Monday, March 7, 2011

Winners and Losers in the Madoff Case

Irving Picard
Irving Picard, the trustee in the Madoff case, was in court last week as a panel of three judges heard arguments on whether net winners in the Madoff case ought to be able to collect money from the government. Net winners are those who took more cash out of Madoff's funds than they put in. Apparently, there are several of these guys who think they should get more money. Hmmmm.....

The WSJ had this to say about the case: "The judges' decision is likely to determine which Madoff customers may collect up to $500,000 apiece from the Securities Investor Protection Corp., an industry association created under federal law to insure investors in failed brokerages. It is also expected to affect how to divide billions of dollars Mr. Picard is recovering through legal settlements with people who withdrew money from the Ponzi scheme."

Now, it seems just a bit greedy to me that investors who got more money from Madoff than they put in would also be trying to collect from the taxpayers simply because Madoff sent them a statement showing they had more fictitious profits than they had already withdrawn! Apparently, the judges showed signs of wonder too as the WSJ reported the following:

At points, the three judges from the U.S. Second Circuit Court of Appeals appeared skeptical of the notion that customers should be able to make claims based on trades Mr. Madoff invented, even if the investors thought they were real. The judges said they would issue a ruling at a later date.

The question is whether accounts should be valued … based on a figment of the imagination," Judge Pierre Leval said.

Among the leading proponents of the view that investors were entitled by law to rely on their final statements are Fred Wilpon and Saul Katz, the owners of baseball's New York Mets, along with their relatives and associates. Their lawyers have said their balances with Mr. Madoff were $500 million at the time of the scheme's collapse in December 2008.

Chief Judge Dennis Jacobs asked a lawyer for the Mets owners, Karen Wagner, why claims should be evaluated by "whatever amount Madoff made up chewing on his pencil and looking at the ceiling."

Ms. Wagner, however, argued that the whole system of investing in securities is "dependent on the customer statements."
Meanwhile, Mr. Picard is trying to recover money for the poor saps who took out less than they put in. Here are some thoughts given in the article from his perspective:
As Mr. Picard watched from court Thursday, his lawyer, David Sheehan, told the judges that reversing his policy would divert money from investors who lost funds to those who had already made fictitious gains.

He said it would (be) "absurd" to give "other people's money" to net winners when some investors hadn't yet been repaid their lost principal. "This is a Ponzi scheme," Mr. Sheehan said. "This is a zero-sum game."
The one perspective I didn't read in the article is whether anyone is considering what kind of precedent this might have for future fraud perpetrators. Let's say the judges allow the SIPC to pay up to $500k to every investor whose statement showed he or she had more than $500k more than they had deposited with Madoff. This could be quite a money making scheme. Here's how.

First, a  fraud perpetrator starts a Ponzi scheme by hiring some innocent college liberal arts student to manage the statements of the scheme. Using a fictitious identity, the fraudster sets up a brokerage firm to manage his scheme. Then, the perpetrator and all his friends and family send $50 to the scheme and the college student credits their accounts. The scheme pays 12% per day (like the 12 Daily Pro scheme promised). Each month, the student sends statements to the investors. After four short months, they each show a balance of over $500k!

At this point, the investors try to redeem their funds and they call the student, who is the only employee. When they don't get their $500k, they call the FBI who arrests the student. The student reports the person who hired him, who was one of the scammers and is nowhere to be found. Then, the case is given to a trustee who files claims on behalf of the investors and they each collect $500k from the SIPC.

Now, I realize this scheme would be hard to pull off since the company would probably never get set up as a brokerage and therefore qualify under the laws applicable to the SIPC. Even so, I think it illustrates the absurdity of protecting someone from losing fictitious profits in an illegal Ponzi scheme.

It may be that these net winners who are trying to get more will eventually be in court with Picard in a clawback suit and be required to return their net gains. Wouldn't that be interesting?!

1 comment:

  1. By way of introduction, I am Tim Murray quoted in the WSJ article referenced in your post.

    The enactment of SIPA in 1970 allowed broker-dealers to hold customer securities in their own name (Street Name) instead of tilting each certificate in their customer's name. Broker-dealer's back offices were straining under the burden of dealing with paper certificates. Some were on the verge of failing — others did fail because of this.

    SIPA also mandated that Wall Street fund an insuring entity to protect customers against dishonest acts or simple business failures of broker-dealers. The Madoff victims were sent trade slips and statements on which they relied for decades. These are the only documents the investing public has access to — these are the only documents on which they can rely because relying on paper stock certificates ended in 1970.

    Try to imagine the FDIC telling bank customers that we are only going to insure you for original deposit. The interest that you took out over the last 25 years wasn't real the owner of the bank was committing fraud. In fact we are going to sue you for the interest you took out to pay your income tax and to live on.

    Our financial system cannot exist without these protections. Bank and stock market investors are legally entitled to rely on their bank and brokerage statements as an indication of what their bank and brokerage owe them in a liquidation for purposes of SIPC and FDIC insurance or there is no insurance - there is no protection.