Apparently Cheung’s team informed Madoff that the SEC had opened this investigation and intended to question him as well as some of the fund managers whose assets he was handling. It turned out that Bernie thought even less about the capabilities of the SEC than I did. During a December 2005 telephone conversation with Amit Vijayvergiya, the chief risk officer of the Fairfield Greenwich Group, and General Counsel Mark McKeefrey, Madoff warned, “Obviously, first of all, this call never took place.” Then he urged Vijayvergiya not to show any anxiety: “You don’t want them to think you’re concerned about anything. You’re best off, [if] ] you just be casual.”
According to transcripts, Madoff told Vijayvergiya that this was simply a “fishing expedition,” and the best way to handle the SEC’s questions was to avoid them. “You don’t have to be exact on this stuff because . . . no one pays attention to these types of things.” Later in the conversation he gave them some advice about how to handle the investigators: “These guys ask a zillion different questions and we look at them sometimes and we laugh and we say, ‘Are you guys writing a book?’ ”
Madoff told him how to answer the questions he anticipated they would be asked, primarily how the relationship between Fairfield Greenwich and Madoff theoretically was structured. “Your position is to say, listen, Madoff has been in business for 45 years, you know, he executes, you know, a huge percentage of the industry’s orders, he’s a well-known broker. You know, ‘We make the assumption that he’s doing everything properly.’ ” It appears from this conversation that Vijayvergiya had very little knowledge of what Madoff was actually doing, that he was little more than a middleman; he simply handed over his clients’ money to Madoff and distributed Madoff’s returns to those clients. So he needed to be told how their relationship would have worked if it was legitimate. For example, when Vijayvergiya asked Madoff how he would have been certain that his clients were receiving a pro rata allocation of profits based on their allocation if this was a real fund, Madoff replied that he should simply tell them that he knew it was correct because Bernie told him it was, but then Madoff reassured him: “You know, you don’t have to be too brilliant with these guys because you don’t have to be; you’re not supposed to have that knowledge and, you know, you wind up saying something which is either wrong, or, you know, it’s just not something you have to do.”
Madoff continually reassured Vijayvergiya that there was nothing to be concerned about, that the SEC basically was incompetent. “Fifty percent of the marketplace and the hedge funds operate in totally different ways than they used to. You know, you have all these funds; you know, it’s just, it’s just changed the landscape and the Commission has no idea what the hell is going on and of course they always think the worst, which is what they’re supposed to do.”
He concluded, accurately and derisively, “These guys, they work for five years at the Commission, then they become a compliance manager at a hedge fund.” And, he added, he knew that was true because every time an SEC investigator came up to his office he or she would ask for an employment application.
Remember, I didn’t know that my submission had led to an investigation. So I also didn’t know that Madoff testified voluntarily, without being represented by an attorney, on May 19, 2006. That was typical Madoff bravado; the natural assumption is that a man who is trying to conceal something certainly would bring his lawyer with him. There are many people who believe that in order to successfully manage this scam as long as he did without being discovered, Bernie Madoff had to be a genius. That reminds me of the story of the two hunters who were trapped by a bear. The first hunter said to the second hunter, “Don’t move. You can’t outrun a bear. Stand perfectly still and maybe he’ll go away.”
The second hunter looked at him, then took off running as fast as he could. “Don’t!” the first hunter yelled. “You can’t outrun a bear.”
As the second hunter picked up speed, he turned and yelled back, “I only have to outrun you!”
That was Bernie Madoff’s challenge. He didn’t have to be a genius; he just had to be smarter than the SEC. And as the inspector general summed up Madoff’s interview, “During Madoff’s testimony, he provided evasive answers to important questions, provided some answers that contradicted his previous representations, and provided some information that could have been used to discover that he was operating a Ponzi scheme. However, the Enforcement staff did not follow up with respect to any of the information that was relevant to Madoff’s Ponzi scheme.”
Madoff was smart enough to know that the lies he told could easily be checked by anyone with even moderate intelligence, and when they did check he would be finished. He made several statements that could have been confirmed or proven to be lies with just a single phone call. But there was no attempt to verify his claims. As he later admitted, “I thought this was the end game, over.” Fortunately for him, and unfortunately for the investors over the next two and a half years, he was dealing with the SEC. “I was astonished,” he said about not being arrested. “After all this, I got lucky.”
The SEC Division of Enforcement officially closed this investigation more than a year later, in November 2007. Their report acknowledged that Madoff had lied, or as they described it, “did not fully disclose” to the examiners “the nature of the trading conducted in the hedge fund accounts or the number of such accounts.” But even then they concluded, “The staff found no evidence of fraud. The staff did find, however, that BLM acted as an investment advisor to certain hedge funds, institutions and high net worth individuals in violation of the registration requirements of the Advisors Act. The staff also found that Fairfield Greenwich Group disclosures to its investors did not adequately describe BLM’s advisory role and described BLM as merely an executing broker to FFG’s accounts. As a result of discussions with the staff, BLM registered with the Commission as an investment advisor and FFG revised its disclosures to investors to reflect BLM’s advisory role.
“We recommend closing this investigation because both BLM and FFG voluntarily remedied the uncovered violations, and because those violations were not so serious as to warrant an enforcement action.”
In her 2007 performance review, Meaghan Cheung specifically cited her work in this investigation, writing, “In Madoff, we investigated the asset management services provided by a broker-dealer specializing in hedge funds who was not registered as an investment advisor. After our investigation, we conducted discussions among the staff, the Division of Investment Management, and Madoff’s counsel. We also held separate discussions with Madoff’s largest hedge fund client. As a result of those discussions, Madoff’s firm registered with the Commission as an investment advisor, and its hedge fund corrected its disclosure.”
What really bugs me is that the SEC caught Madoff lying to its investigators repeatedly, and making false statements to a federal official is supposed to carry a five-year (rarely imposed) maximum sentence; yet they never referred him to the Department of Justice for criminal prosecution. It seems that there is a double standard at the SEC where the big firms don’t get prosecuted for anything other than misdemeanors, but the small firms get shut down for anything more than minor infractions. Trained fraud examiners know to immediately expand the scope of their exam as soon as someone lies to them. That’s the signal to dig in and redouble your efforts, because once you catch them in a lie you know you have them back on their heels. One would think that SEC enforcement lawyers would at least comprehend that making false statements is a criminal offense and have the courage to stand up to a powerful Wall Street figure and send a deterrent message to industry that this sort of behavior will not be tolerated.
I like to tell a joke about the SEC that sometimes gets me into trouble. The difference between a male and female SEC employee, I explain, is that a male employee can count to 21—but only if he takes off his pants. That usually irritates the women, until I add, “But that assumes that he can find it, and unfortunately at the SEC none of them can actually find
it. That’s how clueless they are.”
These were the people who knew my identity. And as I also learned later, they hadn’t hesitated to identify me by name in internal e-mails, e-mails that were seen by several people, which was precisely what I had tried so hard to avoid.
While this dubious investigation was taking place, I was regularly in contact with John Wilke at the Wall Street journal. On December 27 the journal ran his front-page investigative piece reporting that legendary mutual fund billionaire Mario Gabelli had set up phony small companies, fronts, to enable him to bid for Federal Communications Commission (FCC) cellular band wave licenses potentially worth hundreds of millions of dollars. This was a False Claims Act case brought by a whistleblower, and Gabelli and his associates eventually agreed to pay a fine of $130 million.
But as soon as I read the story I knew Wilke was about to start working on our story. I even sent an e-mail to the team, alerting them to Wilke’s Gabelli story and informing them, “He’s going to be writing the Madoff story starting in January, but I don’t know how long it will take. The Gabelli story took time and I’m sure this one will too.”
In late January John and I agreed that he would meet me in Boston in mid-February. I made copies of all our material in preparation for this meeting. In addition I made suggestions about how he could bring himself up to date on Madoff. I suggested he speak with five people—Frank, Neil, Mike, Erin Arvedlund, and Matt Moran, the vice president of marketing at the Chicago Board Options Exchange (CBOE). I then provided him with my list of 47 derivatives experts in the financial industry, including Northfield Information Services founder Dan DiBartolomeo, my friend who had first checked my math and agreed that Madoff’s returns couldn’t be derived from the market; Meaghan Cheung; and Goldman Sachs (Boston) Managing Director Daniel E. Holland III. I wanted them to speak with him because “Goldman Sachs is one of the largest traders of equity derivates and if they don’t handle Madoff’s flow or see it in the markets then something’s rotten,” and Citibank’s Leon Gross, whom “I met with in September 2005 when he came right out and said to me, ‘I can’t believe that Madoff hasn’t been shut down by the SEC yet. How can anyone invest in that stupid strategy? It shouldn’t even be able to earn a positive return.’ ”
While I knew most of these people, with the exception of Dan DiBartolomeo, only a few of them knew about my investigation. In fact, I’d guess that about half the people on the list probably didn’t even know that Madoff was running a hedge fund. They were all derivatives experts, and if they were asked the proper questions they would have told Wilke that Madoff could not have achieved his returns with this strategy. The big negative was that many of the people on the list worked for large firms with compliance lawyers on staff who would squash any attempt by an employee to report out to either the SEC or the press without first reporting up through the company and obtaining permission. And naturally these compliance lawyers would never grant permission for fear of rocking the boat, for fear the information might be wrong or that a nasty lawsuit might result from it.
But there were several derivatives experts on this list who knew that Madoff was a fraud, and if the SEC had called their firms and requested interviews with them, they would have been very happy to cooperate—and what they would have said would have toppled Madoff. It wouldn’t have required any legal action to get them to speak. Unfortunately, the SEC didn’t train its investigators to reach out to independent third witnesses for assistance. The SEC staff never picked up the phone to contact even one of my witnesses, nor did they ever express interest in obtaining my comprehensive master list of 47 witnesses even after I offered it to them. The SEC’s employees are not trained as fraud examiners, nor are they trained to call witnesses.
I also suggested two sets of questions for John Wilke to ask everyone he interviewed. If those people he interviewed responded that they were not aware of the strategy used by Madoff, after explaining the strategy he should ask questions such as: Could $20 billion plus be run by a single hedge fund manager using the strategy I just described without you having heard about it? Could this split-strike option conversion strategy be capable of earning average annual gross returns of 16 percent with only seven monthly losses during the past 14 years? But if this person had heard of Bernie Madoff, among the questions I suggested were: Do you know who Bernie Madoff trades his over-the-counter OEX index options through? Have you ever seen the footprints of Bernie Madoff’s trades in the markets that you trade? How realistic do you consider Bernie Madoff’s performance numbers to be? Have you heard any stories about Bernie Madoff going to cash ahead of major market sell-offs? If so, how do you think he manages to sell ahead of the market?
In the world of numbers, it should take only a few pointed questions to figure out what’s real. If Wilke had asked these questions to several people on the list, any doubts he had about our Madoff claims would have been settled right there. As I had told the SEC, give me Madoff for five minutes and three questions and I could have put him away. Ironically, this was the same month that the Integral Investment Management hedge fund fraud went to trial five years after being discovered. That one hadn’t surprised me at all. Several years earlier Frank Casey had pitched the Rampart product I’d created to the Chicago Art Institute, and its directors had shown a lot of interest. At that time, they told Frank, they were heavily invested in a very successful Integral derivatives fund, so Frank had borrowed Integral’s PowerPoint presentation and asked me to take a look at it. After looking at it, I couldn’t figure out what the hell they were doing. Like Madoff, their strategy made no sense. Frank and I called a manager at Integral and claimed we were interested in investing. We asked him seven questions and he responded with seven totally wrong answers, making it obvious the whole thing was a fraud. Integral didn’t know the first thing about options. Integral was basically a much smaller Ponzi scheme than Madoff, but we were too deeply entrenched in Bernie to take on another fight. Its founder, Conrad Seghers, was convicted of violating the antifraud provisions of the securities laws and was barred from the investment industry.
But all it took to find out was asking seven questions on the telephone.
Wilke couldn’t make it to Boston in February because he was working on a major political story, as well as a report on alleged price fixing by Chinese vitamin supplement suppliers. In April he broke the story about Congressman Alan Mollohan, who, according to the Journal, set up several nonprofits in his West Virginia district and then helped those organizations obtain millions of dollars in congressional earmarks, while at the same time increasing his own personal wealth from about $500,000 to more than $6 million in four years. When it ran I sent a copy to the team, explaining, “John Wilke, the senior investigative reporter for the Wall Street Journal,published this cover story on Friday, which is why he is so late in getting to Boston. He said he’s coming up either late this week or late next week and that his next big cover story will be Madoff.
“John’s working on a drug scandal that likely gets into the WSJ next week but then he’s going to work on Madoff. John’s been covering the Lipitor scandal pretty heavily lately but he’s just doing maintenance follows as that investigation continues.”
When I spoke with John Wilke I still could hear his enthusiasm in his voice. Admittedly I was starting to get a little anxious, knowing that once this story was published I would no longer be in jeopardy, but when the finest investigative reporter in the business tells you he’s doing your story, there is no reason to doubt him.
He was still coming in May and June, but by this time I had started worrying. Was Madoff so big he had a line into the editors of the journal? If Wilke had turned down this story six months earlier I would have accepted it, but he hadn’t. He’d actively pursued it, and he had continued to assure me that he intended to pursue this story.
While this was being played out, whenever possible Mike Ocrant would urge a reporter he knew at the New York Times to pursue this and several other possible
stories. Ocrant was no longer reporting at MARHedge, instead having joined Institutional Investor, a global publisher and conference operator, as director of alternative investment conferences. When Mike told this Times reporter about Madoff, she had responded with some mild interest. She’d read his story and asked a few pertinent questions. But every time he brought it up to her she replied that, just like Wilke, she was under pressure to finish another piece or was in the middle of another assignment or any one of the many other reasons she just didn’t have time to conduct an investigation.
In June, Ben Stein, the Barron’s financial writer and TV comedian, was the featured speaker at the Boston Security Analysts Society’s annual dinner. I had always admired him. I felt he was a lot smarter than the reporters in the finance world, and when he showed up at this dinner wearing a nice suit and yellow sneakers, my respect for him grew even more. I introduced myself to him at the cocktail party before the dinner, explaining I was investigating securities fraud cases and I had discovered several billion-dollar frauds. He seemed interested and we exchanged e-mail addresses. While I didn’t mention Madoff to him, I thought he’d be the perfect person to go to if the Journal didn’t work out. He already had his own soapbox and he was funny enough to be taken seriously.
No One Would Listen: A True Financial Thriller Page 21
