Madoff Enablers Winked at Suspected Front-Running
Madoff Enablers Winked at Suspected Front-Running

By John Helyar, Katherine Burton and Vernon Silver

Jan. 27 (Bloomberg) -- For Swiss banker Werner Wolfer, the memory of his first encounter with one of Bernard Madoff’s emissaries nine years ago is as clear as the waters of Lake Geneva.

To hear Patrick Littaye talk, the Wall Street money manager could walk on those waters. “It was like a religion,” Wolfer, 57, says of the promise of steady returns, which would be echoed by other acolytes. “These people firmly believed in the story.”

Littaye, 69, was co-founder of New York-based Access International Advisors LLC, one of more than a dozen feeder funds that acted as middlemen between investors and Madoff. Wolfer visited Littaye at his office near the Champs Elysees in Paris in 2000, after becoming chief investment officer at Banque Marcuard Cook & Co. in Geneva, to learn more about how Madoff made his money.

Banque Marcuard, a private bank catering to the wealthy and now part of Swiss lender St. Galler Kantonalbank, had invested about $50 million of its clients’ money directly with Madoff in the mid-1990s on Littaye’s recommendation.

Banque Marcuard made money with Madoff along with its clients. They paid fees based on the profits Madoff reported, which averaged a net of 11 percent a year. There was never a losing year, regardless of whether markets went up or down. The proof was in the trading statements sent to clients every month.

‘It All Looked So Good’

“It all looked so good,” says Wolfer, who has a master’s degree in economics from the University of St. Gallen.

The truth turned out to be something else -- and far more complex than a criminal masterminding a $50 billion Ponzi scheme that bilked investors from Palm Beach to Paris, as Madoff allegedly confessed to doing on Dec. 11.

If the 70-year-old money manager was running a con, then his marketers like Access International, wittingly or not, were part of the scam.

The purported mission of such feeder funds was to vet hedge funds for wealthy clients. Instead, the line between victim and perpetrator was blurred. Middlemen like Littaye funneled billions of dollars to Madoff, even, in some cases, when they suspected he was engaged in questionable trading practices. In return, they reaped hundreds of millions of dollars in client fees.

Lower Returns

Wolfer says he heard of traders trying to replicate the split-strike conversion strategy Madoff told investors he used -- buying shares of large U.S. companies and entering into options contracts to limit the risk -- and getting far lower returns. He also says he heard Littaye and other middlemen talk about how Madoff may have used the knowledge he gained from his market- making firm, New York-based Bernard L. Madoff Investment Securities LLC, to get in and out of stocks ahead of market swings.

That’s front-running, a term usually applied to brokers’ trading for their own account -- and profit -- ahead of clients.

It’s also applicable to Madoff’s purported practice, says Peter Henning, a law professor at Wayne State University in Detroit and a former federal prosecutor.

“Front-running isn’t who’s getting the benefit; it’s who’s paying the price,” says Henning, noting that Madoff’s market- making customers expected the firm to obtain the best price available when buying or selling stocks. Instead, their interests were apparently subordinated to those of Madoff’s investment clients.


While front-running is illegal, it didn’t horrify Madoff’s champions.

“They were convinced that the risk was only that the Securities and Exchange Commission would do something about breaches of the Chinese wall in the Madoff organization,” Wolfer says. In the worst case, he says, “what could be expected was that at a certain point the SEC could say stop.”

Wolfer, who says he doesn’t speak for his former employer, now manages a fund of funds at Geneva-based Banque SCS Alliance, which invested in another Madoff feeder fund, Fairfield Sentry Ltd. He says he handled the risk that Madoff might be front- running by sharing this suspicion with clients who put money into the fund.

“With every year passing, the worries were a little bit less,” Wolfer says.

Other money managers made similar winks and nods about Madoff’s advantage, according to people who were pitched the funds. One Swiss bank, Geneva-based Union Bancaire Privee, which had $700 million invested with Madoff, told clients in a Dec. 17, 2008, letter that “in essence, the perceived edge was Madoff’s ability to gather and process market-order-flow information to time the implementation of the split-strike option strategy.”


Some of those eager to profit from what they thought might be illicit trading must have been surprised to learn that the scheme Madoff said he was engaged in wasn’t front­running.

It was theft.

A spokesman for Union Bancaire Privee says it didn’t believe Madoff was engaged in any fraudulent activity. Littaye, who now runs Access by himself and has not been charged with any wrongdoing, says he lost his own savings. His fund had more than $2 billion invested in Madoff.

“I’m ashamed of my foolishness,” he says.

The alleged crime couldn’t have been pulled off without the participation of dozens of enablers. It was a Ponzi scheme built on the respectability of others.

Raising Funds

Tremont Group Holdings Inc., a fund of funds based in Rye, New York, that had $3.3 billion invested with Madoff, is owned by OppenheimerFunds Inc., a unit of MassMutual Financial Group.

Robert Jaffe, a son-in-law of Carl Shapiro, founder of clothing maker Kay Windsor Inc. and an early Madoff investor, brought in fellow Palm Beach Country Club members.

A key Madoff fundraiser in New York was J. Ezra Merkin, a money manager and synagogue president, who turned over $2.5 billion to Madoff. He tapped his charitable and educational circles, including Yeshiva University, whose investment committee he chaired.

Regulators were ineffectual. Swiss and Luxembourg money managers believed they had made safe investments in the regulated Dublin-based Thema International Fund Plc, only to learn that all of the fund’s $1.1 billion of assets were with Madoff.

The SEC received complaints about Madoff dating back at least to 1999, including an allegation that he was running a Ponzi scheme, and never uncovered a fraud.

‘Where Were the Watchers?’

“Where were the watchers?” asks Sally Kimball, who runs a Palm Beach consignment shop piled high with garments of the nouveaux poor -- among them residents of the Florida resort community who invested their fortunes with Madoff and are now liquidating their closets. “Where were the lawyers and accountants and regulators?”

Fiduciary duty stood no chance against the profit motive. “It was a whole economy unto itself,” says Craig Stein, a Boca Raton, Florida, lawyer who represents two Madoff victims. “There were people all along the line taking a cut of the money going to Madoff.”

The most important middlemen were the feeder funds that enabled Madoff to evolve from a retail asset manager running money for individual clients to a wholesaler managing large pools of capital. At the end, seven of Madoff’s top feeders had a combined $25 billion in assets with him, led by Fairfield Greenwich Group’s $7.5 billion.

New York-based Fairfield Greenwich, which was founded by Walter Noel in 1983 and named after the county and city where he lives, was an international money machine. Its Fairfield Sentry Ltd. fund channeled all of its $7.3 billion in assets to Madoff, taking a cut of 1 percent of the total and 20 percent of the gains each year.

Family Ties

Noel, who declined to comment, built his global business in part on marriage. Three of his five daughters -- who were profiled in a 2002 Vanity Fair piece titled “Golden in Greenwich” --married husbands who took Fairfield Greenwich’s business to far-flung lands.

One husband, Yanko Della Schiava, based in Lugano, Switzerland, was responsible for selling Fairfield’s offshore funds in Southern Europe, according to the firm’s Web site.

Another, Colombian-born Andres Piedrahita, led the European and Latin American businesses, working out of London and Madrid.

The third, Philip Toub, son of Swiss shipping magnate Said Toub, marketed the group’s funds in Brazil and the Middle East.

A fourth son-in-law, Matthew Brown, worked for the firm in New York.

For Madoff, the feeder funds weren’t only a way to gather money. They also enabled him to distance himself from individual investors. He didn’t like to socialize or hustle or answer questions, friends say.

Royal Treatment

The feeders were the gatekeepers, and they qualified for royal treatment. A money manager for a family office recalls accompanying Sonja Kohn, whose Vienna-based Bank Medici AG funneled $3.2 billion to Madoff, to a meeting with Madoff in New York in 1991.

He says Madoff treated her as if she were the Queen of England. The money manager also says Madoff wouldn’t answer any questions about his strategy.

A delegation from Credit Suisse Group AG, led by Oswald Gruebel, then head of private banking, had a similar experience in 2000. Gruebel, whose bank had about $500 million invested in Madoff funds at the time, wanted to know why the firm had an obscure auditor, why Madoff didn’t have a ­third-party custodian hold his clients’ assets and how much money he was running.

After the fifth or sixth query, people who were at the meeting say, Madoff ended the session.

Gruebel’s Warning

“You guys, if you are not happy with the returns you are getting,” he said, “you can take your money.”

Gruebel, 65, who retired as chief executive officer of Credit Suisse in 2007, urged clients to withdraw from Madoff’s funds, according to three people familiar with the matter.

Only about half of the money was taken out, the people say, indicating that many clients preferred Madoff’s returns to Gruebel’s advice.

That’s why it’s hard to weep for some of Madoff’s victims, says James Walsh, author of You Can’t Cheat an Honest Man (Silver Lake, 1998), a study of Ponzi-scheme perpetrators and victims.

“We’ve become a nation of investors, but nobody wants to do the work of applying Benjamin Graham’s analysis tools,” Walsh says, referring to the father of value investing. “They want a genius to give them a shortcut. That’s what made it a target-rich environment for Madoff.”

It’s the same mind-set that’s behind economic bubbles, which are “naturally occurring Ponzi schemes,” says Robert Shiller, a professor of economics at Yale University and author of Irrational Exuberance (Princeton University Press, 2000). Successive waves of investors generate gains for the last wave until the bubble bursts.

Suspending Disbelief

“The essence of a Ponzi scheme is a story that justifies these enthusiasms,” Shiller says, whether the phenomenon is Internet stocks or housing prices or Madoff. “The social feedback loop of other people making money causes people to suspend disbelief.”

Madoff certainly had a good story. A graduate of Hofstra College in Hempstead, New York, he pooled $5,000 saved from working summers as a lifeguard to start a brokerage firm in 1960.

One of his first backers was philanthropist Shapiro, who told the Palm Beach Daily News on Dec. 16 that he gave Madoff, 22 at the time, $100,000 to invest. Shapiro was frustrated as an investor. The stock exchanges were swamped by paperwork then, and orders could take three weeks to execute.

“This kid stood in front of me and said, ‘I can do it in three days,’” Shapiro told the newspaper. “And he did.”

Early Adopter

By the early 1990s, Madoff had established himself as an early adopter of electronic trading and a leading market maker on Wall Street. He served for three years as chairman of the Nasdaq Stock Market.

And he started acquiring the trappings of wealth: houses in Palm Beach and Montauk, on Long Island; apartments on the Upper East Side of Manhattan and the French Riviera; and a 55-foot Rybovich sport-fishing yacht called Bull.

Investors were clamoring to get into his fund. Those who did spread the word.

“Carl Shapiro went from medium rich to big rich,” says Richard Rampell, a Palm Beach accountant. “People said it was because he was in early with Madoff.”

While many who made fortunes off the bull markets of the 1980s and ‘90s courted media attention, Madoff shunned the limelight. He so avoided attention that, until news of the Ponzi scheme broke, his name hadn’t appeared in the Palm Beach Daily News, which chronicles society life, in at least eight years.

Personal Contacts

Instead, his investment business was built on personal contacts in the right crowds, notably Jewish country clubs and charity circles. He preferred to delegate interfacing with prospects and clients to others.

At the Palm Beach Country Club, the liaison was Jaffe, vice president of Cohmad Securities Corp., a New York broker-dealer co-owned by Madoff.

At the Oak Ridge Country Club in Hopkins, Minnesota, where early estimates of members’ losses approached $100 million, the go-between was Michael Engler, a partner at a local securities firm, who died in 1994.

In Los Angeles, it was Stanley Chais, 82, a prominent Jewish philanthropist and investment adviser.

Often, Madoff’s lieutenants would make potential investors cool their heels, according to people familiar with the operation. Supplicants were told they didn’t have enough money or that Madoff’s fund was closed. That only augmented his appeal.

Invitations Needed

“He knew how to play on scarcity,” says Robert Cialdini, a professor of psychology at Arizona State University and author of a book on the subject of influence. “Madoff communicated the exclusivity of membership in his club. You had to be invited in. If you weren’t, you would lose the returns. That overwhelmed any caution people might normally have felt.”

Madoff applied the same principle in the 1990s, as well- heeled investors began flocking to hedge funds.

“I no longer want separate accounts,” he told Sandra Manzke in ‘94, when she was CEO of Tremont, according to people familiar with the firm.

Manzke, 60, had known Madoff since the ‘80s because some of her clients had accounts there. To play the game now, Madoff told her, he needed investors’ cash pooled.

Manzke, now chairman of Maxam Capital Management LLC in Darien, Connecticut, formed a feeder fund called American Masters Broad Market Fund LP. Robert Schulman, who joined the firm in 1994, became Madoff’s point man.

Offshore Fund

Tremont teamed up with London-based investment firm FIM Advisers LLP to provide clients with an offshore fund, Hamilton, Bermuda-based Kingate Global Fund Ltd. FIM, run by Federico Ceretti and Carlo Grosso, took over the sole marketing of Kingate in 2005.

It invested $3.5 billion with Madoff on behalf of clients, including Bilbao, Spain-based Banco Bilbao Vizcaya Argentaria SA, Milan-based UniCredit SpA’s Pioneer Alternative Investments unit and Union Bancaire Privee.

Kingate funds represented about 70 percent of the money overseen by FIM, which collected annual fees equal to 1.5 percent of assets, plus an initial payment of 5 percent.

Tremont invested 57 percent of its clients’ money, about $3.3 billion, and took 2 percent of assets.

Fairfield Greenwich put 53 percent of its assets into Madoff’s hands and charged clients 20 percent of profits; it added a 1 percent management fee in October 2004.

Ceretti, Grosso and Schulman declined to comment, and Manzke didn’t return calls.

Where Money Went

The feeder funds became Madoff’s ad hoc sales force. The payoff was the steady flow of fees. Every billion dollars invested in Madoff generated $150 million in paper profits a year for clients, based on a 15 percent return.

If a fund charged its clients 1 percent of the assets under management and 20 percent of the gains, as the largest one did, that translated into $41 million in annual fees.

Assuming Madoff didn’t do any investing on behalf of his clients, as investigators now suspect, the feeder funds were, in effect, being paid out of principal, which would have been depleted after 15 years.

In other words, much of the money invested in Madoff through feeder funds wound up in the pockets of fund managers.

Geneva was a fertile source of business because Swiss bankers were further rewarded with so-called retrocession fees. The feeder funds would make legal payments of 0.5-1.5 percent to the bankers from the client fees they collected to compensate them for steering money to the funds.

Expanding Outside U.S.

Clients of Credit Suisse now face losses of about $1 billion, even though the bank pared back exposure after the meeting between Gruebel and Madoff. Across Europe, banks had reported $12 billion in losses as of early January.

As distributors of Madoff funds expanded their reach outside the U.S., they went beyond their traditional base of wealthy individuals by repackaging the investments for smaller retail clients.

In 2006, a banking arm of Tokyo-based Nomura Securities Co., Japan’s biggest brokerage, issued certificates that tracked the performance of Fairfield Sentry, the Fairfield Greenwich fund that channeled most of its money to Madoff, according to a promotional brochure published online by a Nomura derivatives unit and Zurich-based asset manager NPB New Private Bank Ltd.

European Clients

NPB acted as the sponsor of the certificates, selling them to clients, mostly in Europe, the brochure says.

The Fairfield Sigma 3X Leveraged Certificates cost 10,000 euros ($12,900) each and included a loan that magnified the potential returns or losses. For each 10,000 euro certificate, investors had 30,000 euros riding on the fund’s performance.

Nomura spokeswoman Nicola Scola in London declined to comment beyond the company’s Dec. 15 statement that the bank had exposure to Madoff equivalent to about $300 million.

“We regard this as nonmaterial considering our capital base,” the bank said.

In 2007, Paris-based BNP Paribas SA produced and issued for Bank Medici a tracking certificate to replicate the performance of the bank’s Herald USA Absolute Return Fund, according to a document on BNP’s German-language Web site.

The certificates let people bet as little as 100 euros on the Madoff-invested fund. Bank Medici’s Herald funds invested all of their $2.1 billion with Madoff, the bank said in a Dec. 16 statement.

The bank charged clients an upfront fee of about 5 percent, plus 2 percent of assets and 10 percent of profits.

Meeting With Kohn

Some bankers had their doubts. Glenn Gramolini, a Geneva- based asset manager with Themis MN Fund Plc, which has about 20 million pounds ($27 million) under management, recalls his first visit in the mid-1990s from Bank Medici’s Kohn.

She explained Madoff’s split-strike strategy, he says, and then reported that as one of the biggest market makers -- claiming to handle 10-20 percent of New York Stock Exchange order flow at the time -- Madoff had an edge.

“She was very pushy but very convinced and very confident,” Gramolini says. “It looked to me at the time that she already had a very strong financial interest in it.”

In 2002, Gramolini decided to invest about 3 percent of his assets under management in Bank Medici’s Dublin-based Thema International Fund.

It seemed like a safe bet: The fund was registered as a UCITS (Under­takings for Collective Investment in Transferable Securities) vehicle, which made it subject to European Union regulation. London-based HSBC Holdings Plc, Europe’s biggest bank, was custodian of the fund’s $1.1 billion in assets.

Madoff Role Hidden

Gramolini learned too late that it was all managed by Madoff. “Nowhere in the prospectus was it written that the funds would be handed to Madoff,” he says. Bank Medici spokeswoman Nicole Baeck-Knapp declined to comment.

That was the Madoff universe, where regulators vanished and investors didn’t care. An executive at a fund of funds that invested in Kingate says he once examined Madoff’s trading records to see whether they reflected the stocks’ publicly reported activity. He found Madoff consistently bought stocks at their lows and sold them at their highs.

The executive, who wouldn’t be identified, says he reported back to his boss that he thought Madoff was front-running his clients. He says the boss’s reply was “Yeah, so what? That’s his edge.”

Investors also assumed that Madoff used their capital to fund his brokerage operation because he told them he didn’t have any debt and that he made his money from markups on stock prices, known as the trading spread. Funding a brokerage business with clients’ money is legal as long as it’s disclosed, Wayne State’s Henning says.

Debt Free?

“The only time I was in debt was when I borrowed $50,000 from my wife’s parents to start my own firm, and I paid that back,” Madoff told Credit Suisse and Fairfield Greenwich executives in 2002, according to a person who attended the meeting. “I’ve got a stronger balance sheet than 95 percent of the investment banks.”

Madoff’s sweet business model -- if it ever was his business model -- started to sour in 1996.

That’s when the U.S. Justice Department forced market makers to change their pricing structure to settle an antitrust suit that alleged they were colluding with brokers to inflate investors’ trading costs and thus their own profits. The settlement narrowed trading spreads.

Profit margins were shaved again in 2000, when stock exchanges shifted from calibrating shares by fractions to decimals. Before decimalization, stock prices moved in increments of 116 of a dollar, or about 6 cents.

Stature Diminished

After, they traded in penny increments, meaning the ability to make money on the spread between the bid and the ask price was diminished. According to New York Stock Exchange data, net profit for all exchange specialists dropped to $166 million in 2005 from $708 million in 2000.

Madoff’s stature in that business also declined. The firm described itself in a 1999 press release as a “leading market maker” in more than 200 Nasdaq stocks. In 2005, it was handling just 0.5 percent of Nasdaq trading volume, according to exchange records.

Top-ranked firms like Citadel Derivatives Group LLC, Goldman Sachs Group Inc. and Knight Capital Group Inc. handled about 5 percent each.

As fast as that business was running off, Madoff was piling up investment assets. The growth of Fairfield Greenwich is a good proxy. In 2000, the feeder fund had about $3 billion of assets; by 2008, it had $7.5 billion.

Proprietary Trading

Madoff suggested, during an October 2007 roundtable discussion at the Philoctetes Center for the Multidisciplinary Study of the Imagination in New York, that he had gone into proprietary trading.

“Today, the big money on Wall Street is made by taking risks, and firms were driven into that business, including us,” he said. “If you couldn’t make money charging commissions, people said, ‘I might as well risk my own capital and trade.’”

If Madoff was trading the firm’s own money, that doesn’t explain what he was doing with his clients’ assets. Investigators at the Financial Industry Regulatory Authority say they have been unable to find evidence that Madoff made any trades through his brokerage with funds he had raised as an investment adviser.

“Our examinations showed no evidence of the Madoff broker- dealer executing trades for the investment adviser or any customer account statements being issued by the broker-dealer,” says Herb Perone, a spokesman for the regulatory group.

Roots of Ponzi Scheme

Just when the alleged Ponzi scheme began remains a mystery. Harry Markopolos, a former money manager based in Boston, started complaining to the SEC in 2000 that Madoff was either front- running his clients’ money or operating a Ponzi scheme.

In a 19-page document sent to the SEC in November 2005, he argued that it was impossible for Madoff’s firm to collect as much money as it did from feeder funds and still execute his stated split-strike strategy.

SEC investigators focused on the front-running theory and, after encountering obstacles, didn’t finish verifying trades Madoff claimed were for the clients of his advisory business, a person familiar with the case said in December. The investigation ended there.

Whenever the alleged scheme began, there was no exit strategy for the man behind the curtain. In December, Madoff told one of his two sons that he was struggling to meet redemption requests from clients for about $7 billion, according to a U.S. attorney’s complaint.

Madoff’s Confession

Not even a $250 million investment on Dec. 1 by Shapiro could help. On Dec. 9, Madoff confessed to his sons, Andrew and Mark, both of whom worked at Madoff Investment Securities, that his business was “a giant Ponzi scheme” and that losses could exceed $50 billion, said Martin Flumenbaum, an attorney for the sons, who have not been charged.

Two days later, Madoff was arrested.

For those who enabled what may be the biggest financial crime of all time, things are getting uncomfortable. New York Attorney General Andrew Cuomo subpoenaed Merkin, the New York fund manager who invested with Madoff, as part of an investigation of alleged charity fraud.

Massachusetts officials subpoenaed Jaffe for questioning about Cohmad. A judge said yesterday he must appear before state securities investigators before Feb. 6.

The Financial Services Authority, Britain’s financial regulator, is investigating the feeder funds it regulates, including Fairfield Greenwich’s and FIM’s, people with knowledge of the case say.

Investors Sue

Chais’s Brighton Co.; Bank Medici, which was taken over by Austrian regulators; Fairfield Greenwich; Merkin’s funds; and Tremont have all been sued by investors claiming the firms should have known better than to invest with Madoff.

The fallout isn’t only legal. Merkin resigned as chairman of Detroit-based auto financing company GMAC LLC and from Yeshiva’s board. Littaye of Access International says he expects to lose his house in Saint-Malo, France. His business partner, Thierry Magon de la Villehuchet, 65, was found dead in his New York office on Dec. 23, an apparent suicide.

Madoff’s recruiters say they were duped. Shapiro, who faces losses of $545 million, says through spokesman Elliot Sloane that he felt “betrayed.”

Jaffe says through his spokesman, attorney Stanley Arkin, that he was a victim of a “despicable fraud.”

Chais and Tremont Holdings say they were victims too.

In a note e-mailed to Bloomberg News on Jan. 14, Kohn wrote that she was not a personal friend of Madoff’s.

‘Unbearable’ Pain

“Having fallen victim to a company supervised by a U.S. regulator, as did many of the world’s most illustrious financial institutions, does not ease the pain,” she wrote. “Reading that some voices believe that I should have known better makes the pain even more unbearable.”

Jeffrey Tucker, a founding partner of Fairfield Greenwich, struck a similar note. In a Dec. 12 statement to clients, he wrote, “We are shocked and appalled by the news.”

Meanwhile, Madoff remains under house arrest in his Manhattan penthouse, where he lives with his wife, Ruth. Prosecutors tried to have his $10 million bail revoked because he sent $1 million worth of watches and jewelry to relatives after his assets were frozen. The motions failed. A trial, if there ever is one, remains months away.

Investigators say it could take that long to figure out what happened. For Madoff’s enablers and victims, that means the fight to assign blame -- and to distribute what few assets remain -- could drag on even longer.

-- With reporting by Cynthia Cotts, Saijel Kishan, Edgar Ortega and David Scheer in New York; Tom Cahill in London; Matthias Wabl in Vienna; and Alan Katz in Paris. Editors: Robert Friedman, Laura Colby.

To contact the reporters on this story: John Helyar in Atlanta; Katherine Burton in New York at
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