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Authors: Harry Markopolos

No One Would Listen: A True Financial Thriller (20 page)

BOOK: No One Would Listen: A True Financial Thriller
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So he wasn’t front-running. For a Ponzi scheme to continue to survive you have to bring in new money faster than it is flowing out, because you’re robbing Peter to pay Paul. The more Pauls you have to pay, the more Peters you need to find. It’s a ravenous monster that needs to be continuously fed. It never stops devouring cash. To me, the amount of money invested with Bernie, and the secrecy he required, were vital pieces of information.
 
But it became clear to me that the Europeans believed he was front-running—and they took great comfort in it. They thought it was phenomenal because it meant the returns were real and high and consistent and that they were the beneficiaries of it. They certainly didn’t object to it; there was a real sense of entitlement on this level. To them, the fact that he had a seemingly successful broker-dealer arm was tremendously reassuring, because it gave him plenty of opportunity to steal from his brokerage clients and pass the returns on to them. They never bothered to look a little deeper to see if he was cheating other clients—like them, for example. What they didn’t understand was that a great crook cheats everybody. They thought they were too respectable, too important to be cheated. Madoff was useful to them, so they used him.
 
They were attracted to Bernie like moths to a flame.
 
Just like the Americans, they knew.
They knew.
Several people admitted to me, “Well, of course we don’t believe he is really using split-strike conversions. We think he has access to order flow.” It was said with a proverbial wink and a nod—we know what he’s doing. And if the American Madoff got caught, well,
c’est la vie.
They believed that the worst that could happen was that he could get caught and go to prison for a long, long time; but they would get to keep their ill-gotten returns and would get their principals back because they were offshore investors and the U.S. courts have no legal hold on them.
 
But for me, the most chilling discovery of this trip was the fact that many of these funds were operating offshore. It was not something that was spoken about; it was just something I picked up in conversation. Offshore funds are known as tax havens, places for people to quietly hide money so governments won’t know about it. It’s a means of avoiding law-enforcement and tax authorities. They’re particularly popular in nations with high tax brackets, like France. While offshore funds certainly can be completely legitimate, to me it indicated that at least some of these funds were handling dirty money, untaxed money.
 
An offshore fund allows investors from a high-tax jurisdiction to pretend their income is coming from a low- or no-tax jurisdiction. While I have no direct knowledge, I definitely don’t believe that all income from offshore tax havens is eventually declared to the proper government. But what was a lot more frightening to me was the fact that offshore investments are used by some very dangerous people to launder a lot of money. It is common knowledge that offshore funds are used by members of organized crime and the drug cartels that have billions of dollars and no legitimate place to invest them.
 
For me, that suddenly added a frightening new perspective. It wasn’t just the people in these luxurious offices who were going to be destroyed when Madoff went down; it also was some of the worst people in the world. I was pretty certain the Russian mafia had to be investing through one of those funds. I didn’t know about the Latin American drug cartels, but I knew they went offshore and were probably into Madoff in a big way. Obviously Bernie had to be worried about a lot more than going to jail. These were men who had their own way of dealing with people who zero out their accounts. Maybe Bernie was close to being a billionaire—we had no idea how much of the money he was keeping for himself—but we knew that even he couldn’t afford that.
 
The knowledge that offshore funds were so heavily invested in Madoff staggered me, absolutely staggered me. It wasn’t until this trip that I realized that my life was in danger. People kill to protect their money, and if my team was successful, a lot of people were going to lose a lot of money. And while I didn’t know the names of these investors, I felt quite certain that if these people discovered what I was doing they would have to try to take me out. I was the most active threat to them. Even Bernie Madoff, the respected Mr. Madoff, was potentially a threat to my life. He was playing a dangerous game of unimaginable complexity. How was he going to respond if he found out that I was trying to bring him down? Was it better for Bernie to get rid of me or let these offshore investors get rid of him?
 
This wasn’t paranoia. Everybody in the money business has heard stories and rumors about what happened to people who made bad decisions and created problems. Some of them may be apocryphal—but a lot of them aren’t. I remembered the story Frank Casey had told me about a problem he’d had early in his career. In 1980 he had devised a strategy that fell into that gray area of legality. Its legality depended completely on an interpretation of the tax law. It was called a commodities straddle, a very complicated, highly leveraged strategy that allowed him to move money from one tax year to the next for individuals who needed that done, and then convert it to long-term capital gains. Basically it involved buying a commodity in December and taking all the tax benefits, then selling it the following year. These were riskless trades designed solely to create short-term losses for one tax year while providing long-term capital gains for the following year. Wall Street firms were doing it for their wealthy clients with a variety of commodities, ranging from silver to soybeans. And like the product I created, it could go south quickly. If it worked it was beautiful—it would save clients about 30 percent of their taxable dollars. The product Frank designed was slightly different. While his product had the same benefits—it would save clients about 30 percent—it also included some risk, which made it ethical and completely legal. And even if it blew up, the way Frank hedged it the most his clients could lose was 10 percent. So it had a 3:1 reward-to-risk ratio, a very nice ratio.
 
In late November 1980 a Merrill Lynch broker who specialized in private wealth management asked Frank to meet several of his clients in Carteret, New Jersey. The clients wanted to do a commodity tax straddle; for tax purposes they wanted to move income into the following year. Because Frank’s strategy depended on some market volatility for success, he normally started by early September, which gave the market plenty of time to move. Beginning too late in the year was risky, because if the market stayed flat the strategy wouldn’t work.
 
As Frank described this meeting, “Four guys with no necks were sitting there and one of them is a lawyer. It seemed obvious to me that the other three men were not exactly legitimate businessmen. I didn’t care. This investment was legal and ethical and was going to be reported as required. The lawyer explained that they had flipped some property and ended up with a one-and-a-half-million-dollar short-term capital gains liability that they wanted stretched into the following year. I told them the risks—that if the market flatlined there was nothing I could do about it. They agreed to pay me a fifty-thousand-dollar commission, which I would split with the broker.
 
“I set up the strategy and the market went flat. Nothing happened, no movement. The lawyer with no neck began calling me every day. ‘How much did we save today?’ he’d ask. When I’d tell him, ‘Nothing,’ I could hear the silence.
 
“Finally, the second week in December he called me and said pretty clearly, ‘Frank, you gotta make something happen. I don’t think you understand the situation. There are extenuating circumstances. We can’t be caught flat-footed like this. This money cannot be on the books. You need to create a million-two in losses.’
 
“I reminded him that I’d warned his clients about this possibility. That there was nothing ...
 
“ ‘Frank, that is not an answer. And if I don’t get the right answer I’m gonna put a bullet in you.’
 
“I didn’t think I heard that correctly, or maybe I was just hoping I hadn’t heard it right. ‘Excuse me?’ I said.
 
“ ‘I said you either do this thing right or we’re gonna put a bullet in you.’
 
“But the market didn’t move and I was trapped. Late one afternoon they showed up at my office. ‘Do something now,’ the lawyer said. The whole scenario was out of a bad movie. These were just dumpy-looking guys, wearing brown suits. They looked like anybody out of the neighborhood, except they seemed serious about shooting me. I went to my boss and I told him I had to lever up my position about five to one over what I had already leveraged, knowing I could get at least some movement out of that. I told the people from Carteret that I needed another twenty-five grand, which they handed over, and I put this monster position on. I warned them that they easily could lose thirty percent of their money on this deal.
 
“It did occur to me they had no intention of losing any money.”
 
Frank had been through military Ranger training; he was capable and experienced with a weapon. So he began carrying a .357 with hollow-point bullets. This was a pretty tough time in his life. He was going through a difficult divorce, he had started drinking heavily, and four mob guys from New Jersey were threatening his life. It wasn’t precisely what he had envisioned when he decided to work on Wall Street.
 
It got very scary. As he explains, “I was scared. I’ll bet I rotted out a dozen shirts from sweat. I was drinking heavily. One night in Boston, I remember, I’d been drinking and I was driving home late at night. I looked in my rearview mirror and realized a car was following me, tailgating me. Whoever was driving made no attempt to hide the fact he was trailing me. I took back roads I knew and he stayed right on my ass. Finally I got to my house. I raced into the driveway and slammed on my brakes, rolled down my window, and leaped out of the car. As the other stopped by my driveway I scrambled to get behind my door for protection. As I did I pulled out my .357, and as soon as I got behind the door I pointed it through the open window at the driver. He just sat there, staring at me, then pulled away. I never saw his face. I do believe they were sending me a message: They knew where I lived. I got the message; believe me, I got it.”
 
Gradually, Frank’s strategy began working. He took his gains in small pieces—$10,000, $15,000, occasionally $100,000. It was painfully slow, but it was working. Finally the lawyer called again. As Frank remembers, “He said, ‘This isn’t fast enough. You got one week or we’re gonna have to do something about it.’
 
“That was it for me. I called the broker who brought me into the deal and told him, ‘You call that lawyer in Carteret and you tell him if I receive one more call I’m coming down to get them. Trust me—they won’t even know what hit them.’ I never got that call. I successfully moved $1.1 million of the one and a half million dollars before the end of the year. I wanted to get out then, but these people loved the profits and insisted we stay in. I had positions that were worth millions of dollars and I did not have discretion over the account so there was nothing I could do about that. They wouldn’t let me out. They thought it was a money-making machine; they didn’t understand it simply deferred taxes. I told them this was designed for one purpose, to move $1.2 million in two weeks. ‘I just built you the atom bomb,’ I said. ‘Trust me—you don’t want to use it.’ But all they saw were the profits.
 
“Of course they eventually lost most of it and left me with a debt of a hundred twenty thousand dollars. I actually wanted to sue them for the money, but Merrill Lynch was beginning to understand that this was potentially a bigger problem than it was worth to them and pushed me into arbitration. I got most of that money back. Merrill Lynch eventually absorbed the remaining losses.
 
“But there was no question in my mind that my life was at risk if this strategy had failed.”
 
Professionally, the European trip was a failure. For my product to be profitable we had to raise at least $10 million, and we came home with commitments of slightly more than $6 million. It wasn’t going to be profitable enough to pursue. And the truth was that these funds didn’t need me; they had Madoff. There was no reason for them to invest in riskier products. At no time during the trip did I even consider revealing what we knew to any of these asset managers. There was no reason for them to believe me, and they were already addicted to his returns. Just like the American funds, they needed him to survive—and they needed him a lot more than they needed me. Who knows what they might do if they knew I was trying to expose him? So it was just too risky, and in retrospect that probably was one of the most intelligent decisions I made during this whole investigation.
BOOK: No One Would Listen: A True Financial Thriller
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