear,” he said.
Prosecutor Marc Litt summarized the government’s case, which accused DiPascali of having conspired with Bernie Madoff “and others” to violate the law. He had misled regulators with faked records, had given perjured testimony to the SEC, had wired money around to simulate phoney commission income, and had aided and abetted other unnamed people in carrying out these crimes, Litt said.
DiPascali was facing a prison term of 125 years, but Litt explained that the government had agreed that if he provided “substantial assistance”, prosecutors would ask the court to be lenient in imposing a sentence.
DiPascali then stood and read a statement describing his crimes.
“From the early 1990s until December of 2008, I helped Bernie Madoff and other people carry out a fraud,” he said.
He recalled having been hired by Madoff in 1975, right after secondary school. “By 1990 or so, Bernie Madoff was a mentor to me, and a lot more. I was loyal to him,” DiPascali said. “I ended up being loyal to a terrible, terrible fault.”
For years, he continued, he had handled inquiries from Madoff’s investors. But there was “one single fact” that he did not tell clients or regulators. “No purchases or sales of securities were actually taking place in their accounts. It was all fake, it was all fictitious.”
He took a breath. “It was wrong and I knew it was wrong at the time, sir,” he said.
“When did you realize that?” Judge Sullivan asked.
“In the late ’80s or early ’90s,” he said—slightly amending his earlier statement that the fraud had begun in “the early 1990s.”
He admitted that he had created a lot of the false paperwork that had fooled the SEC so many times, and that he had lied directly to the regulators during his testimony in January 2006.
Why did he lie to the SEC lawyers?
“To throw them off their tracks, sir,” DiPascali answered.
“Did you have the sense that they were on the track?” the judge asked, with evident scepticism about those hapless investigations.
“Yes, sir.”
DiPascali concluded, his voice breaking, “I don’t know how I went from an eighteen-year-old kid who needed a job to where I am standing before you today.
I never intended to hurt anyone. I apologize to every victim. I am very, very, very sorry.”
Litt quickly explained that the fraud had started “at least as early as the 1980s,” but he offered no evidence for this. As the prosecutor addressed the court, DiPascali, seated at the defence table, wiped away a tear, and Mukasey put a steadying hand on his shoulder.
All that was left was for the judge to hear from the victims. The only speaker was Miriam Siegman, who once again urged that the judge reject the plea agreement and send the case to trial to satisfy “the public’s quest for truth.”
“I am sensitive to the points you’ve made,” Judge Sullivan responded, “but there’s a difference between a criminal trial and a truth commission.” He added, “I don’t believe the quest for truth ends today.”
He accepted DiPascali’s plea—but he stunned Mukasey and Litt by refusing to accept their deal to let DiPascali remain free on bail.
The defendant was facing a “fairly astronomical” prison sentence, the judge said. And his participation in a twenty-year fraud “doesn’t give me great confidence.” Was there enough cooperation in the world to trim a meaningful amount off a 125-year prison term? “I am not persuaded,” he said.
He ordered DiPascali to jail. At 5:18 PM, Madoff’s protégé, in obvious shock and distress, was handcuffed and taken from the courtroom. Months would pass before his lawyers and the government could finally come up with a bail package the judge would accept.
The investigations of Madoff’s crimes in Europe were announced with great fanfare in the weeks immediately after his arrest, but by the summer of 2009 they had produced few results.
Official interest in Sonja Kohn’s once-prestigious Bank Medici remained high. In April, Kohn was questioned privately in a Viennese court for three hours, with officials from the US Justice Department, the SEC, and the FBI in attendance. And, in May, Austria’s senior financial regulator revoked Bank Medici’s banking licence. But Kohn continued to deny that she had been anything but another of Madoff’s trusting victims, and there was little public evidence of a formal case being developed.
The Serious Fraud Office in London launched an investigation of Madoff’s British affiliate within days of his arrest. But for months there was no news of any indictments. In the early months of 2010, the SFO would quietly announce that it was closing its examination without filing charges against anyone.
Acting on complaints from investors, Swiss prosecutors were looking into the role of Banco Santander’s Optimal hedge fund unit in Geneva, and that of other fund managers who invested with Madoff or one of his feeder funds. But they filed only preliminary fraud charges against a handful of executives, who all denied any wrongdoing.
In France, the examiners focused on banks involved in derivative investments linked to Madoff. But no criminal charges were filed. The Paris prosecutors’ office was investigating specific complaints from defrauded investors. In November, an investigating judge would accuse Patrick Littaye, the cofounder of Access International, of a criminal breach of trust for putting a client’s money in his firm’s Madoff feeder fund, but those charges would later be dropped after the judge determined that Littaye himself was a victim of the fraud and no charges against him were warranted.
The official investigations and private lawsuits in Luxembourg, an emerging European hub for hedge funds and other pooled investments, were piling up almost as rapidly as in New York. At least twenty Madoff-related civil disputes were filed with the Luxembourg courts.
All these cases were closely watched by lawyers hired by Irving Picard, who was trying to ensure that any feeder fund that had made major withdrawals from the Ponzi scheme held on to the money long enough for him to claim it for Madoff’s victims.
Ultimately, much of the private investor litigation against banks and feeder funds in Europe would be settled out of court by the summer of 2010, shedding no light on what had happened there or who was responsible.
In the US the civil courts were not making much progress either. The limits on securities lawsuits that had been enacted by the Congress in the late 1990s made it difficult for investors to sue the bankers, accountants, hedge fund consultants, and feeder funds that had left them in Madoff’s hands, and many such cases were being thrown out of court. One of the cases dismissed was the SEC’s lawsuit against Cohmad Securities, the tiny brokerage firm that Madoff founded with his longtime friend Sonny Cohn.
The SEC lawsuit was able to assert only that Cohmad and its executives “knew or should have known” that they were dealing with a Ponzi scheme. But in a ruling that cast doubt on a number of similar pending cases, US District Court judge Louis L. Stanton declared that the SEC’s assertion simply wasn’t enough to sustain the case, even after he examined the agency’s assertions in the most favourable light possible.
“Nowhere does the complaint allege any fact that would put defendants on notice of Madoff’s fraud,” Judge Stanton observed. There were no references to revealing e-mails, no affidavits about overheard conversations, no allegations from Madoff himself that the Cohmad team had been in on the fraud.
“Rather, the complaint supports the reasonable inference that Madoff fooled the defendants as he did individual investors, financial institutions, and regulators”—including the plaintiff, the SEC.
The judge, who had handled key elements of the case since the day of Madoff’s arrest, refused to dismiss a few technical violations relating to the accuracy of Cohmad’s annual filings with the SEC, and he gave the agency a chance to try again by dismissing the complaint without prejudice. Nevertheless, the decision was a warning that, even for federal regulators, the question that mattered to the courts was not “who should have known?” but “who actually did know?” And the answer to that question would remain elusive.
By the late summer of 2009, the SEC had filed only two other Madoff-related lawsuits—against Madoff’s accountant David Friehling and Madoff’s first feeder fund manager, Stanley Chais.
As civil regulators, SEC officials necessarily had to defer to the criminal investigation being conducted by the US Justice Department—although it was not making much visible progress either. Its only arrests by October 2009 were Madoff, who’d confessed; Friehling, who wasn’t clearly charged with knowing about the Ponzi scheme; and DiPascali, who’d turned himself in.
The Madoff case had landed in the US Attorney’s Office in Manhattan when it was in the middle of a massive investigation of insider trading in the hedge fund industry, and manpower had been strained from the beginning. Moreover, the case was an upside-down version of the typical criminal investigation. Instead of the classic process of working up the chain and getting the small fry to nail the mastermind, prosecutors had locked up the mastermind and now had to work back down the chain, largely without his help.
Even so, the SEC’s Mary Schapiro felt it had built a strong enough roster of important regulatory actions to reclaim some of its lost respect. It had sued Halliburton, the giant oil services company, accusing it of violating laws against foreign bribery. It had accused the Swiss banking giant UBS of helping thousands of US citizens evade federal income taxes. It had sued three major banks for allegedly misleading investors about the risks of a disastrous product called “auction rate securities”. And it had sued the high-profile chief executive of a major subprime mortgage lender, asserting that his company’s notorious practices had not only helped to undermine America’s credit markets but had also undermined the company itself. Behind the scenes, it had a major investigation under way against Goldman Sachs.
In a warm and relaxed speech to a bar association group in New York in early August, the SEC’s new enforcement chief, Rob Khuzami, disclosed that the commission had dismantled restrictions put in place in previous regimes and had agreed to let him issue subpoenas on his own authority—an authority he intended to delegate to other appropriate senior staff members.
There would be no more limp tolerance for stonewalling suspects, he warned the
defence lawyers in his audience. If they resisted requests for documents or witnesses or dragged their feet on responding, “there will very likely be a subpoena on your desk the next morning.”
It was the kind of tough talk that should have been used with Madoff but wasn’t—as the entire world learned in great detail a few weeks later, on August 31, when the SEC’s inspector general, H. David Kotz, sent Mary Schapiro the final report on his monumental eight-month investigation of the agency’s failures in the Madoff case. Four days later, the full report became public.
The only good news in it for the SEC was that Kotz had not found any evidence that Madoff had corrupted the previous investigations by paying bribes or that agency officials had deliberately tried to protect him and cover up his crime. Shana Madoff’s romance with the former SEC lawyer Eric Swanson, whom she married in 2007, was closely examined—even his former girlfriends were interviewed—but Kotz concluded that the relationship had not influenced the SEC’s handling of Madoff or his firm, although it looked dreadful in hindsight.
The rest of the report was a humiliating litany of well-documented incompetence and bungled opportunities. In the years leading up to Bernie Madoff’s arrest, the agency received at least six complaints suggesting that he was operating a Ponzi scheme. A basic step in detecting a Ponzi scheme is to verify trades or confirm the existence of assets. “Yet, at no time did the SEC ever verify Madoff’s trading through an independent third-party,” Kotz concluded. In fact, it “never actually conducted a Ponzi scheme examination or investigation of Madoff” at all. This failure persisted in the face of frequent, blatant evidence that Madoff was a liar.
Bernie Madoff, The Wizard of Lies Page 38