I’m no hedge fund manager, but this much I know: If someone handling my clients’ wealth coaches me on what to say to federal agents, I’m going to suspect the guy is doing something wrong. Bernard Madoff in 2005 instructed executives at his biggest client, Fairfield Greenwich Advisors in Connecticut, on how to handle SEC questions about him. “Obviously, this conversation never took place,” Madoff said in a recorded telephone call that was recently made public.
He told them to tell the SEC he has a “Chinese Wall” between his money management and brokerage businesses, though Fairfield had no way of knowing that. He told them not to mention paperwork “because any time you say you have something in writing they ask for it,” according to a transcript of the phone call.
If that conversation raised the hair on the back of the necks of the two Fairfield managers listening, it didn’t stop them from sending billions of dollars to Madoff (including millions from their own pockets.)
Likewise, you might think someone smart enough to earn a Harvard law degree would be spooked after a trusted adviser warned him that the man investing his clients’ money looks like he is doing something shady, maybe a Ponzi scheme.
SHIPPING FUNDS
Such warnings didn’t stop Harvard-educated Ezra Merkin from shipping billions of dollars of his clients’ funds to Madoff’s care (and not so much of his own.) At least, that is the story as alleged in civil complaints filed against Fairfield in Massachusetts and against Merkin in New York. Seeking restitution for victims, state attorneys general say Merkin and Fairfield’s managers ignored signs Madoff wasn’t what he claimed to be. In both cases they are accused of lying to investors time and time again, on paper and in person, to hide that they were acting as mere cash pipelines to Madoff.
Lawyers for Merkin and Fairfield say the complaints are unfair and untrue, and that may be so. Purely for the sake of argument, let’s say that Attorney General Andrew Cuomo in New York can prove everything his office says about Merkin. Ditto for Massachusetts Attorney General William Galvin about Fairfield.
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CRIMINAL CHARGES?
My question is: Why are these civil lawsuits instead of criminal charges? If these men indeed lied to investors in material ways to keep their business, isn’t that fraud? You can’t get them for making false statements to authorities because hedge funds don’t have any reporting requirements to speak of.
Beyond that, neither Cuomo nor Galvin accuses the fund managers of acting as accomplices to Madoff’s Ponzi scheme. But can we infer they ignored that he may have been crooked and didn’t care?
To make criminal charges stick, prosecutors have to prove the accused meant to cheat people. It isn’t enough to show negligence or neglect of fiduciary duties. It isn’t enough to prove they lied, unless you can show they did it with the specific intent to steal. That means you have to prove they knew what Madoff was doing and helped him do it.
No evidence has emerged the investment managers had that kind of knowledge. Madoff himself said at his plea hearing last month that he lied to everyone. OK, so what if the managers suspected wrongdoing and went out of their way to not find out? That is called “willful blindness” or, in less stilted language, the “ostrich defense.”
If prosecutors can prove the defendants were willfully blind to Madoff’s crimes, it’s as good as proving they knew about them and that puts them closer to a criminal indictment.
That isn’t so easy. As U.S. appeals court Judge Richard Posner wrote in a 1990 case, ostriches “are not merely careless birds. They bury their heads in the sand” to “deliberately avoid acquiring unpleasant knowledge.” To be deliberately blind, you have to take some sort of action to keep yourself ignorant. Otherwise, it’s just negligence — a civil offense, not a criminal one. In Massachusetts, Galvin’s office concluded that Fairfield executives “were blinded by the fees they were earning, did not engage in meaningful due diligence and turned a blind eye to any fact that would have burst their lucrative bubble.”
CRIMINAL BLINDNESS
Failure to investigate suspicions isn’t enough to turn that into criminal blindness. Besides, in the weeks before Madoff’s arrest, Fairfield insiders put $14.8 million of their own money into his funds. You don’t pour money into what you believe to be a rat hole. Cuomo’s suit against Merkin raises more serious questions. It accuses him of telling clients a “panoply of lies” to keep them investing billions of dollars in his Madoff feeder funds while he risked little of his own. In both cases, though, fund managers were a step removed from Madoff. “They were feeding the beast, but they weren’t controlling it,” says Peter J. Henning, a corporate law and white-collar crime professor at Detroit’s Wayne State University. He says it would take a Madoff insider with evidence of direct involvement by fund managers to make a criminal case. At least there is a civil way to make people pay if their negligence and lies cost others everything they had.