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Judge Decides Some Madoff Investors Not Entitled to Recovered Funds

A federal bankruptcy judge in Manhattan has sided with a trustee appointed by the court that investors with Bernard Madoff who took out more money from Madoff’s investment firm than they put in over the years are not eligible to recover funds from the unraveling of the scheme.

Federal Bankruptcy Judge Burton R. Lifland agreed with trustee Irving Picard that victims’ losses be calculated as the difference between what investors put in and what they took out over time, not the fraudulent totals on investors’ account statements, which at the time of Madoff’s arrest exceeded $64 billion. The judge decided that those statements “were bogus and reflected Madoff’s fantasy world of trading activity,” according to his opinion. Lawyers for the ‘net winners’ from the scheme are saying they will appeal the decision.

For a more in-depth look at the decision, we spoke to New York Times senior financial writer Diana Henriques, who has been reporting on the Madoff scheme since news of it broke in December 2008.

What’s at stake in the judge’s decision today?

DIANA HENRIQUES: This is clearly going to be appealed – and it’s important that it is appealed. A lot of the confusion about how to calculate the victims’ losses stems from Second Circuit decision in a case called New Times. So getting that issue back in front of the Second Circuit is extremely important and the first step in that is Judge Lifland’s decision [in bankruptcy court] today.

The people most affected by this decision are perhaps the people that were Madoff’s oldest investors – the ones who entered into the Ponzi scheme the earliest – and who drew money out as a regular source of living expenses. They drew out more than they originally put in. [According to the decision,] they aren’t eligible for additional compensation from the bankruptcy case.

Lawyers have argued for them quite vociferously that this is unfair, that the Securities Investor Protection Corporation (SIPC) provides some limited protection and compensation for customers of failed firms based on [customers’] final statements. Those final statements are dated November 30, 2008, and the total balance added up is nearly $65 billion. If that approach is used, then almost every victim is eligible for compensation from SIPC. As you can imagine, their advocates are fiercely seeking some compensation.

Are the majority of Madoff victims net winners or net losers? Is there any precedent for excluding net winners from recovering additional funds in schemes of this type – if not of this magnitude?

DIANA HENRIQUES: As luck would have it, [the number of net winners vs net losers] splits almost down the middle. There’s no guide that would make the judge’s decision any easier.

What makes this case distinctive is not that it was a Ponzi scheme. What’s different here is that the Ponzi scheme occurred in a SIPC-protected broker-dealer – that is the first time that has happened. So you have a collision here between SIPC law and the very long case law about what to do with Ponzi schemes. The very long case law with Ponzi schemes favors the trustee – and that’s what he did. He looked at that long body of law, and it says “cash in and cash out” [governs eligibility]. His adversaries are arguing that that law doesn’t apply here — that SIPC law trumps those cases.

How much is Irving Picard, the trustee, expected to recover for victim compensation and where does that money come from?

DIANA HENRIQUES: In a news conference late last year, Irving Picard estimated that he could recover, very optimistically, as much as $10 billion. Perhaps $7-8 billion is more plausible. And it will come from settlements and lawsuits against the big hedge funds and major investors who took out hundreds of millions before the scheme collapsed. They will be asked or forced to put that money back in the pot to share. There are several settlements in the works – it won’t be an empty pot.

How much is the average Madoff victim expected to recover?

DIANA HENRIQUES: There has been some back-of-the-envelope math – it’s very slippery – and here’s why. If [net winners are ruled eligible for funds] and the denominator is $65 billion, and the numerator is $10 billion, you can see that doesn’t go far. It’s about 15 cents on the dollar. If the net winners are excluded, however, that amount so far is about $20 billion – it might grow as they research the records. [If the trustee] can get about $10 billion – that’s 50 cents on the dollar. For the people who have taken nothing out, their position is that they won’t be made whole, but they will be lucky to get half back. But others have already gotten their money back and then some. That’s the argument of fairness.

What makes it slippery is if Judge Lifland is overturned, some of the people Picard will sue to recover assets will suddenly not be net winners anymore and may challenge the claims, reducing the pool even further. He would be confronted with the perfect storm: more people to pay with fewer funds to pay them.

So this is not the final say on victim compensation?

DIANA HENRIQUES: Technically the next step is an appeal to the U.S. District Court in Manhattan, and from there, you would then take it to the Second Circuit. The next stop after that is the Supreme Court. There is a way to short circuit the way directly from bankruptcy court to the Second Circuit. If that happens, we would almost certainly see a decision before the end of the year – perhaps the end of the summer. Then of course if the loser wants to take it further, they have to petition the Supreme Court.

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