The Diary of a Fraudster | James Brandolino Part 1

0:00Look, as a manager of people, as an employer, as an entrepreneur, and as an investor in startups, I can tell you the most important thing for your business is the quality of people. people you hire. The best part is that great candidates are already on LinkedIn. Employees hired through LinkedIn are 30 % more likely to stick around for at least a year compared to those hired through the leading competitor. And I will tell you that the great thing about LinkedIn is that you're not just looking at random people. You're able to see the people who your friends and trusted peers and colleagues who they trust and who they've hired in the past and who they recommend.

0:42And hiring doesn't have to be complicated. Realistically, when you have a business to run, you don't want to spend hours on hiring. You want to hire the right person as quickly as possible. That's why LinkedIn Jobs AI Assistant suggests immediately 25 great big candidates daily so you can invite them to apply and keep things moving. Hire right the first time. Post your job for free at linkedin.com slash Altature, then promote it to use LinkedIn Jobs' new AI assistant, making it easier and faster to find the top candidates. That's linkedin.com slash Altature. Post your job for free. Terms and conditions apply.

1:25James Randolino started a hedge fund, which was a fraud, a Ponzi scheme, all the illegal activity, how he went from civil to criminal. We really dive in to the details of his fraud, the psychology of it. What's critical is that not all frauds have the same flavor. all frauds are bad. Don't get me wrong. It is morally bad to do a fraud. It is, there's a reason why he went to jail. He wanted to go to jail. He, you'll, he tried to kill himself and it's amazing. The story of how he failed to do that. Um, but before I give too much away, um, we're going to discuss in detail the fraud. And then tomorrow I'm going to release the story of him going to jail, what happened there, and how he came out the other side.

2:17Let's dive into the details of the fraud that James Brandolino committed.

2:27This isn't your average business podcast, and he's not your average host. This is the James Altucher Show.

2:44James, thanks so much for coming on the show. And you're going to describe your story in a moment. But when I was reading your story, so I was running a hedge fund that I had started from scratch around the same time as you were. Yes. I could totally understand what was going through your mind and why you did what you did. And of course, the eventual outcome. But maybe in your words, describe what happened. And again, I appreciate you coming on the show. It's very interesting and it's very interesting lesson about the psychology of fraud. Yeah. The psychology of fraud, James, and really how fast things happen.

3:24You know, most investment fraud does not start out as investment fraud. I think that's probably where I want to start first. You know, most people don't wake up one morning working at Amazon and say, you know, I want to steal 5, 10, 15, 20, $50 million, right? And so they go out, they get a website, and they get some legal and marketing documents. They open up a bank account and start soliciting for investor funds. And then when the Feds or the SEC knocks on the door or they hit the phone call, they're on the jet going to Brazil to hide with the money. That rarely happens that way. And in my case, I had been trading for a long time.

4:02I have a background that's very heavy in the futures and securities market. I worked on the trading floor in college, on the grain floor and in foreign exchange. So I knew the floor very well. I was an ops manager and a trading desk manager at a firm that is now defunct, but a former global leader, MF Global, based out of New York. I worked in the Chicago office. When you say you're the trading manager, what does that mean? Is that, are you trading or is at the back office or what is that? No, I was actually, so when I was an ops manager, I was an ops manager, a junior ops manager over probably 40, 50 employees who were on the trading desk.

4:41But when I was a desk manager, there was another person to myself who were running their own book of business. Okay, so you knew what you were doing. You knew how to trade. I've been trading since I was in high school. And just to do a quick backstory, I mean, my whole motivation to trade came, after my freshman year in high school in 83 when the movie Trading Places came out, right? And Dan Aykroyd and Eddie Murphy are trying to corner the frozen concentrated orange juice market at the Eurofort trade. That's really kind of where my impetus to start trading and have a career in trading began. And, you know, when I was at MF Global, I had designed an intermediate term bond trading strategy, trading basically the yield curve, 10 versus, you know, a 30-year treasury bond futures.

5:29and so what does that mean so the u.s government and just from very basics the u.s government issues bonds which are essentially they're borrowing money from other people and some are three-year bonds and some are five-year bonds and some are 10-year bonds and i guess they always trade kind of a certain distance from each other and you would you if that distance went out of whack you would arbitrage it somehow you would like buy one and sell the other right Exactly right. Trading the 10s versus the 30s. The yield curve, the spread changes every day, although it's not quite as volatile as trading the outright instruments.

6:08But there are certain patterns that I thought I'd recognized. And we traded that really for three years before I decided to go out on my own. And how were you doing when you were trading for MF Global? Were you generally up? So when I was in F Global, I was very limited in terms of approaching clients with our trading system. It was more of a discount, kind of a Charles Schwab operation in terms of the clients that we had. It was a lot of funds that we had, and basically they're calling their own shots. We're just basically placing orders and developing business that way. So I left MF Global in 99 and formed my own small futures brokerage firm so I could solicit clients and trade this system with the ultimate goal of eventually going out on my own.

6:58And, you know, I was shooting probably five and a half to about six and a half percent. And, you know, drawdowns were pretty low. And, you know, after about three and a half years of having that track record under my belt, I decided to become a member of the board of trade and start a futures hedge fund. And that's what I did. Can I ask a question? I'm sorry to always interrupt, but if I don't ask now, I'll never ask. Absolutely. So 5.5%, 6 % in 1999, everybody I knew then was quitting their hedge funds and their brokers because they didn't understand that 5.5%, 6 % was a great return if you had no drawdowns.

7:39It was a good, solid return. But this was the internet boom. Everyone wanted 200%. Correct. Correct. So, and basically, you know, my clients were mostly high net worth individuals, business owners, and this was just a small piece, kind of an alternative investment for, you know, for their portfolio. So, you know, I wasn't, you know, managing, you know, 50 % of somebody's portfolio with this strategy. It was, you know, maybe, you know, 5%, 8%, no more than 10 % as an alternative strategy. How would they justify investing with you when they see all their friends making like, you know, oh, just buy any internet stock and you're going to make that in a day?

8:15Like you're making five and a half percent a year plus your, you know, a hedge fund. So it's a little more risk because it's, you don't have access to the money or the investor doesn't like, how would you sell such a strategy? It's a small piece of their portfolio. And a lot of these guys were, were making, you know, we're, we're sling for the fence kind of guys. Right. So they were, they were doing really well in other parts. It's just a, just a small piece and it definitely was a a part of the sales process i mean everybody that you know most of my initial investors were were family friends of family people that i knew a long time and of course my my long-standing brokerage clients so i had already a relationship with with everyone that that i solicited to invest in my fund right and how much were you able to raise in this period We raised a couple of million dollars initially.

9:08So it was like a good start. You wanted to build up, prove a track record, and then go for the gold. At that time, a large fund would be like$100 million. Correct. But even at that point, if I could have raised$10 million, I mean, I understand I didn't come from a bank. I didn't come from JP Morgan or Morgan Stanley or any of the big banks. I was just someone who kind of came up from the bootstraps and learned on my own and didn't really have a lot of contacts at the time and basically just raise money where I could, which was former clients and family and friends. So, so, and again, I'm sorry for asking so many questions, but like with a few million and you're charging like a two and 20, like 2 % of assets, 20 % of profits, something like that.

9:49Correct. Were you able to make a living at that point or you had money saved? Well, we're not even going to get to that. Well, so I had quite a bit of money saved, but I think we need to take a step back and really kind of talk about the catalyst for how the front started. Which is really interesting because the catalyst was, I became a member of the Board of Trade. All of my documents were done and I'm waiting literally on the floor. And I had three or four jobs on the floor. I knew people, I knew how it operated. So it's not like I was new to the floor. I'm waiting for the Board of Trade IT department to come and hook all of my equipment up at the desk.

10:28And I'm just kind of walking around and there's the Dow Jones futures pit, right? And I'm just mesmerized about, you know, these huge orders coming in, huge paper coming in that just moving the Dow, you know, 50, 80 points in a matter of a minute or two or three minutes. And I'm just kind of thinking to myself, boy, wouldn't it be interesting if I could rework my models a little bit and to account for this volatility and maybe earn another 100, 200, 300 basis points and I could be at that 8%, 8.5%, 9 % and I'd be a hero. Now understand, And, you know, none of my clients had ever suggested, boy, you know, we wish that you were, you know, making more money or we wish that you were, you know, trying to, you know, be a little bit more aggressive in your trading.

11:07And they were all happy with, you know, the little piece that I was managing in their portfolio. And kind of just like that, I took about a week before I started even trading for the fund. And I reworked some models and I did some real quick backtesting. And it backtested, okay. I mean, nothing great, but I go, well, I'll make it work, right? I've traded for a long time. So my first week of trading, I lost 3%. And that just feels so bad, particularly you're just starting. These are your friends and family. They see all their friends making 100 % a year and boom. Yeah. And it's not so much 3 % because I had a few months where I was down over 3 % when I was managing their funds as a broker.

11:51But like you just said, it's month number one of the new fund. And I had a couple of weeks because I had it scheduled that a independent CPA firm would get all the documents from the brokerage firm and they would run all the numbers and they would send statements to clients. And I'm just kind of thinking, what am I going to do? I've got two weeks before this is going to happen. I've got to get everybody on the phone or go visit everybody. I've got to do something, right? And just to show you how fast it happens, I'm sitting in an office in the board of trade with one of my colleagues. He's on the phone, I'm paging through.

12:25in, you know, Institutional Investor Magazine and the light bulb goes off. James, I see an advertisement for hedge fund accounting software. And just like that, I'm like, here's the answer. All I've got to do is buy the software, put all the information in there, show a small gain instead of a loss. I mean, you know, 3 % is actually 2.89%, right? I could make this back. I've been trading for a long time. I can make it back in a month, two months tops. And we'll, you know, at that point, you know, after two, three months, whatever it would be to make it back, you know, I can hire the old CPA firm again and everything will be fine.

13:01Right. So, so, so this is like step number one, like, okay, in numeric terms, like if you had a$2 million fund, you're down 2.89%, you're down, I don't know,$57 ,000, which it feels like you could make that up and it doesn't feel like you're robbing anybody of$5 million or anything like that. It just feels like something you could, you could get to, and then it's all good and nobody loses money and you're a hero again. Absolutely. Yeah. And, and that, that was, that was the, the motivation to do it. And it was, it was, you know, then not that I wanted to let everyone down, that's definitely part of it.

13:36The other part I'm thinking, well, if I show a 3 % loss, I mean, you know, what are these guys going to think? It's your first month. I mean, you know, we trusted you and, you know, you know, are they going to pull out and, you know, if so many people pull out, I'm going to have to close the fund and then what am I going to do? Right. So yeah, it was, it was that kind of situation. Because, and again, I'm diving into like what you were thinking, you thought like, then what am I going to do? Because a, it feels good to be on your own. It doesn't feel good to then go back to the job admitting failure, but B, how are you going to get a job as a trader, which is what you were doing when, or this is what could be going through your mind.

14:11How are you going to get a job as a trader when you just lost this money trading? So it's not only feels bad, it's like you really were calling your existence into question. Exactly right. And just to make another point with what you said, not that I lost money trading. I lost money trading a system that was not my system. I had never really studied that, although I took orders for clients who traded indices when I was a broker. But in terms of studying that volatility in that market and those players and what moves that market, et cetera, in the psychology, it was just something that was kind of foreign to me.

14:46So I was, it's the worst part about it was that I wasn't even trading my strategy. I was actually trading a market that I was not familiar with, which was a recipe for disaster, of course. Well, you were trading the stock market instead of the bond market. Correct. And what month are we talking about? Yeah. So this, this is a February beginning of February of 2003, February of 2003. So I was trading pretty actively then. And at that time, the best strategy, not so much on Dow futures, but on NASDAQ futures or NASDAQ 100 futures was basically if something dipped, you'd buy it and it would go up.

15:20So I don't know if you were counter trend trading or what you were doing. I was trading a mean reversion strategy. Yeah. So mean reversion strategies did work, but February, 2003, you know, we were kind of preparing for war at that time, which started a month later. and things were pretty volatile. You had to have some guts at that. February and March was a little more volatile. Those were probably the most volatile months of 2003, if I remember correctly. Correct. So what's interesting is that in terms of trading a mean reversion strategy, yeah, buying the dips is great. But when you're trying to sell the upper channel, going back to the mean, that's where I would get crushed.

16:04So, you know, I would have maybe three, four, five winning trades, small winners. And then I get crushed on that, you know, you know, trying to sell the upper channel and to go back and that that's when I would just get hit. It would just take one or two trades to wipe everything out. Plus. So on that average for every, every, you know, 2 % winner, there was a, you know, a 3 % loser, 4%. That's the thing about mean reversion strategies is that you're going to have lots of winners in a single month of 20 trading days. You might have 19 winners and one loser, and you still lose money. And you're exactly right.

16:37And it's really, really, really tough. And I understand, too, when I was trading my bond strategy, I was probably doing a couple trades at most a week, probably three trades every two weeks. When I was trading the S &Ps and the debt-out futures, I was trading probably five, six, seven, eight times a day. So in terms of the psychology involved, and I'm sure you can attest to this, the psychology involved in that kind of trading is completely different than something that's intermediate term or long-term trading. Yeah, very much so. You're living and dying. I would feel my whole blood pours through my body every heartbeat, like every tick would affect my psychology.

17:21I mean, it's awful. It's like sports. It's like, you know, you've got two pieces in terms of trading, you've got the quantitative models that are telling you what you should be doing. And then you've got the psychology part. Should I actually do it or can I follow that model? Right. And if I have five losers in a row, how can I take that next trade? Or if I have five winners in a row, can I take that next trade? Right. And that's the worst part. You know, you have three, four big losing trades and the next trade you don't take. And that's the one that's going to get you to about even or maybe a little bit above even.

17:53So it's, you know, psychology is so important in training as you know as you know

18:12look as a manager of people as an employer as an entrepreneur and as even an investor in startups I can tell you the most important thing for your business is the quality of the people you hire. The best part is that great candidates are already on LinkedIn. Employees hired through LinkedIn are 30 % more likely to stick around for at least a year compared to those hired through the leading competitor. And I will tell you that the great thing about LinkedIn is that you're not just looking at random people. you're able to see the people who your friends and trusted peers and colleagues who they trust and who they've hired in the past and who they recommend.

18:55And hiring doesn't have to be complicated. Realistically, when you have a business to run, you don't want to spend hours on hiring. You want to hire the right person as quickly as possible. That's why LinkedIn Jobs AI Assistant suggests immediately 25 great fit candidates daily so you can invite them to apply and keep things moving. Hire right the first time. Post your job for free at linkedin.com slash Altature, then promote it to use LinkedIn Jobs' new AI assistant, making it easier and faster to find the top candidates. That's linkedin.com slash Altature. Post your job for free. Terms and conditions apply.

19:31What can 160 years of experience teach you about the future? When it comes to protecting what matters, Pacific Life provides life insurance, retirement income, and employee benefits for people and businesses, building a more confident tomorrow. Strategies rooted in strength and backed by experience. Ask a financial professional how Pacific Life can help you today. Pacific Life Insurance Company, Omaha, Nebraska, and in New York. Pacific Life and Annuity, Phoenix, Arizona. This message comes from Capital One. With the Spark Cash Plus card from Capital One, you earn unlimited 2 % cash back on every purchase and get big purchasing power so your business can spend more and earn more.

20:14Steven, Brandon, and Bruno, the business owners of SandCloud, reinvested their 2 % cash back to help build the company's retail presence. Capital One, what's in your wallet? Find out more at CapitalOne.com slash Spark Cash Plus Terms Apply.

20:33There's three stages of my fraud. This first stage lasted about a year and a half. So after about a year and a half, I've probably got about$50 ,000 in the hedge fund. And I'm thinking, well, what am I going to do? I'm a sales introvert. I didn't want to go back to everybody and say, I need to raise more money, right? Let's put more money in. Let's make this thing bigger. So what do I do? I, you know, I raid my 401k account. I get a home equity plan. I credit it my condo. I basically put my entire net worth into the fund to try to make it work, right? And at this point, when you said you had$50 ,000 in the fund, you were roughly$2 million down to$50 ,000?

21:10You had lost everything? Correct. And that's because were you taking bigger and bigger swings? Were your position sizes going up? They weren't huge positions, but they were large enough to, in a year and a half, lose about$2 million. bucks. And at this point, I just, it's very important to realize the problem here was not that you were down money. The problem here is that your investors didn't know you were down. You were, you, if you had never said anything to your investors, nothing illegal would have happened at this point, but you were telling investors that they were actually up. They think they're making, you know, you know, 1%, you know, one and a quarter percent per month.

21:52And actually they're down, you know, at the end of the year and a half, about a hundred percent. Correct. Yeah. So they had, so they thought maybe there was like a 2.1, I was making a 2.1 million in the fund, but in reality, there was$50 ,000 in the fund. Exactly. So, so after, after that year and a half, I put my, began putting my own money into the fund, which of course is against sec rules, because I didn't let everyone, my investors know that i was i was flooding the fund with my personal money because basically i'm trying to you know cover the losses right so that was really stage two and that lasted for about a year right what was illegal there well why why is that against sec rules because oh if you had disclosed to your investors listen i'm down but i'm gonna pay you back with my personal money here it is that wouldn't have been illegal no it well it would have been it would have been fraud it would have been civil i would have been i probably would have been kicked off the board trade it would have been censured by the SEC.

22:50But at that point, it was civil because I had not taken any money, right? They were just losses that I, they were legitimate losses that I was hiding. Right. And again, if you had been disclosing losses, it wouldn't have been any problem at all. So, so yes and no. So, you know, people, fund managers lose money all the time. And as long as they lose it legally, technically I didn't lose it legally because I was not trading my bond system. Now, if I had lost the money trading my bond system, then, and I had all the risks disclosed in my, in my hedge fund documents, absolutely that there'd have been no issue.

23:28People are going to hate me for interrupting all the time, but I'm just wondering, you know, people always say, oh, you're, let them talk. But I have to, I've just really want to understand. So, so the hedge fund docs said specifically what your strategy was and you didn't leave room for on occasion, the hedge fund manager might trade other strategies. Correct. Okay. So now I understand why, at the very least, you were in trouble with the SEC, if not breaking the law. Correct. But at that point, it's just civil. So, you know, I dump my personal net worth in the fund. And this lasts about another, maybe another year, just over a year.

24:03So now we're almost at the three-year mark, right? And, you know, I'm basically back down to that, you know,$50 ,000 to$100 ,000 in the fund. And I'm like, man, what am I going to do? I've got no money. I'm, you know, I'm, I'm, I'm broke. I'm going to have to sit down with everybody. I'm, I'm not sure what's going to happen here. Right. Were you married? Um, I w I was actually divorced. I actually got divorced in Oh four. And that was because of the stress related to what was going on. Well, that was definitely part of it. Um, uh, my ex-wife was, was not from the, although she was a U S citizen, she was not from the United States.

24:36And I just really, really felt, I didn't want to get her involved in the whole mess. And basically I just, you know, decided that, you know, we should get divorced. And yeah, I basically told her I didn't want to have kids. And that was like a, you know, being, being, you know, European, that was real important to her. And I just didn't want to get her involved because she had absolutely nothing to do with the whole situation. Cause she was also a, a, a, a registered rep in the futures industry with another firm. So I didn't want to get her involved at all. So, but at this point, this is, this is where you're neck deep in your isolation.