It Appears That The Madoff Scam Was Not, Repeat Not, A Ponzi Scheme.

July 18, 2012

It Appears That The Madoff Scam

Was Not, Repeat Not, A Ponzi Scheme.

From the time Bernie Madoff’s fraud was uncovered in December 2008 until today, a period of over 3½ years, his scam has been regarded as a Ponzi scheme.  I know of only one person, a brilliant lawyer named David Bernfeld, who did not concede it was a Ponzi scheme, but nobody accepted his view.  Victims, (very importantly) the media, and courts all thought and said Madoff was a Ponzi scheme.  Of enormous importance the Trustee in the Madoff case, Irving Picard, and his chief lawyer, David Sheehan, regularly insisted it was a Ponzi scheme because, they said, there were no securities transactions, and accordingly there were no securities, and no earnings (and could not have been any earnings).  Crucial legal and factual consequences, some of which are mentioned below, flowed from the fact that the scam was regarded as a Ponzi scheme.

But now it is beginning to look as if Madoff was not a Ponzi scheme.  It was a huge fraud to be sure, but not the species of fraud called a Ponzi scheme, with the consequences attendant upon that species of fraud.

As I have always understood matters (I think and hope correctly), in a Ponzi scheme the crook tells people that he will be investing their money in particular stocks or particular goods or what have you, and then fails to do so.  Instead he blows the money, uses it for other purposes, etc.  The key point, the central point, is that he does not purchase or acquire the investments that he told victims he would acquire in order to induce them to give him their money.  Along this line, in the Madoff case the Trustee has always insisted -- in court filings, in remarks, whenever and wherever -- that none of the securities that were shown in victims’ monthly account statements -- none of the securities that Madoff inducingly told victims he would buy and sell for them -- were ever bought or sold.  There were, the Trustee and his lawyer have told victims, the courts and the world, no transactions in these securities.  Ergo, a Ponzi scheme.

But apparently there were purchases and sales of these securities -- untold and currently unknown billions of dollars of these purchases and sales.  On his books, however, Bernie Madoff did not, as he should have, credit the investor-victims with ownership of the billions of dollars in securities he was buying (and selling).  Instead, on his books he unlawfully kept ownership for himself.  There was a fraud alright, but the fraud was not the Ponzi fraud of failing to buy the very items the crook said he would buy.  The fraud, rather, was in failing to credit his investors with the ownership of the securities on Madoff’s books, as should have been done, and instead keeping the securities for Madoff himself.  The securities, that is to say, were bought and sold for what was called the proprietary trading arm of Bernie Madoff’s company, the arm which bought and sold securities, and attempted to thereby make a profit, for Bernie’s company.  They may also have been bought for the market making arm of his business.  The monies given to Madoff by his investor victims was used not to purchase the promised securities for them, but instead to purchase those securities for Madoff himself -- for his own account, as it is said, and, when necessary, to support another arm of his business, the market making arm.  (The monies were also used to fund the Madoff family’s extravagant life style.)  The account statements received every month by victims, and showing that they owned the securities, were a lie, a fraud.

It would be fair for the reader to ask at this point, “How do you know all this?  Can you be sure of it?”  Let me answer this way:  For reasons discussed below, and for other reasons too, we already know enough to be virtually positive that the foregoing is what occurred.  But we do not know enough to know certain of the details, e.g., what was the total value at any given time of the securities that Madoff purchased for his own account, and how closely did the value of these securities match up with the amounts of monies victims invested with him; how much of the money invested with him was used to support the market making arm of Madoff’s business or the family’s life style instead of being used to buy the securities for Madoff’s own account that he fraudulently told victims were being bought for them; what amounts of profit or loss did Madoff make or suffer on the purchases and sales of securities for his own account.

Well, then, why do we not know these details over 3½ years after the Madoff scam was uncovered?  The answer (or answers) to that, I’m afraid, is (or are) pretty simple.  The only persons or organizations that have the information needed to flesh out the details are the Securities Investor Protection Corporation (SIPC) and its Trustee, Irving Picard (and his army of lawyers, workers, and acolytes).  In order for the rest of us to flesh out the details, we have to obtain what lawyers call “discovery” from SIPC and the Trustee.  That is, we have to obtain from SIPC and the Trustee, in law cases, the documents and information that will enable us to figure out the details.  I am assuming, of course, that SIPC and the Trustee will not give the information to us voluntarily, outside the four corners of law cases, because they benefit, and for years have benefitted, from us not knowing the details, as discussed later, and to date they have vigorously resisted any discovery of anything in law cases.

Also to this day, however, the lawyers arrayed against SIPC and the Trustee in law cases have basically not pushed for, or even sought, the needed discovery or any discovery.  There has been only one exception.  (Guess who that was?)  This writer, acting as his own lawyer, sought discovery on a number of issues in the Bankruptcy Court, sought to have the Second Circuit require requested discovery, and then told the Supreme Court that the absence of discovery was an important reason to hear the Second Circuit’s ruling on net equity.  In the Second Circuit and the Supreme Court a small number of other lawyers at least mentioned the absence of discovery, after totally ignoring it in the Bankruptcy Court, but there has been only one person really pushing for it.  That person -- me -- lost in every court, with SIPC and the Trustee vigorously, even stridently, and on one or two occasions even falsely, resisting discovery and telling the courts, ultimately with the support of the SEC and the sainted Solicitor General’s Office of the Department of Justice, that discovery was unnecessary or unneeded or what have you.

So . . . . when you get right down to the truth, the reason we cannot yet know all the details we would like to know about what Madoff did, the reason we cannot know the full truth of what happened, is that the Trustee and SIPC, supported by the courts and by the Solicitor General, have not provided, and have strongly resisted providing, the information needed to determine the full truth.  We know enough anyway to be pretty certain of the broad outline of what happened, but not enough to know certain relevant details.

            But we do know that Madoff Securities was a single corporation that was internally divided into an investment advisory arm, a market making arm, and a proprietary trading arm.  We also know that Bernie Madoff ran and had sole control over the whole shooting match -- over the entire business and all of its operations, including all three of its arms.  Also, persons who traded for Madoff apparently have said that the securities in which Madoff traded for his own account were generally the same securities that appeared in investors' monthly statements as the securities he allegedly was buying and selling for them.  And we know that every year Bernie Madoff transferred scores of millions of dollars from the so-called 703 Account at Chase Bank, the account in which he put monies received from investors, into the so-called Madoff 621 account at The Bank of New York, the primary bank account for the proprietary trading and market making arms of Madoff’s business. 

This last point was told to us by SIPC itself at page 20, and in a table on page 20, of a January 24, 2011 letter SIPC sent to a Congressman in answer to questions he asked SIPC.  The letter thus said:  “The table below includes amounts transferred directly or indirectly from the Madoff 703 Account at Chase Bank, the primary bank account used by House 17 (the investment advisory business), to the Madoff 621 Account at The Bank of New York, the primary bank account used by House 5 (the proprietary trading and market making business).”  The table referred to shows almost $734 million being transferred from 2000 to 2008 from the investment advisory bank account (Chase 703) to the proprietary trading and market making bank account (Bank of New York 621). 

SIPC further said, on the next page of its letter (page 21), that “the funds transferred from House 17 [the investment advisory business] were recorded by House 5 [the proprietary trading and market making businesses] as revenue” for the latter and “represented a substantial part of House 5’s liquidity.  Without these funds from the IA [investment advisory] business, House 5 would have incurred annual net losses . . . .”  In other words, SIPC itself has told us that the monies Madoff took in from victims/investors in his IA business were used to prop up and support his market making and proprietary trading businesses, the latter of which deals in the purchase of securities for his own account.  As indicated, we do not know the total amount of such securities he owned at any given time, though the collective amount of securities and associated cash he had in any given year must have usually been hundreds of millions or billions of dollars more than the amount of monies transferred from Chase 703 to Bank of New York 621 during that year, since the collective securities and cash included stocks and cash from all prior years.  But, as previously indicated, we do know that Madoff was taking money from the investment advisory business account (Chase 703) to support the proprietary trading arm of the business which bought and sold securities for Madoff himself and to support his market making.

            To deliberately repeat myself, even if we do not know all the details, we know for certain that Madoff was using investors’ money not to purchase securities for them, but for himself.  And these were -- in some proportion currently unknown to us because SIPC and the Trustee will not disclose the information necessary to calculate it -- the same securities as he told investors he would buy for them and, on their monthly statements told them that he had bought for them.  Because he used investors’ monies to buy the very things he said he was going to buy - - to buy the very securities he told the investors he would buy -- Madoff was not running the kind of fraud called a Ponzi scheme, which exists when the crook does not buy what he says he will buy, and simply blows the money in one way or another.  He was nonetheless, of course, running a fraud, with his fraud, as said, being that he was not buying the securities for the investors, but for himself (and for market making).  (In law, I gather, the securities and any profits, dividends or interest on them belonged to the investors even though Madoff bought the securities himself and thereby stole the investors’ money.)

            So . . . we know enough to be pretty certain of the broad outline of what happened, but not enough to know certain relevant details.

            I suspect, in this connection, that good old Bernie is sitting in his cell laughing at us.  For in various statements that we need not get into or parse here, he practically told us what he had been doing.  But with only one guy as an exception, for over 3 ½ years nobody seems to have caught on to what he was saying -- he had hidden the truth in plain sight, if you ask me -- and instead everyone was talking about a Ponzi scheme in which there were no transactions and no profits or earnings.

            Calling Madoff’s scam a Ponzi scheme has certain huge advantages for SIPC and the trustee, of course, some of which I will discuss below.  Because they will wish to retain these huge advantages, they are quite likely to reply that I am wrong -- that Madoff was running a Ponzi scheme because there were no purchases or sales of securities for the investment advisory arm of the business, the arm that investor victims were “associated with.”  The purchases and sales, they will say, were rather for the proprietary trading arm (and the market making arm) of the business, arms the investor victims were not associated with.  But this excuse does not wash.  Consider, if you will, a big law firm which is a partnership and has many different sections, a tax section, a securities section, an antitrust section, a banking section, a bankruptcy section, and so on.  The work in each section is significantly different and separate, the clients are different, the lawyers are different, may be in separate cities and may not even know each other.  But if the tax section does something illegal or unethical, the whole firm, including every section, will be hammered -- every lawyer, no matter his or her section, will have to pay.  Or take a huge company which, in a single corporation, makes a variety of drug products, with manufacture of different products being in different plants, with different scientists for different products, etc.  If one of those drugs culpably causes injury, the whole company will be liable, not just the people or plants associated with the culpable product.

            Or look at it somewhat in reverse.  Suppose a parent corporation which manufactures products X and Y creates a subsidiary corporation to manufacture product Z, which causes injury.  If the injured party sues the parent corporation, the latter will say that he can’t sue it, because Z was made by a different  corporation, its subsidiary.  Will this defense work?  It depends.  Courts will look at who sets policy for the subsidiary.  Who are its directors, executives and employees?  Do the two corporations use the same plants and sales force?  And so forth.  The more that the two corporations use the same policies, offices, officers, plants and so on, the more likely it is that the parent will be held responsible for the misconduct of the subsidiary.  The corporate veil will be pierced, as they say.

            Now let’s look at the Madoff situation.  Madoff did not even have separate corporations for his three business arms.  It was all just one entity, so there is not even any corporate veil to be pierced.  Bernie Madoff owned everything.  He controlled everything.  He set all policies.  The three arms were run in tandem, with Bernie’s investment advisory arm being used to finance the other arms.  The whole business was Bernie Madoff, plain and simple.  As he used to tell people, it was his  name on the door.  So there is no way that it is legally proper to say that one can ignore the fact that the very securities Madoff told people he would buy were in fact bought, or can correspondingly say that there was a Ponzi scheme because the securities weren’t bought by the investment advisory section of the integrated business but by the proprietary trading arm to which investors gave the money that Madoff transferred over to the proprietary arm’s bank account.

            Let me turn now to the question you’ve all been waiting for.  What difference does it make whether Madoff was a Ponzi scheme or was, rather, a different kind of fraud, a fraud in which he simply bought for himself the securities that he falsely told investors he was buying for them?  I believe that for SIPC, the Trustee, his lawyers and victims, it makes a huge difference whether Madoff was or was not a Ponzi scheme.

            To begin with, take the concept of net equity.  Without refighting the battle in which courts have found for the Trustee and SIPC and have, if I may be so crude, screwed innocent investors, SIPC and the Trustee have argued from day one, and have gotten the courts’ agreement, that investors’ so called net equity is not measured by the amounts shown owing to them on their last monthly account statement (the final statement method), but is instead the far smaller amount calculated by subtracting the amounts an investor physically put into Madoff from amounts he physically took out of Madoff.  Investors got no credit for the amount of earnings shown on these account statements.  This method is called the cash-in/cash-out method (CICO), has been used in only two or three percent of SIPC’s cases -- the rest all measured an investor’s net equity by what is shown on his account statement -- and has been used, as I understand it, only where there have been Ponzi schemes.  The CICO method, by greatly reducing an investor’s net equity, results in investors, especially small ones whom Congress enacted the Securities Investor Protection Act specifically to protect, getting greatly reduced or no recompense from the SIPC insurance fund. 

The fund allows an investor to get up to $500,000, if his net equity is that high.  But many investors -- even thousands perhaps, especially small ones who are suffering great hardship -- have ended up with tremendously reduced net equity or no net equity, and accordingly with greatly reduced or no payments from the SIPC fund, because SIPC and the Trustee have measured net equity by the CICO method rather than by the standard final statement method used 97 or 98 percent of the time.  SIPC and the Trustee say it is proper to use the CICO method because Madoff was a Ponzi scheme in which there were no purchases or sales of securities, no transactions in securities.  But there were purchases or sales of promised securities, there were transactions in promised securities, apparently in the many, many billions of dollars.  It’s just that, instead of giving the victims ownership of the securities, as he was legally obligated to do, Madoff kept the ownership for himself.  To reemphasize the obvious, the fact that Madoff illegally kept for himself the ownership of securities in which he was conducting billions and billions of dollars worth of transactions does not mean that there were no transactions.  (Nor, of course, did keeping the ownership for himself relieve him of any duty, as the holder of discretionary customer accounts, to allocate trades to the customers before trading for his own account.)

            Make no mistake about it:  the vast reduction or elimination of payments to victims from the SIPC fund, and the consequent savings to the fund, were matters of enormous consequence not just to thousands of small, often elderly victims in their 60s, 70s and 80s who found their savings depleted and often had to scramble to live, but also to SIPC and its managers (who make up to or more than $750,000 per year).  One estimates that the savings to the SIPC fund were between one billion and 2.5 billion dollars per year.  (Once again the precisely accurate information is in the hands of SIPC, although the numbers may be calculable (I really don’t know) from complicated information released by SIPC in answer to a Congressman’s questions.)  There was deep concern in SIPC that, had the final statement method of determining net equity been used, with consequent far greater payments to victims from the SIPC fund, the fund would have gone broke.  In order to save the fund, SIPC -- which had refused to increase the size of its fund when leading federal legislators urged it to do so in the early-mid 2000s lest the fund prove incapable of handling a major disaster -- would have had to levy assessments upon members of the financial services industry (who for years had been paying only $150 per year even if they were Goldman Sachs or Morgan Stanley), or drawn down upon a huge private line of credit that SIPC then had (but soon ceased renewing), or ask Congress for more money.  SIPC did not want to do any of these things, especially, one assumes, because it would have looked very bad if it had been necessary to do them in order to save the fund:  the necessity would have cast great doubt on the competency of management (which had, as said, refused a few years earlier to increase the size of the fund upon congressional urging, lest the fund prove inadequate if there were a major financial disaster -- as occurred with Madoff).  Very likely, heads would have rolled at SIPC:  managers making half a million or 750,000 dollars per year -- which is still good money even in the profligate Washington, D.C. area -- would have lost their jobs.  The way to save the fund without assessing and aggravating the financial services industry which supports SIPC and its fund, without drawing down the then existing line of credit, and without asking Congress for more money, was to use the CICO method of determining net equity -- the method which arguably could be used if there were a Ponzi scheme but not if there weren’t -- and to thereby vastly reduce or eliminate payments from the fund.  So CICO was used on the theory that there was a Ponzi scheme even though Madoff was buying and selling billions upon billions of dollars of the very securities he told investors he would buy, payments from the fund thereby were dramatically reduced, and the fund and management’s lucrative jobs were saved.

            So, as said, calling Madoff a Ponzi scheme, in which there were no transactions and no profits, was of tremendous importance to, and had tremendous consequences for, not just newly impoverished, scrabbling victims, but also SIPC and its management.

            There also were tremendous consequences for the Trustee, Irving Picard, and his law firm.  Picard reached a deal with and joined his law firm (he left another one) in mid December 2008, just a few days after SIPC asked him to be the Trustee.  We know, because of statements made in open court and from a GAO Report, that under his deal with his new firm he receives a portion of the firm’s fees attributable to the Madoff case.  We do not know the percentage, because neither Picard nor his firm will disclose that information.  But the legal and associated fees thus far are around 500 million dollars, and estimates are that ultimately the total such fees will be around one billion dollars.  I would guess that about 300 or 400 million dollars of the already incurred 500 million dollars has gone to the law firm, and, based on what (little) I know of the kinds of deals in which lawyers receive a percentage of what they bring into the firm, I would estimate (or guesstimate) that Picard himself already has personally made somewhere between 50 and 75 million dollars and that his firm’s take and Picard’s personal take will double before the case is over if the relevant fees mount to around a billion dollars, as Picard says they will.  If any of my guesstimates are remarkably wrong, there is an easy remedy to correct them:  Picard and his firm could disclose how much he is making under his deal with his firm:  could disclose what percentage of the fees go to him personally, how much he thus has personally made so far, and how much it is expected he personally will make in future.  Why do I think that neither Picard nor his firm will voluntarily disclose the specific relevant information to correct my mistaken estimates if those estimates are mistaken?

            Of key importance here is the question of what legal and associated work is it that produces the huge fees.  As I understand it, and I believe I am almost surely correct, it is work that arises because SIPC and the Trustee are using not the standard final statement method of determining net equity, but instead the CICO method which they can employ if there is a Ponzi scheme.  Under the final statement method, the question of the amount of a person’s net equity is usually pretty straightforward and simple:  his net equity is what his brokerage account statement shows to be owing to him.  Oh, there can sometimes be some complications, I assume, such as when a person has two accounts, one with a positive net equity and one with a negative net equity (because of loans from the broker, for example), and the question is whether you should combine the two accounts, so that the investor’s overall net equity will be less and he will receive less from the SIPC fund (and from so-called customer property, if any) because his positive net equity in one account will be reduced by the negative net equity in the other, or whether you should instead keep the accounts separate so that he will receive more from the SIPC fund (and from customer property) because his net equity in the positive account will not be reduced by the negative net equity in the other account.  But though there can occasionally be complications, usually the amount of one’s net equity is straightforward:  it is what the account statement shows it to be, and no elaborate legal or accounting work is needed to calculate it.

            The situation is completely different, however, when CICO is used to determine net equity for SIPA purposes because there is a Ponzi scheme.  Now the legal and accounting work can be, and in the Madoff case often (even usually?) is complicated and difficult.  To determine what was put into an account (and taken out of it) might require reconstruction of records going back 40 or 50 years, as in the Madoff case.  It might require assessment of what was put into and what was taken out of the accounts of grandparents, parents, uncles, aunts, brothers or sisters whose accounts were, by inheritance, gift or in other ways merged into the victim’s account over the decades.  Needed records may be missing and/or very hard to find.  The whole process is something of a mess requiring extensive forensic work by the Trustee and his people, and the numbers and ideas they came up with, which almost inevitably will favor SIPC, which has billions at stake collectively, will almost surely be contested by the victims (as is regularly occurring), who individually have large sums at stake, think the Trustee’s numbers and notions about what happened over decades -- over scores of years -- are quite wrong, and who bring long-lasting, expensive lawsuits to contest the Trustee.  It is little wonder that, when CICO is used, the work of the Trustee and his minions mounts into untold numbers of hours, hundreds of millions of dollars in fees for the Trustee’s law firm, and gigantic fees for the Trustee himself.

            So, once again, enormous consequences attach to the claim that Madoff was a Ponzi scheme.  The work and fees of the Trustee, his law firm, and his other minions are increased almost beyond belief (as are the costs to victims of contesting the determinations of the Trustee and SIPC).  The work and fees of the Trustee and his minions, which would be far less, perhaps almost incalculably less, under the simple, standard final statement method, are increased under the CICO method of Ponzi cases to the point where fees now total around 500 million dollars in the Madoff case and are estimated to ultimately reach about a billion dollars.  (I personally think it possible that, conceivably, one billion dollars ultimately could prove to be a low ball estimate.) 

            Calling Madoff a Ponzi scheme also has major consequences for so-called “clawbacks.”  “Clawbacks” mean that the Trustee can recover, from victims, amounts of money that they completely innocently took out of their Madoff accounts, thinking that the money was theirs because it was shown on their account statements as being theirs, either as principal or as earnings on invested principal.  Often such monies were elderly victims’ dominant, even almost sole, source of income (along with Social Security) on which to live.  Now victims, often elderly ones, find themselves without this source of income, and, horrifyingly, being subjected by the Trustee to clawbacks of the money they took out of Madoff.  Large numbers of victims are truly terrified by the possibility of these clawbacks.

            Now, I am the first to say that the subject of clawbacks is, legally speaking, a very complex topic about which I don’t know a whole lot.  True, I am a member of a committee of about 20 victims’ lawyers who are submitting consolidated briefs on subjects relating to clawbacks, but I desired to be on this committee only because I have 50 years of brief writing experience and feel qualified to comment on such things as logic, persuasiveness, style, etc., not because I pretend to have significant substantive knowledge on the subject of clawbacks.  Fortunately, the committee has many other lawyers, excellent ones, some from Wall Street firms and some from smaller firms, who do know a lot about clawbacks.

            But though my knowledge of clawbacks is limited, I do think it true that sometimes -- perhaps even often, or possibly always -- a clawback of monies taken out by a victim cannot be obtained by the Trustee unless the fraudster gave the money to the victim with the actual or constructive intent of thereby hiding the fact that there was a fraud.  To prove this intent can be difficult for reasons we need not canvass here.    

            If there is a Ponzi scheme, however, the situation is altered to the Trustee’s benefit in a crucial way.  It is automatically assumed that the broker -- Madoff -- gave money to the victims in order to hide the existence of a fraud.  (This is the so-called Ponzi presumption.)  The Trustee is then relieved of the oft-difficult task of proving that the fraudster -- here Madoff -- gave money to the victims for the specific purpose of hiding the fraud.  This is presumed.

            So . . . to call Madoff a Ponzi scheme has important ramifications benefitting the Trustee in his clawback work for SIPC (and benefitting SIPC too in various ways).  For to claw back, the Trustee does not have to prove the fraudster was acting with the purpose of hiding his Ponzi scheme when he gave the investor the money requested by the investor.  The Trustee is relieved of bearing this oft difficult burden of proof -- a burden he might not be able to meet -- and the illicit purpose is instead presumed in his favor.

(I note that, in the absence of the Ponzi presumption, one of the many factors that can be looked at to determine if hiding the existence of a fraud was the fraudster’s purpose in transferring money to the victim is whether the fraudster was insolvent when he gave the victim the money.  Was Madoff insolvent when he honored requested withdrawals, or did he instead own enough in securities and associated cash to pay back the monies he had taken in (about $17 billion at the end) or to pay back the vastly greater amounts that victims’ account statements showed he owed them (about $64 billion at the end)?  And which of these was the true measure of insolvency in this particular case?  (Or is neither the measure of insolvency here because, I have been told (I presume correctly but don’t really know), that by law a broker need not have on hand enough securities and cash to cover the full value of customers’ accounts (like, I suppose, a bank’s reserves are only a fraction of the deposits owing to bank customers)?  Also, in a related vein, when did Madoff’s indebtedness to investors become so much greater than his assets that it became clear he could never repay his entire debt, so that at that point his scam conceivably could be thought to have become a partial Ponzi scheme (if there can be a partial Ponzi scheme)?  These are all questions to which we do not know the answer (at least I do not), and it is hard to believe that Madoff ever had $64 billion in securities and associated cash, though it is not so hard to believe he had $17 billion (or at least around $10 billion). But who knows what the situation was or what all the factors are that could bear on it?  All that one knows for sure is that, by labeling Madoff a Ponzi scheme, and by getting courts to agree to this (mistaken) view, the Trustee was relieved of any possible need to prove that Madoff had the requisite illicit intent when he transferred to an investor the money that the Trustee now wants to claw back.)

            Also, to reiterate, by calling Madoff a Ponzi scheme, the Trustee is enabled to claw back any monies an investor took out over and above the amounts he put in.  For, according to the Trustee, such monies cannot be earnings accruing to the investor, since there were no transactions and thus no earnings. The Trustee thus need not prove that the monies taken out over and above principal were not earnings -- they are presumed not to be earnings.

            But what is the truth about earnings?  Were there earnings, because of appreciation in, and dividends and interest paid on, the securities Madoff bought and sold for his own account with the monies provided by investors, instead of buying and selling the securities for his investors’ accounts as he should have -- securities which in law, although not on Madoff’s internal books, apparently belong to the investors?  Only the Trustee and SIPC know if there were such earnings, and they are not saying, but instead are simply benefitting from the fact that, in a Ponzi scheme, it is assumed there were no earnings and the Trustee therefore need not show there were not sufficient earnings so that monies taken out by investors, over and above the principal they put in, were not earnings but simply other people’s money as the Trustee claims.

            Let me now turn to the unintentionally somewhat humorous story of how I came to realizations discussed above, and to a question that has been put to me by laymen with whom I have discussed them, to wit, what is the responsibility before the law, if any, of the Trustee (and his minions, and SIPC) for the long prevalent belief that Madoff was a Ponzi scheme, a belief which they continuously propounded and, I think, caused to be the accepted wisdom.

            Like everyone else I know, except the lawyer named David Bernfeld, I myself long accepted and thought that Madoff was a Ponzi scheme.  Even though I had read and noted the statements quoted above from the SIPC report relating to the two computers called House 17 and House 5, the statements, and their full meaning, had not penetrated my thick skull any more than they had penetrated others.  About three weeks ago, however, I was again discussing aspects of Madoff with Bernfeld and another individual.  Bernfeld made some comments that struck me -- they must have had to do with the fact that Madoff used the monies he took in to float the rest of his business, and later that day I mentioned Bernfeld’s comments to my wife.  Her response stopped me cold, absolutely cold, and got me to thinking.  Her response was something like this:  “Of course, she said, “Madoff is a smart guy.  He wasn’t going to do something that would necessarily fail.”  The implicit assumption underlying her remark, she confirmed, is that a Ponzi scheme always fails in the end.  None of us have heard of one that succeeded -- although if there is one that succeeded, of course we’ve never heard of it, since one hears of Ponzi schemes only when they are uncovered, usually after failure.  To put her underlying assumption a different way, Madoff probably did not initially intend to start a Ponzi scheme, because such a scheme is inevitably destined to fail one day, with disastrous consequences for its perpetrator.  (If I remember correctly, after Madoff was caught, the telly showed a video of him at some meeting or conference, telling the attendees something to the effect that he thought Ponzi schemes resulted from persons starting some financial arrangement that ultimately got away from them and became a Ponzi scheme.)

            Well, if Madoff, as my wife said, is a smart guy who would not have intentionally started something destined to fail -- a Ponzi scheme -- what had he intended to do?  The answer was obvious.  Initially expecting his business to be profitable, he was using investors’ money to float his proprietary trading in the very securities he told the investors he was buying for them and, to some extent, to float his market making operation, too.  Indeed the fact that he was dealing for his own account in the securities he told investors he was buying for them was probably one of the reasons he knew so much about the securities that he apparently could judge whether the prices for the securities shown on the account statements sent to customers made sense.  It was also, probably, one of the reasons -- although only one of them -- why nobody in his firm thought boo about what he was doing.  For the most part, all that they could see was that, as expected, the proprietary trading (and market making) arms of his firm were buying and selling Fortune 100 securities.  And it enabled Madoff to parade himself before the world as what one suspects his ambition and psyche demanded that he be:  a brilliant and enormously successful Wall Street investor. 

            So the scales fell from my eyes because of the perspicacious comment of a lay person -- my wife -- who is not a lawyer, knows quite a bit about the Madoff case for a layman but not nearly so much as all the experts I deal with or myself, and simply made a perspicacious comment about Madoff as a person.

            In the few weeks since I began to understand what Madoff had been doing, I discussed my views with a few people, some being Madoff experts and some being lay people.  The initial reactions, I think it fair to say, were some degree of disbelief.  After all, Madoff’s scam had been portrayed for 3½ years as a Ponzi scheme in which there were no trades and no profits, everyone had accepted that Madoff ran a Ponzi scheme, and now, after 3½ years, I was saying that his scam wasn’t a Ponzi scheme?  Get real.  After listeners came to understand what I was saying and why, however, people asked whether the Trustee had known all of this; asked why, if he did know it, he and SIPC had continued to propound that Madoff was a Ponzi scheme; asked whether the Trustee is culpable for doing so; asked whether his doing so was a second fraud on investor victims; and, shockingly to me (but upon reflection perhaps not so entirely shocking -- I don’t know), asked whether the Trustee could go to jail because he (and SIPC) perpetrated this second fraud on victims. 

            My initial response to questions was that, even if they knew the facts, I didn’t know whether, and even doubted that, the Trustee, his lawyers and SIPC actually understood what the facts meant:   actually understood what Madoff was doing and that he was using the monies he took in from victims to run the other arms of his business, especially the proprietary trading arm.  My response received the equivalent of hoots and catcalls.  Nobody else had the doubts I had (and I have to admit that, for all my world-induced cynicism, I am pretty naïve when it comes to whether people are good, though I do draw the line at Hitler and Stalin). Everyone else seemed to think that the Trustee and SIPC knew exactly what Madoff had been doing and exactly what they were doing themselves for their own benefit.  Thus, the question from laymen of whether what the Trustee was doing, which they considered a second fraud upon (oft-impoverished) victims for the benefit of the Trustee and SIPC, could result in jail time -- a question which absolutely knocked me off my feet when I heard it.  Lawyers, I guess, are not used to the idea, are staggered by and disbelieving of the idea, that a Trustee could end up in the slammer.  To laymen, I guess, there would be no surprise in the possibility that a Trustee -- a lawyer -- might do illegal things for the benefit of himself and his law firm.

            I have to say that I still give Picard and his lawyers -- and maybe even SIPC -- the benefit of the doubt.  I just can’t believe that they set out to screw victims via a second fraud so that they themselves could benefit greatly.  I do believe that they set out to screw victims in order to benefit SIPC, but this is not the same as them realizing that they were fraudulently screwing victims -- even possibly criminally screwing them -- by saying Madoff was a Ponzi scheme when in reality it wasn’t.  I’m even willing, personally, to believe it possible that, notwithstanding the statements quoted above from the letter of January 24, 2011, SIPC and the Trustee didn’t realize that the overall effect of the operations that were combined in one corporate entity, run and controlled entirely by Bernie Madoff, was that he was not running a Ponzi scheme, and I’m also willing to believe that they thought -- very wrongly, I think, but honestly -- that it was proper to separate out the investment arm of the business as if it stood alone without regard to the rest of the business.  I do fear, however, that others will think my willingness to give these benefits of the doubt are simply more examples of my endless naiveté about people.

            In any event, I am sure about one thing, about something I have been sure about since early days in the case and that courts have inflexibly resisted.  We will never know the truth about what Madoff did, about what SIPC has done, or about what the Trustee has done unless and until lawyers are granted discovery into these matters in law cases, unless and until lawyers are given access to all pertinent documents and information and are allowed to depose witnesses -- the Trustee, his lawyers and minions, and SIPC’s personnel, about the relevant events.  Discovery in legal proceedings is one of the greatest engines for obtaining truth ever invented, is perhaps the best engine for determining it.  And unless we get discovery regarding the Madoff case, an awful lot of truth will remain hidden as a factual matter even if we rightly believe that various things happened.