Suh shifted again to the issue of who handled Madoff’s trades, and he acknowledged that they were all cleared and settled through the Depository Trust Company. This time he said the assets and trading for hedge fund clients were segregated in a separate account from all other activity by Madoff acting as a broker-dealer.
“There are codes that are attached to the activity that say whether it’s held for the firm or whether it’s held in seg.”
“You mean in segregated?” Cheung asked.
“Segregated.”
“Do you remember what those codes are?”
“No.”
“But DTC would know.”
“Yes.”
“And what kind of report does the firm get from DTC on the transactions in this account?”
“Everything gets generated online to the firm on a daily basis. That’s the way the DTC works now. As a clearing corporation, you get data on everything, the transactions and all that sort of stuff.”
“And in the DTC account, the activity that’s in the segregated account, that’s solely institutional trading business and solely what’s perceived as the strategy we’ve been discussing.”
“Right.”
This flatly contradicted what Madoff had told Suh only a few weeks earlier on the phone, which was that all the trading was in a single account. Moreover, this was a significant admission, since all Madoff’s trading for hedge fund clients could be verified with one request to the DTC.
Suh shifted to another line of questioning. “Are there any other accounts for which you trade the split-strike conversion strategy that we’ve been discussing?”
“No.”
So there could be no misunderstanding, Bachenheimer asked explicitly, “Mr. Madoff, do you personally trade money for anybody else?”
“What do you mean by ‘anybody else’?” Madoff asked.
“Is there anybody else who provides you capital to invest and you trade on their behalf, whether it be an individual, an entity, a partnership, a corporation, your neighbor, anything or anyone?”
After insisting for years that he only managed money for a few institutions, Madoff allowed that there might be some so-called friends and family accounts, and Bachenheimer asked him to provide a complete list.
Finally Suh got to the confrontation with Madoff she’d discussed with Bachenheimer that morning. “Do you recall an examination conducted by our staff last summer of your firm?”
“Yes.”
“Do you recall discussing the institutional trading business with Mr. Lamore?”
“Yes.”
“Do you recall telling Mr. Lamore in substance that because of the complexity of incorporating options into the investment strategy of the institutional trading business, you stopped utilizing options as of January 1, 2004?”
“I said that the–what?”
“Do you recall telling Peter that as of January 1, 2004, you no longer incorporated options into the strategy for the institutional trading business?”
“I said they’re not part of the model,” Madoff stated as Lamore sat incredulous across the table. “The options are not deemed to be part of the model. I did not say–my recollection certainly is not that I said that the accounts don’t use options anymore to trade. I said the options, that the options were taken out of the model, and they’re not part of the model anymore.”
“So what change were you referencing in that statement?”
“Well, they used to be part of the model. As a matter of fact, the change in the trading authorization directive, originally it had the options as part of the model.” This coincided with the story he’d told Fairfield’s Vijayvergiya to tell the SEC.
Suh continued, “Do you recall telling Mr. Lamore in substance that since that change, as of January 1, 2004, the clients may hedge the strategy themselves but that you did not discuss or provide any guidance to clients for hedging the strategy?”
“No.”
“You do not recall making that statement?”
“I recall saying what I just said, that they were part of the model, that they were no longer part of the model, but I remember specifically saying that the options are still used to hedge the transactions.”
L
amore was furious at Madoff’s testimony, which implied that Lamore had either lied about or misstated his previous accounts of Madoff’s answers. “I just remember sitting there in the testimony thinking he’s lying,” Lamore later said. “It was just remarkable to me.” According to Ostrow, Lamore “was jumping up and down at the attorneys and letting them know about all the discrepancies.” Suh, too, thought Madoff was lying. “Madoff wasn’t truthful and I knew he was not giving us full information,” she said. And clearly, Madoff had withheld the names and number of his customers, which grew every time they asked him about it. “Bernard Madoff misled NERO examination staff earlier this year about the nature of his trading strategy,” Suh subsequently e-mailed a colleague.
On June 7 Madoff e-mailed the SEC staff a list of not just a few, as he’d implied, but eighty-six previously unmentioned friends and family accounts. When Suh called demanding to know why he hadn’t provided the names before, he said he didn’t consider the accounts “discretionary,” whatever that meant. “He has a Clintonian definition of discretionary,” Cheung commented.
“Or anything,” Suh responded. “It still is not clear to me on what grounds he didn’t disclose these accounts when we had that ‘is there anything else’ exchange of letters.”
Madoff’s testimony was replete with contradictions. He said he maintained segregated accounts with DTC; previously he’d said there was just one account. He said he traded options over-the-counter through the New York office, not in London, as he’d told Lamore before. He said he had electronic records of the options contracts; earlier he’d said no documentation existed. And with a firsthand witness who could contradict him sitting at the table, he had baldly denied he had told Lamore that he’d stopped trading options. Just about the only consistency was his assertion that “some people can just feel the market,” a proposition that was, as Markopolos had asserted, dubious on its face.
Lamore thought there was enough to refer the case to the Justice Department immediately. At the least, Madoff was lying under oath, which begged the question of why. As Lamore put it, “So I’m sitting there thinking, You got to be kidding me. I mean, this is huge. This guy just lied on the record to your face.” But the enforcement lawyers, especially Cheung and her superior, Bachenheimer, didn’t seriously entertain the possibility. As Ostrow put it, “Peter [Lamore] was extremely upset that the [enforcement lawyers] weren’t taking seriously the fact that everything was a lie. There were so many contradictions to what Bernie said in testimony or [DiPascali] said to what we were told on our exam.” Suh later explained, “Meaghan [Cheung] did not think that this was likely to lead to an enforcement action or this was likely to lead to anything.” Lamore was assigned to other matters and had no further involvement in the Madoff investigation.
At the least, the contradictions cried out for further investigation. A few relatively simple inquiries should be able to resolve the fundamental questions. The Depository Trust Company, as Madoff himself acknowledged, could verify the equities trading and demonstrate that the hedge fund assets were held in a segregated account. Now that Madoff had identified the dozen options counterparties, the enforcement staff had only to contact them to verify the massive number of contracts that Madoff traded. They needed to follow up on Madoff’s promise to provide the “electronic” records of the options trades. Some simple fact-checking could establish whether over-the-counter options trades typically generated any paperwork or whether Madoff’s assertion–that options volume in the over-the-counter market far exceeded that on the exchanges–was true. These tasks fell to Simona Suh.
But by now, the focus of the Madoff investigation appears to have shifted away from Markopolos’s original attention-getting allegation–that Madoff was running a massive Ponzi scheme–to the far more technical issue of whether Madoff needed to register as an investment adviser. The staff was no longer even looking at front running. As Suh described the evolution of their inquiry in an e-mail in April:
We initially began looking at BLM’s institutional trading business because of suggestions in the press that the returns reported by BLM’s customers were too good to be true and that BLM could be engaging in some improper conduct, such as front running or false reporting of returns. So far, we have not found evidence of any such wrongdoing. It does appear to us, however, that BLM’s institutional trading business is actually [an] investment advisory business and that BLM should be registered with the Commission as an investment adviser.
Nonetheless, Suh did follow up on at least some of the outstanding issues from Madoff’s testimony. She spoke by phone with Susan Geigel, director of legal and regulatory compliance at the DTC. This was a critical call, but later, Suh didn’t remember making it, didn’t remember the name of the person she spoke to, and had difficulty remembering the outcome. Suh seemed confused about just what the DTC did and how it maintained records, and solicited advice from Lamore about what questions to ask. He didn’t seem to know any more than she did. When they did speak, Geigel apparently indicated there was only one account for Madoff at DTC, through which all the firm’s trading was routed. Thus, Suh concluded it wasn’t feasible to confirm any specific trades for Madoff’s hedge fund clients, since they were commingled with the broker-dealer’s trading.
This was a startling assertion whether or not it was true the DTC couldn’t identify specific hedge fund transactions. (Geigel said she could have identified trades in specific stocks if Suh provided the CUSIP [Committee on Uniform Securities Identification Procedures] number, a nine-digit code that identifies every security, and which would have appeared on Madoff’s trading records.) Commingling client funds in one account is illegal. It also undercut Madoff’s claim that the accounts were segregated and that DTC would supply the account number for his institutional and hedge fund trading. And apart from whether any accounts were segregated, it didn’t occur to Suh to check whether total trading volume or equities holdings in the single Madoff account on any given day matched the trading volume reported to Madoff’s clients. For example, the Fairfield Greenwich account statement in Suh’s possession showed that Fairfield held $2.5 billion in S&P 100 equities as of January 31, 2005. But DTC records showed that on the same date, the Madoff account with DTC held less than $18 million.
Considering her DTC approach at a dead end, Suh made no further inquiries. She didn’t report the conversation to Cheung, who in turn never asked Suh whether she’d followed up with DTC, Bank of New York, or any other custodial or clearing entity.
Suh also commenced efforts to obtain trading records from the European banks Madoff had identified as his options counterparties. Ordinarily the SEC’s Office of International Affairs (OIA) handled such requests, but Cheung advised her to contact their U.S. subsidiaries. “I hate the OIA–they are probably the slowest part of our bureaucracy, and that is saying a lot,” Cheung noted.
UBS resisted, saying Suh would have to ask the parent in Switzerland. But Royal Bank of Scotland said it would provide the information, provided Madoff signed a consent letter giving his permission. In July an RBS lawyer drafted a letter for Madoff to sign and faxed Suh a copy. It was a significant step forward in the investigation, the closest anyone at the SEC had gotten to an actual counterparty to Madoff’s options trades. If Madoff signed the letter, they’d get the records. If he refused to sign, it was anther red flag, a serious indication something must be amiss. Suh told the RBS lawyer that as a “courtesy,” she might call Madoff to let him know he’d be getting the request.
Suh reported this development to Cheung, who said it was no longer anything they should pursue. “I spoke to Meaghan [Cheung] about it and asked whether we should pursue this, and she said no,” Suh later recalled. (In response, Cheung said, “I don’t believe that I unilaterally said, ‘Stop it, we’re done, that’s enough.’ ” But Cheung’s superior, Bachenheimer, said she had no recollection of Cheung ever raising the issue with her and couldn’t imagine why Cheung didn’t have RBS send Madoff the letter.) Cheung herself was later unable to recall why she blocked the effort, but it may have reflected what had become her singleminded focus on getting Madoff to register as an investment manager. “One possible reason is that given the scarcity of resources and the difficulty of obtaining such records, it made more sense” to pursue the investment manager issue “rather than persist in an investigation which thus far had not uncovered evidence of a Ponzi scheme,” she later said–despite the fact that an enormous amount of evidence had surfaced. It may also have reflected her conviction, almost from the beginning, that the Madoff investigation wasn’t going to lead to anything.
Whatever the reason, on July 27, Suh left a message for the RBS lawyer and, according to her phone log, “told him that we decided not to pursue the request at the moment and asked him not to send the letter to Madoff unless he hears from us again.” He never did.
On August 10, 2006, Madoff agreed to register with the SEC as an investment adviser. He initially hired a lawyer, Brandon Becker, to dispute the enforcement staff’s conclusion, but didn’t seriously resist. Suh didn’t pursue any other open issues from Madoff’s testimony. The letter from RBS was never sent. Madoff never produced any electronic records of options trading, as he’d promised. “I overlooked that,” Suh later admitted. “I kind of assumed we were done.” Suh may also have been preoccupied by the fact she was pregnant with her first child. She went on maternity leave soon after Madoff agreed to register.