Tomorrow we celebrate the first night of Chanukah. For eight days, Jewish children around the world will enjoy candle-lighting, songs, unique games, food, and especially the sundry gifts associated with the festival. Last year, for many boys and girls, men and women, endowments, foundations and other charities, the gifts never arrived and the holiday turned into financial ruin. Exactly one year ago, right before Chanukah, the world learned that someone made off with all the gelt.
Until December 12, 2008, hardly anyone ever heard of Bernie Madoff -- including many of his victims, who had invested through “feeder” funds, not knowing they were in any way connected to some third-party fund manager. He has since become the most notorious financial criminal in history.
Bernie’s printing press
Madoff admitted to having stolen over $50 billion in an elaborate Ponzi scheme lasting at least 20 years. Alongside a presumably legitimate trading operation occupying two floors of a midtown Manhattan office building, he had a secret hedge fund operation on half a floor in the same building. However, he wasn’t managing any funds in the conventional sense. Rather, Bernie Madoff was in the printing business, producing massive, intricate statements that were designed to demonstrate a genuine process.
From personal experience, I can attest that financial advisors and money managers trying to do any business with Madoff’s customers were generally rebuffed, albeit politely. They would declare proudly that it was impossible to compete with Bernie’s unparalleled track record. He was able to generate respectable (though in almost all cases, not outrageous) returns with hardly any volatility. These averaged about 1%-1.5% a month, each and every month. Cynics referred to Madoff investments as Jewish T-bills, with returns as predictable as those paid by the US government, although about 5 times higher.
I reviewed statements that he produced for clients three times over the seven years before his arrest. He had one down month out of 84! While the statements looked very realistic, they lacked the complete transparency that one should expect from an investment manager. Madoff explained that this was part of the “secret sauce” in his investment recipe that he couldn’t share, especially because he was also the major market maker in most of the securities and index options that he traded.
Lure of exclusivity
Many of his victims were sophisticated business people. They could, and should, have asked questions. But they knew that if they did, they would be asked to take their money elsewhere. Moreover, once you closed your account, you could never get back in. That was the true genius of Madoff’s marketing strategy. His velvet rope reputation meant you had to be referred by someone already in the exclusive guild in order to merit the right to have him to invest your savings. While never disclosing the size of his operation, he created a perception of scarcity that enabled investors to boast that they made into the club. Moreover, when some of the wealthiest and savviest people you know are also “with Madoff,” you wear that membership badge with pride -- and peace of mind.
Even among those who dealt with Madoff directly, very few gave him all their money when first allowed in. However, over time, his returns were so comforting, particularly as the rest of the world was becoming so volatile, that it was hard to justify investing in anything else. These were gradual decisions motivated as much by fear as by greed. Therefore, I empathize with many who fell into the Madoff trap, especially those who were incrementally seduced by the Madoff trance.
On the other hand, I have no sympathy for Madoff’s feeders, especially those investment professionals who earned juicy fees, did not disclose that someone else was managing the money they collected from clients, and breached their fiduciary duties to clients in every other way. It’s reckless enough to be willfully blind with your own money. It is inexcusable and, in my view criminal, to behave that way with someone else’s.
Some lost money, some lost more
Directly and indirectly, the numbers are staggering. One list had 13,500 accounts covering 162 pages, though some investors held multiple accounts. I personally know quite a few of his victims. Some were very wealthy and remain so. Some had to cut back their lifestyle in one way or another. A classmate of mine married the daughter of one of Madoff’s main feeders. He chose to be a law professor, knowing his financial future was secure. Now he has cancelled the extravagant family vacations, golf club memberships, private school tuition and, quite likely, will have to consider a career change. Another family sold their plane and their two resort homes. They are now flying commercial or staying put in their one remaining residence. Another family is trying to sell their only Rembrandt painting to replace lost funds. While these victims’ travails may not engender tremendous sympathy, the families did have to make unanticipated decisions, learning overnight that certain things they took for granted will never be the same.
For others, the impact has been absolutely devastating. Dozens had to return to work, including retirees in their 70s, 80s and even 90s who are now driving taxis, working as super-market “greeters”, or stocking supplies in a drug-store. They are performing menial jobs for hourly wages just to survive. Many didn’t even know their life savings were invested with Madoff.
The lawyers always win
However, while the revelation of Madoff’s crime created financial Armageddon for thousands of victims, it has also generated a windfall in billable hours for nearly an equal number of lawyers.
For them, the miracle of Chanukah was, and remains, more powerful than ever. Many law firms specializing in bankruptcy have enjoyed legal fees that didn’t last only one day or eight days, but over 300 days with no end in sight. One firm alone, Weil Gotshal and Manges, has billed over $100 million in fees for its work on the Lehman Brothers bankruptcy. As trustee in the Madoff case, Irving Picard can possibly earn substantially more.
On behalf of all creditors, Picard is seeking recourse against investors who took out more funds than they put in during the course of their relationship with Madoff. For example, assume you invested $10 million, enjoyed “profits” of $30 million and, over time, withdrew half the money, leaving $20 million with Madoff. On December 12, you may have felt that suddenly $20 million of your net worth disappeared. However, according to Mr. Picard, not only do you have no claim for those $20 million, you are now liable for the $10 million excess that you withdrew, regardless of where those funds may be and how you may have spent them. Picard doesn’t care if you are a widow or a charity, nor if you spent the money on food, yachts, tuition, private planes, or building a hospital. Moreover, he has the authority, the resources, and a tremendous incentive to “claw-back” as much of the money as possible.
Picard can ask for up to 3% of what he recovers for victims. At that rate, if he recovers $2 billion, he’ll earn $60 million. If he recovers $10 billion, that’s a $300 million fee! The Bankruptcy Court must approve these fees subject to a reasonability standard so the actual amount of money paid is likely to be much lower. However, so far, $17 million has been approved for Picard through April 30th alone and the fun for lawyers is just getting started. Add to that what all the individuals, charities, trusts, feeder funds and everyone else on both sides of the Madoff fence have and will pay their counsel and you get an unprecedented number of latkes.
When the game was up
I am an adjunct professor of Business Law and Ethics. This past year alone, I have been given a lifetime worth of teaching material. The case studies generated by Madoff, Alan Stanford, Marc Dreier, Scott Rothstein and the many others who felt they could cheat the system inevitably end badly for nearly everyone involved. While charlatans have existed throughout history, it seems like a disproportionate number has been exposed this past year. The reason is that it is much harder to keep the game going when investors need to withdraw “profits” to cover other losses -- and new money is nowhere to be found.
By mid-December 2008, the financial markets were reeling. Lehman Brothers had collapsed entirely. Merrill Lynch, Wachovia, Washington Mutual and AIG essentially went bankrupt and had to be rescued, respectively, by Bank of America, Wells Fargo, JP Morgan (which also bought Bear Stearns in March) and the US government. Madoff couldn’t bring in nearly enough new investors to meet increasing client demand for liquidity from “Bernie’s magical money market.” He realized the game was over and choreographed his “self-whistle-blowing” skillfully.
Time to come clean
“I do not get the sense that Mr. Madoff has done all that he could or told all that he knows,” said District Judge Denny Chin as he sentenced Bernard Madoff to 150 years in prison in June 2008. While Madoff serves his sentence, so far only two others have been found guilty in his scam. His CFO, Frank DiPascali and his accountant David Friehling will be sentenced early in 2010. A couple of other accomplices have been arrested, though still a ridiculously small number given the scope and scale of the fraud. Madoff’s wife, brother and two sons, all involved in the business, claim to have no knowledge of the scheme, asserting unequivocally that they believed all along that they were part of an entirely legitimate business. I suspect that once others start singing, Bernie’s family will not be humming along.
A few special investors, including three who each withdrew billions (not a typo) more than they had invested, are under investigation. They were among those Madoff selected to receive annual returns in excess of 100%, yet they also claimed they had no reason to suspect foul play.
The case against the wealthiest one, Jeff Picower, may wind up drowning in the same pool that he was found in last month. He was 67. The initial report was that he suffered from Parkinson’s, which precipitated the drowning. However, there are 7 billion reasons (corresponding to Picower’s realized profit on an initial investment of a few hundred million) to challenge that conclusion. Incidentally, Picower is not the first high-profile death among Madoff’s “Circle of Trust.” Ten days after the disclosure, Thierry Magon de La Villehuchet, a French investment advisor who funneled over $1.4 billion of client assets into Madoff’s scheme, committed suicide.
Madoff himself will likely die poor, alone and in jail. His precious homes, boats, monogrammed watches, shirts, suits, hunting equipment and personalized baseball jacket have all been sold at auction. One tell-all tale by a former client and mistress even describes his physical endowments as being almost as ephemeral as his financial ones proved to be. Few, if any, will or should feel sorry for him. There have already been hundreds of articles, dozens of books and a few television documentaries about this case.
However, as we approach Chanukah, let’s remember that the holiday miracle was not only finding oil for the eternal flame but also cleaning the Temple of filth, idol worship and other unsavory practices. Similarly, our capital markets are currently undergoing greater scrutiny and, hopefully, will enjoy greater integrity in the years ahead. We should expect remedial self-policing measures by market participants themselves and smarter supervision by the regulatory authorities. Only time will tell how effective these will be, but in any case it's too late for too many of Madoff's victims.
Lyon (Lenny) Roth is a senior executive at an international wealth management firm and a member of Ben Gurion University's Board of Governors.
Published by Globes [online], Israel business news - www.globes-online.com - on December 10, 2009
© Copyright of Globes Publisher Itonut (1983) Ltd. 2009