The most impressive thing for me, though, was the darkened trading room. Bernie was strict about how much paper you could have on your desk: none. The screens were the first 19-inch IBM 3290 flat gas-plasma models I'd ever seen; the orange hue they cast on the traders' faces was the only bright colour in the room. The machines could display up to four windows of market information at once. I was drooling: This was the business I wanted to emulate.
The trading room also appeared to be the very profitable—and totally legitimate—guts of Madoff's operations. Bernie offered investment advisory and asset management services as well, but those were run separately, and not something DS needed. What we wanted was immediate execution of buy and sell orders for the most popular Nasdaq stocks. Although there were online services that quoted stock prices, you still generally had to phone a broker to do the trade for you. It was a pain in the ass. The market prices could shift quickly, and brokers could make you pay an unfavourable price if they felt like it.
Technically, Madoff was an "off-floor" dealer registered with the National Association of Securities Dealers—the firm didn't have traders on the New York Stock Exchange floor. Bernie and Peter weren't the only game in town in this niche, but they were the best. How did they do it? By capturing much of the spread between the quoted bid price on a stock (the highest a prospective buyer is offering to pay) and the quoted ask or offer price (the lowest a prospective seller says they'll accept).
It worked like this: Prices for major stocks were quoted in fractions of a dollar, often in 1/8ths—increments of 12.5 cents. If a stock was trading around $30, you might see a bid price of 29 7/8 quoted onscreen, and an offer price of 30 1/8. Madoff guaranteed to buy or sell up to 2,000 shares of the most popular Nasdaq stocks at the best quoted price, do it within seconds, and pay a small and entirely legal rebate of one cent a share to a trading client for the transaction.
If DS had a client who ordered us to sell, say, 2,000 shares of something at the market price, Madoff would pay us a $20 rebate for the order, on top of the $29.875 bid price. If, as was usually the case, Madoff got an order from another brokerage within minutes to buy 2,000 shares at market, he would sell them the stock for $30.125. Bernie's take: the spread of 25 cents a share, or $500 on the two orders, minus the $20 rebate on each, for a total of $460, or 0.77% on $60,000. Do a round-trip transaction like that every day for a year, and the return is 279%.
Madoff's brokerage clients, like DS, loved it. We charged our own clients commission on the trades, we were guaranteed the best price fills, and Bernie took the risk—which was that he could quickly rebuy what he sold, and resell what he bought, and do it at a profit. And his operation was totally automated.
In 1993, inspired by Bernie, I co-founded my own online trading business in Toronto called Versus Technologies Inc., which ran E*Trade Canada until it was bought by E*Trade in 2000. I kept in touch with Bernie in the '90s, and I wanted other people in the industry to study his operation, too, to see how electronic trading could enhance market liquidity. He'd raised his maximum buy or sell order for clients to 5,000 shares for Standard & Poor's 500 stocks, and offered the same execution for convertible bonds, preferred shares, warrants and share purchase rights. He'd also expanded his London trading desk.
The fact that Madoff offered so many services, and that Bernie's name was all over everything, gave people confidence. "In an era of faceless organizations," said an online brochure of the firm's at the time, "Bernard Madoff has a personal interest in maintaining an unblemished record of value, fair-dealing and high ethical standards." The pitch also leaned on the family's positions of leadership in industry organizations. Those roles reflected "the respect the firm and its management have achieved in the financial community."
I believed every word, and so did a lot of heavy hitters on Bay Street and Wall Street. I wanted everybody I knew in the business to meet this guy. I flew down to New York for a day along with super securities lawyer Ed Waitzer, during his term as chairman of the Ontario Securities Commission. He wanted to get a better understanding of how the market for trading services was changing. The highlight was a lunch meeting with Bernie and Peter. They answered all Waitzer's questions in detail, including explaining arcane U.S. trading rules that they'd incorporated into their system.
A few months later, I was at the headquarters of Goldman Sachs, near Wall Street, sitting in the office of Bob Steel, then the partner in charge of the firm's equities division. (Subsequently, Steel served as undersecretary of the Treasury for Domestic Finance in the George W. Bush administration, and he was hired by the troubled Wachovia bank last July as CEO.) When I explained Madoff's electronic trading operation to Steel, he didn't believe it could be that sophisticated. He told a handful of his younger trading-wizard partners to check it out. Bernie agreed to a meeting immediately, so we jumped in a town car and were uptown in his boardroom 30 minutes later.
One of the Goldman guys was the then-already-renowned Jacob Goldfield, a brilliant, 30-something Yoda of eccentricity, unshaven and carrying a knapsack on his back. As he walked around Goldman in his stocking feet, I figured that if this physics and Harvard Law School grad could act like that and become a partner, maybe an off-the-wall guy like me could succeed in this business, too. He and Victor Simone, a Goldman pal of mine who was in charge of electronic trading, toured Madoff's trading room together.
By the late 1990s, Madoff was not so cutting-edge. Bernie was now just one of many firms and alternative trading networks offering immediate electronic-order execution. The decisive shift came in 2001, when U.S. markets completed the switch to stock pricing in cents, rather than in fractions of a dollar. Spreads between quoted bid and ask prices that had been 25 cents or more a few years earlier shrank to a penny or less.
I had left E*Trade Canada by then, and was trying to get another automated trading business going. I lost touch with Bernie and his firm for a while, and when I resumed contact, I talked mainly with his sons. They didn't volunteer too much about the firm. None of my friends on the Street knew how they were making money. It's still possible to earn trading profits on a one-cent spread, but it's a grind. I figured Bernie might have a new arbitrage gig going. I didn't know how big his asset management and investment advisory businesses—where the alleged Ponzi scheme was rooted—had become.
I can't remember exactly when Bernie and I last met. It was at a lunch, two or three years ago. No boardroom that day, though, just sandwiches in the ground-floor café of the Lipstick Building. I was there mostly to talk to his son Mark, who was, for a time, on the board of Market Regulation Services Inc., the spun-off enforcement arm of the TSX that regulated Canadian stock markets. I had some gripes about the rules for new Canadian electronic marketplaces. Bernie wasn't his usual talkative self. Even when I probed, all he would say was that everything was fine. I remember thinking that maybe he should retire.
It's always hard to tell from the outside exactly what a money manager is doing—even if a fund submits all its regulatory filings. Some analysts and reporters questioned Madoff's results over the years, but the red flags weren't glaring. Its flagship hedge fund, the $5-billion Fairfield Sentry Ltd., reported not huge returns, but eerily consistent ones—almost always between 1% and 2% a month.
Harry Markopolos, an independent investigator, first contacted the Securities and Exchange Commission about Madoff in 1999. The regulators dismissed Markopolos as a crank, even after he sent them a 19-page memo in 2005 about Madoff, titled "The World's Largest Hedge Fund is a Fraud." At various times, rival money managers also tried to figure out Madoff's strategy, but couldn't. Now we know why: Bernie, it is alleged, was paying off early investors with money from later ones.
Although it was a shock to me, it was not a surprise. The most duplicitous of fraudsters are often charming, intelligent and helpful. I imagine that almost everyone who knew Bernie admired the same thing I did—his quiet confidence. Like him, many fraudsters are also tireless charitable donors. I knew another one in the late '80s and early '90s: Christopher Horne, a top-selling broker at DS. A lot of us wanted to study his apparently super sales techniques. He was active in art circles, and had assembled one of Canada's top collections. But Horne abruptly quit in 1994, and later pleaded guilty to defrauding clients, many of them elderly women, of $7 million (Canadian).
What sense do I make of it all? Three things: First, if something looks too good to be true, it may well be.
Second, if the way a company makes money is opaque, it could be doing something illegal.
Third, beware of excessive charm; and know, too, that prestige is something you can buy as well as earn.
But I hasten to add: There are no sure-fire warning signs telling you someone is a con artist. Up to the last minute, you might want to be just like them, until you find out the truth.
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