FBI Arrests AS/400 Programmers in Madoff Scheme
November 16, 2009 Alex Woodie
The FBI on Friday arrested two programmers who allegedly created the AS/400 applications that generated the fake account statements that helped conceal Bernie Madoff’s $65 billion Ponzi scheme from victims and authorities for nearly two decades. The programmers, who started working for Madoff in the early 1990s, face up to 30 years in prison if convicted. Also, a new report uncovers more details about the programs, processes, and personnel involved with the AS/400 at the heart of Madoff’s scam.
Jerome O’Hara, 46, of Malverne, New York, and George Perez, 43, of East Brunswick, New Jersey, were arrested at their homes Friday (November 13) and arraigned before a U.S. magistrate judge in Manhattan on charges of conspiracy, falsifying books and records of a broker-dealer, and falsifying the books and records of an investment advisor. The Security and Exchange Commission (SEC) also brought parallel civil charges against the two in federal court.
“Jerome O’Hara and George Perez allegedly helped construct Bernie Madoff’s house of cards,” stated United States Attorney Preet Bharara. “The computer codes and random algorithms they allegedly designed served to deceive investors and regulators and concealed Madoff’s crimes. Today they have been charged for their roles in Madoff’s epic fraud, and the investigation remains ongoing.”
From ‘House 17’ to the Big House
Generating authentic-looking but fake client statements from the Bernard L. Madoff Investment Securities (BLMIS) AS/400 known as “House 17” was just a small part of the fraudulent work that O’Hara and Perez allegedly did. According to officials, the programmers were instrumental in creating a range of fraudulent reports and documents with the sole aim of concealing the giant heist that was BLMIS’ main goal.
Much of this deception was ad hoc in nature, and aimed at throwing investigations awry. For example, the U.S. Attorney says that the SEC reviewed BLMIS at least five times between 2004 and 2008. During these reviews, O’Hara and Perez were ordered by Frank DiPascali, the finance chief of BLMIS and Madoff’s right-hand man, to create books and records for a small subset of BLMIS clients to help hide the Ponzi scheme. (DiPascali pled guilty to fraud earlier this year and is in prison awaiting sentencing in 2010.)
The programming pair is also accused of changing the names of account holders to explain to the SEC why they couldn’t find investment advisory client securities held in custody at the Depository Trust Co. Reviews by an unnamed European accounting firm in 2008 met similar chicanery, according to the complaint.
The duo’s AS/400 expertise came in handy in a number of different ways for Madoff and his scheme. The U.S. Attorney says algorithms created by O’Hara and Perez were responsible for generating random results on the daily “trade blotters” that investment firms like BLMIS are required to submit to the SEC. They are also accused of creating fake order entry and execution reports, and fake commission reports, and fake reports for European authorities.
And when O’Hara and Perez tried to leave BLMIS in 2006, Madoff bribed them to stay and continue to help perpetrate the Ponzi scheme. Officials say that, following their work in deceiving an SEC review, one or both of them attempted to delete more than 200 “special programs” on House 17, and withdraw hundreds of thousands of dollars from their own accounts with BLMIS.
The FBI says it found a handwritten letter in O’Hara’s desk that said: “I won’t lie any longer. Next time, I say ‘ask Frank [DiPascali].'” But when Madoff got word of this, he ordered DiPascali to give them 25 percent raises and $60,000 bonuses, officials say.
Unmasking a Fraud
The arrest of the programmers allegedly at the heart of Madoff’s scheme came just two weeks after an investigative news report was published that shed previously undisclosed details on how Madoff pulled off the scam of the century. The details were published in a November 2 Securities Industry News report by John Dodge, titled How Bernie Made Basket Cases of His Customers’ Accounts.
According to Dodge’s report and court documents, BLMIS ran two AS/400s. A system called “House 5” located on the 18th floor of Madoff’s firm was involved in legitimate business. On the infamous 17th floor was “House 17,” the AS/400 that was the heart of Madoff’s giant scheme. BLMIS also ran Windows-based systems that were used by “younger traders who wanted familiar software instead of the rigid green screen system,” Dodge writes.
The real “market making” work done on House 5 helped to mask the crimes being perpetrated on House 17, according to a filing by Joseph Looby, an accounting forensics expert that’s been hired by Irving Picard, the court-appointed trustee in charge of liquidating Madoff’s remaining assets. Looby’s revealing 257-page declaration can be located at www.madofftrustee.com.
According to Looby’s declaration, “[House 17] was a closed system, separate and distinct from any computer system utilized by the other BLMIS business units; consistent with one designed to mass produce fictitious customer statements,” the report says. “House 17’s expressed purpose was to maintain phony records and crank out millions of phony IRS 1099s on capital gains and dividends, trade confirmations, management reports and customer statements.”
BLMIS was reportedly employing something called a “split strike conversion” strategy to make money for most of his clients. However, instead of actually investing money in stocks or bonds, investor money was diverted to a J.P. Morgan bank account, where it was used to pay withdrawals from Madoff’s Ponzi scheme, to pay employees, and to enrich Madoff family members. While real stock data was used in perpetrating the fraud, the fictitious stock trades were assigned a value after the markets closed, according to Looby.
Under DiPascali’s direction, the basket program would be modified to generate the fake proceeds. Each basket could be replicated to thousands of customers, and used to quickly create official-looking client statements that were filled with fake information.
Securities (Fraud) Through Obscurity
According to Dodge’s report, the obscurity of the AS/400 was critical in helping Madoff to conceal the scheme for such a long time.
“The statements were always perfect, neat and immaculately presented. They came on time and everything was like clockwork,” Sue Ambrosino, a victim of Madoff, was quoted as saying in Securities Industry News.
Dodge also interviewed Bob McMahon, a former BLMIS employee who now works at the banking services company Fiserv, which is a big Power Systems partner and user. McMahon, who worked for Madoff for only a short time, says it didn’t make any sense for a firm the size of BLMIS to employ so many IT personnel.
He also questioned why they were using relatively old technology. “[If] technologists’ replaced the proprietary systems with more modern and open computers, they would have invariably found the absence of data on countless stock trades that supposedly took place,” Dodge paraphrased McMahon as saying.
Dodge concludes: “The preservation of old computer technology helped Madoff successfully go undetected for years until his massive Ponzi scheme collapsed.”