Thursday, February 26, 2009

Re: Aspects Of The General Economic Disaster; More On The SEC's Culpability In Madoff.

February 26, 2009

Re: Aspects Of The General Economic Disaster;
More On The SEC’s Culpability In Madoff.

Just as an orthodox blogger might, I am writing this post on an airplane. Several points will be made, each with relative brevity -- at least for me.

1. Let me start with Obama’s appointments, and what some of them might portend for the economy or foreign policy.

Now, I think that all but the most partisan Republicans would hope that Obama succeeds in efforts to fix the economy and stop wars. But, to an extent I think too great, he has appointed people with a record of failure. In the economic realm he has appointed, for example, Summers and Geithner. Was this wise? True, Summers has long been considered the genius of geniuses (regardless of my dubiety about this), and Geithner too is regarded as very smart. But if my recollection is correct, Summers, in his prior incarnation under Billy Boy, was important in doing away with the Glass-Steagall Act, and put the kibosh on greater regulation of derivatives. Destroying Glass-Steagall meant commercial banks and investment banks could merge, just as they were one before the Great Depression, and then the commercial banks could be dragged down by their investment bank sides when the stock market collapsed, as happened in the Great Depression (before Glass-Steagall) and has now been repeated (after the repeal of Glass-Steagall). And as for putting the kibosh on regulation of derivatives -- is it really necessary to say anything about the economic disaster this created?

As for Geithner, he was a major player in the great disaster wrought by Henry Paulson’s view of what should be done. Need anything else be said?

In the foreign field, it is said that Obama is going to appoint, as the head of his National Intelligence Council, a man who is claimed to be heavily anti-Israel and very pro-Chinese-government-repression. If these claims are true, stay tuned for more disaster in the Middle East and in our relations in the Far East.

But, people say, Obama will control what his underlings do, instead of being controlled by what they think and what they therefore tell him. This is a nice theory. But, as a person who has headed an institution for 20 years and who also reads a lot of history, I can tell you it is only partly true. The man at the top will often be influenced heavily by what his advisers think, especially if the advisers are smart. This is only the more true where the head man or woman is at the helm of a large organization and therefore cannot know most of the everyday details which so significantly determine the strength or weaknesses of policies, and sometimes is not even much of an expert regarding the policies. And when the advisers have a history of bad judgment and serious mistakes, like Summers, then it does not matter if they have IQs of 180 or 200 or twice as high as Einstein’s. Rather, they are likely to keep making the same kinds of mistakes because, perhaps sad to say, people’s fundamental attitudes and beliefs usually do not change much. Rather, most people are guilty of what Einstein himself described as insanity: they keep doing the things which failed before in the expectation that the results will change. Bah!

2. Another example of the above relates to the banks like CitiBank, perhaps Bank Of America, and others, and to the auto companies as well.

Although there is now the beginning of some talk about the government possibly nationalizing the big banks, the administration has for a while seemed fixed on continuing to pour money into these entities and the auto companies, while keeping them private and under the same management, on the theory that they are too big to be allowed to fail. This “philosophy” is usually hogwash. The reason is itself philosophical, I suppose, but not untrue for that.

When institutions have gone dramatically downhill, and only the more so when they have gone dramatically downhill because of horribly mistaken and inept management -- which is the story of the banks for about a decade and the auto companies since the early ’70s -- you are far more likely to resolve the situation successfully by getting rid of them and starting over with new institutions and new, competent management. We need new banks, and new auto companies, with new managements. Only in this way do you get people who are not devotees of, are not ridden with, the ways of thinking and the habits that caused failure in the first place. (So, you see, the point being made here is the same as the one made with regard to Summers and Geithner). The auto companies have been an off and on disaster for over 30 years, the huge, now crippled banks have been a budding disaster for ten years. If you want to succeed, get rid of them, get rid of their managements, and start over with new, competent banks and auto manufacturers under new, hopefully competent managements.

(For those who like sports, I note the obvious analogy that, the vast preponderance of the time, a football or basketball coach who is a bust one time is a bust again -- and again, and again. The exceptions -- Bill Belichick, Pete Carroll when he went from the pros to college -- are exceptions.)

3. There is a theory floating about that one of the reasons for our regulatory difficulties is that, once Glass-Steagall was vaporized -- significantly at the behest of Sanford Weill, who wanted to create the financial colossus that is now semi-expiring because its investment banking arm has brought it down -- the various regulatory agencies lost control, as it were, because each of them had only a partial vision of the institutions it was regulatoring. For instance, the SEC knew from nothing about commercial banks, and the Federal Reserve knew from nothing about investment banks. According to this theory, the solution is to have a superregulatory agency that regulates all aspects of the financial system.

Hogwash. All that a superregulatory agency will accomplish is to insure that one day the institutions will all go down at the same time, in a reprise of today. Antitrust professors and lawyers of my generation, particularly those who write favorably about or represent huge mega companies, like to proclaim -- without evidence -- that bigness is not badness. Like hell it’s not. When institutions of any type get too big they are going to go downhill. There are reasons, which I and others have argued elsewhere, but the reasons need not be plumbed here. Here all that matters is the regularly observable fact. And when we get one huge regulatory body, regulating huge, Sandy Weillish, created-by-greed-and more greed financial supermarkets, the huge agency and the financial supermarkets will one day fail and carry down the whole economy, just as the supermarkets have done now. A much better idea is to divide up those supermarkets into human-sized institutions, each devoted to one field instead of all fields, and then have human sized regulatory bodies which each focus on one type of financial institution. When failures occur in smaller institutions, they do not take down the entire economy (notwithstanding the contrary bovine defecation which claims they do because of interlinkage).

4. The Wall Street Journal reported on Wednesday about a hedge fund manager named James Simons (who, I believe, was the hedge fund guy who made a cool 1.7 billion dollars a few years ago, in 2005 or 2006, I think). Simons had advised Stony Brook to put money into Madoff. But in 2003, it seems, Simons began “voicing concerns about Mr. Madoff, according to people familiar with the situation.” He urged Stony Brook “to pull out all of its money,” and though Stony Brook did not pull out all of it, his urgings led it to reduce the amount it had with Madoff.

The Journal goes on to say “It isn’t clear exactly what bothered Mr. Simons” about Madoff. But during “a routine exam” of Simons’ hedge fund, the SEC got fund employees’ emails that “expressed worries about Mr. Madoff. ‘We at Renaissance have totally independent evidence that Madoff’s executions are highly unusual; one employee wrote.’” (Emphasis added.)

So, Simons -- the 1.7 billion dollar man, no less, one of Wall Street’s most successful investors -- was worried about Madoff (but as far as one knows, did not notify the SEC), the SEC got hold of emails from fund employees expressing concern, with one email saying that the fund had “totally independent evidence” that something wasn’t kosher, and the SEC did nothing. This, if true -- and I’ll bet it is true because the Journal is damn good on factual reporting even if its editorial pages are appalling -- is still more evidence that the SEC is a co-cause with Madoff himself of the horrible events that have occurred and of the devastation wreaked on so many lives.

But maybe the Simons revelation isn’t even the half of it when it comes to new revelations. In a recent story New York Magazine claims the SEC looked at Madoff’s books when it was investigating Bienes and Avellino -- which was 1992. “Bernie showed the SEC his books and maintained that he could return any money requested,” though many customers then decided to leave their money with him, says NYM.

But though it looked at his books -- probably cooked ones -- if the NYM claim is correct (as I suspect it is precisely because the SEC did publicly announce in the WSJ of December 1, 1992 that there was no evidence of fraud, an announcement that makes it logical to think the SEC might have looked at the books), the SEC did nothing. Why didn’t it demand to see the securities Madoff claimed to have? Why didn’t it investigate whether the purchases and sales that he claimed to have taken place in the past had in fact occurred? Why didn’t it especially do such things because it had started the investigation fearing a massive fraud, as was reported by the Wall Street Journal on December 1, 1992? Why did it just take Madoff’s word for everything? One assumes all this was because Madoff had so ardently and lengthily ingratiated himself with the SEC over the years, but who knows? What we can say is that the SEC looked at Madoff’s books but did nothing, and this at a time when the Bienes and Avellino accounts apparently were only about one-half of one percent of what the SEC’s horrendous negligence allowed the fraud to become if Madoff’s claim about its size, when he was arrested, is correct. The SEC’s horrendous negligence was thus a co-cause of about 49.5 billion dollars being lost to fraud if, as said, Madoff, when arrested, was correct about the size of the fraud.*

* This posting represents the personal views of Lawrence R. Velvel. If you wish to comment on the post, on the general topic of the post, or on the comments of others, you can, if you wish, post your comment on my website, All comments, of course, represent the views of their writers, not the views of Lawrence R. Velvel or of the Massachusetts School of Law. If you wish your comment to remain private, you can email me at

VelvelOnNationalAffairs is now available as a podcast. To subscribe please visit, and click on the link on the top left corner of the page. The podcasts can also be found on iTunes or at

In addition, one hour long television book shows, shown on Comcast, on which Dean Velvel, interviews an author, one hour long television panel shows, also shown on Comcast, on which other MSL personnel interview experts about important subjects, conferences on historical and other important subjects held at MSL, and an MSL journal of important issues called The Long Term View, can all be accessed on the internet, including by video and audio. For TV shows go to:; for conferences go to:; for The Long Term View go to:­_LTV.htm.

Monday, February 23, 2009

Re: Of Markopolos And Madoff, New Times And Conventional Wisdom, SIPC And Clawbacks, Equitable Estoppel And Declaratory Judgments.

February 23, 2009

Re: Of Markopolos And Madoff, New Times And Conventional Wisdom,
SIPC And Clawbacks, Equitable Estoppel And Declaratory Judgments.

The hearings before Congress on the Madoff scandal on February 4th put one in mind of some pertinent, hopefully salient, ideas.

There is, to begin with, Harry Markopolos’ claim that many people in the financial world -- dozens, maybe even hundreds -- either knew or suspected that Bernard Madoff was a fraud. Some, to whom Markopolos explained his ideas about Madoff in the course of his investigations, thereafter avoided investing with the man whom Markopolos chooses to call BM, an alphabetically correct appellation that likely is not based just on literal initials. Others figured it out for themselves for one reason or another. Some of these thought Madoff’s results could not be real, others worried because Madoff refused to give them information during the course of their due diligence examinations, still others suspected strongly that something illegal was going on -- the unlawful act of “front running,” for example -- but went ahead and invested anyway because there was money to be made.

Add to this widespread Wall Street knowledge two other factors: One is that Madoff, according to Markopolos, was in effect bribing investment managers to send him money. He did this by offering them an unheard of fee for doing so -- he gave them four percent annually of the amount of money they had sent him. Some investment managers, in addition, were charging their customers an additional one percent “management fee” annually -- for doing absolutely nothing -- plus 20 percent of the profits, again for doing nothing. At least one was, I gather, also arranging for bank loans enabling customers to invest 4 times what they could ordinarily invest -- to invest three dollars of loaned money, on which the customer paid interest -- for every one dollar of the customer’s own money. By arranging for this dangerous leverage -- the customer, who may have lost a fortune, now has to repay the bank 75 percent of what he invested in Madoff -- the investment manager quadrupled the amount he himself made in fees, since the customer was now investing, for example, $400,000 instead of $100,000.

But, though lots of Wall Streeters knew or suspected that Madoff was a fraud, plenty of Wall Streeters were making a boatload of money off of “BM,” and some of them suspected illegality, not a single one of the Wall Streeters went to the SEC. Not one (except, of course, Markopolos). Markopolos says this is due to the Wall Street code of silence. You don’t rat out the next guy. Instead you let him defraud the innocent. (Subprime mortgages, anyone?)

Now all of this is relevant to a question on which I expressed skepticism in a series of blogs posted in January. The question is whether the investment managers of funds, large banks, etc., may be liable to persons who didn’t invest with BM through them. That they are liable, for failure of due diligence or worse, to people who did invest through them, seems beyond doubt. But how about people who didn’t?

Until the February 4th hearing, my view was that there was no reasonable chance of legal liability to such people, regardless of the investment managers’ moral responsibility arising from having failed to blow the whistle on BM. The moral responsibility arises because, had enough of them -- not just Markopolos -- talked to the SEC, it might have felt compelled to act. This is, you know, much the same principle as the moral responsibility of nearly the entire German people in the 1930s and 1940s for failing to act against Hitler, and the moral responsibility of so many Americans for Viet Nam and now Iraq. But though the investment managers bear moral responsibility, do they also bear legal responsibility?

Until now, as said, one would have thought it very unlikely. The reason is the legal concept of duty. This is quite often kept a crabbed, narrow concept in the securities field. Supreme Court Justices, several of whom place little value on truth or honesty (e.g., Rehnquist (previously), Roberts, Alito, Scalia), keep both liability, and the associated concept of duty, narrow in the securities field lest, they say by way of excuse, a defendant be liable to many people. So here one would have thought the duty -- and therefore the liability -- of fund managers, for negligence or worse, would extend only to their funds’ investors. But when you listen to Harry Markopolos, one wonders about this limitation. Lots of the fund managers seem to have been bribed, in effect, to do no due diligence and to keep their mouths shut about deep-seated suspicions instead of blowing the whistle. The defacto bribe money seems, again defacto, to have turned them into coconspirators with BM -- or aiders and abettors of BM -- who would say nothing lest they end the incredible gravy train he was providing them. And as coconspirators, or aiders and abettors, they would be liable to everyone whom BM injured, not just to the people who invested in BM through their institutions.

That these money mangers who were in effect bribed to go along and to keep their mouths shut may be considered coconspirators and/or aiders and abettors is a possibility enhanced by another instrumental role they played. From Markopolos’ testimony, it appears that, from about 1999 or 2000 onward, Madoff needed a continuing influx of really big money to keep his scam going. He got these needed large sums from the funds and institutions, whom he defacto bribed, in order to keep his fraud going and to grow it, according to Markopolos, from between three to seven billion dollars to perhaps fifty billion dollars. Without getting the needed money from large institutions that in effect accepted bribes to look the other way, BM’s Ponzi scheme would have collapsed eight or nine years ago. In those eight or nine years, thousands of new people were sucked in, older investors increased the amount of principal they put in, and people paid large, even huge, amounts of taxes on phantom earnings. None of this would have happened had the major feeder funds and feeder banks not accepted huge defacto bribes to ignore due diligence and look the other way. The culpable funds and banks were thus coconspirators with regard to, and aiders and abettors of, the entire scheme and everyone’s losses in the last ten years or so, not just the losses of those who invested through them. For they made possible the continuation of the scheme and the last ten years’ losses.

Over the course of the next year or two, a lot more is going to be learned about the feeders and their managers. Sometimes these institutions (like European banks) or persons still have gazillions of dollars despite Madoff; they are certain to be sued by their own investors (unless they make good the investors’ losses); they might very well be sued by others; and the prospect of such suits, and of all manner of victims being the plaintiffs in those suits, are likely to increase, perhaps to increase exponentially, as more and more facts come out showing that they were in effect bribed to such an extent, and in various ways, that they became defacto coconspirators and aiders and abettors.

Let me turn now to some of the remarks made at the hearing by Congressman Ackerman. If there can be humor to be found in such a disastrous situation, Ackerman’s bitterly critical comments and the SEC’s preposterous responses provide it. They also provide a lesson in the incompetence we have had in government not just for the last nine years since the imbecile became President in 2001, but since about 1965.

Seeing that once again members of the SEC were refusing to answer legislators’ questions and statements about what had happened, Ackerman said, “We’re talking to ourselves and you’re pretending to be here.” Now that is really funny when you think about it: “you’re pretending to be here.” What a line.

Just afterwards, Ackerman said to the SEC witnesses “one guy [Markopolos] with a few friends and helpers discovered this thing nearly a decade ago, led you to this pile of dung that is Bernie Madoff, and stuck your nose in it, and you couldn’t figure it out. You couldn’t find your backside with two hands if the lights were on.”

They couldn’t find their ass with two hands if the lights were on. Now that’s funny. Markopolos put the same point a bit differently. He said that, if you put the entire SEC into Fenway Park, they wouldn’t be able to find first base. The two analogies -- finding one’s derriere and finding a base -- used to be combined in Chicago in the 1950s, where an expression was that a person couldn’t tell his ass from third base. No matter which expression is used, the description previously has fit most of the federal government most of the time since 1965 or so. A lot of us thought the SEC was competent; I personally thought hard before turning down the offer of renowned SEC Chairman Manny Cohen to work for him, in 1964 or 1965, because the SEC was regarded so highly then; but we now have learned that for several years the SEC -- like the Department of Defense, the Department of Education, the CIA, the National Security Council and other federal bodies -- hasn’t been able to tell its ass from third base.

The SEC official who took the lead in trying to make excuses while saying nothing substantive tried to ward off Ackerman by saying the SEC now has a case pending against BM. To which Ackerman replied: “You took action after the guy confessed. He turned himself in. Don’t give yourself any pat on the back for that.” The fool official responded that she cannot talk about the Madoff case itself, but only in (meaningless) generalities. To which Ackerman replied, “You know, if anybody made the case better than Mr. Markopolos -- and I don’t think anybody could -- about you people being completely inept, you have made the case better than him.” The high SEC official he was talking to resigned her position a few days later. Does anyone not think she was pushed out? -- Deservedly.

Ackerman subsequently got after the SEC’s General Counsel, who was attempting to pull the wool over the Committee’s eyes as to why the SEC officials were refusing to discuss what happened on the Madoff matter. That jerk tried to seriously mislead the Committee as to the reasons the SEC witnesses wouldn’t talk. When he got blasted for giving one bullshit reason or another, he would then ignore that reason or repair to another. He apparently wasn’t claiming the 5th Amendment privilege against self incrimination. He wouldn’t say yes or no as to whether he was claiming Executive Branch privilege, other than to later claim it was one of the reasons for not answering questions. But he hadn’t put the question of executive privilege to the Department of Justice. But it wasn’t just his interpretation, it was the position of the agency. But the Commission, not he, makes decisions for the agency -- yet the Commission hadn’t considered specific reasons for taking the position here, although it somehow supposedly approved the refusals to answer.

The General Counsel was engaged in gobbledygook. Ackerman disgustedly ended by saying “. . . you came here and fumble through make believe answers that you . . . concoct and attribute it to executive privilege, that you’ve not consulted with the Executive Branch on.”

“Make believe answers.” “Concoct.” What a hoot. And how true, figuratively if not literally.

Congressman Kanjorsky, the head of the subcommittee holding the hearing indicated at various times that under the SEC’s position it can’t make disclosures now about what happened because the Madoff matter is under internal investigation and is in litigation, it won’t be able to make disclosures for years into the future because the matter will continue to be in litigation, and it thus will be of no help to Congress in determining what needs to be done. Kanjorski is absolutely right about the SEC’s position before Congress -- a position which, by the way, the SEC cannot continue unless it also intends for its Inspector General’s report to not be made public, to remain secret, thereby exacerbating the Madoff matter. The SEC’s current position is sheer hypocrisy, sheer self protectiveness -- as is true of all the (largely incompetent) federal agencies (the secrecy and self protectiveness of DOD and now the DOJ too are legendary). It also causes one to be even more certain than American experience in the last four decades already makes certain anyway that the Inspector General’s report will be a whitewash insofar as the SEC finds it possible to present a whitewash.

Let me now turn to the last two major topics of this posting, involving ideas not fired up by the February 4th hearing, but instead relating to a subject hanging over the heads of Madoff victims from December 11th onward. (September 11th and December 11th. What an unlovely symmetry. Does anyone remember that November 11th was the day the guns stopped in 1918? (Armistice Day.))

It has long been feared and the Trustee, Irving Picard, appeared to time and again confirm at a public meeting on February 20th, that the amount an investor will be credited with will not be the amount shown in his/her account on the November 30th statement. For that amount includes not only the principal the investor put (and left) in, but also the phantom income with which the investor was credited by Madoff. Thus, for example, suppose an investor put in principal of $475,000, was credited with phony income of $100,000 (for a total of $575,000), but took out $75,000. The amount shown on the November 30th statement will be $500,000 ($475,000 originally invested, plus $100,000 in phony income, minus $75,000 taken out.) If one is not credited with the phantom income of $100,000 (on which she paid taxes), the amount she has is only $400,000 (the $475,000 initially invested, minus the $75,000 taken out).

This is important with regard to SIPC, which can advance up to $500,000. If the investor’s holdings total $500,000, as is the case if the $100,000 of phantom income shown on the November 30th statement is included in his Madoff holdings, then he will recover $500,000 from SIPC: $475,000 in principal, plus $100,000 phantom income, minus $75,000 taken out equals $500,000, so SIPC will pay $500,000. But if the phantom income of $100,000 included in the statement is subtracted from the investor’s holding, the investor will get only $400,000 from SIPC. $475,000 in principal, plus zero for phantom income, minus $75,000 taken out equals $400,000, so SIPC will pay only $400,000.

So the question is: will the investor be credited with the $100,000 in phantom income (on which she paid taxes) when SIPC calculates how much to pay her? The conventional wisdom, based on the New Times case in the Second Circuit Court of Appeals, and Irving Picard, say no. But the New Times case said no on the facts of that case, in the context of those facts and none other. Are those facts the same as, and the holding therefore equally applicable to, the Madoff situation? Unthinkingly, yes. Thoughtfully, not at all. Not one little bit.

In the New Times situation there were two kinds of investors. One kind was those who were fraudulently induced to buy, through the fraudster, shares of mutual funds that actually existed, such as Vanguard and Putnam funds. After victims gave him their money, the fraudster never bought the mutual funds. Instead he stole the money. But he sent the investors account statements which tracked the actual funds (though he hadn’t bought them) and which enabled the victims, as the court said the Trustee noted, to “have confirmed the existence of those funds and [to have] tracked the funds’ performance against [the fraudster’s] account statements.”

People who were induced to purchase mutual funds that actually existed, and on which they could have checked, thus received, as I understand it, SIPC protection of up to $500,000 if the value of the real securities they thought they had purchased would have equaled $500,000 when the fraud was exposed.

But the investors who thought they had purchased real, existing mutual funds -- just as Madoff’s victims thought he was buying for their account real, existing stocks of Fortune 500 companies, real Treasuries, and real puts and calls -- were emphatically not the investors involved in the New Times appellate case. The investors in the New Times appellate case were in a wholly different position. They were people who invested in new mutual funds which were supposedly offered by the fraudster but which did not in fact exist. Let me repeat this: unlike the Vanguard and Putnam funds, which did exist, the funds bought by the claimants in the New Times appeal did not exist. This made all the difference in the case, for reasons I shall discuss.

Thus, the appellate court, early in its opinion, made the following statement:

To be clear -- and this is the crucial fact in this case -- the New Age funds in which the Claimants invested never existed. They were not organized as mutual funds, they were never registered with the SEC and they did not issue any of the requisite prospectuses for investors. [First and third emphases supplied, second emphasis in original.]

The first of the two specific issues decided by the court was whether the claimants in the case should be credited with owning securities, rather than merely having a claim for cash, even though the mutual funds they thought they invested in never existed, i.e., the securities never existed. After much legalistic mumbo jumbo, including extensive mumbo jumbo about whether it should defer to the opinion of SIPC, defer to the opinion of the SEC, and which it should defer to more, the court mumbojumboed its way to holding that the victims had claims for securities, a claim that creates $500,000 of SIPC protection rather than only the $100,000 of protection given to cash. When one cuts through all the legalistic mumbo jumbo, the fundamental reason for this ruling is that holding that the investors owned securities (not mere cash), even though they did not really own securities, better accomplishes the purposes of the Securities Investor Protection Act (SIPA) to “‘provide protection to customers of broker-dealers . . . to reinforce the confidence that investors have in the U.S. securities markets.’” The “statutory goals [are] promoting investor confidence and providing protection to investors,” and these are better achieved by holding that investors owned securities. They had “‘legitimate expectations’” of ownership of securities, expectations “based on written confirmation of transactions” that the fraudster sent them,” and investor protection and confidence, the goals of SIPA, were best served by honoring their “legitimate expectations,” as was urged by the SEC, to which the court deferred.

But when it came to the second issue in the case, the court’s tune changed because the mutual funds had never existed. Again the court deferred to the SEC (which agreed with SIPC on this issue though they had disagreed on the prior one). So deferring, the court ruled that the investors should be credited only with the amounts they invested, and not with the dividends and interest the fraudster had credited to their accounts. In other words, though the court did not mention its own inconsistency, and did not even appear to recognize that there was inconsistency, on the second issue the court frustrated investors’ expectations, failed to protect them, and harmed investor confidence. For the investors obviously must have expected that they had in their account the dividends and interest reflected in their account statements, just as they thought on the first issue that they had securities, not cash. But while the court honored their legitimate expectation that they had securities, it frustrated their equally legitimate expectation that they had amassed dividends and interest.

Why, then, did the court, deferring to the SEC and SIPC, rule that investors did not have interest and dividends in their accounts? What are the reasons for this ruling, are they valid, and, valid or not, do they apply in the Madoff matter?

The fundamental reasons for the court’s deferral and its ruling were that allowing investors to recover “fictitious amounts” that they were credited with by the fraudster “would allow the customer to recover arbitrary amounts that necessarily have no relationship to reality,” leaves the SIPC unacceptably exposed, the SEC and SIPC agreed that “such an approach is irrational and unworkable,” and the approach “would create potential absurdities” because the numbers would be “entirely artificial.” But this is all nonsense; it is all completely out of step with what is done every day in courts.

As a lawyer and professor who litigated very large antitrust cases involving up to many hundreds of millions of dollars back in the day when this was still real money, I can tell you that every day, in antitrust cases, airplane accident cases, and numerous other kinds of cases, the courts use various methods of finding out what profits would have been, what losses would have occurred, if things had been different. That is one of the things that expert economic witnesses are for. The same kinds of calculations could easily have been done in New Times. One could have chosen to say, for example, that the percentage of interest, dividends and appreciation for the mutual funds that did not exist should have been assumed to be the same as for those which did exist. Or they should have been assumed to be the same as the average over the relevant years for the type of mutual fund -- value fund, growth fund, etc. -- that the non-existent funds were advertised as being. Or investors could be credited with a rate of appreciation plus dividends that was reasonable in the economy during the time period, say 7.5 percent, for example. These kinds of simple calculations -- less sophisticated and much easier to make, I must say, than those involved in cases that I was in -- would mean that the interest and dividends that people were credited with in court were not arbitrary, would pose no threat to SIPC, would not be irrational or cause absurdity, would be grounded in reality and wholly rational. Otherwise, economic calculations taking place every day in courts all over the country are absurd, arbitrary, have no relationship to reality etc. That neither the SEC nor SIPC, nor the federal court whose location in New York causes it to be regarded as the premier federal court in the country in regard to the financial system, could think of such a simple solution, one used every day in all kinds of litigations all over the country, causes one to understand even more deeply the truth of Gary Ackerman’s statement that the two agencies could not find their backsides with two hands with the lights on. Or, as we expressed it equally colorfully in Chicago . . . . . . . . . . . . .

The stupidity of the SEC’s position, and the really horrendous results it will produce if it is followed by the SEC, SIPC and the Trustee in the Madoff case, as is the present intent, are an excellent reason for not following it in Madoff, and for not deferring again to the SEC and SIPC if they were to repeat it in Madoff. For the dumb position, by holding that people should not be credited with the interest, dividends and appreciation shown in their accounts nor with any reasonable substitute calculation, causes them to be denied their “legitimate expectations.”

And investors will be denied their legitimate expectations, rest assured of that. Not only did they legitimately expect that they had amassed appreciation and dividends, but many took action accordingly. They used the money to live, to pay taxes, to pay for children’s education. They took out loans against it that they must now repay somehow.

And just to add horrible insult to horrendous injury, now (1) SIPC and the Trustee will give many of them no SIPC recovery because, relying on the legitimate expectation that they had appreciation in their accounts, over the course of many years many investors took out more than they put in, and (2) the Trustee may try to claw back huge sums from those who took out what they legitimately expected was appreciation in their account.

But there is even more to it than this. Remember that the reason for deferral to and adoption of the SEC’s and SIPC’s dumb position in New Times was that the securities bought by the claimants never existed. Investors thus could never look them up and track them, could never determine whether their performance as reported in the financial press or as reported to the SEC matched the performance shown in the investors’ account statements. That is why it supposedly was arbitrary, irrational, not grounded in reality, etc. to give investors credit for the dividends and interest shown on their accounts. But in Madoff the fraudster claimed to be buying and selling, and the account statements showed, purchases and sales of real securities, Fortune 100 stocks no less. An investor, if suspicious, could, and we now know some did although most had no reason whatsoever to be suspicious, compare what was shown on account statements with actual purchase and sale prices of the same securities in the market at the same times. My understanding is that in most instances the match was perfection itself (although there apparently must have been some (few?) instances when -- due to slip-ups in Madoff’s offices, one would think -- this was not precisely so, a fact which did not become public knowledge when discovered by people hired by big shots to do due diligence).

So the very reason underlying New Times’ holding that fictitious appreciation on securities that never existed would not be credited to investors even though they would fictitiously be credited with securities, does not exist here, is inapplicable here. Here the securities were real, could be checked as to purchase and sale prices. Thus, under the very logic of New Times -- that because the securities never existed, the investors would not be credited with fictitiously-increased amounts that they thought they had, that they legitimately expected they had -- is completely inapplicable in Madoff. For in Madoff the securities did indeed exist.

Incidentally, if one asks the perfectly good question, as at least one person has, of whether the Trustee in New Times credited fictitious appreciation to those who owned Vanguard and Putnam funds, funds which did exist but were never bought by the fraudster (and whose performance in the real world could be looked up), the answer is this: while I don’t know for certain, based on statements in the New Times opinion I believe the answer is yes. For the account statements of those investors “‘mirrored what would have happened had the given transactions been executed,’” and those investors, as the court quoted the Trustee as noting, “could have confirmed the existence” of the relevant funds and could have tracked the performance of the actual mutual funds against the amounts shown in their account statements. And apparently, for these reasons, those investors received the actual value of their securities when the fraud was discovered -- actual value which would have included appreciation (or decline). If the answer is therefore yes, as I think, this is certainly unfavorable to the position taken by the Trustee in Madoff. For the investors in Madoff could have confirmed and tracked the performance of the real securities against the performance shown in their account statements, just as could be done by the investors who thought they had bought real mutual funds in New Times.

I shall turn now to one final issue: clawbacks.

Now maybe I’m all wet, but I thought that money withdrawn from Madoff in the last six years cannot be clawed back by the Bankruptcy Trustee if the investor had given equal value and had no knowledge that should have made him suspicious that a fraud might be occurring. This does not seem to enter the news media’s discussions, however, nor investors’ discussions. Rather, often it seems simply to be assumed, I think wrongly, that any monies withdrawn in the last six years can be clawed back. But if an innocent person did not withdraw more than she put in, then I think there cannot be a clawback (unless, perhaps, money was withdrawn within 90 days of December 11th), because the amount put in is “equal value” (or more) to the amount taken out. Picard seems to agree with this.

But let’s face it. There must be lots of people, including older people, who now have taken out more than they put in. These investors would include older people, in their mid to late 70s or 80s, for example, who have long been withdrawing money in order to live. They might include people who had to withdraw money in order to pay their income tax on their Madoff income -- unlike more privileged others, they couldn’t afford to pay their taxes on Madoff income without withdrawing money from Madoff. They might include people who withdrew money to pay for grandchildren’s schooling or to buy a house. Should people like this be subject to clawbacks?

The Trustee, if I understand him correctly, says yes. He says these people are subject to clawbacks although he may forego clawbacks in circumstances he declines to identify other than to indicate that the investor must be innocent and it will help if he/she is very old and poor.

My view is that innocent people should not be subject to clawbacks at all, and I think the Trustee should do a lot more to publicly disclose circumstances that he will regard as “non clawable.” (He already has been accused of saying little in this regard in order to preserve the ability to be arbitrary.) Take, for example, people in their mid to late 70s or 80s who depended on Madoff monies to live, are now wiped out, may lose SIPC recovery because they took out more than they put in, don’t know where their next dollar will come from or how they will buy food. You want to claw back money from people like this? You want blood from a stone? Why not flatly announce that you will leave such people alone if they had no knowledge of possible fraud?

Or take people who withdrew money to pay income tax on phantom Madoff “earnings” because, unlike far wealthier people, they could not pay the tax on such phantom income without withdrawing money. The money those people took out was to pay tax on income that was phony, on income that would never have existed, and on which tax therefore would never have been paid, but for the government’s fantastic negligence -- or worse -- going all the way back to 1992. Yet these people’s withdrawals to pay tax should be clawed back, while the wealthier suffer no such penalty, and should be clawed back for six years although refunds for phony tax payments only go back three years? Gimme a break, as it is said. Why not announce that money used to pay taxes on phony income, taxes which would not have been owed but for the government’s fantastic incompetence, will not be clawable if the victim had no knowledge of Madoff’s fraud?

I think there is a point of view, however - - one which, if I heard him correctly, the Trustee defacto is taking -- which holds that the Trustee is legally obligated by the language of the bankruptcy statute to seek clawbacks. I don’t know if this is true of the statutory language -- somebody should check it out -- but I will assume that it is true. Nonetheless, its presumed truth settles nothing. For the Trustee, like any litigant, like any prosecutor, can always exercise discretion about whom to seek money from, or whom to prosecute and whom to let off the hook, or with whom to settle a matter for a song or with little or no penalty. All this is inherent in our legal system and to claim lack of discretion to take account of important facts is pure “bovine defecation,” as Norman Schwarzkopf so delicately put some matters. Indeed, at his public meeting, the Trustee claimed discretion not to seek clawbacks in cases or in circumstances which he would not elaborate. So here the Trustee should exercise judgment and discretion and not seek clawbacks from the small, injured and innocent and should say he won’t seek them. Focus on the big boys -- the gazillion dollar banks and funds which, it seems, were in some cases both culpable and withdrawing gazillions in the last four to five years.

Unless and until he changes his mind, however, the Trustee apparently will not pledge to lay off small folks who are harmed, are innocent, and were withdrawing monies for understandable purposes like obtaining money needed to live, or to pay tax on the phony income that would not have arisen but for fantastic governmental negligence or complicity, or to pay for kids’ education. If so, I have two suggestions for the injured. First, assert the principle of equitable estoppel against efforts to claw back money -- and efforts to reduce SIPC recoveries. Under that principle, the government -- and here the bankruptcy court trustee and SIPC are the government -- is not permitted to make claims whose assertion is made unjust and inequitable because of its own conduct and statements. Here the conduct of the SEC, governmental conduct of unimaginable horrificness as discussed in prior blogs and as blasted by legislators in hearings, is a co-cause of the disaster that has befallen so many. Here the government is a defacto coconspirator, an aider and abettor, a joint tortfeasor, call it what you will. And here, therefore, the government, the co-cause of the disaster, should be estopped from trying to further screw people by clawing back monies from the innocent or reducing their SIPC recoveries. Justice demands this.

The use of equitable estoppel is my first suggestion. My second is: bring declaratory judgment suits. A declaratory judgment is a type of action used to prevent injury from actions that are almost certain to occur unless a court declares them illegal before they take place, declares them illegal before the fact, as it were. In view of the circumstances of this case, if the Trustee and SIPC do not quickly agree to reverse course and not take the kind of unjust actions under discussion, then I suggest injured investors bring declaratory judgment actions against them. Courts don’t always grant declaratory judgments when asked, and a court that granted one might of course rule against the investors despite the awful circumstances. But it is worth a shot: courts might rule in favor of the investors in advance; investors’ bargaining position would be enhanced, if a court were simply to refuse to rule in advance, by letting the trustee know he is in for a battle royal after he takes the unjust actions; and, were a court to rule against the investors, this would be more grist for the mill of trying to get Congress to act.*

* This posting represents the personal views of Lawrence R. Velvel. If you wish to comment on the post, on the general topic of the post, or on the comments of others, you can, if you wish, post your comment on my website, All comments, of course, represent the views of their writers, not the views of Lawrence R. Velvel or of the Massachusetts School of Law. If you wish your comment to remain private, you can email me at

VelvelOnNationalAffairs is now available as a podcast. To subscribe please visit, and click on the link on the top left corner of the page. The podcasts can also be found on iTunes or at

In addition, one hour long television book shows, shown on Comcast, on which Dean Velvel, interviews an author, one hour long television panel shows, also shown on Comcast, on which other MSL personnel interview experts about important subjects, conferences on historical and other important subjects held at MSL, and an MSL journal of important issues called The Long Term View, can all be accessed on the internet, including by video and audio. For TV shows go to:; for conferences go to:; for The Long Term View go to:­_LTV.htm.

Thursday, February 05, 2009

More On The Madoff Mess: A Post In Three Installments. Part III.

February 5, 2009

Re: More On The Madoff Mess: A Post In Three Installments. Part III.

I wish to conclude by discussing possible legislative action in Congress. Some of what I shall say has been discussed in my prior six-installment posting that ran from January 19th through January 24th.
To date there has been little discussion in the MSM -- actually, there seems to have been no discussion there -- of a variety of possible legislative steps to ease the pain and suffering of thousands of people. I am not speaking here of what is generally called a bailout, which shall be discussed below. I am speaking here, rather, of lesser steps, such as increasing the number of years for which victims can obtain refunds for income tax paid on phantom income, of extending those years back to 2000 when the SEC first began ignoring Markopolos’ warnings and thereby allowed disaster to continue, or back to 1992 when the SEC complicitously sucked people into Madoff by announcing that all was well, that there was no fraud. I am speaking here of allowing the defrauded to take theft deductions now instead of requiring them -- requiring people in their 70s and 80s, no less -- to wait five or ten years into the future, when many of them will be dead, before taking theft deductions, as is now the law. I am speaking here of increasing the amount recoverable from SIPC, which was set in 1970 at $500,000 for lost securities and $100,000 for lost cash -- even SIPC personnel concede that other governing financial rules established in the 1970s are not adequate today, after the vast inflation of the last 39 years, and should be increased by 300 roughly percent. I am speaking here of allowing people who invested through a feeder fund to have individual SIPC claims, which they do not now have because now only the feeder fund has a claim (and only for $500,000).
These rule changes, made necessary by the gross failure of the SEC, as well as by the gross failure of an organization which was established by Congress though it is a private membership body, FINRA, and perhaps by a failure of the IRS too, would alleviate much of the present misery. But Congress has not been discussing them because, in the main, it has been focusing simply on the regulatory failure and ignoring the human wreckage caused by the regulators and by its own failure to effectively oversee the regulators.
There are a variety of reasons why Congress has not focused much on the human problems. The immediate, overwhelming shock at the degree of regulatory failure and incompetence is one. A second is anti New Yorkism -- read anti-Semitism if you want the real truth. A third is the celebrity worshipping mass media’s focus on the losses of the hugely wealthy, the focus which makes it appear to the average guy on the street that the Madoff problem is one involving only the hugely wealthy who deserve no sympathy. (The average man in the street in Arkansas is often used to supposedly exemplify this attitude because of that state’s poverty, which has led to the bitter joke that the state motto is “Thank God for Mississippi”.) But the mass media’s portrayal is extensively false just as is so often the case in other matters (e.g., its treatment of WMDs in the run up to the Iraq War).
Because of my prior postings I have spoken to or dealt with a lot of persons who were ripped off by Madoff, and would venture to guess that many of them, maybe far and away most of them, have their roots in the working class or the lower middle class of this country; that many of them, maybe even all or nearly all of them, are either the first generation, or are children of the first generation, to escape poverty in this country. They are not your Citibanks, or your Lehman Brothers, or your Merrill Lynches, or your Goldman Sachs -- they emphatically are not your minion of enormous wealth for 80 or 100 or 150 years. Nor are they the many-millions-of-dollars-per-year -- scores and even hundreds of millions or even billions of dollars per year -- Wall Street types who greedily caused the current economic disaster, have caused there to be a need for a trillion dollar bailout, and have now paid themselves nearly 20 billion dollars in bonuses for doing so, have apparently paid themselves these bonuses from about 400 billion dollars in bailout funds already passed out to them, and who, despite receiving the bailouts, are still not lending money.
So many Madoff victims are none of that. They are persons who worked their asses off for scores of years to rise from poverty or the lower middle class, who invested for their old age in a way that seemed safe and prudent, and that gave them a far smaller return than people were getting from stocks and stock-buying mutual funds, but who were screwed over by the incredible negligence, the defacto complicity, of the government that was supposed to protect them, of the very agency, the SEC, that was set up specifically to protect people like them and who now find themselves penniless and having to sell their homes in their old age because this agency is the gang that couldn’t shoot straight.
You would not know this about Madoff investors from the mass media. Nor does the MSM have the faintest idea of another salient fact. I have been interviewed by various members of the MSM, including producers of major national TV shows, and all of them are shocked to learn a fact so basic as to be primitive. Falsely thinking and portraying Madoff victims to all be a bunch of wealthy capitalists, the MSM is completely ignorant, and never mentions, that Madoff investors did not pay tax at the rate of 15 percent applicable to the long term capital gains which provide so much of the income of fat cats. Madoff investors did not pay tax at the low rates applicable to the hedge fund manager who made $1.3 or $1.7 billion a year, or by the capitalists who make their money in stocks and real estate. Rather, Madoff people paid tax at the roughly 35 or 36 percent rate applicable to what in tax law is known as “ordinary income;” they paid at the same rate as is paid on salaries, or as is paid, because they are salaried people, by most of the folks who are losing their houses because of Wall Street’s greed-driven subprime mortgage fiasco, folks who, unlike the greed-driven banks, have not been bailed out so far and who, like the Madoff investors, are so far getting screwed over by the government. The capital gains made by Madoff investors, you see, were not long term capital gains taxed at a rate of 15 percent. They were short term capital gains, plus (to a much lesser extent) dividends and interest, all of which, including the short term capital gains, is taxed at roughly 35 or 36 percent rather than at the 15 percent applicable to the gains of the fat cats who give Congressmen and Presidents millions of dollars.
Lastly, let me briefly discuss a bailout. I have discussed before, in the last (January 24th) installment of my prior posting, the concept of a staggered-percentage bailout, which provides a higher percentage of recovery to those who are most in need and lower percentages to those not in the same need. Whether it were to use a staggered percentage bailout or a full bailout, the Congress should use a bailout. Right now, legislators’ views are widely thought to be viscerally against one, because the Madoff victims are supposedly just a bunch of wealthy Jews -- which is grossly false, because there is no real appreciation for what happened to victims, because Congress has not yet come to grips with the fact that a mass of human wreckage has been caused by the gross -- and complicitous -- failure of the SEC to stop a horrendous crime even though warned of it to a fare thee well, and because of Congress’ own failure of oversight.
Nor has Congress focused on the fact that a bailout would write finis to what already is known to be a fantastic legal mess in which nobody knows which end is up and that will provide a lawyers’ relief bill until somewhere between 2015 and 2020. Questions whose answers are currently unknown but are likely to be litigated to a fare thee well for years into the future in the absence of Congressional action obviating the whole mess include theories for obtaining tax refunds for many more than three years, for obtaining immediate theft deductions, for suing the government for its own incredible negligence, for suing FINRA and forcing it to assess the entire brokerage industry for billions of dollars in damages owed to victims, for allowing persons who invested through IRAs to recover, to require SIPC to pay every victim $500,000 no matter what he or she withdrew from Madoff, to obtain billions of dollars in recoveries from funds and banks because of their failure of due diligence, and more.
If Congress wants this kind of a years-long mess to be avoided, as well as the human misery that will prevail in the meanwhile, it should provide a bailout. It is said, of course, that people are sick of bailouts and they haven’t been shown to work. Hundreds of billions have already been thrown at banks (and AIG) and they are still not lending. They instead use the money to buy other banks, to give out billions in bonuses, to try to shore up what bids fair to be unshorable capital bases. More billions are going to be thrown at Wall Street -- whose fat cat lobbyists spend every waking moment lobbying for the gigantic sums -- and even then there may be no societal benefit, but rather just a waste of money.
You know, I agree with all of that. I surely do. The disasters brought upon us by the scions of Wall Street and their representatives in the past and/or present Executive -- Rubin, Summers, Paulson, Greenspan, Geithner, Weil et. al. -- are beyond belief, beyond greed, and may be beyond fixing by any conceivable bailout of the banks. But none of that is any excuse for failing to help the people who are not responsible for the Madoff mess -- which is most of the people who have lost or will lose their homes -- nor for failing to help innocent victims of a scam that succeeded only because of the gross, complicitous failure of the very agency that was set up to protect people against such scams, the SEC.
Nor are we talking here about a bailout on the order of the trillion dollars that will be thrown at the banks (plus the auto companies whose horrible decisions are responsible for their plight). Using a concept thought of by a gentleman in California, a bailout of Madoff victims could be accomplished for, I would estimate, about two billion dollars per year, which is one-fifth of one percent of the trillion dollar bailout, and which, unlike the monies received by the banks, will be spent for the intended purposes -- here to enable people to live. Under the Californian’s idea, people would receive government bonds, whose principal would not be payable for ten years unless, and only to the extent that, the principal is needed for living or medical expenses. During the ten years, the government would pay bondholders interest of seven percent tax free. This would minimize the government’s annual cost, which I would estimate, for various reasons, would not be more than about two billion dollars a year until it has to pay off the bonds ten years from now. (It could create a sinking fund in the meanwhile to cover the payment of principal -- or is this sensible idea too much to ask from the government?) Two billion dollars a year for ten years is a lot less than the trillion dollars the government will have thrown at the banks in a total of just a year or two, and unlike the money thrown at the banks, will accomplish its purpose, here the purpose of allowing people to live.
You know, it is time that Congress and the Executive started paying attention to and helping out with the real, true human disaster caused by things like people being thrown out of their homes because of subprime mortgages and the Madoff scam, instead of being primarily worried only about abstract economic concerns like bank capitalization or the sufficiency of obviously incompetent regulators.*

* This posting represents the personal views of Lawrence R. Velvel. If you wish to comment on the post, on the general topic of the post, or on the comments of others, you can, if you wish, post your comment on my website, All comments, of course, represent the views of their writers, not the views of Lawrence R. Velvel or of the Massachusetts School of Law. If you wish your comment to remain private, you can email me at

VelvelOnNationalAffairs is now available as a podcast. To subscribe please visit, and click on the link on the top left corner of the page. The podcasts can also be found on iTunes or at

In addition, one hour long television book shows, shown on Comcast, on which Dean Velvel, interviews an author, one hour long television panel shows, also shown on Comcast, on which other MSL personnel interview experts about important subjects, conferences on historical and other important subjects held at MSL, and an MSL journal of important issues called The Long Term View, can all be accessed on the internet, including by video and audio. For TV shows go to:; for conferences go to:; for The Long Term View go to:­_LTV.htm.

Wednesday, February 04, 2009

February 4, 2009

Re: More On The Madoff Mess: A Post In Three Installments. Part II.

At this point in time, there still has not been much talk about lawsuits against the government or FINRA. I think the relative silence on these subjects to date arises from people’s shocked focus on more immediate questions: what can they recover quickly and how do they go about this; will the bankruptcy trustee try to “claw back” from the innocent -- from people who were financially hurt or wiped out -- money they took out of their Madoff accounts in order to live; can they quickly sell their homes to raise money to live on; can they successfully get back into the work force, often by seeking entry level jobs though they are in their late 50s or their 60s or 70s. But the time will be fast approaching when people will begin to focus on trying to obtain recovery of lost monies by the long term means of lawsuits against the government, FINRA, negligent feeder funds and negligent banks.
What is more, if I had to make a guess, it would be that, despite the expectable efforts of the SEC to minimize its negligence (I’ve even heard that it may be trying to get investors to pin the blame for their woes not on it but on their feeder funds), over time more and more will come out about how horrible its conduct was. This will be akin to the slow hemorrhaging of information about the derelictions of the Department of Justice with regard to torture, illegal electronic spying, politically inspired firing of U.S. attorneys, etc. -- information the DOJ always wanted to keep secret but that ultimately would not down.
Two things should now be said with regard to potential suits against the SEC. First, suit probably should not be brought against the SEC itself, or at least not against the SEC alone, but against the United States (i.e., the federal government). Second, as has been said here before, there likely is error in the (ignorant) conventional wisdom -- that the federal government or one of its constituent parts cannot be sued because of “sovereign immunity” -- mouthed by the celebrity lawyers and academics whom the mass media love to quote -- and who become celebrity lawyers and academics in part because they are willing to shoot off their mouths to the media in order to be quoted even if they don’t know what they are talking about.
One should not sue the SEC, or the SEC alone, because the amount of money needed to make people whole is not in the SEC’s possession, but in the possession of the United States Government. And the SEC is part of the United States Government, which is liable for the SEC’s derelictions (just like a corporation is liable for the unlawful action of one of its parts).
As well, there is some possibility that not just the SEC, but the IRS too -- another part of the USG -- may have negligently failed to blow the whistle on Madoff’s scam. As I (incompletely) understand the latter possibility, it arises because the IRS, I’m told, carefully checks taxpayers’ declarations of dividends and interest against corporations’ submitted records of payments of interest and dividends, in order to insure that a taxpayer is not shortchanging it and is not withholding taxes to which it has a right. But, not caring if a taxpayer is overpaying it and giving it taxes to which it has no right, the IRS does not tell him when a comparison of his reported interest and dividends against the amounts a corporation says it has paid shows that there were no such interest or dividends paid by the corporation. I’m told, in short, that the IRS plays a heads we win, tails you lose game with the taxpayer. Had it played it straight -- had it told taxpayers that corporations were not reporting having paid dividends and interest on which the taxpayers were paying tax, the whistle would have been blown on Madoff years ago. (The IRS plays another, similarly unfair game because, if a taxpayer defrauds it out of taxes, it can go back 10, 20, 30, 40 years to collect the taxes it was owed, but, if fraud on the taxpayer causes him to pay the IRS taxes it is not owed, the taxpayer is allowed to recover only the last three years of taxes.)
So one should sue the USG as well as, or instead of, the SEC. Is a suit against the USG permissible even though the USG and the SEC will claim they cannot be sued because of so-called “sovereign immunity”? I think the answer very likely is yes.
Sovereign immunity is an obnoxious doctrine. It is a relic of the divine right of kings, and was created when the king literally owned the courts -- he was not about to be sued in courts that he himself owned. It is the death of the rule of law, since it allows the government to illegally injure someone, even illegally kill someone, yet be immune from suit for damages.
Recognizing the obnoxious, the horrific, character of this doctrine, the courts and Congress have made various inroads on it. One is the Federal Torts Claims Act (FTCA), under which a citizen can sue the government for negligently injuring him, among other things.
When a citizen sues the government under the FTCA for injury it caused him, the government can defend by saying that its act (or the act of its employee) was within its discretion even if it turned out to be a mistake, was in accordance with the social, economic or policy goals of the statute, or was mandated by a particular regulation. But if its act was not in accordance with the statutory policy, was not mandated by a particular regulation, was not one it had discretion to take or not take under the statutory policy, its defense falls to the ground.
Here it is very hard to understand how the government’s defense could do anything other than fall to the ground. Can the government seriously claim that it had discretion to ignore the largest fraudulent Ponzi scheme in history under the social, political and economic policies of the federal securities laws -- enacted in the early 1930s in order to stop frauds because they had contributed heavily to the depression and enacted to safeguard investors against fraud? Can it seriously claim that under these laws, it had discretion not to conduct a thorough, non-horribly-negligent investigation when presented with a memorandum of warning as thorough, as detailed, as Markopolos’? Can it even point to any internal policy or regulations, however out of joint with the underlying laws such internal policy might be, that allowed it not to thoroughly investigate an extensively documented -- and correct -- claim of the largest Ponzi scheme in history? Moreover, there are lawyers with extensive SEC experience who think that the legal process called “discovery,” in which the SEC will have to turn over its internal manuals and policies, will show that it grossly violated its own internal policies by its slipshod -- or even complicitous -- conduct.
So . . . . it seems to me, at least, that the SEC and the USG are going to be liable in damages here under the FTCA for the horrendously negligent, anti-the-policy-of-the-securities-acts conduct of the SEC.
Just a word about FINRA. Little need be said because the pertinent points were made in my prior six-installment posting. FINRA’s negligence was virtually as bad as the SEC’s. It, and its predecessor, the NASD, could have discovered and put a stop to this fraud decades ago by simply demanding answers to questions, and relevant documents, pertaining to the brokerage operation (questions like “Where are the securities you are holding for the firm’s clients? Show them to us.”) It can assess the members of the brokerage industry -- who have been paying it only $150 per brokerage company per year for many, many years -- to obtain the money to pay investors for all the money they lost due to its negligence. And it is only a matter of time until lawyers begin to realize that FINRA should be a defendant and begin to make it a defendant.*


* This posting represents the personal views of Lawrence R. Velvel. If you wish to comment on the post, on the general topic of the post, or on the comments of others, you can, if you wish, post your comment on my website, All comments, of course, represent the views of their writers, not the views of Lawrence R. Velvel or of the Massachusetts School of Law. If you wish your comment to remain private, you can email me at

VelvelOnNationalAffairs is now available as a podcast. To subscribe please visit, and click on the link on the top left corner of the page. The podcasts can also be found on iTunes or at

In addition, one hour long television book shows, shown on Comcast, on which Dean Velvel, interviews an author, one hour long television panel shows, also shown on Comcast, on which other MSL personnel interview experts about important subjects, conferences on historical and other important subjects held at MSL, and an MSL journal of important issues called The Long Term View, can all be accessed on the internet, including by video and audio. For TV shows go to:; for conferences go to:; for The Long Term View go to:­_LTV.htm.

Tuesday, February 03, 2009

More On The Madoff Mess: A Post In Three Installments. Part I.

February 3, 2009

Re: More On The Madoff Mess: A Post In Three Installments. Part I.

For the last six weeks or so, I have been dealing with a large number of people whom I never previously knew and who did not previously know me. They are victims of Madoff. They are not the billionaires, huge international funds, or gigantic banks that the media focuses on. They are plain Americans who worked like dogs all their lives, managed to save some money, thought they had invested it wisely, were fooled by, and got sucked in by, the complicitous SEC’s 1992 pronouncement that there was no fraud and/or its failure of retraction or of any action thereafter, and now, in their senior years, suddenly find themselves financially wiped out or gravely injured. They are selling their houses to raise money to live, they are trying to unretire and get back into the workforce at a time of depression and high unemployment caused by the barons of Wall Street -- which has just passed out nearly $20 billion in bonuses -- who were aided and abetted by Greenspan, Rubin, Summers, Bush and Bush’s laissez faire Republican Party. They are desperate and in agony.

One of these plain Americans recently sent me an email. It was poignant. She gave me permission to print it, with her identification deleted:

Dear Sir
I have been reading your articles on line. I write you this email with tears in my eyes engulfed with great emotion. I too am a victim of Bernard Madoff's masterful Ponzi scheme and I too am left with nothing. You are the first one I have written . Your articles have made more sense to me than any thing I have read or seen (and I follow the stories on the internet/TV carefully). I have no lawyer, accountant, advisor - just me. Your words resonate.
I am not the stereotypical investor the reporters seem to love to showcase, to sensationalize their stories. I am a regular plain person, mom, wife, grandmother. I am the working poor - owning a small yard maintenance business in [redacted] with my husband - earning enough to "get by". No more. We live in a 1500 sq foot house, have 1 car that runs . Going to the dentist., the doctor is only on an as absolutely necessary basis. There are no summer houses, jewelry, art, travel, no steaks or fine wine just a hamburger / beer and Walmart. My last job was as a maid. My husband and I have 3 daughters. For the most part, I have stayed home with our girls (the youngest is now in college locally) as they grew up. I worked here and there if we needed money, mostly as a maid. Oh yes I am poor and a jew.

I invested in BLMIS 17 years ago with my 3 sisters - each of us putting in money jointly to have enough so Mr Madoff would take our account. He did. (collectively we had under $100k.) A brother in law did all the accounting work. I never even saw a statement, just got tax forms at the end of the year from him.(K-1) We split our group 7 years ago so those that wanted could add more to their account. At that point I began getting monthly and quarterly statements, flying solo. My sister (her husband did the accounting with our group) died the next year so I have no records of the past.
I never worried about the luxury of being a stay at home mom. I had a Madoff account. It grew steadily but not by huge amounts as the news reports. My wealthy friends were making tons of money investing with their brokers (who wanted nothing to do with me since I wasn't a big enough account as told to me by a broker). Apple, Microsoft grew, split - my friends got in on hot tips etc etc not me. But I finally had an investment that I could do well with and knew as my children grew under my loving care, not day care, I would have Madoff.
To this date, I think I am the poorest Madoff investor with the smallest account, at least based on what the media has reported. I haven't gone from riches to rags. I never had riches. Stories like mine are uninteresting because they don't make the public, those viewing the media, happy or feel good to know someone like them was a victim. It is more sensational, a thrill to think it was only the rich, the elite, the movie stars -- people the working class can laugh at, feel the situation was caused by the greedy rich.
I have no way to recoup what I thought were my life's savings. I have very few quarters for social security - Madoff was for both my husband and me.
Based on my November 2008 statement -- I could file 2 1/2 SIPC claims and be with in their limit! That is how small for some but huge for us my account was worth. I never withdrew any funds, just paid taxes all 17 years.
The scary part now is the unknown -- with very little news from the trustee/SIPC -- my emotions go from initially being hopeful to total despair. Nights are sleepless. There are no jobs where I live -
So I appreciate your thoughtful comments on OpEdNews -- the only ones that have uttered any reason to me. Rich or middle class or poor - a loss of one's life savings is devastating. I feel like a failure. My only hope right now for a modest life in the future is SIPC -- to pay out something soon -- for those that need living money now and for those of us that will need to quickly reinvest what ever we can salvage. The clock is ticking.
Sincerely yours
[Name Redacted]
I responded to this email with one that expressed my sympathy, and received back the following email:
How kind of you to respond to my email. Please know I was the one that was touched by your articles. I am sad and grieving about what could have been, a modest retirement for my husband and me, I am frightened about our senior years, but I am almost more overwhelmed with the realization that our government (SEC), our culture is so corrupt, uncaring, filled with greed.....SEC can say mea culpa and be done with Madoff investors....Bernie will end up in a country club jail while his wife and kids live happily on factious profits that won't get clawed back ...... Mr Picard will earn more by paying us less......I have become cynical . My husband and I will survive this - after all as I said in my email we never had a high life - I actually think we are better off then most victims that lost everything because we are accustomed to a simple frugal life already. It is easier in life to move up in station than down.!! We are already down! I have many weak moments and feelings of disbelief but I am trying very hard not to go there. It is time to replant my vegetable garden here - this year it is with more meaning.

I have no objections to you sharing my letter provided you can assure me full anonymity. Right now this is still a very private matter for me. I realize there is little understanding of the spectrum of victims involved and agree the public needs to know the truth.

As an aside, do you know if amongst the victims there is any activism happening in the case - for example letter writing or calling Congress/Senate ?

Thank you again for your articles - I wish you good health and happiness
[Name Redacted]
This woman’s emails poignantly reflect the agony visited on so many by the combination of Madoffian fraud and governmental irresponsibility.
But now contrast her poignant emails with a view expressed during an exchange on a CSpan call-in show (“Washington Journal,” I believe) by a Republican Congressman, Mark Steven Kirk of Illinois.
Kirk represents a number of suburban towns north of Chicago, including ones that traditionally were havens of the WASP and wealthy, are still havens of the well off, sometimes are still heavily WASP, and have been bastions of Republicans forever. Kirk, who has the smooth-faced visage so often endemic to politicians, could not exactly be called underprivileged. He attended one of the country’s most elite public high schools, New Trier, which has served the elite of the Northern Chicago suburbs forever -- for around 100 years I would bet, including a long period when those suburbs were exclusively WASP and wealthy. His B.A. is from Cornell, he has a Master’s degree from the London School of Economics, and he has a legal degree from the elite Georgetown University Law School in Washington. He has spent almost all of his career, except for two or three years, in politics or government. He was not out there scrabbling for a living in the private sector like Madoff’s victims were.
When Kirk was on the CSpan call-in show, he would lengthily pontificate in answer to telephonic questions, the way that legislators always do. No question was to minor not to be worth hundreds of words. Philip Roth once satirized Eric Sevareid as saying blah, blah, blah, blah, blah, blah, blah, blah, blah, blah. And more blah. That was Kirk too, until one fellow called in and asked whether Kirk would support a bailout for the victims of Madoff. Suddenly, the loquacious Congressman who is supposedly a moderate Republican, and who held forth at great length on even the trivial, became an exponent of the one word, clipped response. “No” was his expostulation.
This supposedly moderate representative of the Bushian Republican Party which led the country into foreign, economic and regulatory disaster from 2000 (when Kirk was first elected) until today, this supposedly moderate representative of a Bushian party which aided and abetted such fantastic economic disaster that it requires a bailout of one or more trillion dollars to the culpable private side actors it collaborated with, this child of continuous privilege in high school, college, graduate school and life, this “worthy” who has not had to scrabble in life as Madoff’s victims have, this motor mouth who holds forth loquaciously on television on even the most trivial non Madoff subjects -- this person’s tersely expressed attitude towards helping innocent, non culpable, hardworking unprivileged persons such as the woman who wrote me the poignant emails essentially is “fuck ’em.”
Is it ironic that Kirk means church?
* * * * *
Regardless of party, not all legislators have the attitude of the “church” from the wealthy northern suburbs of Chicago. There are those who are horrified at what has happened. True, so far their horror has mainly focused, sometimes almost exclusively focused, on the regulatory failure, on the question of how could the SEC -- and FINRA too -- have missed this gigantic fraud and how do we correct whatever led to the regulatory failure. Generally, little concern has been shown for the human wreckage caused by the incompetence and complicitousness of the regulators. But some have shown concern for the human wreckage, particularly a few Congressmen at a hearing of January 5th and, even if to a somewhat lesser extent, some Senators at a hearing on January 27th.
Let us briefly discuss aspects of the January 27th hearing of the Senate Banking Committee. The witnesses, who comprised a panel, included John Coffee, a nationally famous professor of securities law and regulation at the Columbia Law School, Stephen Harbeck, the head of FINRA, Stephen Luparello, the head of the SIPC, Dr. Henry Backe, the head of a 140 employee medical practice that serves people in Bridgeport Connecticut, including the uninsured, Lori Richards, director of the SEC’s Office of Compliance Inspections and Examinations, and Linda Thomsen, the Director of the SEC’s Division of Enforcement.
The last two, of course, would seem to bear extensive responsibility for the SEC’s failure. Little wonder that, as further discussed below, they refused to answer any questions about what happened with regard to Madoff.
The Senators’ views were pretty much of a piece. They simply could not believe that the SEC, and FINRA too, missed this fraud. They could not believe that the SEC never issued subpoenas to Madoff despite Markopolos’ constant warnings to it, or that FINRA had not caught Madoff though FINRA and its predecessor, the NASD, inspected Madoff once every two years since 1960 and had the power to make, and should have made, inquiries regarding Madoff’s brokerage business that would have revealed the fraud. Senators commented on the detail and thoroughness of the views Markopolos presented to the SEC and certain of the red flags he presented. Those red flags included ones often talked of now: the absence of an independent custodian of securities, the use of a three person -- in reality a one person - - accounting firm, the articles written circa 2000 and 2001, the discovery circa 2006 or 2007 that Madoff -- and, it seems likely, members of his family and other personnel -- had lied to regulators about his accounts, the number of customers, and his investment strategy, the fact that Madoff was willing to leave on the table fortunes made by other investment managers (which indicates he wanted nobody questioning him), and the fact that word was out all over Wall Street that Madoff was not on the up and up, several houses refused to do business with him because of such concerns, and Markopolos had named names regarding the Wall Street experts the SEC should talk to. (Most of these points have been discussed here previously.)
Professor Coffee pointed out that, as has also been discussed here previously to some extent, the absence of an independent custodian and the less than puny nature of the accounting firm should have set off alarm bells and that, as one who has participated in the FINRA disciplinary process, he knew FINRA most certainly did have the power to make relevant inquiries and to throw people out of the broker-dealer business if they refused to answer the inquiries. He also made clear that the SEC, by rule, had deliberately and inexcusably permitted incompetent accountants to audit brokers, and that (although the SEC had done little to combat them) Ponzi schemes have been a growing industry in recent years, with $9.6 billion lost to them in 2002 and over one billion dollars being lost to them in four others of the last dozen years.
Dr. Backe explained the havoc being caused the people in the medical practice, who had relied on the SEC and FINRA. Luparello, the head of FINRA, admitted the system had failed to protect investors, but, as one would expect, tried to excuse the failure by false claims that Coffee debunked.
Harbeck said that SIPC has $1.7 billion, does not know the total amount of claims, can draw on a two lines of credit, and should have a much larger line of credit because of inflation and the growth of the market since its one of its lines was set in 1970.
The two officials of the SEC took the cake. They were delighted to repeatedly tell the Committee how passionate they and their colleagues are about their jobs, how hard they and their colleagues work, how much they want to stop fraud, how seriously they take the Madoff matter, how they follow the evidence, what the Commission does in the abstract. But answer questions about the facts of what happened in the Madoff mess, for which they apparently bear some or a lot of responsibility? Not a chance. No way. Answering such questions supposedly would jeopardize a pending internal investigation and possible criminal cases for perjury (presumably against one or more members of the Madoff family and its supporting personnel.) It would seem that the Senate Committee must have agreed in advance to this limitation on their testimony, although why it did so was never explained, nor did the two officials ever explain the reasons why answering questions about the facts of what happened in the Madoff case would injure an internal investigation or subsequent prosecutions. Simpleton though I may be, such reasons are surely not self evident to me. To me, the refusal to answer seems part and parcel of an impending SEC cover-up, the way that federal agencies always try to cover up their delicts: via secrecy; the way federal agencies always cherry pick and put forward only the good things while hiding all the bad that they are able to hide.
So, testify about the SEC’s examination of Madoff? No. Testify about “how we dealt with Mr. Markopolos’ complaint and the investigation we began and then closed?” No. Testify about questions regarding Madoff’s auditor? No. Testify about the question of a custodian for Madoff? No. Testify about who in the SEC saw Markopolos’ complaint? No. Testify about whether the bad consequences the SEC was warned of by Markopolos came true? No. Testify about other pertinent matters? No.
You know, I think these two officials, who each are likely to share in responsibility for wrecking the lives of thousands but now won’t tell Congress what they or their colleagues did, should do the decent thing, the honorable thing, and commit suicide.*

To Be Continued

* This posting represents the personal views of Lawrence R. Velvel. If you wish to comment on the post, on the general topic of the post, or on the comments of others, you can, if you wish, post your comment on my website, All comments, of course, represent the views of their writers, not the views of Lawrence R. Velvel or of the Massachusetts School of Law. If you wish your comment to remain private, you can email me at

VelvelOnNationalAffairs is now available as a podcast. To subscribe please visit, and click on the link on the top left corner of the page. The podcasts can also be found on iTunes or at

In addition, one hour long television book shows, shown on Comcast, on which Dean Velvel, interviews an author, one hour long television panel shows, also shown on Comcast, on which other MSL personnel interview experts about important subjects, conferences on historical and other important subjects held at MSL, and an MSL journal of important issues called The Long Term View, can all be accessed on the internet, including by video and audio. For TV shows go to:; for conferences go to:; for The Long Term View go to: