The Wizard of Lies: Bernie Madoff and the Death of Trust (38 page)

Late that evening, SEC chairman Christopher Cox emerged from a daylong meeting of the commission and issued a statement about the Madoff affair. He said that SEC investigators were working with law enforcement to review “vast amounts” of information that showed “the complicated steps that Mr. Madoff took to deceive investors, the public and regulators.”

This face-saving reminder about Madoff’s criminal ingenuity was eclipsed by Cox’s next revelation: “The Commission has learned that credible and specific allegations regarding Mr. Madoff’s financial wrongdoing, going back to at least 1999, were repeatedly brought to the attention of SEC staff, but were never recommended to the Commission for action…. I am gravely concerned by the apparent multiple failures over at least a decade to thoroughly investigate these allegations.”

Cox had reached out personally to the agency’s aggressive inspector general, H. David Kotz, directing him to open an independent investigation of what went wrong. He also ordered all SEC staff members who had “more than insubstantial personal contacts with Mr. Madoff or his family” to remove themselves from the ongoing investigation.

Cox’s announcement landed with a thud—the sound of a once-proud agency hitting bottom. The SEC, which had been coasting for years on an outworn reputation for excellence, slammed into the rock-hard consequences of more than a decade of neglect and denial. Cox himself had endorsed many of the deregulatory policies and budget priorities—and had overlooked the management deficiencies and dwindling skills—that contributed to the disaster. But there was more than enough blame to go around.

The agency’s reputation had already been bruised earlier in the year by its clumsy supervision of the giant investment banks and other regulated institutions that had fallen into failure or folly—including Bear Stearns and Lehman Brothers. The SEC had seemed increasingly irrelevant during the post-Lehman panic, when Cox was routinely relegated to the edges of press conferences dominated by Secretary of the Treasury Hank Paulson and Federal Reserve chairman Ben Bernanke. Now it was clear that the agency had spectacularly failed to fulfill its core mission: investor protection. It was almost impossible to comprehend. Missing Madoff’s crime, despite years of “credible” tips and warnings, began to look like the most appalling failure in the SEC’s seventy-five-year history.

Cox, however, was on his way out. President-elect Barack Obama was just days away from announcing that he intended to appoint Mary Schapiro as Cox’s successor as chairman of the SEC. Schapiro, a small, neat woman with chin-length blond hair and a warm, soft-spoken manner, had been president of FINRA, the self-regulatory agency that evolved from the NASD, since 1996. Bernie Madoff had become less active in the organization by the time she arrived, and she met him only a handful of times during her tenure; she had not seen him in years. Schapiro hadn’t known that Madoff managed money on a large scale—there was no reason she would have, since neither the NASD nor FINRA had any jurisdiction over hedge fund managers or investment advisers. Nor had she noticed the articles that were published in 2001 about his mysterious prowess as an investor.

When the news about Madoff’s fraud first broke, Schapiro was cleaning out her desk at FINRA’s Washington office. She was distracted by the demands of the appointment process—the financial disclosure forms, the FBI questions, the preparation for her confirmation hearings. As she worked, she had her office television on and looked up when she heard the news about the arrest. She was shocked. But like the prosecutors who agreed to Madoff’s bail arrangements, she did not immediately appreciate what a catastrophe Madoff would be for his investors—and for the agency she had just agreed to lead.

Obama announced Schapiro’s appointment on Wednesday, December 17, the day after Cox’s stunning disclosure. But she would not take office for more than a month; she could not be confirmed by the Senate until after Obama’s January 20 inauguration. So she could only watch as Cox and his senior staff grappled with the early days of the devastating scandal.

It was clear to her that the agency’s response needed to persuade the public that the SEC could restore competent and effective regulation to the marketplace—or it might not survive as an independent agency.

Alone in the penthouse on Christmas Eve, Bernie and Ruth Madoff were sorting through some of their personal treasures. They had accumulated some lovely things over the years: a pair of antique diamond earrings from the early 1800s; graceful old Edwardian bracelets and earrings in combinations of black onyx, emeralds, and diamonds; dozens of new and classic wristwatches; and a remarkable rope of 320 baroque pearls that could be unclasped into sections to form chokers, bracelets, and necklaces.

Madoff surely knew that most, if not all, of his treasures had been purchased with stolen money. Indeed, the day after his arrest, he agreed to a court-imposed freeze on all his assets. Ruth’s jewelry was not as clearly under the court’s control—she had not been charged with a crime and had not yet submitted to a voluntary asset freeze, although she would do so in a few days. But regardless of the legal details, they both surely knew that Ruth’s jewelry—like the walls around them, the furniture they sat on, the coats and boots in the closet—would soon be claimed by the government for her husband’s victims.

Yet the penthouse and the furniture and the clothing were all still there, assembled around them within easy reach. After the almost surreal drama of the past two weeks, perhaps these treasures and the whole comfortable world inside the penthouse still seemed to be theirs.

Ruth gathered four diamond brooches, a diamond necklace, an emerald ring, a jade necklace, and a few other nice pieces. Bernie picked out two sets of cuff links, one of them an inexpensive gift from a granddaughter; some costly fountain pens; and more than a dozen samples from his cherished collection of wristwatches, some of them detailed with diamonds or cased in platinum, gold, or silver.

They packed the articles carefully, a stack of tidy parcels, and included small notes of remorse and affection. The same day, Ruth put them in the mail to their sons and a daughter-in-law, to her sister and brother-in-law, to Bernie’s brother, Peter, and his wife, and to some close friends.

A few days later, one of their sons alerted prosecutors to his receipt of the valuable gifts and turned them in to the government. The ill-considered holiday gifts would hand Marc Litt one more opportunity to argue that Bernie Madoff could not be trusted free on bail.

A week later, at a meeting with one of her husband’s lawyers, Ruth mentioned the gifts that she and Bernie had mailed out before Christmas. The lawyer quickly warned her that she had to try to retrieve the parcels—immediately. She then sent urgent e-mails to her sons asking for the gifts to be returned.

There was no response.

As with every event of personal devastation, they remember exactly where they were and what they were doing when they learned that they were ruined.

Tim Murray, a property manager in Minnesota, whose family had first invested with Madoff through Mike Engler, was traveling and nearly drove off the road when he heard the news of Madoff’s arrest. At first he thought it was just another of the jealous rumors that regularly surfaced about Madoff—always investigated, always disproved. Given Madoff’s stature on Wall Street, he said, “I am supposed to believe that one day he gets up in the morning and does something to get arrested for? Not likely.” But Madoff
had
been arrested, and all the money that Murray and his family had entrusted to him was gone.

Another second-generation investor was having her hair cut when her sister called with the news that “everything had vaporized.” The realization that her elderly parents had lost everything “came quickly and hit hard. We were so worried.”

The gray-white paper rolled out of Mary Thomajan’s fax machine the day after she had returned from a soul-searching journey to India. She expected it to be the account statement that would confirm she had the money to build the dream life she’d planned to create in Santa Fe, New Mexico. The fax was from the small feeder fund she had trusted for eighteen years, telling her that all her money had been invested with Madoff, who had been arrested. “In the 50 seconds it took to read that fax, I went from being a multimillionaire to having my life savings wiped out and life as I knew it forever altered.”

Ellen Bernfeld, a singer and songwriter with dreams of being an author, was having lunch with friends when she got the “life-shattering phone call that changed my world.” She reflected sadly, “My father was not around to see this terrible disaster and to feel its aftermath, but my mother is, and she is a child of the Great Depression, so this is her worst nightmare.”

Robert Halio’s son called him at his retirement home in Boca Raton with the news. “I almost fell to the floor,” he remembered. “I couldn’t catch my breath and thought I might be having a heart attack. I was in total shock.” A lifetime’s savings, the cashed-out value of insurance policies—95 percent of his and his wife’s modest wealth—had been entrusted to Madoff and was gone. His wife, Stephanie, was just entering a nearby movie theater with a friend, also a Madoff investor, when the friend got a call with the same dread news. Robert’s call to her came a moment later. “I was hoping that it was all a terrible mistake,” she recalled.

One investor was with her husband at her orthopedist’s office in New York City, getting a cortisone shot for her sore hip. As she was pulling up her jeans, her husband got the news on his cell phone. He was devastated, almost hysterical. She had to help him to the car and make the drive to their home in suburban New Jersey. “Everything he worked for all his life was gone—‘poof!’” When they finally walked into their house, she said, “I went into the bathroom and threw up.”

Steven Norton of Fort Lauderdale had just driven quietly home from a memorial service for his life partner’s brother. A voice-mail message from his broker delivered the news that their retirement savings were gone. Norton then called his partner’s widowed sister-in-law in Miami to break the same awful news. Having just lost her husband, also a Madoff investor, she had now lost everything that he had set aside to keep her comfortable.

Kate Carolan heard the news when her husband, Gordon Bennett, shook her awake and said, “Kate, we just lost our house.” Bennett had sold his successful natural foods business in 1988 to devote his time and money to environmental causes, and, on the strength of their savings, all invested with Madoff, he and Kate were working on a new half-finished home near the magnificent coastal preserve at Point Reyes, north of San Francisco. At first she thought he was joking. “Kate, I’m telling you—Madoff has been arrested for securities fraud,” he repeated.

Another victim of very modest means said she felt as if a treasured talisman had suddenly fallen from her grasp. Knowing her money was invested with Madoff “was like Dumbo’s feather,” she said, reflecting on the classic Disney movie about a flying elephant who thinks his ability results from a magic feather he got from a friendly crow. “The feather doesn’t enable you to fly,” she said. “But [it] makes you think you’ve got some magic thing…. We felt like we had this nice safety net and now there’s no net.”

Frantic phone calls went out from nieces to aunts, from daughters to fathers, from grandsons to grannies, from one old friend to another: “Bernie Madoff—he’s just been arrested!” And with his arrest, their worlds changed forever.

On Tuesday, December 23, 2008, the anguish that had seized tens of thousands of invisible Madoff victims around the world suddenly became vividly and tragically evident to the public.

René-Thierry Magon de la Villehuchet, the aristocratic French financial salesman who cofounded Access International, had been personally warned about Madoff. One warning came in the spring of 2006, from the hedge fund analyst he and his partner had hired but did not heed. Another supposedly came from Harry Markopolos, who recalled in his memoir that he and the Frenchman traveled together in Europe to market a new financial product Markopolos had designed. Markopolos said he issued his warning before that trip, but the Frenchman became “extremely defensive” and rejected the possibility of fraud out of hand. Markopolos further claimed that de la Villehuchet ignored his offer to make his case to Access International’s research director.

When the news broke on December 11 that Madoff had been arrested, the staff at Access International’s Midtown office on Madison Avenue crowded around the television in their boss’s office, slack-jawed and silent. “It was such a moment of eternity,” one staff member later recalled. “A castle of cards falling down in one CNBC news flash.”

De la Villehuchet, who was sixty-five years old, spent the days after the arrest frantically consulting with his partners and their lawyers about his funds’ stake in Madoff—a total of about $1.6 billion, including $50 million of his own money. At the time, there seemed little hope of recovering anything. “It’s a complete nightmare,” he told a devoted client in Paris during an early morning phone call on Monday, December 22.

That day, de la Villehuchet calmly asked his young assistant to purchase a box cutter, as if it were just something he needed around the office.

“Leave it on my desk,” he said.

Later, he asked to borrow the young man’s office key, saying he would be working late that night and needed the key to lock up. He called his wife to tell her he had a late engagement and that she should not wait up for him, and then he hurried the cleaning staff out by 7:00
PM
and locked the door behind them.

Sometime during that night, he positioned a trash basket to protect the carpet, slit his wrist and upper arm with the box cutter, and bled to death.

Irving Picard was a thoroughly prosaic man. He would raise an eyebrow at the fanciful notion that the legal drama surrounding the bankrupt brokerage firm for which he was the trustee was a heroic journey out of chaos or a mythic quest for lost treasure. At a rational level, where he preferred to operate, it was just a bankruptcy case under the Securities Investor Protection Act—the biggest, saddest, hardest, angriest, and possibly longest case ever litigated under that law. Nevertheless, a bankruptcy case.

This made it one of 10,629 cases pending before the ten federal bankruptcy judges in Manhattan, a tally that included the giant Lehman Brothers case and would soon include the bankruptcies of Chrysler and General Motors. And a bankruptcy case, which marks the death of a business enterprise, moves at the stately pace of a funeral march. It does not gallop, it does not sprint, and it does not take detours or shortcuts.

In a typical corporate bankruptcy, that dirgelike tempo is aggravating but tolerable. The debtor is reorganizing or liquidating a failed business and has work to do, and the banks, vendors, and other experienced creditors know what to expect. But in this bankruptcy, many of the creditors were desperate crime victims who had lost everything in a massive fraud, and some of them were relying on money from the debtor’s estate to make their next mortgage payment or buy next month’s medicines. The poetry of the judicial system may be that “justice delayed is justice denied,” but the prose translation is that it takes a long time for justice to arrive in a complicated SIPC liquidation wrapped up in a continuing criminal investigation of a fraud that stretched around the world and affected millions of people.

The way Madoff organized his fraud magnified the complexities for SIPC, creating a knot of temper-fraying issues that would not be unraveled for years.

First, there was the question of who qualified as a “customer” eligible for SIPC’s protection. Were Madoff’s customers only the feeder funds such as Fairfield Sentry and Ezra Merkin’s Ascot Partners, whose names were on the account statements? Or did all the various investors in those feeder funds qualify individually as customers? Over the long haul, it might not matter—any assets recovered should wind up in the right hands, whether directly or after a detour through the feeder funds. But in the short term, the answer determined whether a feeder fund would receive a single $500,000 cash advance from SIPC to share among all its investors—or whether
each
of those investors would be eligible for a cash advance of that size.

Second, and arguably far more significant, was the question of how much an eligible customer could claim as a loss. Was it the amount shown on the final statement, the one received a few weeks before Madoff’s arrest? Or the amount of cash the customer originally invested from his own pocket, with no fictional profits added? Should a victim who had a sizable balance but who had already withdrawn the cash he originally invested be allowed to share in whatever assets Picard could recover? Or should every penny the trustee recovered be reserved for those who didn’t get all their cash back before the scheme collapsed?

And what about the victims who had withdrawn millions of dollars more than they had put in, thinking they were only drawing out their legitimate profits? Could the trustee sue them to get that money back? If so, would he base his decision on how much they had taken out? On how much they had left? Or, somehow, on how much they might have known about what Madoff was doing?

Someone was going to have to play King Solomon with these questions, and every possible answer would leave someone enraged or bereft. And, as with the biblical precedent, getting the “right” answer would require wisdom about the human heart, not just knowledge about the rules of justice. The imperfect search for answers to these questions would impede the liquidation of the Madoff firm for more than two years and inflict bruises on everyone involved.

Picard and Sheehan believed that the law that applied to Ponzi schemes was clear: victims could recover only the cash they had put in, not the fictional profits allegedly generated by the fraud itself. Their view was shared by SIPC’s lawyers, senior officials at the SEC, and a large number of bankruptcy lawyers.

It was also supported by rulings already coming out of the pending bankruptcy of the Bayou hedge fund, the Ponzi scheme whose collapse in mid-2005 nearly capsized Madoff’s own fraud. As early as 2007, the judge in the Bayou case ruled that if a victim had withdrawn cash in excess of his original investment, those fictional profits had to be returned to the estate. Almost all of the Bayou fund investors who had withdrawn money within six years of the fraud’s collapse—the statute of limitations under New York’s creditor protection laws—were ordered to return their fictional profits.

But in adopting this view of how to calculate losses in the world’s biggest Ponzi scheme, Picard and Sheehan became the lonely champions of some of Madoff’s victims (those who had taken out none, or only some, of the cash they put in) and the bitterly despised adversaries of the others (those who had withdrawn all of their original cash stake and perhaps much more).

The Madoff investors who opposed Picard would soon argue that Bayou was different because it was not a SIPC case—and that SIPC was required to honor customers’ “legitimate expectations,” as reflected on their final account statements before the fraud collapsed. As they saw it, to do anything less was simply illegal.