Authors: James B. Stewart
Tags: #History, #United States, #General, #Law, #Ethics & Professional Responsibility
Tangled Webs (71 page)
Not only was Madoff plainly trading options for Fairfield, but when Lamore analyzed the Fairfield statements, he had concluded that “the number of S&P 100 index options traded by Madoff, purportedly over-the-counter, is an order of magnitude greater than the total exchange-traded volume for these options,” Suh wrote Cheung.
Lamore added, “According to Bernie Madoff, all equity transactions occur in Europe . . . and clear through Barclays capital. . . . I believe that we should find out more about the counterparties to these transactions and the agreements /arrangements between Madoff and the counterparties.”
By now, Lamore was worried that Madoff might be running a Ponzi scheme. Suh assured him that they were demanding that Madoff produce documents identifying who had custody of assets for all his customers as well as contracts with his counterparties to the options contracts. “Sounds good. I’ll sleep better with the answer to this question,” Lamore responded.
In response, Madoff provided a write-up of his strategy and a list of customers, and voluminous customer account statements and balances, but no original documents, no indication of who held custody of the assets, and no contracts with counterparties. Suh called Madoff and asked for an explanation. Madoff said he had no written contracts with any counterparties, but he promised to identify them as well as the asset custodians.
Neither Suh nor Cheung had any experience with over-the-counter options trading, which in fact required detailed documentation and extensive paperwork. Suh asked Lamore for help analyzing the account statements, but Lamore wrote back, “I don’t have clean answers to your questions. However, I do believe your questions go back to the custody of assets issue. Where are the assets held and where does BLM [Madoff] settle the trades (wiring instructions)?”
“Thank you–I am glad I am not the only one confused,” Suh said.
“Ha. No problem. It’s very confusing to me as well,” Lamore e-mailed back.
Despite their shared confusion, on January 23, 2006, a little over three months after receiving Markopolos’s report, Suh and Cheung concluded there was enough evidence to open an informal investigation. In a status memo summarizing the investigation, Suh noted that Madoff had “misled” the examination staff in a prior investigation and withheld information. “The staff is trying to ascertain whether the complainant’s allegation that BLM is operating a Ponzi scheme has any factual basis.”
N
ow that the Madoff case had been designated an informal investigation, it was finally entered into the SEC’s database, and the staff could issue subpoenas and take sworn testimony. The first witness they called was Frank DiPascali Jr., an unassuming forty-nine-year-old with neatly cropped dark hair and a medium build who spoke with a distinct Queens accent. At Madoff Securities he held the lofty title of chief financial officer, but functioned as chief administrative officer for Madoff’s investment services business, overseeing computer operations and a staff of about twenty who occupied the seventeenth floor of Madoff’s offices.
ow that the Madoff case had been designated an informal investigation, it was finally entered into the SEC’s database, and the staff could issue subpoenas and take sworn testimony. The first witness they called was Frank DiPascali Jr., an unassuming forty-nine-year-old with neatly cropped dark hair and a medium build who spoke with a distinct Queens accent. At Madoff Securities he held the lofty title of chief financial officer, but functioned as chief administrative officer for Madoff’s investment services business, overseeing computer operations and a staff of about twenty who occupied the seventeenth floor of Madoff’s offices.
DiPascali had gone to work for Madoff at age nineteen, a year after graduating from a parochial high school. His next-door neighbor in Howard Beach, Queens, a working-class neighborhood in the far outskirts of New York City, was Madoff’s secretary, who recommended him for an entry-level part-time job as a research clerk. He enrolled at St. John’s University and Brooklyn College, but dropped out of both. In thirty years he’d never left the Madoff firm, and everything he knew about markets and trading he’d learned there.
His résumé was unusual for a top officer at a leading hedge fund, but his was also a classic all-American success story. DiPascali now lived in a five-bedroom home with a pool on seven acres in affluent Bridgewater, New Jersey. He owned two black Mercedeses, one a sedan, the other an SUV, and a sixty-one-foot Viking sportfishing boat, the
Dorothy-Jo
, named for his daughter and his wife, Joanne. DiPascali earned $2.6 million in 2006 (over $4 million the next year) and was also an investor in Madoff’s fund.
Dorothy-Jo
, named for his daughter and his wife, Joanne. DiPascali earned $2.6 million in 2006 (over $4 million the next year) and was also an investor in Madoff’s fund.
On January 26 DiPascali arrived at the SEC’s offices, now in Three World Financial Center, just across the street from its former location in the World Trade Center. He came alone, but had been briefed by Madoff. Suh and Lamore were hoping to get a clearer idea of how Madoff generated his returns, how the split-strike conversion strategy worked, and where and how all these trades took place. Suh told DiPascali he had the right to be represented by a lawyer and that failure to tell the truth was a crime. He testified under oath.
“Have there been instances in the past ten years where Mr. Madoff’s overall returns have been negative?” Suh asked him.
“I don’t believe so,” DiPascali replied. “For the year, no. For any particular period of time, definitely, but not over the course of a year. No. I don’t remember one.”
“How does the firm–”
“I don’t want to interrupt you, but keep in mind that there have been market corrections that have occurred. We are not in the market all the time. We are in the market for short periods of time.”
Suh pressed for a better explanation of the firm’s market timing, and DiPascali made clear that the firm’s success depended entirely on Madoff.
“How do you decide when to get out of the market?” Suh asked.
“How do I decide when to get out? Two ways, I guess. The model will dictate when to get out because correlation will break. So when you got in was dictated by the model. When you get out is dictated by the same entry parameters as when you got in. If that breaks, you gotta bail. If it didn’t break, then you can hold on. Now, you may have a situation where it doesn’t break, but he [Madoff] decides that he doesn’t like the market, so he will bail. Those are the only two ways it can happen.”
Cheung intervened, asking, “Is there anybody else at Madoff, the company, who can make these judgment calls other than Mr. Madoff?”
“No.”
“What happens when he goes on vacation?”
“He is never on vacation. Bernie Madoff is available twenty-four hours a day, seven days a week, three hundred sixty-five days a year, anywhere on the planet.”
This should have been a red flag, since the failure to take a vacation is a classic symptom of fraud. Nearly all Wall Street firms require employees to take two consecutive weeks of vacation.
“He is not a young man,” Suh observed.
“I am fearful of that, let me tell you. . . . That often worries me. I would imagine that he has contingency plans in effect with his brother and his sons. Whether this strategy will continue to be as successful as it has in the past under a different . . . with someone else’s helm, if you will. . . . Like I said, I am a salaried employee. I admitted to him, I don’t have the ability to do what he does. I am a numbers cruncher. I didn’t do it well when I traded for him for a couple of years, I couldn’t trade my way out of a paper bag. I can’t call market direction. I am not his replacement by any stretch, you know.”
As Madoff had told Ostrow and Lamore, DiPascali also testified that the options counterparties were European.
“I wanted to make sure that the basket [of S&P 100 equities] is put on during a trading day and the options are put on subsequent to the basket?” Suh asked.
“The basket is put on during the European trading day. The options are put on prior to the New York open and after the European trading day is ended, when I am complete.”
“The people that you execute your equities with, are they the same broker-dealers that you execute the options with?”
“No, they are not.”
“None of them are the same?”
“People I execute the equities with, you are talking about European contra side dealers?”
“Yes.”
“No, no.”
“About how many derivatives dealers do you deal with?”
“Derivatives dealers, twenty, maybe two dozen. It’s not five and it’s not thirty. It’s probably eighteen, nineteen, twenty.”
Suh also tried to pin down whether there were written records of the options trades.
“I have the entry database that comes back from the dealers that is accessible in any format I want to look at it,” DiPascali said. “Trade date, dealer, I want to look at it by price, symbol, by any sort of mechanism.” Madoff himself, DiPascali explained, communicated with the dealers by “telephone. They affirm back to me by computer.”
Later she asked, “You mentioned confirmations and account statements that you sent to customers. . . . Who is in charge of generating them and sending them to customers?”
“The computer actually gets all the information, spits it out and a printer–one of the operators is told to print me that file and they print it out. There are not that many statements.”
So there
were
options trading records, contrary to what Madoff had said.
were
options trading records, contrary to what Madoff had said.
After more questions in this vein, Suh said she wanted “to switch gears and talk about the customers in the institutional business. What kind of customers does this business have? Who are they?”
“Who are they, I guess there [are] about twenty, the largest of which would be Fairfield, which I guess is an offshore hedge fund. I am thinking some of the names, what they do. They are either a hedge fund or some sort of European institution. They are not natural people like a client would be, Joe Schmo.”
“Any rough idea how much [Madoff] is managing?”
“Ten, eleven billion dollars.”
Toward the end of DiPascali’s testimony, Suh asked an open-ended question: “To your knowledge, are there any aspects of the business that give you concern that maybe something improper is going on?”
“No, no,” DiPascali replied. “The guy is the straightest shooter in the world.”
The next day, Lamore e-mailed Suh with what he called some “rambling thoughts regarding Madoff.”
I meant to ask Frank why the strategy is implemented only in Europe and during European trading hours and not New York time? What if there is breaking news having a huge impact on the market such as 9/11? I am still puzzled that Bernie is able always . . . to find counterparties willing to trade options in the size that he needs to for the strategy without freaking out the market. Talk about having difficulty finding liquidity–try calling a large broker-dealer in the U.S. with such a huge options order. I am confident that you would move (scare) the market. Maybe the counterparties are able to hedge themselves, somehow, but I don’t see how.
He followed up with another note: “I don’t know what I’m thinking, but it seems weird to me that the counterparties aren’t the bulge bracket firms (Goldman, Merrill, Lehman . . .) Instead they are smaller, more obscure firms. . . .”
Suh responded, “Excellent points. We can pursue them with Bernie, when we take his testimony,” though she cautioned they wouldn’t be doing so until they had exhausted other sources. But then she largely dismissed his questions. “On the options trading issue, we probably will not be able to get any help from the dealers, since they are all overseas . . . if we had any
real
reason to suspect some kind of wrongdoing in Bernie’s market timing decisions, I would send a document request on the issue, but I am not sure how much stress we want to put on him if all we suspect is disclosure problems. I will talk to Meaghan about it. We can definitely question him about it.”
real
reason to suspect some kind of wrongdoing in Bernie’s market timing decisions, I would send a document request on the issue, but I am not sure how much stress we want to put on him if all we suspect is disclosure problems. I will talk to Meaghan about it. We can definitely question him about it.”
This was the first indication that the enforcement staff’s focus was shifting from the Ponzi scheme questions to the far more modest issue of whether Madoff needed to register his investment advisory business. Suh later acknowledged that despite Madoff’s glaring inconsistencies and failure to produce records, “at that time I think the view was that there’s probably nothing there and that this would be primarily a registration and disclosure case.”
Even so, Suh forged ahead. Despite Madoff’s claims to the contrary, DiPascali had made clear there were computer-generated records of the options transactions (yet another glaring inconsistency on Madoff’s part). In February, Suh sent another written request to Madoff for account documents and trading records for his hedge fund clients as well as for his options counterparties. This time Madoff responded that he traded through his own broker-dealer, the Depository Trust Company, the Bank of New York, and Barclays. He provided a six-page list of four broker-dealers who handled equities trades and twelve, all overseas, who were the options trading counterparties, including UBS in Switzerland and the Royal Bank of Scotland. But he provided none of the records DiPascali had described and Suh had specifically requested.
Suh also sent a lengthy e-mail describing the Madoff investigation to Vance Anthony, an economist in the SEC’s Office of Economic Analysis in Washington, where many of the PhDs Cheung had told Markopolos about worked. She also sent Fairfield Sentry account statements and a copy of the
Barron’s
article, and asked for help analyzing the returns. Two months later, after getting no response, she called and prodded Anthony. They spoke on the phone and Suh forwarded more materials. Anthony later said he “clicked on them to look and see what they were but I didn’t do anything else.” Suh heard nothing further.
Barron’s
article, and asked for help analyzing the returns. Two months later, after getting no response, she called and prodded Anthony. They spoke on the phone and Suh forwarded more materials. Anthony later said he “clicked on them to look and see what they were but I didn’t do anything else.” Suh heard nothing further.
In early May, having wasted several months waiting to hear from the Office of Economic Analysis, Suh drafted document requests to the Bank of New York and Barclays, unaware that Ostrow and Lamore had already contacted Barclays, which had said Madoff’s account showed no trading activity. Suh also called Madoff himself to clarify which accounts at DTC, Bank of New York, and Barclays were specifically for his hedge fund business. Madoff said that “all three accounts are not solely for the institutional trading but for all BLM business,” according to Suh’s notes from the call. However, he agreed to produce account statements for “BLM account 290003 per BMadoff, this one is solely for the institutional trading.”
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