Knowledge Pays

There is a very cliche expression that often makes the rounds of economists, which holds that “we live in a knowledge economy,”—having knowledge pays.

A man who died yesterday, Jeffry Picower, has made that abundantly clear.

You probably haven’t heard of Mr. Picower, but that’s just the way he would’ve liked it. A lawyer and an accountant, Picower was known as an expert in tax shelters. He was famous for making things invisible. For example, on January 2, 2003, Picower withdrew $1,378,852 from a curiously named account, “Jln Partnership”, which was managed by none other than Bernard Madoff. When withdrawals across all his accounts were totaled for that day, they amounted to exactly $250 million. Nothing he did was by accident.

Mr. Picower achieved something amazing. He discerned that Bernie Madoff was a fraud years before securities regulators did, and he was able to profit massively from that knowledge. Picower knew that he could go public about Madoff’s ponzi scheme at any time, and therefore held enormous negotiating leverage over Madoff, who would do anything to avoid the disclosure. What Mr. Picower asked for (in exchange for his silence) was substantial: enormous returns from his investment with Madoff, paid for in dollars that belonged to other investors. Picower could demand precise annual percentage gains for his account–much higher than the returns given to other Madoff investors. Picower would pick the number, and Madoff’s people would dutifully backdate trades to update the account balance to Picower’s satisfaction.

Although Madoff ostensibly produced eerily consistent 10-12 percent annual returns for his clients, the returns he provided Picower were other worldly:

In 14 instances between 1996 and 2007, a group of Picower trading accounts experienced annual returns of more than 100 percent. On 25 occasions, the annual return exceeded 50 percent. During this same period, the biggest annual gain in the S&P 500 was 31 percent (1997). The S&P’s annual average for that period was slightly under 9 percent. In 1999, one of Picower’s accounts earned 950 percent.

On April 18, 2006, Picower wired $125 million to Madoff to open a new account. Madoff’s office began “purchasing” securities in the account, but “it backdated the vast majority of these purported transactions to January 2006″ when the stock market was at its lowest for the period. Twelve days later, the net equity value of the account was $164 million, a gain of $39 million – or more than 30 percent – in less than two weeks.

From 1995 to 2008, Picower made 670 withdrawals totaling $6,746,066,548. Initially, he’d invested some $1.6 billion with the fraudster, so this amounted to quite a return on his initial investment.

Was much of his wealth stolen from others? That’s a question that the courts are trying to find out right now, but considering Picower’s prowess for financial sleight-of-hand, we may never know.

Clearly, Picower’s gain from his knowledge of Madoff’s fraud is not an something to look up to, but it surely illustrates the benefits of having more information than others. After all, Picower died a very rich man.

Madoff Client Jeffry Picower Netted $5 Billion—Likely More Than Madoff Himself – ProPublica
Jeffry Picower, Madoff Investor, Found Dead at Home – Bloomberg