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Madoff Victims: What Will They Get Back?

(U.S. Marshals Service)
By Marlys Harris of

Victims of Bernard Madoff's Ponzi scheme may have allowed themselves a rare smile on July 14, when the 71-year-old was locked up in a prison cell at a federal correctional center in Butner, N.C. His new neighbors behind the barbed wire include terrorist Omar Abdel Rahman, the "Blind Sheik" who masterminded the 1993 World Trade Center bombing, and John Rigas, the disgraced former CEO of Adelphia. Madoff, who reportedly was assigned to work in the prison's engraving shop, is scheduled to be released in 2136. In other words, barring a miracle, Bernie Madoff will never be free again.

But there won't be any real justice until investors recoup at least some of the estimated $65 billion he stole. In letter after letter to U.S. District Court Judge Denny Chin, who presided over the case, Madoff victims wrote of personal privations they had suffered: homes lost, newly destitute parents pressed to move out of nursing homes they can no longer afford, children forced to withdraw from college, people returning to work after years of retirement. Says Ronnie Sue Ambrosino, who with her husband Dominic lost $1.6 million: "Until we get our money, there is no justice."

Past victims of Ponzi schemes have historically recovered only pennies on the dollar, if anything. Often, bankruptcy trustees and other officials moved so sluggishly to recover stolen funds that the miscreant and his family had plenty of time to stash their gains offshore. In this case, however, bankruptcy trustee Irving Picard rushed to locate Madoff's money and to sue any beneficiaries of the fraud. To determine to what degree he and other officials keep faith with investors, I have taken it as my mission in the coming months (and years) to follow the efforts to recoup the money. You'll be able to read all about it here and in my blog, The Consumer Reporter.

Despite the alacrity of the trustee, investors are likely to find their quest for justice long and possibly unrewarding. For starters, nobody knows how much money is available for the 15,400 investors who filed claims with the bankruptcy trustee. Picard has recovered only $1.5 billion from the defunct firm's assets. Some investors — but not all — can count on help from IRS refunds and from the Securities Investor Protection Corporation (SIPC), an industry organization whose mandate is to restore funds to customers of bankrupt brokerage firms. But "indirects" — investors whose money found its way to Madoff's firm through hedge funds, banks, pension funds, and brokerages — cannot qualify for such help from Picard. Their only resort is to file a lawsuit against the entity that sent them to Madoff, its accountants and insurance companies; so far, investors have launched 130 suits.

(Some) Tax Relief on the Way

The IRS, one of the most loathed government agencies, was first to ease the victims' pain. Under its rules, investors are entitled to declare a theft loss and deduct the amount of their investment, including income they've reported in past years, even if it was fictitious. They must subtract from the loss any amount they expect to recover and exclude any insurance payments they receive. IRA investors will not be allowed to take the deduction because they have not paid taxes on the principal or the earnings.

Despite those limitations, says Richard S. Lehman, a tax lawyer in Boca Raton, Fla., who has several Madoff victims as clients, it's not a bad deal. "If you were in the top bracket when you paid your taxes on the profits and maybe you paid 5 percent in state taxes, you would get back 40 percent," he explained. Excess losses can be carried back five years (three years for indirect investors) or carried forward as much as 20 years. Many of the victims, however, won't be able to use all their losses to offset future income because they will have lower incomes and thus lower tax rates. Elderly Madoff investors may die before they can use it. Lehman recommended (in jest) to one of his clients that he take out a personal ad: "Bachelor with $15 million loss carryforward looking for woman facing large future tax bills."

SIPC to the (Partial) Rescue

Only days after the Madoff fraud came to light in December, the SIPC won court permission to extend its protections to the company's investors. The SIPC provides up to $500,000 per account. Investors can qualify for expedited payment if they meet a hardship standard: They are unable to pay for necessities such as housing, food, utilities, and transportation; can't pay for necessary medical expenses; must return to work at age 65 or older after having previously retired; or have to declare bankruptcy. The process takes about 40 days, but investors who put money in before 1996 will have to wait until the trustee unscrambles their account records.

The SIPC safety net has gaping holes through which many investors are falling, however. Only the people who had accounts with Madoff's firm — about 4,600 — are eligible to collect. People who came to Madoff through feeder funds are not covered. A giant feeder fund with one account at Madoff's firm might be able to claim the maximum $500,000, but it would have to divide that among all its customers. (The trustee is suing to keep some feeder funds from collecting SIPC money, alleging that they were privy to the fraud.) Another problem: The SIPC insures each account, not each investor. Extended families or groups, such as medical practices that pooled their savings in one account totaling millions of dollars, still cannot collect more than $500,000.

The trustee, moreover, has decided to value investors' accounts on the basis of "net equity" — their initial investment minus any withdrawals. A Madoff customer who invested $300,000 back in 2001 and withdrew $100,000 over time could collect a maximum of only $200,000, even if his November 2008 statement claimed his account was worth $1.2 million. The decision has sparked controversy. "It's ridiculous to think that the SIPC would compensate people based on what Bernie Madoff made up in his head," said one lawyer. But investors don't see it that way. "The SIPC law says that you should be paid based on your legitimate expectations," says Ambrosino. Even though she and her husband Dominic, a former corrections officer, invested only a few hundred thousand, they planned their lives in retirement based on the $1.6 million they saw on their statement. This June, several investors launched a class-action suit demanding that Picard repay them the amounts that were on their statements.

The Hunt for Assets

So far, the trustee has approved 542 claims worth about $2.9 billion. Of that, the SIPC will pay some $231 million. That leaves those investors on the hook for $2.7 billion, except for any money they can collect from Picard. Picard now estimates that Madoff's total take was about $13.5 billion. The money he recovers will be repaid to direct investors in proportion to their net equity.

Billions went out the door to investors who redeemed funds and also to commissions and fees to feeder funds that brought money to Madoff. To recover that money, Picard has launched lawsuits against the principals of eight large feeder funds claiming that most either knew about the fraud or must have been wearing blindfolds. Cohmad Securities, for example, a brokerage whose major function was to bring customers to Madoff, shared office space with him. With the help of Madoff employees, according to a complaint filed by the trustee, it maintained a list that showed the real balance in each customer's account, minus the mythic profits. Even more telling, Cohmad brokers received a commission based on money under management — the real amounts, not the fictional totals. Ergo, folks at Cohmad must have known what was going on. Fairfield Greenwich Group, which reeled in $7.2 billion from investors, held itself out as a sophisticated hedge fund. As such, its officers should not have missed enough red flags to do China proud, claims a lawsuit filed by the trustee. One of many warning signs: The number of put and call options that Madoff would have had to buy or sell on any given day often exceeded the number of options bought or sold in the entire market on those days. Picard is seeking a total of $11 billion, give or take a few hundred million. That's enough to provide some comfort to investors. But, at this point, nobody knows whether the trustee will win the cases, or even if defendants would have the money to pay such judgments.

'I'll Sue!'

As even Willie Sutton understood, to get something — anything — investors have to go where the money is. They need to find somebody who still has money — or an insurance company to pay the claim. So they have sued practically everyone responsible for delivering them to Madoff. Plumber and Steamfitters Local 73 of Syracuse, N.Y., for example, has filed suit against two investment managers, the Bank of New York, and an auditor for allocating 40 percent of their retirement funds to Madoff. A Philadelphia health care and medical workers pension fund is suing its advisers for much the same reason, saying that they gave Madoff $700,000. Medical practices, New York Law School, the Town of Fairfield, Conn., the Palm Beach police department, the New Mexico teachers union — the list goes on and on — plunked money into funds whose advisers, apparently without much thought or due diligence, wired the money to Madoff's company. The claims are conflicting, to say the least. After all, if the trustee and investors both sue a feeder fund, whose claim takes precedence?

Sorting it all out will take time. Timothy Mungovan, a partner with Nixon Peabody, a Boston law firm that has many Madoff customers for clients, says he expects the process to take 10 years to unwind. "It's like microwave popcorn," he says. "For a while, you'll get nothing. Then, gradually it starts popping, and there's a huge amount of activity, and then it'll drop off." For investors who have lost their homes, their savings, and their peace of mind, however, justice delayed that long is justice denied.

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