Challenging what you think you know about the Madoff Fraud


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Presented to the Texas Society of Certified Public Accountants in September 2013.

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Challenging what you think you know about the Madoff Fraud

  1. 1. THE MADOFF FRAUD Challenging What you Think you Know Texas Society of Certified Public Accountants Financial Services Conference Thursday, September 12, 2013 Presented by: Ilene Kent for 1
  2. 2. The Triple Tsunami 2
  3. 3. Financial Tsunami x 3  Tsunami 1  Madoff investors, many in their 80s and 90s wake up on 11 December 2008 to find themselves victims of a crime - and many are left destitute.  Tsunami 2  Madoff investors find themselves victimized by the very laws they thought were there to protect them – the failure of SIPC to honor its statutory obligation to replace the securities in their accounts up to $500,000  Tsunami 3  Madoff investors are sued under “clawback” statutes and then discover that IRS will keep taxes paid on “fake profits.” 3
  4. 4. SIPC Bankruptcy Court IRS Media Congress 4
  5. 5. Initial Shock  Bernard Madoff is arrested on one count of securities fraud for allegedly operating a multi billion dollar Ponzi scheme on December 11, 2008, one day after he confesses to his sons.  Investors seek answers to questions that will impact the rest of their lives  Is there anything left in our accounts?  Will SIPC be there to provide immediate funds?  Are any assets left at Madoff’s firm, if so, how long to accumulate assets, and who gets compensated?  What action will the government take assist investors? 5
  6. 6. Who is the Madoff Investor? There is virtually not a region in America that has not been affected by the scandal. 6
  7. 7. Bankruptcy Court Trustee Clawbacks Congress SIPCMadoff Victims Big Wheels Keep on Turnin’ 7
  8. 8. InvestorMedia SIPC Bankruptcy Court Congress IRS Trustee 8
  9. 9. Where does our story begin? Securities Investor Protection Corporation 9
  10. 10. The Issue – In a Nutshell Created in 1934 to enforce the Securities Act of 1933 Created in 1970 following passage of the Securities investor Protection Act (SIPA) to Insure small investors Protect investors’ legitimate expectations Bankruptcy Trustee Irving Picard ignores key elements of the SIPA by failing to: •Pay claims promptly •Ignoring statutory definition of net equity 10
  11. 11. SIPA - 1970  “This legislation establishes the Securities Investor Protection Corporation (SIPC), a private nonprofit corporation, which will insure the securities and cash left with brokerage firms by investors against loss from financial difficulties or failure of such firms.” 11
  12. 12. SIPC’s Mission  “In order to restore pubic confidence in the markets, Congress pass the Securities Protection Corporation.”  “legislation, the most important in years, established the Securities Investor Protection Corporation to provide insurance for customer accounts.”  “Customers are now insured.” 37th SEC Annual Report : 1971 12
  13. 13. SIPA and Net Equity §78III (11) The term “net equity” means the dollar amount of the account or accounts or a customer, to be determined by – (A) Calculating the sum which would have been owned by the debtor to such customer if the debtor had liquidated, by sale or purchase on the filing date, all securities positions of such customer (other than customer name securities reclaimed by such customer); minus (B) Any indebtedness of such customer to the debtor on the filing date; …  SIPA mandates that a customer’s claim in a SIPA liquidation be fixed at the customer’s “net equity.”  SIPA defines “net equity” as the value of the securities as of the SIPA filing date (in this case 12.11.2008) less any amount the customer owes the debtor. 13
  14. 14. Intent  The SIPC was intended as an additional layer of protection for investors, should the regulatory organizations, i.e., SEC and FINRA, fail to detect fraud. 14
  15. 15. What Else Does SIPA Say About Net Equity?  SIPA specifically prohibits SIPC from changing the definition of “net equity,” and affirmed by the US Appellate Court - Second Circuit. 15
  16. 16. Public SIPC Pronouncement  Stephen Harbeck, President  that SIPC was indeed investor protection (except for market risk) and agreed it performed an insurance like function.  Source: House Financial Services Committee Hearing 01/05/2009)  Josephine Wang, General Counsel  “ … if clients were presented statements and had reason to believe that the securities were in fact owned, the SIPC will be required to buy these securities in the open market … to make the customer whole up to $500K..  Source: December 16, 2008 Insiders’ Blog 16
  17. 17. And the fight to survival begins  SIPC, underfunded and under pressure, begins cynical fight by changing the rules of the game.  SIPC was woefully underfunded  Members were charged statutory minimum of $150 per year for 18 years  SIPC was repeatedly warned by Congress and the General Accounting Office that it would be unable to manage a “catastrophic SIPC failure.” 17
  18. 18. The Trustee  This is Irving Picard’s 7th SIPC Bankruptcy. To date, his firm, Baker and Hostetler, has billed SIPC nearly$700 million (while expenses go unchecked)  Ignoring 38 years of precedent, Trustee asserts he has a right to recognize investor claims only for the amount of the net investment. 18
  19. 19. The Trustee  In the words of one lawyer, he has “devised a scheme to enrich SIPC and its members at the expense of customers.”  Trustee claims statements are fake, but uses those statements to determine ‘”SIPC Worthiness”  In 2000, Gretchen Morgenson, New York Times financial writer reported that SIPC had spent more money on lawyers than paying claimants. That remains the same today. 19
  20. 20. Legal Precedent  Legal Precedent  For decades and until now in numerous Ponzi scheme cases, including a case that went to the Second Circuit, In re New Times Securities Services, Inc., 371 F. 3d 68, 72 (2d Cir. 2004), SIPC has recognized that customers’ “legitimate expectations” are derived from statements and trade confirmations received from the fraudster and has paid based on the victims’ last statement 20
  21. 21. Effect of Changed Definition  Media campaign to demonize and create dissension between and amongst the various victim classes:  Net Winners v. Net Losers  Direct Investors v. Indirect Investors  Older Investors v. Newer Investors  But most importantly – Bottom Line:  FEWER CLAIMS TO BE PAID  AND SIPC SAVES WALL STREET ABOUT $1.5 BILLION IN SIPC INSURANCE 21
  22. 22. The Final Degradation Clawbacks 22
  23. 23. The Clawback  First time clawbacks are invoked in a SIPC bankruptcy.  New net equity definition leaves thousands vulnerable  Despite protestations to the contrary, smaller investors are included in the clawbacks  Note that many elderly were required by law to take federally mandated withdrawals from the IRAs and other investment vehicles!  Hardship Program 23
  24. 24. Who is a Customer?  When SIPA was written in 1970 the intent was to protect all investors, however, less than 10% of investments at that time were through feeder funds, funds of funds, self-directed retirement vehicles, pension funds, etc.  While there were 5,000 “direct investors” there were an estimated 50,000 or so who were invested indirectly, i.e., through feeder funds, funds of funds, self-directed retirement vehicles, pension funds, etc.  Under current law, these investors are not considered customers at all and are ineligible for any SIPC recovery – at all. 24
  25. 25. Who is the Big Winner?25
  26. 26. IRS  Madoff investors paid an estimated $40 billion in taxes on so-called “fake profits” at the higher short-term capital gains rate.  On 17 March 2009, IRS Commissioner Shulman issued 20-009 that provides a five-year theft loss carryback, yet the Trustee sued for 6 years (depending on the State of Residence at the time of the fraud)  40 cents of every every dollar that SIPC refuses to pay is borne by the US taxpayer since tax refunds will be paid vs. SIPC payments. 26
  27. 27. What do Madoff Investors Want?  Madoff investors are NOT demanding to be made whole  Madoff investors are NOT asking for a bailout.  Madoff investors are NOT asking for one tax dollar.  Madoff investors are asking, quite simply, to require SIPC to follow the law as it is written. 27
  28. 28. Tsunami Relief  NIAP and the Stanford Victims Group have joined forces.  Cong. Scott Garrett will introduce legislation that will:  Prevent clawback of innocent investors.  Mandate SIPC coverage up to $500K based on final account statement  Insist that future Trustees not be SIPC appointed, but rather selected from a panel of SEC approved trustees  Make SEC the plenary authority over SIPC 28
  29. 29. The Club No One Wanted to Join 29 Available on • Kindle • Paperback
  30. 30. For Additional Information30 Network for Investor Action and Protection Investor Protection YouTube Channel