Calling out Bernard Madoff but falling on deaf ears

By Steven Pearlstein
Friday, June 4, 2010

How can a guy like Bernie Madoff snooker so many wealthy, sophisticated people out of so much money over such a long time?

The following local tale offers at least a partial answer.

From the end of World War II until the early 1990s, the commercial real estate industry in Washington was dominated by a handful of Jewish families. Most of the patriarchs had begun in the construction business, building homes and apartment buildings for Washington's growing army of federal employees. In time, they and their offspring also began developing suburban shopping centers and downtown office buildings.

While some of these clans are well-known, like those of Morris Cafritz, Charles E. Smith and Ted Lerner, others were content to stay out of the limelight -- the Gudelskys, the Cohen brothers, the Abramsons and the Kays, to name a few. They frequently did business with one another, selling land and investing in projects, in many instances sealing deals with only a handshake. They used many of the same local lawyers (Arent Fox, Grossberg, Yochelson and the late Max Ammerman), the same architects (Vlastimil Koubeck and Eddie Weihe) and building contractors (Hyman and Magazine Brothers). And you could often find them having lunch together at Duke Ziebert's, sipping a drink at the High Hat Lounge or playing golf at Woodmont or Indian Springs.

Taking it to committee

Of all the family partnerships, however, perhaps none has been stronger, or more successful, than the one linking the Kaplan, Gewirz and Small families, which together have developed and managed numerous buildings over the years, among them 1700 K St., 4000 Massachusetts Ave. and 1000 Connecticut Ave., the last of which was recently torn down to make way for Arent Fox's new offices. All three Northwest Washington buildings were built by William Magazine's construction firm, which took a minority share in the partnerships that owned the buildings. Over the years, the Magazine partnership's share has been subdivided among children and grandchildren, with a less than 2 percent stake eventually flowing to Ross Magazine. And it is there that this little Madoff story begins.

Late in 2006, Ross recalls hearing from his brother Marc, who represents the family on the management committee for the properties. At a committee meeting, Marc had voiced concern that the reserve funds for the buildings -- which at the time were valued at about $30 million -- were entirely invested with a New York money manager named Bernard Madoff. Marc proposed that the portfolio be diversified, but as he recalled this week, the other committee members rejected the idea, explaining that Madoff had generated great returns for them for many years.

It was then that Marc suggested that Ross, a professional investment adviser, dig further into the Madoff accounts. After reviewing a few documents that were sent to him, Ross had a lengthy and, in his view, unsatisfactory phone call with Edward Kaplan, the partnership's managing director, and then followed up with a four-page letter several weeks later laying out several objections to investing the reserve funds with Madoff.

"When I discussed Madoff's firm with you, you appeared to get defensive," Ross wrote Kaplan in January 2007. "As you told me, he has discretion over the account, and to quote you, 'No one knows how he does what he does.' It is my opinion that in an account of over $15 million [the balance of the reserve fund in one of the buildings] somebody should know how he does what he does."

Motion to dismiss

Among other things Ross found fishy was the "veil of secrecy" around the Madoff operation, particularly the absence of any year-end statements summarizing activity in the account. He found it curious that Madoff's firm did not appear to have an investment advisory service registered with the Securities and Exchange Commission or a Web site for the service. He complained about a fee structure that charged 4 cents per share for every transaction, which he argued gave Madoff an incentive to churn the account while yielding a less-than-stellar return of 6.39 percent in 2005. And he questioned the appropriateness of an investment strategy using risky options trading for an account whose primary purpose should have been preservation of capital.

As it turns out, those were just the right questions.

Ross never got a response and, according to his brother Marc, the committee took no action in response to his letter. In hindsight, the members probably wish they had. For it turns out that members of the Kaplan, Gewirz and Small families had more than just building reserve funds invested with Madoff -- they also lost millions of dollars of their own in the Ponzi scheme, along with money in charitable foundations with which they were associated. Several of them knew Madoff from Palm Beach, Fla., where they have winter residences and, with Madoff, were members of the exclusive Palm Beach Country Club.

So why, with so much of their own money at stake, would they so cavalierly dismiss Ross Magazine's warnings and questions? Ed Kaplan declined to return my phone call this week. But he effectively answered that question in a letter he finally sent to Magazine in February 2009, two months after Madoff was arrested. In it, Kaplan rationalized the board's decision by explaining that Madoff's stated investment strategy was a reasonable one, based on "proprietary techniques" that fooled lots of other wealthy investors. Kaplan also dismissed the significance of Ross's earlier questions, saying they failed to "describe any irregularities or fraudulent activity by Madoff that pointed to the kind of massive fraud that was only recently discovered."

The larger truth may be that Kaplan and other loyal customers had more than money invested with Madoff-- they had their reputations invested, as well. Madoff's genius was tapping into his victims' need to see themselves -- and be seen by others -- as sophisticated and well connected. To have questioned the original decision to invest -- even when there were warnings that something might be amiss -- would have meant questioning those other things as well.

I don't know if, under District law and the original partnership agreement, Ross Magazine is owed any money as a result of the management's committee's careless actions. At his request, an outside lawyer was hired to make a recommendation on that.

What I do know is that he is owed a simple and sincere apology. He's still waiting for that.

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