I did appreciate the fact that they were trapped. They had to have Madoff to compete. No one had a risk-return ratio like Bernie. If you didn’t have him in your portfolio, your returns paled in comparison to those competitors who did. If you were a private banker and a client told you someone he knew had invested with Madoff and was getting 12 percent annually with ultralow volatility, what choice do you have? You’re going to either get Madoff for that client or lose the client to a banker who has him. And Madoff not only made it easy; he made it lucrative. He allowed the feeder funds to earn higher fees than anyone else and always returned a profit.
That was the reason so many European funds gave their millions to him. It was after these meetings that I strongly suspected Madoff was even bigger in Europe than he was in the United States. I estimated the minimum amount of money Bernie had taken out of Europe was $10 billion and in retrospect even that probably was low.
Once I realized how much money he had taken out of Europe—and was continuing to take—there was no longer any doubt in my mind that he wasn’t front-running. This was a Ponzi scheme. If he was front-running he wouldn’t want new money, because it would lower his return on invested capital. The money to pay the investors in his hedge fund would have had to come from investors in his broker-dealership. The more money invested in the fund, the more money he would have been forced to drain from the broker-dealership. Eventually it would have been spotted by some of his more sophisticated customers. And once those investors figured out they were getting bad price fills—which eventually they would have—that business would have declined rapidly, making it impossible for Bernie to continue paying such huge hedge fund fees and returns.
So he wasn’t front-running. For a Ponzi scheme to continue to survive you have to bring in new money faster than it is flowing out, because you’re robbing Peter to pay Paul. The more Pauls you have to pay, the more Peters you need to find. It’s a ravenous monster that needs to be continuously fed. It never stops devouring cash. To me, the amount of money invested with Bernie, and the secrecy he required, were vital pieces of information.
But it became clear to me that the Europeans believed he was front-running—and they took great comfort in it. They thought it was phenomenal because it meant the returns were real and high and consistent and that they were the beneficiaries of it. They certainly didn’t object to it; there was a real sense of entitlement on this level. To them, the fact that he had a seemingly successful broker-dealer arm was tremendously reassuring, because it gave him plenty of opportunity to steal from his brokerage clients and pass the returns on to them. They never bothered to look a little deeper to see if he was cheating other clients—like them, for example. What they didn’t understand was that a great crook cheats everybody. They thought they were too respectable, too important to be cheated. Madoff was useful to them, so they used him.
They were attracted to Bernie like moths to a flame.
Just like the Americans, they knew. They knew. Several people admitted to me, “Well, of course we don’t believe he is really using split-strike conversions. We think he has access to order flow.” It was said with a proverbial wink and a nod—we know what he’s doing. And if the American Madoff got caught, well, c’est la vie. They believed that the worst that could happen was that he could get caught and go to prison for a long, long time; but they would get to keep their ill-gotten returns and would get their principals back because they were offshore investors and the U.S. courts have no legal hold on them.
But for me, the most chilling discovery of this trip was the fact that many of these funds were operating offshore. It was not something that was spoken about; it was just something I picked up in conversation. Offshore funds are known as tax havens, places for people to quietly hide money so governments won’t know about it. It’s a means of avoiding law-enforcement and tax authorities. They’re particularly popular in nations with high tax brackets, like France. While offshore funds certainly can be completely legitimate, to me it indicated that at least some of these funds were handling dirty money, untaxed money.
An offshore fund allows investors from a high-tax jurisdiction to pretend their income is coming from a low- or no-tax jurisdiction. While I have no direct knowledge, I definitely don’t believe that all income from offshore tax havens is eventually declared to the proper government. But what was a lot more frightening to me was the fact that offshore investments are used by some very dangerous people to launder a lot of money. It is common knowledge that offshore funds are used by members of organized crime and the drug cartels that have billions of dollars and no legitimate place to invest them.
For me, that suddenly added a frightening new perspective. It wasn’t just the people in these luxurious offices who were going to be destroyed when Madoff went down; it also was some of the worst people in the world. I was pretty certain the Russian mafia had to be investing through one of those funds. I didn’t know about the Latin American drug cartels, but I knew they went offshore and were probably into Madoff in a big way. Obviously Bernie had to be worried about a lot more than going to jail. These were men who had their own way of dealing with people who zero out their accounts. Maybe Bernie was close to being a billionaire—we had
