Kathy Bazoian Phelps
Senior Counsel in Ponzi Scheme Litigation
and Bankruptcy Matters

Kathy is a senior business trial attorney with more than 30 years experience prosecuting and defending claims for high net worth clients involved in Ponzi scheme matters and in bankruptcy proceedings. Kathy’s practice includes recovering assets for clients in complex fraud cases under standard fee and alternative fee arrangements. She also handles SEC and CFTC whistleblower claims. Kathy also serves as a mediator in bankruptcy matters, in complex business disputes, and in matters requiring detailed knowledge about fraud or Ponzi schemes.

Kathy’s Clients in Ponzi Scheme Cases and Bankruptcy Matters
Equity Receivers
Bankruptcy Trustees
High Net Worth Investors
Debtors in Bankruptcy
Secured and Unsecured Creditors

Sunday, November 24, 2013

Who Are the Victims in the Bernard Madoff Ponzi Scheme?

Posted by Kathy Bazoian Phelps

   People lose money in Ponzi schemes. They may have invested directly, or perhaps through a feeder fund. Or maybe they invested in a limited partnership that itself invested in the Ponzi scheme. When the Ponzi scheme implodes, people want their money back.

   Recent activity in the Bernard Madoff scheme raises the question of the best methodology to get money back to the people who have been defrauded. The various agencies of the U.S. government operate under different statutory authorities with varying objectives and sometimes competing methodologies for reimbursing the defrauded.

   SIPA Payments to “Customers”

   In a proceeding under the Securities Investor Protection Act (SIPA) – which the Madoff scheme is – “customers” of the Ponzi scheming entity are entitled to protection and payment from the Securities Investor Protection Corporation (SIPC), administered by the appointed trustee. In the case of Madoff, the SIPA Trustee is Irving Picard, who has been reimbursing customers as statutorily required and pursuant to the court approved parameters of who is a “customer.” SIPA, 15 U.S.C. § 78lll(2)(A), defines a "customer" of a debtor as follows:
[A]ny person (including any person with whom the debtor deals as principal or agent) who has a claim on account of securities received, acquired, or held by the debtor in the ordinary course of its business as a broker or dealer from or for the securities accounts of such person for safekeeping, with a view to sale, to cover consummated sales, pursuant to purchases, as collateral, security, or for purposes of effecting transfer.
   The Second Circuit, has narrowly interpreted “customer,” finding that "the critical aspect of the 'customer' definition" to be "the entrustment of cash or securities to the broker-dealer for the purposes of trading securities." In re Bernard L. Madoff Inv. Sec. LLC, 654 F.3d 229, 236 (2d Cir. 2011); see also Kruse v. SIPC (In re Bernard L. Madoff Inv. Sec. LLC), 708 F.3d 422 (2d Cir. 2011). This means that the feeder funds that directly invested in the Madoff scheme are customers, but not the individuals who invested in the feeder funds. The Trustee has collected about $9.5 billion, of which more than $5.4 billion has already been distributed to customers. Information about claims and his distribution plan can be found at his website at www.madofftrustee.com/claims-03.html.

   Forfeited Funds to “Victims”

   In the meantime, the U.S. government has forfeited about $2.35 billion of additional funds, which can now be distributed to those who were defrauded. Under a variety of criminal and civil forfeiture statutes, payment of forfeited property is to be made to “victims” under the supervision of the Department of Justice (DOJ). Richard Breeden has been appointed as Special Master for the purposes of distributing this forfeited property. His website is at www.madoffvictimfund.com.

   The Special Master will be paying the money to “victims,” which are a different set of claimants from the “customers” who are receiving payments from the Trustee, although there may be some overlap. The Special Master explains on his website that:
Federal law defines a "victim" as "any person" who suffered a "pecuniary loss" as a "direct result" of crime. “Those who invested directly with Madoff or in one of the feeder funds – those who “lost your own money” - will be entitled to a distribution. There may be 10,000 or more “victims” who otherwise are not receiving a payment directly from the Madoff Trustee.
      The Special Master’s website also attempts to explain the differing approaches as between the distribution of the forfeited funds and the distributions being made in the SIPA proceeding:
[T]hese two programs exist to pursue different objectives. The forfeiture program is designed to help all persons who suffered a pecuniary loss as a direct result of criminal activity. It is a very broad program designed to help the victims of crime recover a portion of their pecuniary losses resulting from the criminal activity giving rise to the forfeiture of assets. The MVF and similar forfeiture programs are an integral part of the Department's efforts to deter criminal activity by taking away its profits. Beyond deterring crime, the program also provides a measure of "justice," or fairness, to the victims of crime when it does take place. The ultimate policy objectives of the forfeiture laws are promoting law enforcement and providing recoveries for crime victims.
By contrast, the Bankruptcy Code and the Securities Investor Protection Act (or "SIPA") (which overlays the Bankruptcy Code in the case of Madoff Securities) are narrower sets of laws designed to establish the relative priorities of "customers" and "creditors." Bankruptcy proceedings are enormously important to the U.S. economy, but the goals of bankruptcy are commercial. The two programs have different objectives, and so they may have different results. 
   The inconsistent distributions plans are causing some confusion and consternation. 

  • Are the right people being paid? 
  • Can all of the “victims” even be located?
  • Are the Trustee and the Special Master calculating claim amounts in a similar and consistent fashion, or might different mathematical calculations lead to inconsistent results?
  • As between the payments made by the Trustee and the payments to be made by the Special Master, will anyone examine whether there is any duplication or overpayments to any particular individual? 
  • What happens to victims’ claims that have been purchased in the claims trading process? 

   The good news is that both the Trustee and the Special Master appear to be calculating claims using the same or similar net investment method. Under that method, they will calculate the net equity amount of the claim by deducting withdrawals and redemptions received by investors from the amount of their investments made. They just may not be dealing with the same creditor body in doing the math, however.

   The bad news is that the different definitions of “customer” and ‘victim” will lead to very different and potentially inconsistent results. Someone who is a “customer” for the Trustee’s purposes might not be a “victim” entitled to the forfeited funds, e.g., a feeder fund or a family partnership, but the individual investor in such an entity would be a “victim.” 

   There is an obvious mountain of work ahead of the Special Master in trying to identify the massive number of individual “victims.” This seems a virtually impossible task at this point. Some feeder funds have gone out of business, and it is unclear whether the Special Master has access to the databases of investor names who had their money invested in the Madoff scheme, whether directly or indirectly. It is also not entirely clear that the victims themselves necessarily know that their money was invested in the Madoff scheme if their funds were placed in the scheme through a feeder fund.

   In one other complication, the Special Master has announced that he will not make a distribution to claims purchasers. Once a victim, always a victim, says the Special Master, meaning that purchasers of claims will not be entitled to payment of the forfeited funds from the Special Master. Presumably the “victims” who are contractually obligated to transfer their rights in their claims, including rights to forfeited property, to the purchaser will still be obligated to pass on any distribution received to the claims purchaser.

   One has to wonder whether this will spawn the next layer of litigation in the unraveling of the Madoff Ponzi scheme. Reports are that the inconsistent distribution plans and the Special Master’s recent disclosure of his plan have caused a decline in the price of Madoff claims on Wall Street – about a 5% decline in the price for victims’ claims and as much as a 15% drop in the claims of feeder funds. 

   Is one distribution plan right, and one wrong? Both the Trustee and the Special Master appear to be doing their jobs. By statute, they just have different jobs to do. Let’s just hope that the people who were defrauded can ultimately get their money back through what has become a very complicated and cumbersome process. At least there is a decent amount of money to distribute – almost $12 billion – on about $19.5 billion in losses. What’s a $6.5 billion deficiency among friends? Hopefully more is to come. 

To avoid investing in a Ponzi scheme in the first place, read about my new book Ponzi-Proof Your Investments: An Investor’s Guide to Avoiding Ponzi Schemes and Other Fraudulent Scams at www.ponzi-proof.com

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