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.
