Octopus, by Guy Lawson, is a tragic story in which greed plays the main character. Sam Israel also plays a major role in this story as the disgraced hedge fund trader who ultimately lost it all after his huge fraud unraveled before his eyes. Sam Israel was known for his ability to make money; however, Mr. Israel was actually born into more money than most Americans see in a lifetime. Sam’s ancestors were highly successful commodities traders from New Orleans. Growing up, Sam watched his father and grandfather trade in the New York Stock Exchange; he knew from an early age that he belonged on Wall Street.
Through family connections, Sam was able to meet Freddy Graber, “the king” of Wall Street. Freddy was one of the first men to start a hedge fund in the late 1970s, and Sam (age 18) was given the opportunity to work as a runner for Graber on the floor of the exchange. Through his connection with Mr. Graber, Sam quickly learned of the unlimited success that could be obtained as a hedge fund trader. Sam learned through Freddy that in order to win big in the trading world, you had to be okay with big losses as well; this concept stuck with Sam and later played into his ultimate defeat.
Sam also learned from Mr. Graber a thing called the “brother in law rule”. In Wall Street, there was no such thing as a secret, if a deal was being made, there was always a way to find out about it; Graber hooked Sam up with connections for insider trading. As Sam set out on his own in the mid 1980s as a young married man, he realized that Wall Street was changing due to the introduction in computers and data analysis tools. Sam became obsessed with computer trading and began to form his own program called “Forward Propagation”.
In 1996, Sam began to run his hedge fund Bayou from his own basement. Sam teamed up with another trader, Jimmy Marquez and hired an accountant named Dan Marino to keep the books; the fund began with an initial fund of $600,000. In the first year, the fund doubled to more than one million. The men felt unstoppable at this point and they became more overconfident for the success and growth of Bayou. However, as their confidence grew their luck did the opposite. Bayou began to produce losses in the next year, meaning that investors would soon want their funds redeemed.
Dan Marino then came up with the idea that would be the foundation for the Bayou fraud; Marino used $400,000 of broker commissions to hide the actual performance numbers. From this point on, Bayou was doomed. September 11, 2001 hit Bayou hard; the fund lost $35 million. Marino knew that they needed to close the fund, yet Sam refused. If Sam would have closed Bayou he would have been forced into bankruptcy. Sam unsuccessfully and desperately sought out ways to recover Bayou’s actual losses; each year, Marino would end up cooking the books to meet desired return rates.
The main issue in this story occurs in 2004, when Sam was introduced to Robert Booth Nichols. To Sam, Nichols was a savior who could help him save Bayou. In the end, Nichols turned out to be a well known con artist who successfully stole millions (of Bayou’s money) from Israel. Robert Nichols knew that he could successfully con Sam by becoming his closest business partner. Nichols convinced Sam to start trading in the “Shadow Market”, a secret high yield market run by a secret government.
Sam became captivated by the Shadow Market and Bob Nichols; in April of 2004 Sam wired over $150 million of Bayou funds to be traded; not one penny was ever actually traded. Sam completely stopped trading on the NY stock exchange without informing Bayou investors. Sam Israel was deeply captivated by his new business partner and believed he had taken on a new life. Sam quickly became obsessed with the “Shadow Market”. Nichols had Sam convinced that he was a wanted man by many people, and that absolutely no person could be trusted or invited into the Shadow Market.
Back in New York, Marino dealt with the huge fraud and continued to make numbers, fool investors, and fake audits. By 2005, reality set in for Sam after much frustration and zero trading in the Shadow Market. Israel and Marino were broke and their Ponzi scheme was about to be discovered. Sam announced in July of 2005 that all investors would receive a 100% payout. One of Bayou’s investors, Silver Creek Holdings, received a check for nearly $60 million dollars. When the check was declined due to insufficient funds, Eric Dillon from Silver Creek immediately took action to locate Sam Israel and Dan Marino.
When the two were nowhere to be found, Mr. Dillon contacted the authorities immediately; days later, Sam admitted to being a criminal who had led a $75 million fraud. Another one of the main issues presented in Octopus is that Sam Israel did not like to play by the rules. From the start of his career on Wall Street, Sam learned how to cheat and exploit others in order to succeed. Bayou lost millions of dollars for investors who trusted Sam Israel; Sam was too confident in his abilities and too proud to let the fraud end, so he continued to ignore his fiduciary duties.
Despite Bayou’s huge losses, Sam continued to live extravagantly in order to help mask the situation. Sam was introduced to Butch Trucks of the Allman Brothers and the two hit it off immediately and began hanging out and playing music together. Butch was promoting his business called “Moogus” in which Sam invested nearly $950,000 of Bayou’s money. In the end, “Moogus” never materialized into anything of worth, and Sam had foolishly put up his investor’s capital. In January of 2003 Bayou’s results from the previous year showed an actual loss of $27. million. Sam became more and more depressed about his fraud and relied heavily on drugs and alcohol. His wife, Janice, asked for a divorce and for Sam to leave their house. Despite Bayou’s loss, his failing marriage, and his addiction problems, Sam continued on with his lifestyle. Sam decided to rent a lavish mansion from Donald Trump for $22,000 per month. Sam chose to ignore his financial crisis and continued living inside his bubble until it burst. Another issue addressed in Octopus is developed by the role of Sam’s accountant, Dan Marino.
Marino knew all along that he should end the Bayou fraud, yet like Sam, he chose to ignore his fiduciary duty in hopes to succeed and become extremely wealthy. In 1998 Israel, Marquez and Marino came to the conclusion that they could no longer hide their losses from Grant Thornton, the auditors. The men decided from that point on that Marino would do the audit. As a CPA, Marino knew that faking an audit crossed all legal and professional boundaries, yet he did so anyway. Marino set up a fake accounting firm named “Richmond-Fairfield” and registered it with the New York State Accounting Society.
He came up with a stationary design, set up checking accounts, and rented a small office space with a phone and fax line. He then copied Grant Thornton forms from previous years for his audit documents and put in the fake performance numbers. Marino knew that no auditor would rely in Bayou’s internal controls for the audit due to the firm’s small size, making the task even easier for him to do. Marino had the fake audit ready for investors on March 23, 1998. The audit included a letter to investors from Israel and showed a gross rate of return of 22. 047%.
The performance described in the audit attracted new investors and enabled Bayou to cross the $5 million threshold. The fake audits acted as the major vehicle for the massive Bayou fraud. The accounting issues violated in Octopus verify the importance of the SEC and its role in financial regulation. Dan Marino ignored his duties as a certified public accountant and his professional duty to the investing public when he created fake financial statements and audits. Marino knew that investors and regulators would simply glance over the columns in the financial statements.
Had they paid more attention, regulators would have realized that the huge broker commissions were making up for the trading transaction losses. Marino was exercising one of the darkest truths we know about as modern accountants, the truth that all that is required to keep a fraud going is cash flow; that is exactly what Bayou was doing. Once Sam had taken Bayou’s funds to trade in the Shadow Market, their clearinghouse SLK became aware and concerned. Marino assured those involved that Israel was simply doing trades in Europe, and no further questions were asked.
If regulators and investors had approached Bayou with more skepticism, it would have been easy to find that Bayou’s accountant was also acting as their external auditor. When reading Octopus, I was able to understand Sam Israel’s motives throughout the novel. While Sam Israel did act unethically, he always maintained his moral sensitivity. Sam was always able to identify each situation he encountered as wrong; yet he could not face defeat. Throughout his career with Bayou, Sam battled himself and hated what he had done to the investors.
Sam’s regret and fear for Bayou led to great depression issues in his life that really changed him over time. Sam Israel is not a complete monster; he just believed he could fix a problem that, in reality, was far too large to ever fix. When looking at Kholberg’s six stages of moral development I am convinced that Sam Israel and Dan Marino mainly reasoned at stage two, a pre-conventional level, when faced with ethical dilemmas. At this stage, there is an emphasis on satisfying one’s own needs. Throughout Octopus, the two men continue to hide Bayou’s losses and lie to investors in rder to maintain their own reputations and wealth. If Dan Marino had reasoned at stages three or four like most CPAs, he would have acted ethically and fairly to Bayou’s investors by never agreeing to help hide the trading losses with the large broker commissions. Sam Israel was constantly faced with pressure from his family, investors, and peers to act unethically in his career as a trader. Sam did not have the integrity to withstand these pressures and make the right decisions. Instead, Sam gave into the pressures surrounding him and ultimately lost everything he ever had.
Sam Israel and Dan Marino were each sentenced to twenty year prison terms; Sam received an extra two years for absconding. While reading Octopus, it amazed me to learn about how crooked Wall Street can be. Sam Israel learned this first hand as an eighteen year old in the late 1970s. Israel was completely honest with author Guy Lawson in describing the ways trades were conducted and made and how traders developed relationships to exploit others and find insider tips. It was also quite interesting to learn more about how large hedge funds are run and how much responsibility it takes to run a hedge fund.
Another interesting part of this story was how easily manipulated Sam Israel became by Robert Nichols. In a way, Nichols had Israel brain washed into living a double life. At a certain point, Nichols had made Sam become so paranoid that he attempted to shoot a man in the middle of London. Sam Israel is completely convinced he killed a man, yet no evidence exists to solidify the crime. Sam Israel viewed Nichols as a dangerous and intelligent man, giving him his trust and upmost respect.
The con artist was able to lure Sam Israel into putting up millions in a market that had never been heard of; ultimately Sam’s desperation led to his downfall. Guy Lawson describes Sam’s story in great detail and clarity, enabling readers to understand how such an extravagant con could actually take place. I really enjoyed how Lawson took so much information out of his interviews with Sam Israel and Dan Marino and included their actual testimonies. Octopus is compelling from beginning to end; I thoroughly enjoyed reading the story of Sam Israel and Bayou.