Fortune by Dave Kansas - January 17, 2009
Heartland families lost hundreds of millions of dollars. How the scandal stunned a community that doesn't even like to talk about money.
MINNEAPOLIS (Fortune) -- Tucked into the rolling hills of Hopkins, a suburb west of Minneapolis, the recently refurbished Oak Ridge Country Club looks much like a middle school: beige paneling, a limestone base, and energy-efficient windows. Along the main road to the club is a modest apartment complex with four signs advertising units for rent. Beyond Oak Ridge's modest doors, however, is a well-appointed interior that provides a gathering place for some of the wealthier families in the Twin Cities. In Minnesota's warm summers the club's golf course, tennis courts, and playground bustle with prosperity, but this winter, with the grounds buried in snow, the conversation at Oak Ridge has turned as grim as the weather. Typically at such clubs, members swap tips and ideas. People you golf with, after all, are usually people you trust. And for more than 20 years some of the members have enthusiastically shared one notable financial strategy: investing with Bernard L. Madoff. The predominantly Jewish country club, which dates back to 1921, is the hub of the scandal in the Cities. While fraud victims in Manhattan, Palm Beach, Hollywood, and European cities have grabbed the headlines, Madoff's alleged $50 billion Ponzi scheme reached other towns as well. He had a particularly painful impact on the Cities, where his method of preying on Jewish families and foundations was highly effective in this close-knit and long-established community.
While some regional reports put the losses at $300 million, a local attorney working with victims believes $600 million is a more accurate number. He knows of two families who lost a total of more than $130 million. Dozens of other families lost smaller amounts, representing everything from children's college savings to retirement accounts, while local Jewish-funded philanthropies find themselves scrambling to pay for basic core missions for the poor. As a native of St. Paul, I returned to find my hometown stunned to be a victim of this kind of crime. I know it as a place of quiet money and conservative investors, where the banks rarely need bailouts and the great fortunes created by the likes of Pillsbury, General Mills, and Cargill keep a low profile. But financial scandal has rocked the Twin Cities twice in one season. By a strange coincidence, just two months before the Madoff case broke open, the celebrated local tycoon Tom Petters was arrested and charged with 20 felony counts for his own alleged Ponzi scheme in which he took $3.5 billion from investors. His tactics, in part, were similar to Madoff's, prosecutors allege: He preyed on a religious community, in this case members of his own evangelical Christian faith.
Madoff, operating remotely from Manhattan, developed a network of local feeders to steer business his way, and in the Twin Cities he had a good one: Mike Engler, an unassuming stockbroker. Engler, as part of Engler & Budd securities, backed small, local stocks that traded on the more obscure edges of the financial markets, making him as different from the posh and powerful Madoff as Minneapolis is from Manhattan. Engler began his work in the 1980s, steering families into the machine with promises of sterling but not spectacular investment performance - usually returns of around 12% per year. The Oak Ridge Country Club, whose online history says it was founded for everyone in town "who knew the difference between a golf ball and a matzo ball," was fertile ground for Engler. Madoff investors became like a club within a club. "The illusion was created that Bernard had to pick you to be in there," Minneapolis asset manager John Pohlad told the St. Paul Pioneer Press. "Madoff was one of the most difficult to compete against because he had so much momentum and mystique about him." Even after Engler's death in 1994, the money kept flowing to Madoff as estate lawyers and financial advisors kept up the tradition and families extended their participation, adding new generations to the mill. Besides soaking members of the Oak Ridge Country Club, Madoff worked the other side of the Mississippi river too, attracting a smaller following at Hillcrest Country Club, a predominantly Jewish golf course in St. Paul.
'A safe and conservative investment'
Bruce Graybow, president of Graybow Communications in the Minneapolis suburb of Golden Valley, became familiar with Madoff through Graybow's late father, Marvin, who had regarded Engler as an "honorable" and "trusted" family friend, Graybow told Fortune. After his father sold the family's plumbing and heating business, the family poured that money into Madoff's firm. Bruce built his own business, which provides corporate audio-visual systems, and eventually sold a chunk of it in 2007. As his father and friends had done, he placed most of the proceeds with Madoff.
"I saw this as a safe and conservative investment, a good place to put my discretionary savings," says Graybow. "When I found out what happened, I was shocked and in absolute disbelief." He also felt physically ill and went into a cold sweat. "I put on my coat, and I walked to my friend's house down the street to gather my thoughts and sort things out." The losses have affected people of much smaller means. One woman had kept her ties to Madoff secret for more than a decade. She was a mistress of a rich and powerful man in the Twin Cities. After a chance meeting in a park, they began a relationship that lasted nearly 20 years and included a promise that he would always take care of her. Once every quarter, a check from a Swiss bank account that included the name of Madoff's securities firm arrived in her mailbox. She moved into a new apartment, got a nice car, and like many associated with Madoff, gave away some of the money to charities and favored causes. She had a habit of reading the New York Times to keep track of the world she had intersected with in secret. Even after the man's death a few years ago, the checks continued to arrive on schedule. "Then one morning I pick up the Times, and there's Bernie," she recalls. "What's he doing in the paper? I read the article and realized that my life was over." Now she is struggling to find a way to survive, relying heavily on the generosity of friends. The check scheduled for the first week of January didn't arrive, as she expected, and her car has been repossessed.
Just as the Madoff scandal devastated charities on the coasts, including foundations associated with Elie Wiesel and Stephen Spielberg, it hit hard in the Twin Cities, which are notably proud of their philanthropy. The impact of Madoff's machinations can be seen down to the street level. "As difficult as this tragedy is for some families, it's the loss to the poor and to the charitable programs in the Cities that is even worse," said Andy Parker, an attorney who represents some Madoff victims. Human-rights activism, a Minnesota passion that ranges from voting-rights efforts to campaigns aimed at shutting down the military prison at Guantánamo Bay, has been set back by the scandal. "A lot of money has just disappeared. It's beyond shocking, the widespread damage that has resulted from this behavior," said Barbara Frey, director of the human rights program at the University of Minnesota. "Local charities played a strong role in funding this work, and a lot of them are all of a sudden out of cash."
Many of their supporters find themselves in the position of Violet Werner, a member of the Oak Ridge Country Club whose late husband owned a trucking company and set up a small foundation to support local arts and cultural groups. The foundation had $1.6 million in assets, much of it invested with Madoff. "The whole thing is just the most horrible scam I've ever heard of," she told the Minneapolis Star Tribune. "This money went to help people in need, and to people who do wonderful work. I'm so sad I can hardly speak." Among the Minnesotans absorbing the news were workaday people who most likely had never heard of Madoff. One company, Upsher-Smith Laboratories in suburban Maple Grove, a generic-drug company with 650 employees, placed some of its profit-sharing programs for its employees with Madoff. These Upsher-Smith accounts, which reportedly had built up to more than $100,000 for some workers, were frozen when the Madoff scandal came to light. A representative of Upsher-Smith declined to comment. Even the state government is concerned about Madoff's impact. Because of the allegedly fraudulent nature of returns associated with Madoff, many investors will have the right to reclaim taxes paid on phantom gains at the state and federal level. Given the parlous state of the economy, governments are already scrambling for tax revenue. For a state like Minnesota, the highly localized impact of the losses and the potential for refunds on taxes paid by investors in both the Madoff and Petters cases could have significant consequences.
How is it that the Twin Cities found themselves sharing headline space with Palm Beach and Hollywood? While one seldom sees a Rolls-Royce or other public displays of wealth, the Cities have no small number of rich families. Older money associated with James J. Hill's Great Northern Railroad and the Weyerhaeuser timber fortune clustered around St. Paul. In Minneapolis descendants of the early grain millers and grain traders held sway. This money moved quietly in the shadows, seldom drawing much attention to itself. The wealthy who came later, including the Jewish community, also embraced the understated approach to money. Since the Twin Cities aren't particularly large, some families preferred to invest with money managers in New York or Chicago. "That made it less likely that you'd run into someone at a dinner party or other social function who knew exactly how rich you might be," said an attorney representing local victims.
Under the radar
For Jewish Minnesotans, conforming to the quiet-money standards of the Twin Cities had another benefit: It kept latent anti-Semitism at bay. The Jewish population, despite its relatively small size of about 50,000, or 1% of the total, has had a large impact on philanthropy and politics in Minnesota. Al Franken and Norm Coleman, the two candidates in November's senate race, are both Jewish. Despite this public-sector success, fear of a backlash has always lingered, especially since the Twin Cities were not a welcoming place for Jews as recently as the postwar era. In 1946 progressive author Carey McWilliams called Minneapolis the "capital of anti-Semitism in the United states." Indeed, many Jewish families have expressed alarm that the Madoff scandal will evoke darker thoughts. "There's always some anti-Semitism, and [the scandal] becomes fodder for those gristmills," says Harlan Jacobs, who runs a small-company investment incubator in the Twin Cities and is past president of the local Jewish Community Relations Council. "People who hate will hate, and this unfortunately will give them more excuses to do so." Members of Oak Ridge, meanwhile, have worried that the scandal might threaten the future of their 88-year-old club. Speculation reached such a pitch that club president Rom Zamansky, a Minneapolis attorney, sent a note to members saying that the club would pull through fine. In that letter he extolled the charitable work of Oak Ridge members and admonished members not to talk to the media about Madoff.
Most Jewish houses of worship are already struggling financially amid the economic downturn, and the Madoff situation could make things tougher in the near term. But some rabbis have sought to turn the Madoff scandal into a teaching moment. Not far from Oak Ridge, at the Beth El Synagogue in the Minneapolis suburb of St. Louis Park, Rabbi Alexander Davis maintains an optimistic mien. He acknowledges that people are shocked and that some feel the scandal has brought shame to the Jewish community. At the same time, he feels this is a chance to get a spiritual message across. "It's definitely an opportunity, whether we wanted it or not, to rethink our values," says Davis. "We need to examine the cultural norms that allowed us to get into this situation. There's an opportunity to reorganize our thinking so that it better reflects our priorities." In a letter to his members during Hanukkah in December, he decried Madoff as one who would steal from his own people. "This year the lights of may seem dimmer, the gifts may be fewer," he wrote. "But the message of Hanukkah continues to shine forth brightly. We will not allow Madoff - the Grinch who stole Hanukkah - to dampen the message of Hanukkah. For the light of Hanukkah is not the sparkle of gelt but the spirit of god."
What about the laws of men - can they provide for any recourse to the alleged Madoff sins? Alas, attorneys representing victims are finding it hard to unlock the Madoff puzzle. Some prominent class-action attorneys see no real path to recover lost investments. "He cut a fairly large swath through here, and it's a terrible, awful tragedy," said Karl Cambronne, an attorney in Minneapolis at Chestnut & Brooks. "But as we look at the details, we just can't see anything we can do to help." One reason that locals are so reticent is that not a small number, like the mistress who spoke to Fortune, received funds throughout the alleged scam. Foundations regularly drew down from their endowments invested with Madoff. The potential for "clawbacks," or litigation to wrest money from those who got cash out of Madoff before the scandal surfaced, remains high. Local attorneys are still scrambling to find some angle to recoup losses. The hunt includes a search for potential fiduciaries, those who might have offered enough advice to bear some responsibility for the failed investments. But many lawyers are skeptical about finding a successful legal strategy beyond the standard bankruptcy path and possible recovery of some assets via the Securities Investor Protection Corp.
Graybow, the communications entrepreneur and victim, is particularly incensed that the government failed to spot Madoff's mischief despite repeated warnings and several investigations into the firm. "It is shameful that after numerous inquiries from the investment community," Graybow says, "the regulators didn't thoroughly research and investigate the truth and uncover the underlying mechanics of the Madoff operations." He believes a government fund for victims is an appropriate solution, citing the failure of regulators to catch Madoff. At a time when everyone from auto companies to investment banks to state governments is holding a hand out to the government, Graybow's notion might have a chance, at least in theory. But in reality, the line at the government till is already very long and is likely to grow longer. For some members of the Oak Ridge club, the only solace may be springtime, which will come not a moment too soon.