In the 1970s, new regulation began to allow firms such as Madoff’s to trade more prestigious blue-chip stocks and he began to gain market share in this area. As the decade progressed, Madoff developed a reputation for being a forward-thinker and his firm was one of the pioneers in electronic trading. In fact, Madoff claims that it was he and his brother who laid the foundations for the NASDAQ to be created in 1971 and that he had a defining role in shaping the new exchange. These claims have been countered by others involved in electronic trading at the time who say that Madoff was not involved in creating the NASDAQ at all and actually made his mark in electronic trading later.
Despite this, Bernard L. Madoff Investment Securities was certainly one of the first companies on Wall Street to truly harness technology. The firm specialised in trading over-the-counter with retail brokers, bypassing the exchange specialists using the new trading technology. Soon, Madoff was becoming a big player on Wall Street and began working with huge institutions such as Fidelity and Charles Schwab, and by 1990 executed around 9% of all trades on the NYSE.
Madoff’s stock had risen so high that in the same year he was appointed as Chairman of the NASDAQ and was regarded as the voice of authority on matters surrounding electronic trading, testifying in front of Congress and playing a key role in shaping regulation. Throughout the 1990s, his firm matched his success – growing in size and earning a considerable, honest profit.
The start of the Ponzi
On the 17th floor of 53rd at Third, the office block in New York, which housed Bernard L. Madoff Investment Securities, also resided his other business. Manned by no more than 24 employees, it was from here that Madoff would orchestrate the largest Ponzi scheme in history.
It remains unclear when Madoff began to manage money for clients, due to bad record keeping, yet many speculate that it began in the 1960s. Initially, the operation was small and his investor base largely came from his family and friends throughout the local Jewish community. As time progressed, Madoff’s client list expanded, assisted by his father-in-law, Saul Alpern who channelled him clients. Soon Madoff’s operation had four key clients: New York investors Jeffry Picower and Stanley Chais; Norman Levy, a real estate developer; and Boston clothing manufacturer Carl Shapiro, all of whom over the years would earn a lot of money through Madoff, even more so than Madoff himself.
Just as it remains unclear when Madoff began managing client money, it also remains unclear whether it was ever a legitimate operation. Unsurprisingly, Madoff claims that it was legitimate and that the Ponzi scheme didn’t begin until 1992. He also claimed that he lost a significant amount of money trading that year and rather than coming clean to his investors, he doctored the numbers, hoping that he would eventually recoup the losses.
In an interview with the Financial Times, Madoff highlighted that it was his ego that stopped him coming clean to his investors. “Put yourself in my place. Your whole career you are outside the ‘club’ but then suddenly you have all the big banks – Deutsche Bank, Credit Suisse – all their chairmen, knocking on your door.” Other notable experts on Madoff, including New York Times reporter Diana B. Henriques believe that this story is fabricated and Madoff’s Ponzi had in fact begun long before.
There was nothing particularly special about Madoff’s Ponzi – it worked as all classic schemes did, using money from new investors to pay old investors false returns. What was unique however, was its sheer size and longevity. Traditionally, Ponzi schemes quickly collapse under their own weight, yet Madoff was able to continuously attract new investment and come the end he was ‘managing’ more money than many of the largest institutions on Wall Street.
An exclusive club
So how did Madoff turn a small money management business into the world’s largest scam? The answer, as one might expect because of the size of the scheme, is complex. But the first and vital ingredient was having something to offer to the investor community, in Madoff’s case: steady returns. His investment fund offered returns of around 1% a month, good at the time but not fantastic. But what appealed was that the returns were consistent no matter how volatile the market was. To achieve this, Madoff claimed he was using an investment strategy called ‘split-strike conversion’, a method that saw him investing in a basket of S&P 100 stocks, using a mixture of ‘opportunistic timing’ and a variety of options in order to reduce volatility and in turn limit losses.
In reality, Madoff wasn’t doing anything with the money. He didn’t make any trades and the reports that he sent back to investors were fabricated. Any ‘returns’ were actually paid from new investor’s deposits – and there were plenty of these.
Initially, Madoff’s scheme was run by word of mouth – a friend would tell a friend about their investment and the steady returns, and they would want a slice of the action. But Madoff’s real masterstroke came from his rejections, of even high-wealth investors. In an interview with the New York Times, Jeffery Gural, Chairman of Newmark Knight Frank talked about how he was teased by friends after being turned away by Madoff. “They thought Bernie Madoff was a genius, and that anyone who didn’t give him their money was a fool,” he said. Of course, as Madoff’s scheme gained more notoriety, so did his clients, who invested in Madoff through feeder funds across the world.
The scheme’s appeal was only further reinforced when investors met Madoff in person. As Jerry Reisman, who socialised with Madoff, explained in an interview with the Daily Telegraph: “he moved in some of the best social circles in New York. He worked the best country clubs. He was utterly charming. He was a master at meeting people and creating this aura. People looked at him as a superhero.”
Madoff built up his image even further by working with charities, either as an advisor or by allowing them to invest with him. This not only boosted his legitimacy but by also accepting charities’ money, Madoff gained sticky deposits – which goes some way to explaining the longevity of Madoff’s scheme.