Madoff ‘Schtup’ File Enriched Top Investors, Jury Told

Bernard L. Madoff used a process his inner circle called “schtupping” to boost the fake trading profit of the con man’s richest clients between Christmas and New Year’s, his former finance chief told a jury.

In a file labeled “Schupt,” a misspelling of schtup, a Yiddish term for “push” or “press” that’s also slang for sex, the names of insiders were kept with notes about how much extra to give them on top of the 17 percent returns they were “promised,” Frank DiPascali, 57, testified yesterday at the federal trial of five ex-colleagues in Manhattan.

Joann Crupi, a defendant in the case who managed large accounts in Madoff’s investment advisory unit, where the fraud took place, asked DiPascali to use a reverse of the process on her personal account in 2003 to make end-of-year losses to offset gains and avoid thousands of dollars in taxes, he said.

“We discovered the fact that it would be advantageous for her to take a loss that year,” said DiPascali, who pleaded guilty in the case in 2009 and seeks a lighter sentence by testifying. “The loss would be a meaningless loss on paper only.”

DiPascali, who oversaw the schtupping process, is the highest-ranking former Madoff executive to testify in the first criminal trial stemming from the con man’s $17 billion Ponzi scheme. The five former employees are accused of aiding the fraud for decades and getting rich along the way before the fraud collapsed at the peak of the financial crisis in 2008.

Trial Defendants

Crupi, who faces tax evasion charges in a 33-count indictment against the group, reported to DiPascali and shared an office with him.

The defendants alongside Crupi are Annette Bongiorno, who ran the investment advisory unit; Daniel Bonventre, who ran Madoff’s broker-dealer unit, where real trading took place; and computer programmers George Perez and Jerome O’Hara, who allegedly automated the production of fake account statements. All five have pleaded not guilty and claim Madoff duped them.

An image of the schtup file, labeled by hand in thick black marker, was displayed for the jury. Boosting the returns was accomplished at the end of December each year through a series of fake trades customized for each account to reach the desired change, DiPascali said.

Most of the entries sought end-of-year gains, while Crupi’s loss was an outlier, he said.

Loss Requested

“I need to schupt,” DiPascali wrote on a calendar note to himself for the end of the year, again misspelling the word. A related note from Crupi requested a loss of $5,000 to offset taxes, though she later “changed her mind” and requested a loss of $15,000, DiPascali said.

A page from Crupi’s desk calendar from Dec. 31, 2003, that was seized by investigators and displayed for the jury said “losses my acct” in handwriting that DiPascali said belonged to Crupi.

DiPascali faces as long as 125 years in prison after admitting to authorities in August 2009 that he engaged in conspiracy, fraud and money laundering.

Defense lawyers have said cooperating witnesses such as DiPascali will lie on the stand and implicate others to spend less time behind bars. DiPascali said Dec. 2 in court that he’s hoping for a “substantial” reduction in his sentence.

SEC Letter

DiPascali described an incident in January 2004 when Eric Swanson, a lawyer with the U.S. Securities and Exchange Commission who would later marry Madoff’s niece, Shana Madoff, sent the con man a letter requesting detailed information about the business as part of an audit.

Madoff panicked about how to respond to the questions without revealing the existence of his investment advisory unit, which he didn’t advertise, because the securities he purported to hold for customers were all fake, he said.

“There were a lot of holes in the picture,” DiPascali said. Madoff told his deputies in a meeting that the firm “was not prepared for something like this” because “there were a lot of things that could not be easily explained,” he said.

Madoff chose a “bizarre” response that took advantage of shadow account statements that had been built into the computer system 20 years earlier and were always running in the background as a “safety valve,” DiPascali said. The statements had never been printed out or used until then, he said.

‘Cash Accounts’

While Madoff’s customers believed they had brokerage “cash accounts” that required Madoff to hold their money and securities, the con man used the shadow statements to trick the SEC into believing he used RVP/DVP accounts, DiPascali said. RVP/DVP accounts don’t involve holding customer assets, because third-party banks hold the securities for customers and the broker only assists in part of the trading process, he said.

Madoff was initially displeased with the statements from the shadow accounts, saying they were “no damned good” because they didn’t display a bank as the actual holder of the security for the benefit of the customer, DiPascali said.

As they decided what banks to add to the statements, Madoff told the group to “just make them up,” prompting the group to begin researching the names of banks on the Internet and choosing them randomly, DiPascali said.

Madoff then decided they should use foreign banks whenever possible to discourage Swanson from following up with phone calls to the lenders.

“It’s probably not in his pay grade,” Madoff said, according to DiPascali. “He’s probably not allowed to make an international call.”

‘Story Stocks’

DiPascali also described to the jury Madoff’s strict rules for avoiding insider-trading probes resulting from fake trades and backdated account statements. Madoff’s inner circle was barred from using “story stocks” or “deal stocks” -- companies whose shares surged because of news coverage of involvement in mergers and acquisitions, he said.

If Madoff’s customers appeared to have the “inside dope,” then the trades would “jump off the page” if they were reviewed by regulators, DiPascali said.

Prosecutors yesterday showed the jury a fax from Bongiorno to O’Hara on March 21, 2007, in which she asked him to cancel three trades totaling almost $4 million in Apple Inc., Abercrombie & Fitch Co. and Apollo Group Inc. from the previous year on the account of Madoff’s nephew, Charles Wiener, and “correct” his tax forms. The words “remove sales” were written on the fax in handwriting that DiPascali identified as O’Hara’s. The jury was then shown internal Madoff trade confirmations for the trades with an “X” drawn through them.

Madoff, 75, pleaded guilty and is serving a 150-year sentence in a federal prison in North Carolina.

The case is U.S. v. O’Hara, 10-cr-00228, U.S. District Court, Southern District of New York (Manhattan).

Before it's here, it's on the Bloomberg Terminal.