The Effect Of The Garrett Bill On Indirects

Dear Colleagues:

Allow me to make some points that, as far as I know, no one else has made with regard to the beneficial effect of the Garrett bill on indirects. These effects exist though the bill does not mention indirects.

The indirects have, of course, invested through intermediaries - - through funds, banks, etc. Under Garrett’s bill, as I understand matters, those funds and banks are customers and will be as eligible as any other customer to get back money from customer property. That money, under the Garrett bill, will be calculated under the final statement method, if the funds, banks, etc. are innocent. If they are not innocent, Picard could, I think, choose to calculate it under CICO, though I wonder if he would do so if the funds, banks, etc. agreed in advance to return all the money to defrauded indirect investors, as they should. Thus, if the indirects’ funds are innocent, and the Trustee is anywhere near as successful as he claims he will be - - he claims he may recover $45 billion - - the indirects, under the consequences of the Garrett bill, would get [all] their money back from customer property, up to the amount of their final statements, even though they would not get advances. If the banks are not innocent, they may get back and distribute only their cash-in, unless investors can prevail upon Picard - - as I actually think may be possible for a variety of reasons - - to use the FSM for funds that agree in advance to return to defrauded indirects all the money the funds get from customer property.

What if, however, a fund is potentially one of those which Picard claims is not innocent, i.e., the fund knew or should have known something was wrong. Well, if the fund took no money out (or took out less than is shown in its final statements), then, I believe, it will still get back money from customer property, although (i) the amount it receives may be based on CICO unless, as said, Picard can be persuaded to use the FSM if monies recovered by the fund will be forwarded to the indirects, and (ii) the fund likely will be subjected to clawbacks to the extent it took out money. In connection with such funds getting money back, it is my belief (not a recollected certainty, but only a belief) that Picard or his minion have said that the claims of funds against customer property will be recognized unless the fund was one of the truly egregious culprits in terms of aiding the fraud though it should have known there was a fraud.

But what if a non innocent fund took out more money than is shown on its final statement? Well, assuming the fund was not one of the truly egregious ones, I believe that although Picard will seek to claw back from it, the fund will still have a claim against customer property. (This, as I remember (I am in Florida without access to the relevant papers), was what occurred in the settlement with UBP (or was it UBS?), where the claim Picard recognized was, as I recollect, about 250 million dollars greater on a CICO basis than the payment to Picard from the bank.) So, at least where the fund or bank is a large one with the resources to pay Picard (as many likely are), it will get back from customer property sufficient monies to pay back their Madoff losses, on a CICO basis and maybe on an FSM basis, to its indirect investors (who (unlike directs) would have lawsuits against it, in all likelihood, if they are not paid by it).

But what if a non innocent fund or bank is one of the egregious ones? I suspect Picard may not recognize its claim for customer property, so its indirect investors will not be able to recover in this way.

If my views are correct about the necessary effects of Garrett’s bill on indirects, the bill will prove beneficial to many of them even though it does not mention them. Many of them - - perhaps even most? - - would end up receiving either the full amount shown on their final statements or the amounts they actually invested. The questions which should be inquired into, therefore, are these: (1) Will Picard in fact recover 45 billion dollars so that he can pay everyone in full from customer property under the FSM? (I am assuming (and could be wrong) that $45 billion will do the trick, since I believe the Trustee claims the total ESM losses to now be only $45 billion because he has subtracted the no longer extant huge claims of persons and institutions with whom he has settled, e.g., the Picowers, the Shapiros, etc.) (2) When will the Trustee’s recoveries reach somewhere around $45 billion? (3) When will the Trustee start passing out money - - he has said, if I remember correctly, that he will be submitting a plan of payment this spring, but when will payments start under that plan? (4) Will Picard agree to use the FSM method for non innocent funds that agree to pass through to innocent defrauded indirects all recoveries from customer property? (5) What funds and banks will be regarded as so egregious that the Trustee will seek to avoid paying them anything - - i.e., he will refuse to recognize their claims against customer property - - so that their indirect investors will not be able to recover from customer property via their intermediary funds?

I think it would behoove everyone, especially including the indirects who presently are threatening to try to scuttle the Garrett bill, to focus on these questions rather than on trying to destroy the Garrett bill. For the consequences of the bill could be very favorable for the indirects even though it does not mention them.

Comments On SIPC’s Answers Of January 24th To Questions Asked By Congressman Garrett.

February 11, 2011


A couple of people have asked for my reactions to SIPC’s January 24th answers to questions posed to it by Congressman Garrett. Because SIPC’s answers have now been made public, I am posting some slightly redacted comments I sent on January 28th to colleagues who are in or are working with NIAP.

1. Pages 2, 13-14: In discussing Picard’s “compassion” and his hardship program, SIPC, as it often does, speaks in generalities (which courts, Congress, etc. too often accept without question). Here it is pretended that the hardship program is perfectly reasonable. Yet many victims, speaking of the information demanded of them, find the program deeply intrusive and violative of privacy. I think we should try to get an application to see for ourselves what is demanded and how intrusive the program is. Maybe some victims have and would give us “clean copies” of the applications that victims need to fill out.

2. The Trustee has reached settlements with some large institutions in which he has agreed to recognize their claims in return for payments to him of monies the institutions took out of Madoff. Yet these institutions would seem to be ones that at least “should have known” there was a fraud. Why did he agree to recognize claims of institutions which should have known something was wrong? Picard is implicitly saying that SIPA allows him to recognize the claims of the culpable, whose continuous shoveling of money to Madoff kept the fraud alive from 2000-2008 and thereby caused tremendous increased injury to a huge number of us. And why did Picard, conversely, refuse to recognize a claim on behalf of the Picowers? (I think it likely was because Picower himself was subject to criminal charges; also, his estate could have been sued under RICO.) And why did Picard not recognize a claim for Norman Levy, who, as the January 24th answers show, was a major Madoff player financially.

3. Page 2: Picard will need approval from Lifland to distribute funds to customers and an application is being prepared. We know, however, that the impoverished will get little or nothing from customer property (and indeed will be subjected to clawbacks), and that the customers who will get money are mainly the very wealthy and hedge funds -- while Picard and SIPC claim all the while that this is equity. We should try to find out who the funds and banks are who will be receiving money. Intimately related to the distribution of money is the question of when will enough money be in Picard’s coffers so that possibly he could declare that a certain amount of it exceeds the “needs” of customer property and can be considered part of the general estate and used to pay fraud damages to victims.

Also intimately related to the forthcoming request to distribute money, I am sorry to say, is the question of the identity of the judge. We should have every expectation that as long as Lifland remains the judge, anything Picard wants to do will be approved -- and quickly. He is, I think, totally biased in Picard’s favor -- Picard has, in fact, won everything in front of him as far as I know, except for some very minor aspects of major matters that Picard won, e.g., enlarging the number of potential mediators and removing Adele Fox’s name from an injunction that applies to her anyway. If Picard says it is equitable and legally required to claw money from the now-poor to give to the still-rich, and that this is equity, Lifland will agree. (My experience with Lifland last Tuesday only reconfirms my views about his unshakeable bias in Picard’s favor.) Similarly, Lifland will automatically rule in Picard’s favor on such crucial issues as the (lowest possible) interest rate to be used in calculating fraud damages, the Trustee’s demand for interest from the dates of withdrawals, which can double or triple the amount owed, defacto liens against monies refunded by the IRS, not crediting victims with earnings from short term investments, and other crucial issues. If Lifland continues to be the judge, it will almost certainly be deadly for our people.

In this regard, how did the case come to be assigned to Lifland? Was it a result of some completely random assignment process (of the kind used by District Courts)? Or, as Chief Judge of the Bankruptcy Court, did Lifland -- as we occasionally hear of in District Courts (with accompanying complaints) -- insist on taking the case himself? The answers to the question of how the case came to be assigned to him could be quite important.

4. In explaining why innocent investors are not usually the subject of avoidance in a SIPA case, SIPC -- as it has done since the beginning -- uses numerical examples carefully crafted to provide the answers it wants, while ignoring that the answers would be different if you use different numbers. This constitutes a form of lying with figures.

Moreover, SIPC’s examples depend upon (i) there being enough customer property for everyone to be paid off without an avoidance action (a situation which Lifland told me at the oral argument is not germane to whether there should be a stay of proceedings against small innocent victims -- can you believe that?), and (ii) ignoring that its examples work only because it habitually turns down most claims -- about 90 percent of them, perhaps? If it didn’t turn down most claims, there is no way, I believe, that it would have enough money to pay back all claims without avoidance actions. This is another example of SIPC failing to tell the real truth.

In this regard, SIPC should be asked to state what percentage of claims it has turned down over the years and what percentage it has granted.

5. SIPC’s explanation of the logic behind its claim that investors have unsecured creditors’ claims for fraud against the general estate is on pages 5-6.

6. On page 5 SIPC says if the Trustee is left “unfettered, he will be in the best position to help all of the victims.” Of course, in the meanwhile, he will be desperately hurting the small now-impoverished so-called “net winners” -- which seems not to bother him at all. And he will be hurting them even though clawbacks from them are not necessary to pay off people.

7. Page 6: The SIPC fund is currently $1.23 billion. That is shockingly low. It shows SIPC has learned nothing and is still not listening to Congress. It also shows that the strategy is to pay victims (if at all) with money from other victims.

8. Pages 7-8: Their explanations of why so much time was needed to calculate accounts does not mention that this, as oft remarked, was due to the fact that they used CICO rather than the FSM. In any but the simplest, smallest case CICO will require extensive time, thus frustrating Congress’ desire for prompt payments to victims. CICO is, in other words, a built in frustrater of Congressional intent. This is a powerful reason, I think, why CICO is inherently improper under SIPA.

9. The answers constantly use the phrase “fake profits.’ This is a legalistic and psychological ploy to try to make readers forget that to protect people against being harmed by theft by crooks like Madoff was a specific purpose of SIPA. In this regard, of course, the thieves will provide false statements showing fake profits -- how else would they prevent victims from learning what is happening? It is thus inherent in Congress’ explicitly expressed desire for SIPA to protect against theft that there will be phony statements showing false profits (as occurred, by the way, in Bayou and Visconti and, I would imagine, in New Times).

The continuous use of “fake profits” is also a psychological ploy to make people forget that Picard is taking money from the now-poor to give to the rich. The now-poor are being required to give up what SIPC’s answers continuously call their “fake profits,” so it supposedly is alright to take money from them to give to hedge funds and banks.

10. Pp. 11-12: The answers make claims about assignments, but we’ve never seen one and can’t judge the veracity of what the answers say.

11. P. 12: Their answers to the question on disbursements state the “Number of Disbursements in Excess of Deposits.” (Emphasis supplied.) But the question did not ask for the number of disbursements in excess of deposits (whatever that means), but rather for “the number of disbursements.” Why have they answered a different question than what was asked? What is their game here? Am I missing something?

12. On p. 11 they provide their justification -- in reality, their excuse -- for not crediting customers with short term earnings under CICO. Their excuse is pure balderdash, and, were it true, no fund or bank would have to credit customers with interest on funds the institution has “parked” in short term instruments, since it all would be considered the institution’s money, not the money of customers. I have discussed this matter in a lengthy footnote to a brief, as follows:

The only thing SIPC or the Trustee has publicly said about all of this to date is that Mr. Harbeck told NIAP that the short term earnings were not credited to victims because they are customer property. This is a transparently disingenuous answer which seeks to avoid the issue. The question is not whether such earnings, under SIPA, are customer property after the Madoff bankruptcy. For all Madoff property became customer property under SIPA after the bankruptcy, and under Harbeck’s transparently disingenuous, so-called logic, customer accounts should have been credited with nothing for SIPA purposes after the bankruptcy. The question, is not what is or is not customer property, but is, rather, how much should victims’ accounts have been credited with under SIPA after the bankruptcy.

This question leads in turn to the question of why did SIPC and the Trustee not credit the victims’ accounts with the “cash-in” accruing from interest on short term instruments -- interest which is credited to customers who hold earnings-bearing accounts by every financial institution in the country. Is the answer to the last question that SIPC and the Trustee did not credit interest to the victims because they knew that SIPC did not have the money to pay all the advances which would be required even under CICO if the interest was credited to victims and thereby gave many or most victims a positive net equity? (The interest, whose total amount neither SIPC nor the Trustee has disclosed, could amount to many hundreds of millions or even billions of dollars over the twenty or so years during which the fraud is known to have been ongoing, and thus could easily have made the difference between a positive and a negative net equity under CICO for hundreds or thousands of people.) Is part of the answer to the question that SIPC and the Trustee knew the failure to credit victims with the interest, thereby causing them to have a negative net equity under CICO, would fly in the face of Congressional intent to protect victims, especially small ones, but SIPC and the Trustee decided to do this anyway because otherwise SIPC did not have enough money to pay advances to victims? Is the answer that SIPC and the Trustee simply made a mistake and then refused to own up to it when victims learned and pointed out that there had been short term interest earnings which should have been credited to them?

Whatever the answers to these questions, it is obvious -- obvious -- that the answers (i) can make all the difference in this case as to what customers’ net equity should be even under CICO – can be material and controlling on that score, (ii) can make all the difference on whether victims are subject to clawbacks since properly crediting customers with the interest earned on their accounts -- interest which is defacto cash-in for customers -- may cause customers not to have taken out more than they put in, and (iii) should be subject to discovery, including discovery via deposition of the two people who likely best know the answers, Messrs. Picard and Harbeck.

13. They estimate on page 22 that another $1.1 billion will be spent on lawyers and consultants. Wow!! This, of course, is SIPC money that would otherwise be available to victims.

14. P. 24: They say they in part gave effect to the final statement method -- so that customers would be eligible for advances of up to $500,000 rather than advances being limited to $100,000 (where a customer has only cash at the brokerage) -- because customers had a “reasonable expectation that securities were being held for them.” ($500,000, not $100,000, is the limit for securities.) But they didn’t use the FSM “beyond that” -- i.e., to measure net equity -- because the profits were fake. Yet it is preposterous to say (as they have said explicitly in briefs) that customers had a reasonable expectation that they owned securities because they got statements saying this, but did not simultaneously have a reasonable expectation that the value of the securities was as shown on the same statements. Has anyone ever heard of a customer saying, for example, “I expect I own securities because my statement shows this, but I don’t expect the value of the securities are as shown in the very same statement.”

15. Pp. 24-26: they list cases in which, they say, the final statement method has not been used to determine net equity. Based on my recollection of what was said in briefs filed on the net equity question in the Bankruptcy Court and in the Second Circuit, I think that some of these cases are not SIPA cases. They are, if memory serves, “straight bankruptcy” (i.e., non SIPA) cases. This should be checked out with lawyers who have focused on some or all of the cases in their briefs. They would include attorneys like Karen Wagner of Davis Polk and Jon Landers of Milberg. To the extent that I am right -- to the extent that these cases are not SIPC cases -- the answers provided on pages 24-25 are deliberately misleading because the question asks for cases in which SIPC used the CICO method, and the answer does not tell you that it lists cases which are not SIPC cases (and indeed implies falsely that the listed cases all are SIPC cases).

16. Pp. 25-26: On these pages they list four cases out of more than 314 (or about 1.3 percent) in which, they say, SIPC trustees brought avoidance actions. The number is tiny yet, necessarily, implicitly hearkens back to their prior assertions, discussed above, as to why there are few avoidance actions under SIPA -- assertions which depend on the fact that the reason they have enough money to pay off all claims in a given case without avoidance actions is because they deny most claims, so that there is only a small percentage of claims that they need to pay off. As far as I know -- and in reality I don’t claim to really know -- they are right in claiming that avoidance actions were used in 1.3 percent of SIPC’s cases, but again the accuracy of their claim that the listed cases involved avoidance actions should be checked with the lawyers who discussed the listed cases in their briefs, especially Wagner and Landers. (Such lawyers distinguished the cases and said they are inapplicable here, though inapplicability here would not seem to change the fact, if it is a fact (which should be checked), that trustees used avoidance actions in the cases.)



Larry Velvel

Appellant Briefs and Addendums Filed in Second Circuit.

Below is the link to my appellant brief and reply brief and addendums which were filed in the Second Circuit.

Larry Velvel


http://goo.gl/QmW7t

The Trustee’s Complaint Against JP Morgan.

The Trustee’s Complaint Against JP Morgan Chase.

February 9, 2011


A few days ago, when I was just beginning to read the Trustee’s complaint against JP Morgan Chase, I posted the fairly dramatic introduction to the complaint. Having now read the entire complaint, I would like to add a few comments.

The factual allegations of the complaint are essentially divided into three parts: facts related to JPMC’s sale of so-called “structured products” that would put investors’ monies into Madoff, facts related to the 703 account, which was the account into which and from which purported investment monies flowed, and loans made by JPMC. There were different JPMC groups and persons dealing with differing aspects, but the complaint says, and illustrates, that they were in touch with each other. Information, it seems, was not rigidly compartmentalized, but shared.

Of course, due to the heavy redaction which still exists in the complaint, especially of names, it can sometimes be a bit challenging to track what is going on or who was talking to whom, but still it all seems fairly comprehensible.

I shall not discuss the question of what was known by the developers and sellers of structured investment products, whose knowledge, if I understand the complaint, was at appropriate times passed on to JPMC people in charge of the 703 account and of loans. This knowledge was pretty much, or even entirely, of the same kinds of red flags first publicly revealed by Harry Markopolos and subsequently revealed to have been known by lots of people on Wall Street, though not to us innocent dupes. I speak here of such matters as concern, or potential concern, over the identity and competence of Madoff’s auditor, over Madoff’s refusal to be interviewed thoroughly or to permit thorough due diligence, over the fact that he self custodied and there was no way to know whether purported trades actually took place, over Madoff’s refusal to name counterparties and funds’ consequent lack of knowledge as to who their alleged counterparties were, over the fact that the business was operated at every level by members of Madoff’s family, over the lack of knowledge of how Madoff secured his results and the inability of any experts on Wall Street to “reverse engineer” those results, and over a possible connection of feeders to Colombian drug gangs.

As well as the foregoing red flags that were widely known on Wall Street, there were some other points relating to Morgan’s structured investments business. A Morgan executive was specifically told at lunch that there was a large cloud over Madoff because he was suspected of a Ponzi scheme. There also was concern because other investment schemes -- Refco and Petters -- had been exposed as Ponzi schemes, and, as has been said elsewhere, JPMC got sufficiently concerned about Madoff that it redeemed the money from its structured investments, taking a loss that would not have made sense but for its concerns. It also sought secrecy for this redemption from funds involved with its structured products -- which cannot have been a good sign; notified a British regulatory agency about its suspicions that Madoff was a fraud; and warned off its private bank customers from Madoff -- while continuing to service and make gazillions off the 703 account into which and from which we dupes were putting money and withdrawing what we thought were legitimate profits.

There equally are a raft of allegations regarding the 703 account, which started at Chemical Bank (my first checks went to Chemical), became part of Chase when Chase and Chemical merged, and became part of JPMC when Chase merged with J.P. Morgan to form JPMC. As said by Picard’s lawyer, David Sheehan, the bank -- and therefore this account -- were critical to the fraud; without them, there could not have been a Ponzi scheme. The complaint’s allegations regarding the 703 account are especially interesting to me for two reasons. One is that, as written here on June 16, 2010, JPMC and its predecessors had to know that, although the 703 account was the one used for Madoff’s purported advisory business, no monies ever went out of it to pay brokers or others for securities or options bought by Madoff, and no money ever came into it from brokers or others to pay Madoff for securities or options sold by him. As was written on June 16th:

Chase and Morgan knew, in short, or assuredly should have known, that the account showed no transactions of the kind required by the investment advisory business that the account supposedly was servicing. They thus knew or certainly should have known -- probably since at least the mid or late 1980s -- that a fraud was in progress. Indeed, since there were no monies from securities dealers or options dealers being deposited in the account, yet investors were receiving monies from it, they certainly should have known, if they did not in fact know, that the exact nature of the fraud was that it was a Ponzi scheme. How else but through the operation of a Ponzi scheme, after all, could Madoff be paying billions of dollars to investors if he was not engaging in securities transactions from which he was making money that would have come into the account?

This point is made in Picard’s complaint: I noticed it at least twice. E.g.:

Billions of dollars flawed through BLMIS’ account at JPMC, the so-called ‘703 Account,’ but virtually none of it was used to buy or sell securities as it should have been had BLMIS been legitimate.” Para. 2.

* * * *

JPMC was aware that BLMIS was operating at least two businesses: a market making business and the IA Business. But the activity in the 703 Account did not match up with either of these enterprises. Para. 219.

If JPMC had believed Madoff was using the 703 Account for market making, the bank would have likely seen regular transactions with other brokerage firms with which BLMIS was trading. If Madoff had been using the 703 Account for the IA Business, JPMC would have seen billions of dollars leaving the 703 Account and going to purchase stocks and equities, and corresponding multi-billion dollar inflows as BLMIS sold those securities. In the interim, JPMC should have seen tens of billions of dollars -- nearly all of the IA Business’s assets under management -- moved into T-bills, as that was part of BLMIS’s purported investment strategy. Para. 220.

Instead, what JPMC saw was massive outflows of money that were in no way linked to customer accounts or stock and options trading. Money would come into the 703 Account as customers invested additional funds with BLMIS. An overwhelming majority of funds would then go directly back out to customers in the form of redemptions. Any balance that remained in the 703 Account was invested in short-term securities such as overnight sweeps, commercial paper, and certificates of deposit. Para. 221.

The complaint also cites a host of other reasons why, because of the 703 Account, JPMC (and its banking predecessors) should have known that Madoff was operating a fraud. Several of these other reasons shall be mentioned below, and one might even say the Trustee has an embarrassment of riches on this score. But to me, the lack of payments into or out of the account from brokers and others for Madoff to buy and/or receive payment for securities and options is the absolute and unmistakable key. Because of this, JPMC and its predecessors had to know, and certainly should have known, that something was very wrong.

The other reason why the allegations regarding the 703 Account are particularly interesting to me is that to a significant extent they flesh out how a bank’s oversight of accounts works or at least is supposed to work. This is particularly germane because we dupes sent money to and received money from the 703 Account; it was the vehicle through which JPMC and its predecessor banks directly dealt with us.

Early on after the fraud was exposed I was dimly aware, both from general knowledge and from talking to a major league banker who is a graduate of MSL, that specific persons in a bank are charged with overseeing specific accounts, at least large ones. How the oversight process works within a bank is amply discussed in the complaint. And though the complaint does not detail how or whether information got to the very top of the bank -- to Jamie Dimon, for example, who is discussed extensively in Gillian Tett’s highly regarded “Fool’s Gold” -- it does show relevant processes reaching to a very high level in the bank.

Let me, then, list some of the points made in the complaint in relation to the 703 Account (allegations which incorporate material reiterated in the section on loans).

1. Banks often assign a so-called “sponsor” to an account. The sponsor has the duty of learning enough about “the client’s business to identify suspicious activity.” (Para. 190.) The sponsor for the 703 Account was a person identified only as “JPMC Employee 9,” who retired in the Spring of 2008. Here is what the complaint says regarding old number 9 (emphasis in original):

The sponsor for the 703 Account through 2008 was [redacted] [JPMC Employee 9]. When asked about his duties as a client sponsor at his Rule 2004 bankruptcy examination, [redacted] [JPMC Employee 9] responded that he did not even know what a client sponsor was, much less that he was the sponsor for BLMIS’s accounts. He had received no training regarding his duties as a client sponsor and had taken no action to discharge those duties. When shown a document in which he had recertified that he had performed his duties as a client sponsor, [redacted] [JPMC Employee9] stated that he did not have any recollection of the duties of a sponsor or of the recertification process. (Para. 191.)

192. JPMC utterly failed to “know its customer” when it came to Madoff and BLMIS. Shockingly, after decades of hosting BLMIS’s checking account, [redacted] [JPMC Employee9], the client representative who had been in charge of the 703 Account for more than ten years, admitted, “I don’t know what the checking account was used for.” He did not know whether it was used for market making activities, investment advisory services, both, or neither.

193. [Redacted] [JPMC Employee 9] did receive financial statements from BLMIS on a regular basis. These statements included FOCUS Reports. A quick review of those reports by JPMC would have revealed irregularities that required further investigation.


2. As indicated, banks have a duty to ‘“know your customer’” (KYC) -- to understand the business in which a customer is engaged, so that they can tell whether account activity is suspicious. (Para. 185.) The KYC rule is standard industry practice, existed before the Patriot Act, was reinforced by the latter, and is a common rule of regulatory bodies. Under KYC a bank must determine what the customer’s “normal business activity would look like” (Para. 189), so that it could spot suspicious activity. Many banks, including JPMC, have an entire department devoted to KYC. The problem, however, was that, though it gave lip service to the KYC rule, that is all that JPMC gave it. It did not in fact know its customer and ignored deeply suspicious matters related to the 703 Account.

3. The 703 Account did “not look like a normal broker-dealer account -- customer funds would be coming in, but those funds would not be segregated or transferred to separate sub-accounts.” (Para. 174.)

4. Both before the Patriot Act and as reinforced by it, banks are to have monitoring systems in place to detect whether there may be money laundering. JPMC had such purported systems, but they did not work even though billions of dollars were being laundered -- they did not give a warning except once, when the warning was ignored.

5. JPMC had obtained thirteen quarterly so-called FOCUS Reports (the earliest stemming from October 2001) and annual audited reports; both types of reports are filed with the SEC. Often the FOCUS Reports, and sometimes the annual reports, failed to correctly show assets and liabilities JPMC knew of, and “consistently underreported the amount of cash” held by Madoff, “a fact to which JPMC was privy by virtue of its maintenance of BLMIS’s bank accounts.” (Paras. 201-202.) In addition, the FOCUS Reports did not show any bank loans outstanding owed by BLMIS, although JPMC itself had made large loans to it. The Reports also understated the collateral on the loans, and did not include customer receivables or payables, which would have been shown in the financial reports of a broker-dealer.

6. There were also a number of activities -- some of them distinctly odd -- that should have created suspicions of illegal activity. For example, a customer identified only as Customer 1 -- who almost surely was Norman Levy if one compares what is said in the complaint with what is said at pages 14-15 of SIPC’s January 24, 2011 answers to Congressman Garrett -- received nearly $76 billion from the 703 Account between December 1998 and September 2005; in 2002 Madoff sent 318 checks to Customer 1 for precisely $986,301 each, sometimes sending multiple checks on a given day; for over two years the monthly amount of money going into the 703 Account from Customer 1 was almost always equal to the amount going out to him from it, with no clear economic purpose for repetitive transactions that “had no net impact” on Customer 1’s account; in December 2001 Customer 1 sent the account checks for, “90 million, on a daily basis – a pattern of activity with no identifiably business purpose” (Para. 231 (emphasis added)); from 1998 to 2008 “BLMIS transferred $84 billion out of the 703 Account to just four customers,” representing “over 75% of the wires and checks that flawed out of the 703 Account.” (My bet would be that three of the four were Levy, Picower, and Shapiro. Who might the fourth be?); and there was repeated “wire activity with offshore banking customers or financial secrecy havens.” (Para. 222.)

From the above you can see why I say the Trustee has almost an embarrassment of riches vis-à-vis JPMorgan Chase. To many the evidence will bring up the question -- there has already been chatter on the websites regarding it -- of why JPMC does not become the object of private suits by victims for aiding and abetting a fraud and aiding in a breach of fiduciary duty by Madoff. (The Trustee is alleging these among numerous other causes of action.) As some readers may know, a small group of us has been working on obtaining counsel to sue JPMorgan on behalf of investors, who suffered enormous damages because of Morgan’s aiding and abetting of Madoff’s fraud. We believe JPMC is liable notwithstanding a silly decision in its favor delivered long before most of the facts were known by a federal judge who appeared to be ignorant of how banking works and how it worked in this case. We have moved very slowly in seeking counsel -- far too slowly to suit me personally -- because to some extent one had to see what the Trustee came up with and what he did, so that a suit could be brought on the basis of far more knowledge than existed before the complaint against Morgan was unsealed a few days ago. Now that the Trustee’s complaint is unsealed, and what Morgan did is known to a far greater extent -- and will be known yet more after discovery -- the effort to obtain counsel should be sped up.

There will be two interrelated problems, however, problems that arise from the Trustee’s past and expectable future actions. The Trustee opposes and has obtained injunctions stopping suits against persons and institutions whom he is suing or settling with. He says that only he can represent the claims of victims against defendants. Correlatively, although he of course offers no proof or even hints as to how it will be done, he now claims he may recover $45 billion, which is enough, I gather, to pay victims amounts of money approximating the sums shown as theirs on the final statements of November 30, 2008. On these interrelated grounds (for one of which he of course offers no evidence), the Trustee will ask Judge Lifland to enjoin any suit not filed before Lifland in the Bankruptcy Court.

The Trustee will win before Lifland. He has but to file a brief, or walk into court, before Lifland and he automatically will be the winner on any significant issue (at least against any little person or little people). One has known this for awhile, but it was strongly reinforced on me when I argued before Lifland two weeks ago. I have been a member of the bar for nearly 47 years, but never before in the 47 years was I insulted and assaulted like I was two weeks ago. Lifland lived up to his at least two decades old reputation. To believe anyone can defeat the Trustee before Lifland on any important point seems to me naïve. (The only question, really, is how did the Madoff case come to be heard by Lifland -- the Chief Judge -- out of all the judges in the Bankruptcy Court. Was it purely the result of random chance -- purely the result of the random “wheel” used in federal courts?*)

So, to bring a lawsuit against JPMC in a court other than Lifland’s is to accept at the very beginning that one will have to file and win an appeal from a Lifland decision barring the case, before the case can go forward. This will take time. And whether one could file a suit against JPMC in Lifland’s court, and ride the coattails of the Trustee in that court, is something I do not know.

There are highly competent lawyers who think that victims have causes of action that cannot be “taken over,” as it were, by Lifland in the Bankruptcy Court, and that accordingly can be filed elsewhere. There is, I believe, at least one appeal pending from a Lifland decision barring a suit alleging such causes of action. A decision in that case could alleviate much of the problem under discussion if the decision is in the plaintiff’s favor, or could make the problem nearly insuperable if it is in the Trustee’s favor. There also are highly competent lawyers who believe it possible to file a suit that rides the Trustee’s coattails in the Bankruptcy Court itself. Again, I don’t know the answers here, but one does know that these are matters which will have to be thought about when considering, as we must, a suit against JPMC.



*After completing but before posting this essay, I read an article on the Wilpon/Katz case, in the New York Times of February 8th, which quoted “George Newhouse, a partner at Brown, White & Newhouse, who is a white-collar litigator who has worked on many fraud cases.” The article said:

The stakes are steep for defendants who roll the dice in bankruptcy court because of the often close relationship between the trustees charged with recovering money and the judges who appoint them, Newhouse said. Judges tend to know the relatively small number of trustees, and they assign the biggest cases like the Madoff fraud to trustees that they have become comfortable with over many years.

As a result, ‘you’ll get a fair hearing, but it will be subjectively biased in favor of the trustee,’ he said. ‘Most bankruptcy judges tend to be as pro-trustee as federal judges tend to be pro-prosecutor.’

It is, I think, unusual for a lawyer to go on the record – in a newspaper read by hundreds of thousands or millions, no less -- saying that a court system is biased. That Newhouse publicly said what he did in the Times is, to me, a measure of the problem faced before Lifland by those of us who are small innocent victims being assailed by the Trustee in Lifland’s court. That the problem of inherent bias in favor of the Trustee exists here has been known from the beginning of the case, but lawyers have not commented on it -- out of general fear and fear of making things worse, I suppose. I myself do not know what to do about the problem, or even whether there is anything that can be done. But I equally think there can be no doubt that we have a most serious problem.

Trustee's Complaint on JP Morgan

February 4, 2011

Dear Colleagues:

I have begun to read the newly unsealed complaint filed by the Trustee against JP Morgan Chase. When finished, I may or may not write about it -- I haven’t yet decided. But I do think that all of you should be given an opportunity to read the complaint’s (fairly dramatic) introduction, especially since the media seems to have missed (as usual) some significant aspects of it. I have therefore appended the first five pages of the complaint.

Larry Velvel



Irving H. Picard (“Trustee”), as trustee for the substantively consolidated liquidation of the business of Bernard L. Madoff Investment Securities LLC (“BLMIS”) under the Securities Investor Protection Act, 15 U.S.C. §§ 78aaa, et seq. (“SIPA”), and the estate of Bernard L. Madoff, by and through his undersigned counsel, as and for his Complaint against JPMorgan Chase & Co., JPMorgan Chase Bank, N.A., J.P. Morgan Securities LLC, and J.P. Morgan Securities Ltd. (collectively, “JPMC” or “Defendants”), states as follows:

NATURE OF THE ACTION

“‘But the Emperor has nothing on at all!!!’ said a little child.”

Hans Christian Andersen, The Emperor’s New Clothes

“For whatever it[’]s worth, I am sitting at lunch with [JPMC
Employee 1] who just told me that there is a well-known cloud over the
head of Madoff and that his returns are speculated to be part of a [P]onzi
scheme.”

[JPMC Employee 2], Risk Officer, Investment
Bank, JPMC, June 15, 2007

1. The story has been told time and time again how Madoff duped the best and the
brightest in the investment community. The Trustee’s investigation reveals a very different story—the story of financial institutions worldwide that were keen to the likely fraud, and decidedly turned a blind eye to it. While numerous financial institutions enabled Madoff’s fraud, JPMC was at the very center of that fraud, and thoroughly complicit in it.

2. JPMC was BLMIS’s primary banker for over 20 years, and was responsible for
knowing the business of its customers—in this case, a very large customer. JPMC is a
sophisticated financial institution, and it was uniquely situated to see the likely fraud. Billions of dollars flowed through BLMIS’s account at JPMC, the so-called “703 Account,” but virtually none of it was used to buy or sell securities as it should have been had BLMIS been legitimate. But if those large transactions that did not jibe with any legitimate business purpose triggered any warnings, they were suppressed as the drive for fees and profits became a substitute for common sense, ethics and legal obligations. It is estimated that JPMC made at least half a billion dollars in fees and profits off the backs of BLMIS’s victims, and is responsible for at least $5.4 billion in damages for its role in allowing the Ponzi scheme to continue unabated for years, with an exact amount to be determined at trial.

3. In addition to being BLMIS’s banker, JPMC also profited from the Ponzi scheme
by selling structured products related to BLMIS feeder funds to its clients. Its due diligence revealed the likelihood of fraud at BLMIS, but JPMC was not concerned with the devastating effect of fraud on investors. Rather, it was concerned only with its own bottom line, and did nothing but a cost-benefit analysis in deciding to become part of Madoff’s fraud: “Based on overall estimated size of BLM strategy, . . . it would take [a] . . . fraud in the order of $3bn or more . . . for JPMC to be affected.” JPMC also relied on the Securities Investor Protection Corporation (“SIPC”) to protect its profits: JPMorgan’s investment in BLM . . . is treated as customer money . . . and therefore [is] covered by SIPC.” By the Fall of 2008, in the midst of a worldwide economic downturn, the cost-benefit analysis had changed. JPMC, no longer comfortable with the risk of fraud, decided to redeem its $276 million in investments in BLMIS feeder funds. JPMC also received an additional $145 million in fraudulent transfers from BLMIS in June 2006. The Trustee seeks the return of this money in this Action.

4. JPMC allowed BLMIS to funnel billions of dollars through the 703 Account by
disregarding its own anti-money laundering duties. From 1986 on, all of the money that Madoff stole from his customers passed through the 703 Account, where it was commingled and ultimately washed. JPMC had everything it needed to unmask the fraud. Not only did it have a clear view of suspicious 703 Account activity, but JPMC was provided with Financial and Operational Combined Uniform Single Reports (“FOCUS Reports”) from BLMIS. The FOCUS Reports contained glaring irregularities that should have been probed by JPMC. For example, not only did BLMIS fail to report its loans from JPMC, it also failed to report any commission revenue. JPMC ignored these issues in BLMIS’s financial statements. Instead, JPMC lent legitimacy and cover to BLMIS’s operations, and allowed BLMIS to thrive as JPMC collected hundreds of millions of dollars in fees and profits and facilitated the largest financial fraud in history.

5. In addition to the information JPMC obtained as BLMIS’s long-time banker,
JPMC also performed due diligence on BLMIS beginning in 2006, using information it obtained from those responsible at JPMC for the 703 Account, as well as information provided by various BLMIS feeder funds. At some point between 2006 and the Fall of 2008, if not before, JPMC unquestionably knew that:

a. BLMIS’s returns were consistently too good—even in down markets—to be true;

b. Madoff would not allow transparency into his strategy;

c. JPMC could not identify, and Madoff would not provide information on, his purported over-the-counter (“OTC”) counterparties;

d. BLMIS’s auditor was a small, unknown firm;

e. BLMIS had a conflict of interest as it was the clearing broker, subcustodian, and sub-investment adviser;

f. feeder fund administrators could not reconcile the numbers they got from BLMIS with any third party source to confirm their accuracy; and

g. there was public speculation that Madoff operated a Ponzi scheme, or was engaged in other illegal activity, such as front-running.

6. JPMC looked the other way, ignoring the warning signs, even in the aftermath of other well-known frauds. In response to those who, prior to Madoff’s arrest, found it “[h]ard to believe that [fraud] would be going on over years with regulators [sic] blessing,” Risk Officer of JPMC’s Investment Bank responded, “you will recall that Refco was also regulated by the same crowd you refer to below and there was noise about them for years before it was discovered to be rotten to the core.”

7. JPMC’s due diligence team was further concerned about fraud at BLMIS in the
wake of another well-known fraud, the Petters fraud. Some of these concerns centered on BLMIS’s small, unknown auditor, Friehling & Horowitz (“Friehling”):

The “DD” [due diligence] done by all counterparties seems suspect. Given the scale and duration of the Petters fraud it cannot be sufficient that there’s simply trust in an individual and there’s been a long operating history . . . . Let’s go see Friehling and Horowitz the next time we’re in NY . . . to see that the address isn’t a car wash at least.

8. In or about September 2008, as JPMC was re-evaluating its hedge fund investments in the midst of the worldwide financial crisis, [JPMC Employee 3], of JPMC’s London office, had a telephone call with individuals at Aurelia Finance, S.A. (“Aurelia Finance”), a Swiss company that purchased and distributed JPMC’s structured products. During the course of that call, the individuals at Aurelia Finance made references to “Colombian friends” and insisted that JPMC maintain its BLMIS-related hedge. That conversation triggered a concern that Colombian drug money was somehow involved in the BLMIS-Aurelia Finance relationship, which led to an internal investigation at JPMC of BLMIS and Aurelia Finance for money laundering. Significantly, it was only when its own money was at stake that JPMC decided to report BLMIS to a government authority.

9. As reported in the French press, by the end of October 2008, JPMC admitted in a filing of suspicious activity made to the United Kingdom’s Serious Organised Crime Agency (“SOCA”) that it knew that Madoff was “too good to be true,” and a likely fraud:

(1) . . . [T]he investment performance achieved by [BLMIS’s]
funds . . . is so consistently and significantly ahead of its peers
year-on-year, even in the prevailing market conditions, as to
appear too good to be true—meaning that it probably is; and
(2) the lack of transparency around Madoff Securities trading
techniques, the implementation of its investment strategy, and the
identity of its OTC option counterparties; and (3) its unwillingness
to provide helpful information.

None of this information was new to JPMC—it had known it for years. It was only in an effort to protect its own investments that JPMC finally decided to inform a government authority about BLMIS. JPMC further sought permission from SOCA to redeem its Aurelia Finance-related investments and admitted that “as a result [of these issues with BLMIS] JPMC[] has sent out redemption notices in respect of one fund, and is preparing similar notices for two more funds.”

10. Incredibly, even when it admitted knowing that BLMIS was a likely fraud in October 2008, JPMC still did nothing to stop the fraud. It did not even put a restriction on the 703 Account. It was Madoff himself who ultimately proclaimed his fraud to the world in December 2008, and the thread of the relationships allowing the fraud to exist and fester began to be revealed as well. JPMC’s complicity in Madoff’s fraud, however, remained disguised, cloaked in the myth that Madoff acted alone and fooled JPMC. But that is the fable. What follows is the true story.