Edward Jay Epstein has become the de facto historian of the Madoff scandal. Every time he and I speak, he has found another key to the master Ponzi schemer's evil genius.

There was a time when the Securities and Exchange Commission trusted Madoff absolutely. So he was able to clear two other stock markets by saying that the documents they used in their defense were kosher. Ah, but the rub was that those documents were actually treyf (not kosher) and they had been cooked up by Madoff himself.

So read here.

Madoff’s SEC

By Edward Jay Epstein

Bernie Madoff had become such a trusted advisor to officials of the Securities and Exchange Commission by 1992 that he was able to help them dispose of what appeared to be a possible Ponzi scheme. The problem involved Frank Avellino, a Bronx-born accountant, and his partner Michael Bienes. They had sold $441.9 million worth of unregistered securities to 3100 investors since 1962. Not only did Avellino and Bienes have no license to sell securities, but they had offered a suspiciously high guaranteed annual rate which, in some years, was ten times the banks’ interest rate. Adding to suspicion, they paid vastly different guaranteed rates to different investors. While small investors got a mere 13.5 percent, large investors got up to 20 percent. Such seemingly arbitrary guaranteed rates of returns were reminiscent of the inducement Charles Ponzi used to recruit funds for his eponymously-named swindle in which he paid the “interest” out of new investors’ deposits. The SEC investigators wanted to know how Avellino and Bienes could guarantee such high returns with clockwork regularity over decades. But when the SEC tried to get their data, Avellino wrote the court appointed auditors that he did not keep detailed records since “My experience has taught me not to commit any figures to scrutiny.” He said the SEC did not need his trading data because he had turned over the entire $441.9 million to a single well-established broker, Bernie Madoff, and no money was lost. To prove it he provided the SEC with Madoff’s 1992 account statements, which then Madoff verified and confirmed. Since Madoff had served on SEC advisory panels and been chairman of the NASDAQ exchange, the SEC took this explanation at face value. Since no money was apparently stolen, it resolved the issue by ordering Avellino and Bienes to return the money to investors and fined them $500,000 for their illegal brokerage business. Case closed.

What the SEC did not then know was that all the 1992 records cited by Avellino and verified by Madoff were pure forgeries. They had been produced with invented numbers by Madoff’s organization to further his Ponzi scheme. This crucial information would only emerge in 2009 when Madoff’s deputy Frank DiPascali revealed details of the operation. Nor had the SEC had known then that Madoff had been deeply involved in the money-raising operations from its inception. Indeed, both Madoff and Avellino worked together in the accounting office of Madoff’s father-in-law Sol Alpern until he provided the cash for Madoff to open a brokerage office in 1960. Both Alpern and Avellino then funneled money from investors through Madoff’s brokerage firm. After Alpern retired, Avellino, and Michael Bienes, took over Alpern’s business, changing its name to Avellino and Bienes, and expanded their money-raising business for Madoff. They both became multi-millionaires since Madoff guaranteed them a higher percent than what they were guaranteeing their clients. Even after their company was shut in 1992, much if not all the money, remained with Madoff via front companies.

That Madoff’s name is not even mentioned by the SEC actions against Avellino and Bienes, even though his records were central to the quashing of the case, is an indication of the influence Madoff exerted over those who were supposed to regulate him. How far did his influence go? Consider his effort to get approval in the early 1990s of so-called “pay for flow” which allowed his brokerage arm to pay a legal kickback for orders placed with him by other brokers. Despite staunch protests from the leaders of the New York Stock Exchange (NYSE), he was able to garner SEC approval, which resulted in his corralling almost 10 percent of all the orders on the NYSE (even though he was not even a member of it.) He also was instrumental in getting the SEC to pass an advantageous short-selling rule, which became known on Wall Street appropriately “The Madoff Exception.”
The ability to influence regulators often proceeds from some form of feedback about their agenda and methods. As Madoff’s dealing with the Fairfield Greenwich Group in 2006 demonstrates. The SEC was ten investigating allegations that he was not correctly representing his role as a money-manager with large funds. According to phone records that came to light in a lawsuit filed by the state of Massachusetts, Madoff called two of Fairfield Greenwich’s top executives in Bermuda, telling them this was a “conversation that never took place.” He then laid out a road map of the question that SEC investigators would ask them about their relation with him and the answers that would satisfy them without revealing Madoff’s true role. As for the SEC investigators themselves, he pointed out, “They work for 5 years for the [SEC] Commission and then become a compliance manager at a hedge fund.” The implication clearly was that they had a powerful incentive to be cooperative in this matter since their future lay with hedge funds, not the SEC.

Keeping to the Madoff scenario. The SEC accepted the scripted answers and did not pursue the investigation, indicating Madoff had enough reliable intelligence about the SEC to successfully manipulate their investigations. Such high-value feed-back, which could have come from witting or unwitting sources, would explain how Madoff evaded SEC scrutiny even after it received allegations from analyst Harry Markopolis that he was operating a Ponzi scheme.

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