Certainly one of the more important things I learned was that the numbers can be deceiving. There is a logic to mathematics, but there is also the underlying human element that must be considered. Numbers can’t lie, but the people who create those numbers can and do. As so many people have learned, forgetting to include human nature in an equation can be devastating. Greg Hryb showed me the value of networking; he helped me build the wide spectrum of friends and associates I was able to call upon during the nine years of our investigation.
I stayed at Darien Capital for three years. One of the people who marketed our products was a woman named Debbi Hootman. Eventually I became friendly with Debbi and her future husband, Tim Ng, who was working at Smith Barney at that time. Eventually Tim recommended me to Dave Fraley, the managing partner at Rampart Investment Management Company, in Boston, who hired me as a derivatives portfolio manager.
Rampart was an eight- or nine-person institutional asset management firm that ran almost nine billion dollars, the majority of it for state pension plans. When I began working there it had a suit-and-tie, kind of starchy New England atmosphere. It exemplified the conservative Wall Street firm. Gradually, though, just like in the industry itself, standards were relaxed and we evolved into a more casual dress-down-Fridays place to do business. It was at Rampart that I began my pursuit of Madoff and my battle with the SEC.
The relentless quest pursued by just about every person working in the financial industry is to discover inefficiencies in the market that can be exploited. It’s sort of like trying to find a small crack in a wall—and then driving a truck through it. At one time, the business of Wall Street consisted almost entirely of selling stocks and bonds; it was a staid, predictable business. Stocks went up; stocks went down. But then some very smart people began developing an array of creative investment products, among them indexed annuities, exchange-traded funds, structured products, and mortgage-backed securities. The business of basic investments became extraordinarily complicated, far too complicated for the casual investor to understand. Every firm in the industry and practically every person in the business had a theory and developed their own niche product in which they became expert. Everybody. These products were created to take advantage of every move the market made. Up, down—that didn’t matter anymore. So rather than simply picking stocks in companies whose names they recognized and whose products they used, investors suddenly had a supermarket of esoteric—meaning sometimes speculative and risky—investment opportunities from which to choose. Rampart’s investment strategy was called the Rampart Options Management System. It’s not important that you understand what we did, but simply that Rampart sold call options against client portfolios in a highly disciplined fashion, which would generate cash flow while reducing the overall risk. We were writing covered calls on big stock portfolios for institutions. It was a strategy that over an entire market cycle increased income while decreasing risk—as long as our client didn’t panic at the top. Unfortunately, as I learned, too many clients panicked right before the market topped and pulled out just before the strategy was about to become highly profitable.
Each summer Rampart would bring in an unpaid intern from a local college and I would mentor him or her. In the summer of 1993 that intern was Neil Chelo, a confident, wiry young man from Bentley College, a business school in Waltham, Massachusetts. Several years later Neil was to become a member of my Madoff team. Neil almost didn’t take the intern job. Although his father encouraged him to work for the experience, telling him that Wall Street people were smart and that if he got down in the trenches with them, eventually he would make a lot of money, his mother was strongly against it. “Be something respectable,” she told him. “Be a doctor or a lawyer.” He pointed out to her that they were Turkish-Albanian, not Jewish. But what really upset her was the fact that her Turkish-Albanian son was going to work for a Greek! She told him, “Oh, my God, Neil. That’s why you’re not getting paid. The Greeks always take advantage of the Turks!”
Of course, as I would occasionally point out to Neil, that’s not exactly the way Greeks interpret the Greek-Turkish relationship.
When Neil began his internship, he assumed he was going to sit down at the trading desk and learn by participating in the business. Instead, I handed him a reading list of about 14 books and told him his job that summer was to read all of them so we could discuss them. Among the books on my list were Market Wizards by Jack Schwager (New York Institute of Finance, 1989); Justin Mamis’s The Nature of Risk (Addison-Wesley, 1991); and Minding Mr. Market (Farrar Straus & Giroux, 1993) by James Grant. My objective was to provide him with the education he wasn’t going to get in an academic curriculum. Although I don’t dislike business schools, I believe half of what they teach students will be obsolete within five years and the other half is just outright false. Generally, they teach formulas that no one uses, case studies that no longer apply in the real world, and concepts that are just going to get people into trouble if they try to apply them. These formulas are an attempt to model the financial world in a simplified form, but they can’t possibly take into account the extraordinary complexity of the markets. It’s important to know these formulas, though; once you’ve mastered them you can begin to make the necessary adjustments for the real world.
Neil spent about half his time
