PicoBlog

Sam Israel is only dubiously “of history,” as the most interesting part of his story happened between 1996 and 2008, and he is still alive. However, he makes up for this deficiency with extra weird.

Dan Davies, author of Lying for Money, describes Sam Israel’s story as Bernie Madoff if it were punched up a bit by Quentin Tarantino. So of course I, a clinical Money Stuff addict, bought Octopus: Sam Israel, the Secret Market, and Wall Street's Wildest Con.

Octopus really wants to be Sam Israel’s ghostwritten memoir: the majority of the book is direct quotes from Israel. But Sam Israel is a self-admitted compulsive liar and was elaborately gaslit for years by a series of con artists, so Guy Lawson’s hand is more obvious than in most books of this nature. Each passage from Sam Israel is followed by Lawson: “that didn’t happen”, “that also didn’t happen”, “that’s elaborate conspiracy gaslighting”, “somehow that actually happened, yeah, it’s weird for me too.”

To be fair to Sam Israel, for a compulsive liar, he did say a remarkable number of things that actually occurred, at least from his perspective. It’s just—let me tell the story.

Sam Israel was born into a rich family of commodities traders. His father made a little of his money by clever trading and a lot of his money by schmoozing with dictators— Idi Amin, Manuel Noriega, Ferdinand Marcos. From childhood, Israel learned that wealth came not from hard work or talent but from contacts with powerful people and a flexible attitude about crimes against humanity.

Sam Israel partied through college and dropped out as soon as he got a job on Wall Street. He wanted to earn his own money as a trader, not to be his father’s man. Israel was good trader when he was winning, a bad trader when he was losing. He used to hide his losing trades in his desk in the hopes that they'd turn around and he wouldn't have to tell anyone.

Sam Israel’s mentor, Freddy Graber, broke the law constantly and with impunity. He constantly bought and sold the same stocks, so that it was difficult to prove insider trading: he bought and sold huge amounts of the stock whether there was news or not! Freddy Graber passed around gossip about his favorite stocks (sometimes even true) to affect the prices. He “painted the tape": he traded to move the stock price, such as by calling in buy orders at eight different brokers and then selling stock to them; when traders noticed the interest and started to buy the stock, he sold more of the stock at the inflated price and mdae a killing.

Brokers paid a kickback to get traders’ business. While originally the kickback covered traders' expenses (office space, telephones, computers), by the time Sam Israel was trading brokers paid for cars, home renovations, concerts, first-class flights gambling trips to Vegas and vacations to Europe.

Perhaps Sam Israel’s most formative moment was his introduction to insider trading. Israel was told to get a suitcase from a guy, using James-Bond-style codewords and without any sort of explanation about what the suitcase was for. On the way back, Israel was stuck in the subway for three hours, and Freddy Graber hit the roof: the suitcase had contained $100,000. Israel didn't know how Wall Street worked or why he was carrying around suitcases of money, but he knew to keep his fucking mouth shut.

From this, Sam Israel’s lesson was reinforced: cleverness and dedication—not to mention actually contributing to the world—were overrated. The way to wealth was knowing the right people and breaking the laws and regulations that bound the little people.

In the early 1990s, Sam Israel worked for a hedge fund with a nice side gig of insider trading. He hired people all around the country to front-run for him and split the proceeds fifty/fifty. His scam was working well, no one was suspicious, and he could have kept it going for a few more years and retired early as a rich man. But that wasn’t enough. Israel was ambitious. He wanted to prove himself a better man than his father.

In 1994, Sam Israel quit his job to start the Bayou Hedge Fund Group. He predicted that quant trading was the way of the future and had developed his own computer program, drawing on quantum physics. This program was allegedly so easy to use that Israel's five-year-old daughter could use it to trade while waiting for her school bus.

Bayou Hedge Fund Group was supposed to be an honest hedge fund. No conflicts of interest. Steady, high-quality, undramatic trading. It had two entities: Bayou Funds, the actual hedge fund, and Bayou Securities, a broker-dealer, which found people for Bayou Funds to trade with. Because Israel wasn’t using an outside broker, he kept the commissions on the trades, which meant that Bayou Funds didn’t need to charge the industry-typical 2% per year fee for the capital. Israel was doing right by his investors. He was an exemplar of probity and integrity in the slimy world of hedge fund trading.

…The first trader Sam Israel tried to hire had been convicted for insider trading and wasn’t legally allowed to trade in the U.S. But, you know. Little details.

Unfortunately, Bayou lost a bunch of money on bad trades. The funniest was the Barrick Gold investment. Sam Israel invested in it on the grounds that it was very corrupt, and everything he’d seen in his life showed him that the more corrupt you were the richer you were. Unfortunately, Israel lost money when the deal was slowed as a result of accusations of… corruption.

The primary problem was that Sam Israel lacked self-discipline. When he lost money, he fiddled the books so that it looked like he’d made a profit. When he earned money, he accurately reported how much money he’d earned—if he didn’t exaggerate so that he would seem like even more of a genius. The gap between how much money Bayou Hedge Fund Group was supposed to have and how much it actually had only grew.

Bayou’s accountant, Dan Marino (no relationship to the American football player), used several strategies to maintain the Ponzi scheme.

At first, he decided to have Bayou Securities forgo the commissions on its trades and rebate the commissions that Bayou Funds had paid—after all, the traders had lost money. The auditors accepted this decision because they were used to broker-dealers overcharging hedge funds, not undercharging them. It looked like members were being helped at Israel's expense as broker-dealer. With commissions rebated, Bayou Funds turned a profit—but Bayou Securities didn't. But Israel owned Bayou Securities, so he didn’t have to tell anyone it was losing money, and it looked like he was a genius.

But Bayou’s losses soon outpaced the amount that could be covered up by not having to pay commissions. Dan Marino founded his own accounting firm and hired himself as Bayou’s auditor. Somehow, no one noticed that the only employee of Bayou’s auditor was Bayou’s accountant.

Dan Marino claimed an enormous amount of money was Due From Brokers, i.e. money Bayou had earned but didn’t have in its possession because it was owed to Bayou by its clearing house. No one read the whole sheet; the list of numbers makes people's eyes glaze over. Marino had all his explanations prepared in case someone noticed. But no one ever did.

The clearing house could have noticed that it was a fraud—for example, they had records showing that Bayou had lost $17.5 million in 2001—but they didn't bother to look, because they were making millions clearing the trades. In 2002, the clearing house was bought by Goldman Sachs, which had higher due-diligence standards. They wanted the documents Dan Marino was sending to investors, which would easily allow them to notice the fraud. Marino delayed the financials for several weeks, then ensured they were delivered on Friday afternoon. He gambled that the person whose desk the financials landed on wouldn’t get around to it on Friday, and then on Monday would start with all the new paperwork that came in over the weekend. By the time they got around to looking at Bayou’s paperwork, it would be overdue, so they’d glance at the paperwork and rubber-stamp it.

It worked, somehow.

Regulators sometimes asked questions. Dan Marino and Sam Israel simply said a bunch of stuff about puts and swaps. The regulators would nod seriously and then agree that it wasn’t fraud, because no one understood puts and swaps, and the regulators didn’t want to admit to not understanding the thing they were supposed to be regulating.

Flush with the success of no one ever looking at his obviously fraudulent financials, Dan Marino grew cocky:

Bayou was more than a fraud, Marino concluded. It was a brilliant business model. By rebating the commissions from the broker-dealer to the hedge fund, Bayou Funds could legitimately claim annual returns of 9 percent after paying salaries and expenses. If Israel was able to make only 1 percent a month as a trader, the fund would report 21 percent annual returns. As long as investors didn’t withdraw their money all at once, Bayou would have the cash flow to maintain itself indefinitely. The only thing that could destroy the fund, Marino believed, was the extremely unlikely event that Bayou’s members would suddenly decide to redeem their investments all at once. But why would they do that with such excellent performance numbers?

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