Sunday, July 26, 2009

Did Madoff Act Alone

Madoff did not share the credit for perpetrating the biggest Ponzi Scheme in the annals of crime. After his arrest on December 11th 2008 he insisted to the FBI and federal prosecutors that he, acting entirely alone, organized and ran the confidence game that created over $50 billion in imaginary profits and that resulted in more than 6,500 investors losing $13.2 billion in real money. According to him, here is how the lone swindler operation worked. He confined the fake part of his enterprise to a sealed-off suite of offices called "House 17." It was located one floor below his legitimate market-making business in the Lipstick Building on 3rd Avenue Manhattan. Access required a coded key-card and was limited to only about 20 clerical employees. In the back of suite was the so-called "cage" in which three clerks logged in all the checks and wires that were deposited or withdrawn in the JP Morgan Chase bank account for Madoff’s "Investment Advisory" service (which was the cover for the Ponzi Scheme swindle). They manually recorded the amounts on index cards for Madoff. This tally gave him a running total of how much actual money was available. Outside the "cage" was an open area in which three young researchers filled in the historic prices of stocks and options that Madoff requested, using tables from the Bloomberg wire service and other public sources. This data helped him verify the forged trades. Next, he gave data-entry clerks in a glass-enclosed area in the center of the room called the "fish bowl" a list of the trades he supposedly had made and they would punch it into an 1988-vintage IBM AS 400 computer (which was not connected to any external system.) The computer then calculated "commissions" as well as "profits" or "losses," and generated daily and monthly customer statements for each account, which were then printed and posted by regular mail. As the "profits" were consistently greater than the "losses", the value of the accounts increased accordingly. All these operations were done under the eagle-eyed supervision of Madoff’‘s long-time deputy, Frank DiPascali, who is pleading guilty for his part in the criminal scheme and currently cooperating with the FBI investigation. According to Madoff, neither DiPascali nor anyone else in House 17, had any inkling that the trades they were processing were fictional. As for his 18th floor employees, and his accountants– he used a two-man accounting firm that worked out of a 700 square foot office in Westchester– they saw nothing more than the wealth of computer-generated statements showing the trades for the Investment Advisory accounts.
The flaw in his lone swindler story became evident to me when I was allowed to examine Madoff’s actual confirmation slips. These were made available to me at a global business intelligence company founded by former American and British intelligence officers, which specializes in investigating, as they put it, "opaque business environments". The person there who had obtained these Madoff files from off-shore "feeder" funds that had been supplying Madoff with more than half the money funneled into the Ponzi scheme since 1998. Unlike hedge funds which invest money, feeder funds simply raise money and then turn it over to a hedge fund with which it has an arrangement. Ordinarily, the feeder fund gets a relatively small percent of the money it corrals from the hedge fund– typically 1 percent– while the hedge fund charges the investors both a hefty performance and net asset fee. Madoff had, however, offered select feeder funds a much better deal. Instead of charging them anything for managing their money, he would work for them for free, allowing them to collect the entire performance fee, which could be as much as 20 percent of the profits. This provided a bonanza for feeder funds which deducted the performance fee from their clients’ accounts each year, transferred it to their own "carry" account, and then withdrew it. To justify these fee, these funds verified that the trades reported in Madoff’s confirmation slips were in keeping with the conditions specified in the trading authority that they had agreed upon. Since conditions often varied between feeder funds, and even their sub-funds, Madoff could not make all the same fictional trades for all the funds. As a result, by 2008, he needed to invent a huge number of transaction in order to keep turning over the $64 billion that supposedly was in his accounts (especially since he "sold" all his holding and went to cash before each reporting period). The typical "trade," as far as I could concern from the file, was well under $500,000, which meant he needed to invent hundreds of thousands of trades a year that both conformed to the different conditions in the trading authorizations, was consistent with the price of that security that day, and resulted in his achieving his overall "targeted earnings." Each slip I reviewed contained every relevant details of the transaction, including even the securities "cusip number"
"It is impossible that Madoff could do all this work himself," the person at the private intelligence firm said as he pushed over to me a foot-high stack of Madoff confirmation slips.. "Every price on every slip had to be checked against the actual high and low that day. Just the paperwork for these feeder funds would require the full-time services of a group of people who knew exactly what they were doing." He estimated that "at a minimum, you would need 5 people." These operatives would presumably also have to be willing and discrete participants in a con game.
Furthermore, these feeder funds were not the only part of the criminal enterprise that required systematic forgery. A handful of Madoff’s long-time associates had about 100 accounts that had been used between 1992 and 2008. to siphon off billions through redemptions. To get fictional profits into these men’s accounts Madoff faked transactions on a very different scale from those faked for the feeder funds. Some were credited with fictional trades that produced a rate of return 40 times greater than that of the off-shore feeder funds, In one such favored account, according to the Trustee for the bankruptcy, Madoff "purported
to earn over 950% in 1999" [emphasis Trustee’s], while most of the feeder funds were earning a mere 15 percent. In another favored account, according to a SEC complaint, not a single loss was reported in thousands of trades over a ten year period. These were bespoke accounts, custom- tailored to produce enormous profits. Just two of his long time associates were thus able to withdraw $8.8 billion (which is more than half the money actually lost in the Ponzi scheme.) In addition, such customized padding of accounts was used, according to the SEC, to pay some associates off the books, and, via back-dating, to minimize tax bills. These customized transactions exponentially added to the fraudulent paperwork.
In reality, this was not a financial scandal, but a well-run confidence game. Not a penny of the $13.2 billion that disappeared was lost in the stock market. The lion’s share of this loot exited through a few accounts that had been systematically inflated with non-existing "profits" over two decades and its ultimate whereabouts still remains a mystery. To be sure, Madoff, was the impressive face of the criminal enterprise. As a former Chairman of the NASDAQ stock exchange and well-respected doyen of Wall Street, he lent what is crucial in any confidence game: credibility. As federal prosecutors themselves pointed out before he was sentenced to 150 years in prison, "his demonstrated ability to lie, mislead, and deceive is staggering." If so, his claim that he was the sole employee and sole author of this criminal enterprise can hardly be accepted at face value, especially since he may have a interest, such as fear of the consequences, in not fully sharing the credit.

Wednesday, July 15, 2009

Madoff's Incredible Money Laundry

Bernard Madoff did not merely plead guilty to running a multi-billion dollar Ponzi Scheme.
He’ also pleaded guilty to multiple counts of "international money laundering." This latter
criminal enterprise has not fully come to light because while Madoff talked freely to prosecutors
about the mechanics of the swindle itself, he stonewalled the court-appointed Trustee Irving Picard’s effort to unravel his tangle of money laundering to the extent that his counsel, David Sheehan, wrote the court just before his sentencing that Madoff has "not provided meaningful
cooperation or assistance to the trustee since his arrest." So even looking at a 150 year prison sentence, his money laundering operation therefore remains a crucial missing piece in the puzzle. At stake is the $13.2 billion that his investors lost.The Ponzi scheme itself was relatively simple. Madoff had investors wire their funds into his bank account at JP Morgan Chase for him it for them through his proprietary strategies in the
stock market. But he made no investments. Instead he forged trading tickets providing them with a fictional profit in their account. These imaginary profits exceeded $50 billion by the time
the scheme was exposed in December 2008. As far as the actual money went, Madoff shuffled between two different bank accounts, siphoning off some of it to pay the clients who withdrew their money. He also wrote checks to pay for his life style and operating expenses (both licit and
illicit). These banking records as well as the checks he wrote and credit card bills are now in the hands of the Trustee’s forensic accountants. Their analysis shows that all the money that Madoff withdrew for himself and family members, including everything from his expenditures
on yachts, country clubs, real estate, plane and travel to loans to his children, gifts, and capital calls on his wife’s private equity investments, amount to less than one percent of the stolen money. The money Madoff withdrew from all his bank accounts to run his scam, including rent
for his offices in the Lipstick building in Manhattan, his payroll (which included his boat crew), commercial taxes, accounting, legal bills, and even the surreptitious kickbacks to fund managers through his London subsidiary amounts to, at most, another 4 percent. He paid these expenses by wiring money to his London subsidiary which then wired it back to his account at Bank Of New York Mellon. So the money he withdrew from all his banks account for himself and his business expenses amount to less than 5 percent of the missing $13.2 billion. What happened to the other 95 percent of the looted money? "That is the $13 billion question", a lawyer involved in the liquidation process answered, adding "Lets not forget Madoff was a truly ingenious money launderer."
Madoff’‘s notional system of book-keeping that provided an ideal way to launder money. Unlike the classic Ponzi scheme in which all investors are credited with uniform "profits," Madoff favored some accounts with what the Trustee called "implausibly high" profits and
allowed through large redemptions to convert imaginary to real profits (which of course came out of other investors’ money). This money could then be deposited some place else, such as a numbered account in a off-shore haven. There is no doubt Madoff had some purpose in stuffing
some accounts with notional profits. For example, according to a SEC civil fraud action filed in June against the brokerage firm Cohmad (which operated out of his Madoff’s own offices),
Madoff padded the account of one close associate with $100 million in fake profits by awarding him roughly triple the putative return others were getting. The SEC alleges this was done as a surreptitious pay-off for his steering over $1 billion of investments to him (Madoff also,
according to the SEC, accommodatingly back-dated the non-existent transactions for this associate so that his fake profits taxes were taxable only at the minimal capital gains rate.)
Others Madoff clients got even larger "profits" put in their accounts through this device. The Trustee’s investigation found instances in which Madoff credited accounts with returns more than 40 times greater than his others investors (even though Madoff was supposedly using the
same trading strategies for all his accounts.), For one such favored account, Madoff "purported to earn over 950% in 1999" [emphasis Trustee’s]. The Trustee alleges that such "implausibly high purported returns" resulted in 84 accounts controlled by two of Madoff’s long-time clients withdrawing the lion’s share of the money that other investors lost, and he filed law suits against both of them.
One of these favored clients is Jeffry Picower, a lawyer, accountant, deal-maker, tax shelter promoter, and philanthropist, who knew Madoff for about 30 years. According to the Trustee’s suit , Picower redeemed no less than $6.7 billion from 24 accounts under his control.
Where did this huge sum come from? According to analysis by the Trustee, "at a minimum, more than five billion dollars [came from] other people’s money." One reason that some much money accrued to some Picower accounts is that Madoff favored them with extraordinary
returns. According to the Trustee, a few of them "enjoyed 14 instances of supposed annual returns of more than 100%" (while other clients got returns of only between 10% and 15%.)
The other favored client sued by the Trustee (and the SEC) is Stanley Chais, a former resident of the Bronx who established himself in Beverly Hills an unregistered investment advisor to a wealthy clientele. Like Picower, Chais had known Madoff for three decades, and his access was
such that his name came up first on Madoff’s office speed dial. According to the Trustee’s complaint, Chais withdrew $1.15 billion from 60 accounts for himself, family members, corporations in which he held interests, funds into which he consolidated his clients, and other
entities. He was also favored with inexplicably high phantom profits, with rates of returns in some accounts, according to the complaint, "in excess of 100 %–or even 300%– a year."
The Trustee alleges that Chais and Picower together withdrew a total of $7.9 billion between 1995 and 2008– most of which came from the phantom profits Madoff allocated to them.. If so, they, or the accounts they represented, took away nearly one-hundred times as much money as
Madoff himself siphoned off by writing checks for his personal and family use.
For their part, Chais and Picower, via their respective lawyers, deny any wrong doing and both men say they are themselves victims of the massive swindle and suffered ruinous losses.. Chais even wrote the federal bankruptcy judge that he is so short on cash that he has a "serious problem" paying a lawyer to defend him, Meanwhile, Picower virtually closed down his foundation because of the losses it suffered. Perhaps these men did not ultimately get the billions that the Trustee
alleges were withdrew from accounts under their control. After all, Madoff was not above forging his internal records. As one prosecutor pointed out, "Madoff’s " demonstrated ability to lie, mislead, and deceive is staggering." But if the $7.9 billion moved to other hands, where did it end up? This issue may be cleared up when Picower, Chais, and others have their day in court this summer (if the proceedings are not delayed ). But given Madoff’s international money laundering skills the $7.9 billion may already have been swallowed up by what the Trustee modestly describes as " a labyrinth of interrelated international funds, institutions, and entities of almost unparalleled complexity and breath."

Tuesday, July 14, 2009

The Car Czar Quits

On March 29th 2009, Steven Rattner, the co-chairman of President Obama’s auto task force, met with Rick Wagoner, the chairman of General Motors, in Rattner’s new office in the Treasury Department, and in one of the most dramatic confrontations of the Obama administration in its first 100 days told him he would have to resign because he had lost the confidence of the Obama Administration. Wagoner, a 30-year veteran of GM, fell on his sword. Now, Less than 4 month after disposing of Wagoner, Rattner has announced he himself is resigning.
He now has to deal with the investigation by New York Attorney General Andrew Cuomo into the role that bribes played in inducing public officials to invest pension funds in private equity deals. What brought Rattner, a former golden boy of investment banking, into Cuomo’s investigative cross-hairs was deals he made when he headed Quadrangle Group, which specialized in raising money for leveraged buy-outs in the communications industry. The largest source of money for such buy-out funds was pension funds, which collectively manage about $2.3 trillion, and so he actively recruited money from state and municipal pension funds. To get business. he had employed Henry "Hank" Morris, a top advisor for then-New York State Comptroller Alan Hevesi to act as a placement agent for Quadrangle. In March 2009, Morris was arrested and charged in a 123-count criminal indictment for, among other things, "enterprise corruption" and "money laundering" in regard to selling access to the New York State Common Retirement Fund. Quadrangle had received $100 million from this pension fund just after paying Morris’s firm a placement fee. It also paid Morris for his help in getting money from the Los Angeles pension fund , the New York City pension fund and the New Mexico pension fund.
It is perfectly legal in these states for a private equity fund to pay fees to placement agents for this service so long as it discloses the, Such disclosures are necessary to identify possible conflicts of interest. Rattner presumably was familiar with these requirements since he had himself worked as a placement agent while at Lazard. However, in garnering investments from the Los Angeles and New York City pension funds, Rattner’s firm reportedly failed to disclose the placement fees that went to Hank Morris. In the case of the Los Angeles pension fund, Quadrangle identified two other placement agents it used, but not Morris’ firm. One of the key issues New York’s attorney general is now investigating is whether the New York City Pension Fund was"intentionally misled or deceived "in 2005 by Quadrangle’s failure to disclose paying finder's fees to Hank Morris’s firm.
Further increasing Rattner’s exposure to the bribery scandal, the New York attorney general’s office is also investigating whether Quadrangle might have evaded crucial reporting requirements with New York State Common Retirement Fund in 2005 by having one its private equity holdings buy DVD rights to a movie that was produced by the brother of David Loglisci, New York’s deputy comptroller. Loglisci, a close associate of Morris, was also indicted with Morris on corruption charges. The low budget movie entitled "Chooch," an Italian expression for a bumbling idiot, had failed at the box-office, taking in less than $40,000, before Quadrangle’s private equity holding bought the DVD rights for $88,000. According to a studio executive who deal with DVD distribution, the DVD rights to a movie like "Chooch" would be worth "zilch" since it would "cost more to manufacture the DVDs than a distributer could realistically hope to make from their sales." So was there another benefit to investing in Chooch? About three weeks after buying these DVD rights, Quadrangle got its $100 million from the New York State Common Retirement Fund for which Loglisci was the top investment officer. Adding to the intrigue, an executive at the CarlyleRiverstone fund, a joint venture of the Carlyle Group, which also used Morris’ firm to get money from the New York State pension fund, made a similar investment in Loglisci’s "Chooch." Among the charges against Loglisci (as well as Morris) is "money laundering."
To be sure, Rattner himself may be innocent of any wrong doing in making payments to Morris’ placement agent company and having a subsidiary invest in Loglisci’s "Chooch" venture. But with both the SEC and New York Attorney General Andrew Cuomo investigating these charges, and Morris and Loglisci due to go on trial in New York, Rattner may have unfinished business to settle with Cuomo, and reportedly hired his own lawyer. So ends the brief tenure of Obama’s auto czar.

Monday, July 06, 2009

The Feeder Frenzy

The Third Missing Piece of The Madoff Puzzle is in my article in the Daily Beast today

Like the mythic vampire, a Ponzi scheme needs to find new blood to sustain itself. So while Bernard L. Madoff had no problem creating the illusion of constantly expanding profits through the simple device of wholly inventing the transactions in accounts he managed, the only way he could meet requests for redemptions was to find new money. The amounts he needed became staggering in the 1990s, as a handful of his longtime associates cashed in billions of dollars of imaginary profits in their accounts.
To replace these billions, Madoff needed a new source. The mother lode he turned to was the ganglia of so-called feeder funds.
A feeder fund, unlike a hedge or private-equity fund, does not manage investments. It is simply a marketing operation. Its principals raise money from investors—often through their social, country club, and professional connections—that they then consolidate into a single account, which they funnel to a money manager with whom they have an arrangement.
Typically, in return for finding investors for the money manager, the feeder gets a relatively small placement fee of about 1 percent. The money manager then charges for his investing skills, typically deducts a performance fee of 20 percent from the profits as well as an annual "net asset" fee of 2 percent on the investor’s nest egg.
But Madoff offered feeder funds a much more alluring deal for finding him money. Instead of merely giving them the standard placement fee, he allowed them to take the entire cut of profits usually reserved for the money manager by waiving all his fees. This generous accommodation became extremely lucrative for them because Madoff reported profit annually of about 15 percent. So the principal of the feeder could deduct 20 percent of that putative profit from all their clients’ accounts, transfer it to their own "carry" account, and redeem it, with the result that they got cash while their clients’ fictitious profits grew each year.
But why would a highly successful money manager like Madoff make such an accommodation and essentially work for free for feeders? The explanation Madoff gave was that he was not greedy and content making a mere .04 cents a share from trading stocks in the accounts (which he could have made anyhow if he charged them a fee). As incredible as this rationale might sound, feeders had little incentive to look a gift horse in the mouth. This amazing inducement, together with the track record Madoff had totally invented, brought in enough from feeder funds to more than cover the $8 billion in withdrawals made by his longtime associates.
For their part, his feeder funds fared well, earning hundreds of millions of dollars in fees from their 20 percent cut of Madoff’s imaginary profits and their equally imaginary "performance."
Consider, for example, the success of Fairfield Sentry, a unit of the Fairfield Greenwich Group, whose principals included the socially prominent financier Walter Noel Jr., his four well-connected sons-in-law, and Jeffrey Tucker, a former Securities & Exchange Commission official. According to the complaint filed by Irving Picard, the court-appointed trustee for the liquidation of Madoff’s business, between December 1, 1995, and 2008, "it invested approximately $4.5 billion with Bernard L. Madoff Investment Securities through 242 separate transfers via check and wire."
From its cut of Madoff’s notional profits, the Fairfield Greenwich Group "reaped massive fees, in excess of hundreds of millions of dollars, purportedly for investment performance which has proven to be nothing but fiction."
The Wall Street Journal, which reviewed Fairfield Greenwich’s own records, reported that the firm earned $160 million in the fees it garnered from the money it outsourced to Madoff in 2007 alone. Before the Ponzi scheme collapsed in 2008, the trustee alleges that Fairfield Greenwich, and the entities under its control, withdrew more than $3.5 billion from Madoff. Presumably part of those redemptions included its own fees. Fairfield Greenwich denies it engaged in any wrongdoing and insists that it informed its investors of its relation to Madoff.
But some feeder funds failed to disclose their cozy relationship with Madoff, according to complaints filed by authorities in New York, Massachusetts, and Connecticut.
Consider, for example, the charges files against the entities of investment guru Ezra Merkin, who sits on the board of and invests for a number of universities and charities. Merkin’s three funds had (at least on paper) some $2.4 billion invested with Madoff, according to the 54-page civil complaint filed by New York State Attorney General Andrew Coumo.
Cuomo alleges that Merkin collected hundreds of millions of dollars of performance and net asset fees based on the fictional transactions of Madoff while he "actively obscured" that Madoff, not he, was managing money. Merkin’s three funds, called Ascot, Ariel, and Gabriel, all had money with Madoff. Ascot was purely a feeder fund for Madoff, whereas Gabriel and Ariel, which were supposed to perform complex arbitrages on distressed debt, divided their money between Madoff and two other money managers.
"The incentive fee Merkin collected included 20 percent of the profits reported by Madoff, which, of course, were fictitious," the complaint notes. "Even after subtracting expenses and fees paid to other outside managers, Merkin’s fees for Ariel and Gabriel totaled more than $280 million."
Meanwhile, Ascot produced an additional $169 million in net asset fees. And, according to the complaint, these fees were paid directly to Merkin, who did not reinvest them with Madoff via the feeder fund. While collecting these fees, Cuomo alleges, "Merkin’s deceit, recklessness, and breaches of fiduciary duty have resulted in the loss of approximately $2.4 billion" to his investors.
Merkin denies any wrongdoing. In the court papers filed on July 1, 2009, he asserts that his dealings with Madoff were known to his investors and there was no deceit or breach of his duty. Perhaps so, but if Cuomo’s assessment of Merkin’s financial records is accurate, Merkin raked in nearly $450 million in fees by giving Madoff the lion’s share of his investors’ money.
Madoff may have provided even more extraordinary emoluments to some other of his feeders. Consider, for example, what the trustee describes as "The Curious Case of Sonja Kohn." Kohn met Madoff in the mid-1980s, when she had her own brokerage company in New York. She then founded the Bank Medici AG in Vienna and used it as a feeder fund for Madoff.
Raising money from the newly rich oligarchs of Russia and Eastern Europe, she eventually placed (on paper, at least) an estimated $3.5 billion with Madoff. After the collapse, the trustee sorted through the records of one of Madoff’s front companies and found that sizable transfers had been made to Kohn, even though she did not work for that company.
Next, as The Wall Street Journal reported, prosecutors in the U.S., Britain, and Austria launched their own investigations of alleged payments she received from Madoff. According to the affidavit filed by U.S. prosecutors in Vienna, some $32 million was paid by Madoff over a course of 10 years to a New York company that was "owned by Sonja Kohn personally," while, according to a similar British affidavit, $11.5 million was paid by Madoff’s London subsidiary to another company she allegedly controlled.
If such payments were indeed made by Madoff, they provide an additional inducement for money-raisers to feed Madoff’s insatiable Ponzi scheme. Kohn states through her spokeswoman that neither she nor the Bank Medici received any kickbacks from Madoff and describes herself as "the greatest Madoff victim."
Even excluding such alleged side payments, Madoff’s feeders extracted more than $1 billion in performance and net asset fees from his phantom profits. While there is no evidence in any of the litigation that indicates that any of these feeders were privy to Madoff’s grand Ponzi scheme, they had intriguing clues that might have cast their golden goose in a different light, such as Madoff’s inexplicable generosity in relinquishing his entire performance fee just to get his hands on their money, his curious practice of exiting the market entirely at the very end of each quarter so that his quarterly statements to the feeder funds would list nothing but Treasury bills and cash, and, even curiouser, his employment of an unknown two-man accounting firm in New York's Rockland County—operating out of a 13-by-18 office, no less—to audit all his multibillion-dollar operations.
Missing such flashing signs that something was amiss while they harvested their rich bounty of fees may be understandable on Wall Street but, in my book, it hardly qualifies them for victimhood