More Growth and Illegalities
Businesses borrow money from banks to pay for expansion. Bernie didn’t have to
do this because he had a bank account with money fl owing in and out from his illegal
investment advisory business. He used some of this money, without his client’s
permission, to avoid interest payments. Bernie moved money between his Bank of
New York brokerage bank account and his Chase investment adviser bank account
as needed. Whenever he fell short of the guaranteed 20 percent investment advisory
returns, he made up the difference by taking money out of his brokerage bank account.
If he needed income to grow the brokerage fi rm, he took money from the
investment advisory bank account.11
Bernie got another big break when his father-in-law hired Michael Bienes as
an accountant in 1968. Bienes’ brother-in-law was Jeffrey Picower, a wealthy Wall
Street investor.12 Bienes earned hundreds of thousands of dollars in commissions
from money Picower invested with Bernie over the next forty years.
How did Bernie explain his remarkable results to sophisticated investors like
Picower? Bernie now sold blue-chip stocks and claimed he invested client money
using a complicated three-part “split strike conversion” investment strategy. He told
clients that fi rst he purchased common stock from a pool of 35 to 50 Standard &
Poor’s 100 Index companies whose performance paralleled overall market performance.
The S&P 100 Index represents the 100 largest publicly traded companies
based on market capitalization, and represented a very sound investment. Second,
he bought and sold option contracts as a hedge to limit losses during sudden market
downturns. Third, he left the market and purchased U.S. Treasury Bills when the
market was declining, and then sold the U.S. Treasury Bills and reentered when the
market was rising.13 Bernie never shared his mathematical calculations for determining
when to buy or sell. He considered the information proprietary and did not want
competitors to copy it. Later, fi nancial experts would question whether Bernie ever
used this method.
Key to Bernie’s success was the effi ciency and speed of his trading operations.
Bernie was one of the fi rst brokers to recognize the role computers could play in the
fi nancial industry. In 1970, he hired his younger brother, Peter, to help computerize
operations.14 The speed of their trading transactions attracted a growing number
of clients, such as other brokerage fi rms and investment advisers, to do business
through Bernie’s operations.
Investment advisers were also intrigued by Bernie’s unique one or two pennies
commission for each share invested with his company. Although legal, competitors maintained that these commission payments created a confl ict of interest
for investment advisers, equivalent to paying fi nancial kickbacks to a supplier.
As noted earlier, an investment adviser is legally obligated to make the best
deal for a client. The possibility of investment advisers earning a commission for
directing their client’s money to Bernie introduced another motive— doing what
was in the investment adviser’s fi nancial interest rather than the client’s fi nancial
interest.
While Bernie was pushing other investment advisers into ethically grey areas
with his commission offers, the SEC was trying to break up the virtual trading
monopoly the NYSE and AMEX had in the investment community. The SEC encouraged
Bernie and others to create a “third market” for trading over-the-counter
stocks of small public companies. In 1971, the National Association of Securities
Dealers and Automated Quotations (NASDAQ) was founded for public companies
not listed on NYSE or AMEX. As the name implies, the buy and sell prices for these
stocks were automated by computers. Bernie became one of the fi rst fi ve brokers to
join NASDAQ.15
Bernie also made trades on small regional stock exchanges. The Cincinnati Stock
Exchange, founded in 1885 to raise funds for Cincinnati area businesses, was one of
the many regional stock exchanges that fl oundered under the shadow of the NYSE.
Bernie revived the exchange in the 1970s by investing $250,000 ($950,000 in 2010
dollars) to upgrade its computer system. By 1976, the Cincinnati Stock Exchange
increased its volume of trades signifi cantly by closing its trading fl oor and becoming
an all-electronic stock market.