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A closer look at Madoff's web

A small network of connections helped to facilitate many of the investments.

By Jennifer Reingold
Last Updated: December 22, 2008: 11:27 AM ET

(Fortune) -- It is not easy to stay on the sidelines while others are busy getting rich. Wall Street, moreover, is constitutionally predisposed to overdo things. The stereotype imagines a Wall Street populated by bulls and bears. In reality, the Street itself is neither bull nor bear but shark, constantly shifting direction in an eternal search for food. This feeding process involves massive shifts of capital, which inevitably, is sometimes misallocated. - J. Ezra Merkin, writing in an introduction to a chapter in the 75th anniversary version of Graham and Dodd's Security Analysis.

On Wednesday night, Dec. 10, J. Ezra Merkin held a benefit at his apartment at 740 Park Avenue in Manhattan to support the Israel Museum.

Smiling, cordial, and relaxed as he displayed his world-class collection of Rothkos, he looked totally unaware that the next morning his world - and that of hundreds of others - would fall apart because of that misallocated capital.

Within 24 hours, the man with whom he entrusted his clients' money, Bernard Madoff, was arrested in what may turn out to be the biggest financial fraud in history.

If Merkin decides to attend services tonight at New York's tony Fifth Avenue Synagogue, where he is the president, it's a fair bet that he won't invoke those words, written just months ago, when he was a well-respected investor and one of the top Jewish community leaders in the country. More likely, he won't show up at all.

It's likely to be a strange scene at the synagogue, home to the likes of Ron Perelman and other prominent businessmen, and one of the places where the Bernard Madoff fraud has hit hard.

Although the Ponzi scheme has ricocheted from New York to Boston to Palm Beach to Switzerland and France, and keeps unfolding (lawyer Sean Coffey of Bernstein Litowitz Berger & Grossmann LLP says in a four-hour period this week, he received more than 60 calls from distraught investors whose losses totaled over $1 billion) a close look shows a small web of connections that helped to facilitate many of the investments.

Entangled in at least one of the webs is the synagogue: Madoff wasn't a member, but Merkin, a second generation scion of a prominent banking family, was a proud and active one.

Merkin, who ran two funds - the $5 billion Gabriel Partners and the $1.8 billion Ascot Partners - has lost at least the entire Ascot fund to the scheme.

The fund, it turns out, was entirely invested with Madoff, to the surprise of many of his investors, who thought they were investing in Merkin's own management approach (and paying him fees and a percentage of the profits for the privilege). Merkin's lawyer didn't return calls by press time but has said previously that "Merkin and his family are personally among the largest victims of the massive fraud confessed by Bernard Madoff."

Other reportedly defrauded congregants include businessman Ira Rennert, chairman of the synagogue's board of directors, who is in the hole for as much as $200 million, and the foundation of Elie Weisel, the Holocaust survivor and Nobel Prize winner.

Not everyone bought in: Perelman's spokeswoman says he had no involvement and Joseph Sprung, a synagogue member and financial advisor who says he was approached by another member about investing with both Madoff and Merkin several years ago, decided against it when a former client of his told him not to. "He just thought it was not legit," says Sprung.

The pain extends to Yeshiva University, where until last week, Merkin was on the investment committee and Madoff was chairman of the business school.

Yeshiva University President Richard Joel announced on December 16th that the school had lost about $110 million of its endowment funds to Madoff. Yeshiva apparently had no conflict-of-interest rule barring investments with a board member.

That decision also hurt trustee Michael Jesselson, whose family is both one of the founders of the Fifth Avenue synagogue and the founder of the SAR Academy, an Orthodox school in the Bronx which has suffered a reported $1.3 million in losses through Madoff. Two sources report that Yeshiva University has already lost four promised gifts as a result of the scandal. Neither Joel, Jesselson or the university responded to requests for interviews.

Merkin's ties go far beyond New York Jewish society. Not only was he president of the synagogue, a full-time manager through his $5 billion Gabriel Fund and Ascot, and a board member of multiple institutions; he is also chairman of GMAC, the struggling finance arm of GM (GM, Fortune 500) now owned by Cerberus, the hedge fund named for the three-headed dog that guards the gates to hell.

Merkin has long been friends with Cerberus founder Stephen Feinberg, who Merkin helped to bankroll in his early days and who has invested regularly with Merkin for many years, according to a review of several investment documents that list Merkin as a co-investor. In 2005, the two teamed up to buy a stake in Israel's Bank Leumi, but the deal later fell apart.

Feinberg hasn't announced any losses relating to the Madoff fraud, but as a protégé of Merkin's, it's plausible to wonder whether he might have had some money there. A spokesman for Feinberg did not respond to requests for comment.

In the end, whenever it comes, the lesson is, as always, that trust and reputation are no substitute for good old-fashioned legwork. Merkin himself said so, in the Graham & Dodd book:

As long as investors remain human, and thus subject to greed, fear, pressure, doubt, and the entire range of human emotions, there will be money to be made by those who steel themselves to overcome emotion. Think of Graham and Dodd as embodying the spirit of Hamlet, Prince of Demark, who declared: "Blest are those/Whose blood and judgement are so well commingled,/that they are not a pipe for Fortune's finger/to sound what stop she please."

It's a shame Merkin apparently didn't follow his own advice. To top of page

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