The Wizard of Lies: Bernie Madoff and the Death of Trust (23 page)

By 1991 some Ivy executives had heard disquieting rumors about Madoff, according to e-mails obtained through subsequent litigation. By 1997 they had noticed that the volume of publicly traded index options was too small to cover the implementation of Madoff’s investment strategy just for their own clients—and they believed him to be handling several billion dollars for other clients as well.

Flying back to New York City with Bernie Madoff after a meeting with one of the upstate union pension funds, a senior Ivy executive allegedly asked him about this mismatch between options volume and the assets he managed. Madoff brushed off the question, saying he might trade a few options with banks or foreign exchanges, but that it was rare.

The Ivy executive apparently did not argue with Madoff—although he knew that the mismatch actually happened quite frequently—but he must have looked unconvinced. A few months later, perhaps to head off any lingering doubts, Madoff mentioned to this executive that he occasionally traded options on other exchanges. But the options that Madoff supposedly used were traded exclusively on the Chicago Board Options Exchange. His story still didn’t add up.

In the face of these lame explanations, the Ivy executive theorized that Madoff was lying. Coming close (but not close enough) to the reality of the Ponzi scheme, the executive suspected that Madoff was really using investors’ money to finance his legitimate stock-trading business. The “investment earnings” credited to their accounts might actually just be “compensation for the use of their money,” he suggested in a note to Ivy’s founders in May 1997. In short, Madoff might be lying about how he was making money for his investors—paying them a share of his firm’s legitimate proprietary trading profits, rather than investing in his arcane hedged strategy—but at least he was actually making money for them, the Ivy executive evidently surmised.

This thesis—that Madoff’s investors were actually lenders who were unwittingly financing his own trading activity and getting paid for it with some of his firm’s profits—gained substance two years later when the Ivy executive talked with a prominent hedge fund manager, who was not identified in court records. The Ivy executive described the conversation in an internal memo:

One of Ivy’s founders grew even more pointedly doubtful about Madoff over the next few years, although he later denied he suspected a Ponzi scheme. In an internal memo in 2001, he observed that “Madoff can personally bankrupt the Jewish community if he’s not ‘real.’” Responding in 2002 to a staffer’s attempt to analyze and explain Madoff’s remarkably consistent returns, he wrote, “Ah, Madoff. You omitted one other possibility—he’s a fraud.”

Based on their growing uneasiness, the Ivy executives had eased their own wealth and that of their private clients out of Madoff’s hands by roughly 2000. But they did not remove their pension clients’ money from their Madoff accounts, according to a subsequent lawsuit against them. Apparently the unions were happy with the steady returns. Moreover, Ivy benefited from the continuing fees and from having the pension money counted as part of its “assets under management,” a key benchmark in the investment advisory business. So the small pension plans for a host of union workers, totaling more than $220 million, stayed with Madoff.

These local unions truly were small fry among the legions of pension funds marching into the world of hedge funds. When the giant state public pension funds, such as California’s and New York’s, collectively increased the percentage of their assets invested in hedge funds by just a point or two, the result was a flood of billions of dollars looking for hot new funds run by brilliant new managers.

And one of the people who helped find those managers was a smart, ambitious woman in suburban New York named Sandra Manzke, one of the few women to rise to the top of the hedge fund industry—and one of the earliest hedge fund managers to introduce mainstream pension plans and middle-income investors to Bernie Madoff.

Manzke was an articulate, opinionated, and very astute woman who had risen through the analytical side of Wall Street in an era when the nice executive offices were a very long way from the ladies’ room. In the early 1970s she developed methods for measuring fund performance for a small but prestigious mutual fund firm. After collecting a fine arts degree from the Pratt Institute and dabbling briefly in the movie business, she returned to Wall Street with a mane of blond hair and a theatrical style. By 1976 she had landed a spot at Rogers, Casey & Barksdale, one of the most prominent pension fund advisory firms in the country.

At that time the financially dismal stock market of the 1970s was unfamiliar ground for most pension plans, which had long restricted themselves to bonds and other less risky investments. But bonds were not even keeping up with inflation, much less with the growth in promised benefits to retirees. By the mid-1970s even the proverbial “prudent men” of the fiduciary world were recognizing that prudence required them to add equities to their portfolios.

Manzke’s specialty was to search out promising new mutual fund managers and steer her pension fund clients’ money into their hands. She was one of the first to introduce pension fund clients to soon-to-be legendary fund managers such as Peter Lynch, Fred Alger, and Mario Gabelli.

In 1984 she left Rogers Casey and struck out on her own, forming what became Tremont Partners. It was a struggle at first, but she found her footing, and her little firm soon had a great track record with its clients. Some of her earliest clients were the public pension funds for the town of Fairfield, Connecticut, which signed on with her in early 1985.

But her real fortune was in her Rolodex, and not just because she had Bernie Madoff’s number. She seemed to know almost everybody in the increasingly busy intersection between pension funds and hedge funds, and she had elaborately interwoven partnerships with many of them. By 1990 she had become a director of a new family of offshore hedge funds called the Kingate funds, managed by a London-based pair of Italian businessman, Carlo Grosso and Federico Ceretti. A pioneering Kingate fund was incorporated as early as 1991 and was probably investing with Madoff from the beginning—Madoff himself identified Kingate as one of the first hedge funds to invest with him. By March 1994 a second Kingate fund had opened a Madoff account; less than two years later, there was a third.

Besides these offshore funds, Manzke put Tremont Partners at the forefront of developing accessible hedge funds for domestic American investors. In 1994, Tremont launched what became the Rye funds, a popular choice among advisers to pension plans and individual retirement accounts. Ultimately, more than $1 billion would find its way through the Rye funds into Madoff’s hands.

The Rye funds were born in the same year that Manzke acquired a partner at Tremont: Robert I. Schulman, who had previously run Smith Barney’s $60 billion Consulting Services Division and its “Retail New Product Development Group.” With his round, open face and curly hair, Bob Schulman was a popular and respected figure on Wall Street. According to one lawsuit, he was vocal in his praise for Madoff and his performance over the years, but later testimony showed that Manzke already had access to Madoff before Schulman arrived at Tremont.

In the spring of 2001, as Michael Ocrant and
Barron’s
were publishing skeptical articles about Madoff’s secret money-managing business, the giant OppenheimerFunds group was doing its due diligence on a deal to purchase Tremont Partners. There is no public evidence that the articles caused any consternation among the lawyers and analysts putting the deal together. The deal was done and, by July, Sandra Manzke and Bob Schulman had swept a big pile of chips off the table.

Beyond its Oppenheimer connection, Tremont formed complex and prestigious alliances across the international hedge fund map. In a joint venture with Credit Suisse, it popularized a hedge fund performance index, tempting creative bankers to devise new ways to bet on the hedge fund sweepstakes by designing exotic derivatives pegged to the index.

Manzke and Schulman became sought-after sages as regulators struggled to understand “the implications of hedge fund growth,” the topic of a public forum in 2003. They exuded confidence in the hedge fund industry, although Manzke was fiercely outspoken in her belief that regulators ought to require hedge fund managers to be more cooperative with “fund of funds” advisers like her.

At one forum, she told regulators, “It’s very difficult to get answers out of managers, and they hold all the keys right now. If you want to get into a good fund, and you ask some difficult questions, you may not get that answer.” Indeed, you may not get into that fund. She may have had Madoff in mind when she expressed this frustration—he famously challenged those who questioned him closely to take their money out and leave him alone. Being banished by Bernie would have been a death sentence to any fund whose entire existence, including its lucrative management fees, was based on access to him.

In 2002, Sandra Manzke’s professional past and profitable present collided when analysts from her old launchpad, now called Rogerscasey Inc., took the measure of the Tremont line of hedge funds—and warned its clients away.

The basis for this warning was that Tremont simply could not see inside Madoff’s black box—it “receives limited independent third-party transparency,” the firm said, translating its simple message into the jargon of the financial consultant. Rogerscasey’s analysts did not like Madoff’s habit of moving entirely into Treasury bills at the end of each year, clearing his own trades and sending out his own trade confirmations—which, they noted, he “could be making up.” Rogerscasey’s rating for the Madoff-related Tremont funds was “sell.”

Notes in the Rogerscasey files for the Tremont funds, dated February 26, 2004, actually included some clear, unequivocal English: “The Madoff exposure is a potential disaster. Even though some products would not be directly affected…. Tremont’s products will still see their reputations vaporized when Madoff rolls over like a big ship.”

By 2002, Madoff’s hidden Ponzi scheme was booming. Fairfield Greenwich Group had more than $4 billion invested with him by then, and additional billions were pouring in from the Kingate funds, the various Tremont products, and the three Merkin funds. Hundreds of millions had come in from all the loyal investors originally collected by Avellino & Bienes and plucked from the SEC’s lifeboats by Bernie himself, making calls and having meetings. If anyone running such a gigantic fraud could ever feel secure, Madoff should have.

But beneath the surface, his Ponzi scheme was being plagued by one of his oldest clients, Jeffry Picower. Picower was the aggressive tax lawyer who drifted into Madoff’s orbit in the 1960s, when Saul Alpern’s accounting partner Michael Bienes married Picower’s sister. By now Bienes was married to someone else, but Picower had become one of Madoff’s biggest investors—and one of his growing headaches.

The core job for any Ponzi scheme, of course, is to keep enough money flowing into it so that current investors are comforted and reassured by the ease and speed with which great sums can be withdrawn. By now, Madoff’s earliest investors were elderly, some of them were fabulously rich, and most of those were unflaggingly generous. They were pulling tens of millions of dollars from their Madoff accounts each year to educate grandchildren, support schools, build hospitals, renovate art museums, sponsor medical research, and support a host of worthy charities and endowed chairs.

But no one dipped more deeply or steadily into his Madoff wealth than Jeffry Picower and his wife, Barbara. They were a quiet couple, rarely popping up in the boldface society columns of Palm Beach or on the
Forbes
list of the wealthiest Americans. But they surely belonged on that list. Indeed, Picower was far wealthier than even Madoff realized.

Picower had won spectacular high-stakes bets on promising medical and technology companies and corporate mergers, reaping just over $1 billion on a single deal and circulating his profits regularly through his Madoff accounts. Over time, he invested about $620 million in actual cash and securities with Madoff. With Madoff’s steady rates of return, Picower’s account balances ultimately ran up into the billions of dollars. As early as 1986 he was wealthy enough to invest $28 million in an arbitrage fund run by Ivan Boesky, the notorious trader who boosted his fund’s profits illegally by buying tips from Wall Street insiders and who was the model for the Gordon Gekko character in Oliver Stone’s 1987 movie
Wall Street
. By the late 1990s, Picower’s trading account at Goldman Sachs—almost certainly just one of his many Wall Street brokerage accounts—was reportedly worth $10 billion. At one point, he arranged a $5 billion margin loan in that account, which indicates he was so rich that Goldman knew that he could easily cover the loan if the market turned against him.