The clearest look to date of the relationship between Bernard Madoff and his feeder funds, one of which netted hundreds of millions in fees and which authorities say exposed investors to undisclosed risks, is put forth in new court documents filed by the Massachusetts Secretary of State, William Galvin.
One potentially damning accusation made by Galvin was that principals at the Fairfield Greenwich Group discussed among themselves the risk that Madoff would "blow up" and was aware of the gaps in its knowledge of Madoff's operation.
However, Galvin alleges Fairfield did not disclose those concerns to investors. Fairfield Greenwich, founded by Walter Noel, has been accused of fraud by Galvin who says the firm knowingly misrepresented to its investors what it knew about Madoff's operation and asserted it performed a level of due diligence that it did not actually perform.
The court papers detail a December 2005 telephone conversation that allegedly took place between Fairfield executives and Madoff in which Madoff counsels them on how to manage their conversation with the regulators when it comes to describing what they know about Madoff's operation.
Madoff: "Obviously, first of all, this conversation never took place, Mark, OK?"
Amit Vijaygergiya (Fairfield's Chief Risk Officer): "Yes, of course."
Later in the call, according to the court filing, Madoff counsels Vijaygergiya on how to have a discussion with the SEC, "the less you know about how we execute ... the better you are ... your position is, 'listen, Madoff has been in business for 45 years ... a well known broker. We make the assumption that he's doing everything properly.'"
The court papers also cite an internal Fairfield e-mail between a fund manager in the U.S. and one in the U.K. as evidence that Fairfield, at a time when it should have been offering to repay performance fees, instead was continuing "the ruse that they had actually been doing due diligence."
"You mentioned that Fairfield used to get copies of some trades done by Madoff," the e-mail from Manuel Gomez of Fairfield Sigma to a colleague allegedly began. "In order to cover my ass, can I get some copies of those trades. I need to show people who invested in Sigma that I was doing due diligence in what is the largest scam in financial history."
Fairfield Greenwich Group says they will "vigorously contest the allegations" in the complaint.
"The allegations in the complaint brought against FGG by the Massachusetts Securities Division are false and misleading," said a spokesperson for Fairfield Greenwich Group.
"Contrary to the allegations, FGG conducted vigorous and robust monitoring on an ongoing basis of the Madoff investments. This monitoring was consistent with the representations made to investors in the Sentry funds. FGG has fully and completely cooperated with the Mass Securities Division investigation," said the spokersperson. "Unfortunately, Massachusetts has leapt to erroneous conclusions without completing its investigation and without even granting a meeting with FGG in an attempt to arrive at an accurate understanding of the facts."
According to the civil complaint, the SEC relied on Fairfield's representations in determining Madoff's operation was not fraudulent. The court papers state that based on the conversation, Fairfield had to know Madoff was manipulating the SEC regulators.
It also suggested that Fairfield disclosed proprietary investor information to Madoff in an effort to "curry favor." Fairfield "repeatedly gave him proprietary information," the complaint states.
The facts and allegations that Massachusetts says it used to establish its case against the Fairfield Greenwich Group include detailed conversations between Madoff and Fairfield executives, and chilling depositions in which Fairfield executives admit to facts, including that they knew Madoff's multibillion-dollar investment business was audited by a firm with just one accountant.
The filing cites a September 2005 e-mail sent from a client to Fairfield in which the clients asks about the "small accounting firm" used by Madoff investments. "Is that accounting firm checked and approved by Fairfield Greenwich Group?" the client asked.
Fairfield Greenwich knew that Madoff's accounting firm "only had one employee," according to the filing, but the Fairfield's CFO Dan Lipton replied that the firm was "small to medium-sized." "They have hundreds of clients and are well-respected in the local community," Lipton instructed someone at Fairfield to tell the client, according to the filing.
According to Lipton's testimony, he was told by one of the partners at Friehling that their firm was well-respected.
But the filing says the most telling indicator of the "interconnected, co-dependent relationship" came as Madoff's scheme unraveled.
In November and December 2008, Madoff, apparently desperate for funds to shore up his scheme, reversed a long standing policy limiting the amount of money Fairfield could place under his management. And, the court papers state he 'reacted angrily" when he learned that a Fairfield investor sought to cash out significant amounts of assets under Madoff's management.
In response to his anger, Fairfield, instead of questioning his motive, the complaint asserts, redoubled its marketing efforts "to defend against redemptions" and allegedly began to rapidly set up a series of new funds in cooperation with Madoff.
"In the words of Walter Noel, one of Fairfield's founders, 'we tried to help stem things,'" the court papers state. $14.8 million was raised for one of the new vehicles but "no offering documents for that fund ever existed."
The court papers cite a letter from Fairfield's Jeff Tucker to Madoff dated December 10 -- the very day Madoff confessed his crimes to his sons and the same day his wife withdrew about $10 million from another Madoff vehicle, in which Fairfield noted, "We have taken a number of steps with our other funds in order to put all of our investible capital in Sentry and the new split strike strategy which we call Emerald."
"Fairfield violated its fiduciary duties in myriad ways. It, in essence, served as an outside marketing agent for Madoff, as opposed to an independent investment advisor that was looking for an evaluating the best investments for its investors. Fairfield's lack of meaningful due diligence was so glaring that it comes as no surprise that Fairfield did not discover that Madoff's operation was no more than a large Ponzi scheme," the court papers concluded.
The spokesperson for Fairfield said there are many "misleading" aspects of the complaint "which is based on nothing more than 20-20 hindsight that supposes that anyone familiar with Madoff's operations should have determined that it was a Ponzi scheme."
"The SEC, other regulatory agencies and every other investor in Madoff failed to detect his sophisticated fraud. FGG is appalled by the Madoff losses suffered by its investors, including its employees and the three investors who reside in Massachusetts," said the spokesperson.