The End of a Sure Thing: Madoff’s Long Bet

Posted in Madoff by Nina Mehta on December 22, 2008


The Madoff affair has been unfolding for just over a week, yet the legacy of what is now being learned is likely to resonate long into the future for the Securities and Exchange Commission, the U.S. regulatory infrastructure, legions of individual investors, hedge funds, charities and industry groups. The scope of Bernie Madoff’s Ponzi scheme is breathtaking, and the losses—reputedly $50 billion, according to the SEC—dwarf most previous frauds and scandals.

But while the end of the fraud occurred on Dec. 10, when Madoff confessed to his two sons that the cupboards were bare and he had scammed friends and investors for years, what’s not known is how early the fraud started. Based on several interviews with Madoff clients, it’s clear that Madoff has been managing money both directly and indirectly for investors since the early 1970s, if not before. Those early investors, whose return rates were guaranteed, garnered even more stratospheric rates of return than the high rates the most recent investors received.

Some of those early clients remained customers until Dec. 11, when the FBI arrested Madoff on a single count of securities fraud and the façade of Bernard L. Madoff Investment Securities disintegrated, setting off shock waves of anger and confusion. Madoff’s company was known primarily as a third-market firm, a market-maker that got its start in 1960 trading over-the-counter stocks and then NYSE-listed stocks away from the Big Board. Bernie Madoff was instrumental in helping form the Nasdaq Stock Market in 1971 and was chairman of that market in 1990, 1991 and 1993. He helped shape the regulatory structure for the equities market that affected the way stocks now trade. But during all those years as a macher in the securities industry, Madoff also operated an investment advisory business that colleagues and regulators knew little about. That closely held secret at the heart of Madoff’s company is now gradually coming unglued.

Based on conversations with three individual Madoff investors, including two who invested with Madoff in the 1970s and a third who began investing with him in the late 1980s or early 1990s, a different picture emerges than the one dominating the headlines. That picture fleshes out the early years of what was a four-decade-long saga of exceptionally high returns. It is not known how early the fraud may have begun, but the pattern of returns never changed significantly over the decades. The three investors interviewed are identified as Investor A, Investor B and Investor C. None wanted to reveal his or her name publicly.

 “What should have raised a red flag was that in 1987, when the market dropped, we still got our 20 percent return,” said Investor A, a man who began investing with Madoff around 1971. The investor currently lives in Manhattan and works in the real-estate business. He invested directly with Madoff in the 1970s, and received a guaranteed return of 20 percent annually, regardless of the market’s gyrations. The return never wavered, and the investor received 20 percent per year until 1992.

Madoff’s eventual father-in-law, Saul Alpern, was Investor A’s family accountant in the 1950s and 1960s. The Manhattan accounting firm in the West 40s, called Alpern & Heller, was run by Alpern and his colleague Sherman Heller. Heller was a friend of Investor A’s father. Two junior accountants at the firm were named Frank Avellino and Michael Bienes. These men would wind up playing a key role in Madoff’s brush with a Securities and Exchange Commission investigation in 1992. Heller died in the mid-1960s at the age of 46, according to Investor A, and in the 1970s Avellino and Bienes took over the accounting firm.

In the late 1970s or early 1980s, Investor A recalled, Madoff decided he didn’t want to handle small individual investor accounts. So Avellino and Bienes packaged together the accounts of people who had been invested directly with Madoff. “Madoff traded them as a single entity instead of maintaining them as single accounts with separate statements,” this investor said. “He didn’t want the bookkeeping of all the separate accounts.” This investor met Madoff a number of times over the years, but was not friends with him.

Investor A brought several friends into Madoff’s ambit as investors, via Avellino & Bienes. While he continued to get 20 percent annual returns, paid out on a quarterly basis, A&B gave these friends 19 percent. “As the years went on, as people went in, they offered lower and lower percentages,” he said. “At the end, they were giving [investors] 13 percent.” He added that the investments were considered loans. “My 20 percent was considered interest income on a loan,” he said. “The tax returns treated it as interest income. That’s how Avellino and Bienes set it up.”

Investor B, who is related to Investor A through her husband, a physician in Manhattan, said the couple began investing indirectly in Madoff’s accounts in the 1970s. In the mid-1960s, Avellino & Bienes had become the couple’s accountants. Sometime in the 1970s, when the couple had saved up some money, the accountants recommended an investment to them that they had offered to other clients.

 “Other members of our family had been involved in this,” the woman said. “We put some money in with them. We were guaranteed a very nice interest rate on that money. No matter what happened, we got that money.” The couple never knew the money was managed by Madoff.

Like Investor A, the couple received quarterly checks from Avellino & Bienes, for close to 20 percent. “They sent us a check every quarter for what our money had earned,” the woman said. She does not recall receiving monthly or quarterly statements about the investment.

Investor C, a medical researcher who knows the husband of Investor B, began investing with Madoff through Avellino & Bienes in the late 1980s or early 1990s. He never met Madoff, he said, but instead relied on the faith that several prominent people in the financial arena, whom he knew, had in Madoff. “There were no statements,” he said. “We had put $25,000 or $50,000 in there in the 1980s and got 16 to 20 percent interest because, we were told, it was an arbitrage. We always got a quarterly check and the principal stayed the same.”

The guaranteed profits lasted until 1992. On Nov. 17 of that year, Avellino and Bienes were charged by the Securities and Exchange Commission with having run an unregistered investment company since 1984. The civil complaint, filed in New York federal court, also alleged that from 1962 until 1992 the two accountants had sold unregistered securities to the public in the form of notes. According to the SEC summary, Avellino and Bienes had “accepted funds from customers and guaranteed those customers interest rates ranging between 13.5% and 20%. The money the defendants collected from investors was then invested in securities with one broker-dealer.” The complaint noted that more than 3,200 investors had purchased these notes and that the accountants had raised over $441 million from investors.

The broker-dealer that invested the money was Madoff’s firm. Madoff had been the chairman of Nasdaq’s board in 1990 and 1991, according to a Bloomberg report, and would again be chairman in 1993. Bloomberg did not explain he gap year in Madoff’s leadership of Nasdaq’s board.

On Nov. 25, 1992, another firm, Telfran Associates, was charged by the SEC with having run an unregistered investment company and with selling unregistered securities, from 1989 to 1992. The two partners at Telfran sold notes that paid about 15 percent to investors and used those funds to purchase notes from A&B. The SEC said that more than $88 million had been raised from 800 investors who bought the Telfran notes.

The following year, in November 1993, A&B agreed to pay a civil penalty of $250,000, and Avellino and Bienes each agreed to pay civil penalties of $50,000. The same penalties were applied to Telfran and its two partners, Steven Mendelow and Edward Glantz. Ira Lee Sorkin, one of Madoff’s current attorneys, represented Avellino, Bienes, Mendelow and Glantz in 1993.

According to an article in the Wall Street Journal on Dec. 16, 1992, Madoff told the WSJ reporter that he hadn’t known A&B had raised the money illegally. The article also quoted Richard Walker, the SEC’s New York regional administrator, saying SEC officials had initially feared a scam. “We went into this thinking it could be a major catastrophe,” Walker had said. But Lee Richards, the court-appointed receiver, found all the money in Madoff’s investment accounts. Richards last week was named the court-appointed receiver for Madoff’s Ponzi scheme. The 1992 WSJ article also raised a number of questions about how Madoff’s investments had achieved consistently high returns.

In 1992, Richard Breeden was chairman of the SEC. One of the other three commissioners was Mary Schapiro, who is President-Elect Obama’s choice to be the next SEC chairperson (the fifth commissioner had resigned earlier that year). Schapiro is currently CEO of the Financial Industry Regulatory Authority, which oversees about 5,000 broker-dealer member firms.

None of the investors who had bought the A&B notes lost their money. “Avellino and Bienes weren’t registered securities dealers, and someone complained to the SEC,” said Investor A. “Every account was closed with Avellino & Bienes, but everyone got every penny back. Madoff then agreed to take on everyone [who had invested through A&B], and everyone who wanted to opened accounts with him.”

Investor B concurred. “Everyone got their money back, every cent,” she said. “[Avellino and Bienes] were taking funds and investing them with Madoff. That was the first I heard of Madoff, when the two were put out of business.” After that, she said, Madoff gave the accountants’ former clients the option of investing directly through him. “He didn’t call it a fund,” she said. “He didn’t guarantee a certain [return] percentage, compared to what the original people did. But compared to what was around in those economic times, we always got a nice return.” She signed a letter of agreement with Madoff in December 1992.

According to Investor B’s husband, the SEC had caught wind of A&B’s scheme when the stock-broker boyfriend of the daughter of a big investor, who was hard-pressed to believe what his girlfriend had said about her father’s investments, contacted the SEC. That led to the November 1992 charges. Investor B’s husband said Bienes contacted him at the time and told him investors would get their money back. Investors, he recalls, were “urged” to return the money to Madoff. This investor said Madoff had worked at Alpern & Heller in the late 1950s, with Avellino and Bienes, and was friendly with them [this last statement could not be independently verified].

Once investors were investing directly with Madoff, the documentation associated with those investments began to flow. “Once we were back with Madoff, we got transaction slips and a statement every month,” Investor A said. “We got a list of stocks we owned, the number of shares, and what we paid for them. On another page were the dividends. We could set up the account in two ways—we could roll the profits over or have a check issued every quarter.” This person added that the quarterly statements showed the initial investment, how much had been made to date, the balance and the percentage return for the quarter or year to date. He did not remember what information had been included in the statements he had received directly from Madoff in the 1970s, or whether those earlier statements were similar to those he later received.

The level of Madoff’s investment returns were in the same ballpark each year after 1992, but on a quarterly basis the returns varied, according to Investor A. His annual returns through Madoff were in the range of 10 percent to 11 percent. Asked if his Madoff account ever had a negative quarter, he replied: “No, never.” The lowest quarter, he said, “was maybe 1 percent,” or 4 percent on an annualized basis. “But [the lower return] was made up the next quarter.”

Investor B’s post-1992 experience was similar. “We got transaction slips every month,” she said. “It was forests and forests of trees—two inches worth a month, plus a big spreadsheet statement reflecting all of the [trading] activity.” She and her husband also received quarterly statements that said how much they had earned so far that year.

Investor B said she noticed, in flipping through recent records, that the annualized return in one quarter had been about 3 percent. “That was unusual,” she said. She added that she didn’t remember ever seeing a negative quarter. This year, her quarterly statements showed annualized returns of 3.30 percent, 11.96 percent and 10.01 percent. In 2007, they were 8.95 percent, 10.33 percent, 11.02 percent and, finally, 10.86 percent.

Some investors took their quarterly returns out of their Madoff account, while others left the returns in their account since statements showed they were consistently outperforming the market. Investor A said he took money out at various times. “If I ever wanted a check, I’d drop a letter off at their office, and within a week I’d have a check,” he said.

Investor B and her husband never took any money out. “We know of people who did, and they always could get it within a few days,” the woman said. “I’m assuming that because of bad economic times now, people wanted their money back. [Madoff] just must have never had so many people anxious about needing the money. I don’t think they suspected him, they just must have needed the money.”

The woman estimated that the couple had given Madoff about $100,000 to invest over the years since 1992. “We added money, but with no regularity,” she said. “We never took it out. We let it sit there as a cushion.” Her portfolio management reports came from Bernard L. Madoff Investment Securities LLC, New York and London. According to the statement, the firm was affiliated with Madoff Securities International Ltd., Mayfair and London.

So what did these investors know about Madoff’s strategy? Precious little. “Zero, zero,” said Investor A. “It was all based on confidence in [Madoff]. I’ve been in there for 37 years. I had no reason to question it.” Investor B said she knew the investment strategy had to do with “arbitrage,” but didn’t know what that was. She said that was the strategy in the 1980s with A&B as well.

Investor C, who also transferred his money to Madoff after A&B were charged in 1992, is angry that the deception and fraud may have gone undetected for years. “Everyone had a high opinion of Madoff, he was the chairman of Nasdaq,” Investor C said. “He was helping the SEC set up regulations. It’s like finding out that a Justice of the Supreme Court is a gangster.”

Investor C is focused on trying to regain as much of the money he gave Madoff to manage as possible. He wants to know who should have uncovered Madoff’s vast fraud. “If the SEC is part of the federal government and we as investors pay taxes to the federal government for regulation, policies and procedures, why isn’t the federal government responsible?” he said. “Their SEC went in 10 years ago, and just admitted that in September 2006 they gave Madoff a clean bill of health. Who is responsible for what happened, other than Bernard L. Madoff?”

Harry Markopolos, who a decade ago was chief investment officer at Rampart Investment Management Co. in Boston, first contacted the SEC’s Boston office in May 1999 with doubts about the veracity of Madoff’s investment returns. He pursued his suspicions and in November 2005 sent the SEC a 19-page report detailing evidence he had accumulated indicating that Madoff was either front-running customer order flow in the broker-dealer arm of his business or running the “world’s largest Ponzi scheme.” Markopolos’s prescient memo said the latter was “highly likely” and estimated that Madoff was managing between $20 billion and $50 billion. He also provided a detailed list of 29 “red flags” suggesting that Madoff’s investment business was generating fraudulent returns. Last week the Wall Street Journal published the November 2005 document.

The SEC’s Division of Enforcement opened a case file in January 2006 to determine whether Markopolos’s allegations were true and whether Madoff was running a Ponzi scheme. It closed the file in November 2007, after finding that Madoff had misled the SEC examination staff about his investment strategy and had withheld information about customer accounts. It also found that Madoff had acted as an investment adviser to several hedge funds without registering as an adviser. However, the first line of the report’s conclusion noted: “The staff found no evidence of fraud.” Prior to the case closing, Madoff registered as an investment adviser.

During this time and subsequently, individual investors had no cause to doubt Madoff. Their confidence remained a high as it had ever been. Investor C gave Madoff $1 million this year after taking money out of other accounts because those investments had fared poorly. “I am sick about it,” he said. Investor C kept his quarterly profits in the Madoff account. “There was one time when I took out $100,000, but I quickly replaced it,” he said. He got a cousin of his into Madoff’s investment business as a client earlier this year.

Investors B and C both said that friends and relatives who tried to open accounts with Madoff over the years were rejected. Some of those individuals had a net worth of millions of dollars.

Investor C said he never questioned his Madoff investment. “There was a never a negative quarter,” he said. “We had years with Madoff where we got 6 or 7 percent. But other accounts we had were getting that amount, so it didn’t throw us off. And it was taxable.” He added that an overall taxable income of 8 or 9 percent wasn’t that far “off the wall.” In his view, the A&B investment returns had been more unusual, but he believed those returns were as high as they were because the investment was risky. Of course, the investment turned out not to be risky.

Investor C said his November statement from Madoff showed that his account was up 1 or 2 percent for the month. Reading that November statement, he said, was the first time he thought, “Wow, how could this be, when the markets are down so much?” The statement showed a portfolio of T-bills, a Fidelity Spartan fund investment, a range of blue-chip stocks, and a lot of puts, indicating short positions.

When Investor C heard last week that Madoff had been arrested by the FBI in connection with his investment business, he was shocked. “I couldn’t eat dinner, I was ill,” he said. “When I first heard, I said ‘Oh,’ but I never thought my account was in jeopardy.” He said two-thirds of his life savings were invested with Madoff.

Investor B was equally stunned. “When you think it’s been working and working for many years, you just don’t question it,” the woman said. “There were a lot of well-known companies on the list. He tells you in each of these statements how much you own, the price and symbol, and how much you sold it for or bought it for.” She said her last statement indicated long positions in Wells Fargo, Walmart, Johnson & Johnson, Intel, McDonald’s, Oracle, Apple, Amgen, Bank of America, Pfizer, UPS, Cisco, Verizon, General Electric, United Technologies, U.S. T-bills and a Fidelity Spartan fund. She said she now doesn’t know if any of the buys and sells listed in the statement were actually made.

Investor A, who began investing directly with Madoff around 1971 and stuck with him for nearly four decades, said he was floored by Madoff’s arrest. “It was a complete shock, complete shock,” he said.

But even now, these investors can’t pinpoint where things went wrong. “I don’t think I would have done anything differently,” said Investor A. “Because of [Madoff’s] track record, I never questioned it. You started out small over the years, gave him more, and never really thought twice about it because it was so consistently good.” He describes the amount of money he lost through Madoff as “significant.” He added that a “lot of friends invested with Madoff, and the whole family.”

Investor B said she, too, never questioned the returns from her Madoff investment. “Who’ll rock the boat when it’s so lovely?” she said. “No one thought it was dishonest. We thought we’d wandered into a good deal, and we were grateful.”


5 Responses

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  1. leCorbusier said, on December 23, 2008 at 4:36 pm

    solid article, what’s an ambit?

  2. Hank said, on January 6, 2009 at 2:39 pm

    Yes, very good article, though I am in shock that these people were duped for so long by this criminal.

    I think it was supposed to read ‘gambit’

  3. dave said, on January 7, 2009 at 5:30 pm

    ambit is from Latin ambio, go around or frequent, and if I’m in someone’s ambit, I’m in their bailiwick or their circle, at least at the fringes, or like that.

  4. dave said, on January 7, 2009 at 7:16 pm

    They were only “duped” for forty years! By a Ponzi scheme where you couldn’t see the money or find out what was done with it. Just average for CPA’s, I guess.

  5. […] run by Madoff’s father-in-law and his partner, called Alpern & Heller (see this blog’s Dec. 22 post). Mendelow ran his firm, called Telfran Associates Corp., with Edward R. Glantz of Lake Worth, […]

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