Madoff "victims" may have unwittingly profited from Ponzi scheme

Some of the investors who lost money when Bernie Madoff' $50 billion Ponzi scheme imploded may still have turned a profit after all. Investors who withdrew money from their accounts may have taken out more money than they originally invested, even they lost whatever was left in their accounts when the scheme finally went bust:

What they thought were profits was likely money stolen from other clients in what prosecutors are calling the largest Ponzi scheme in history. Now, they are confronting the possibility they may have to pay some of it back.

The issue came to the forefront this week as about 8,000 former Madoff clients began to receive letters inviting them to apply for up to $500,000 in aid from the Securities Investor Protection Corp.

Lawyers for investors have been warning clients to do some tough math before they apply for any funds set aside for the victims, and figure out whether they were a winner or loser in the scheme. [AP]

Madoff investors who made a profit face an ethical quandry. It appears that the "returns" on their investment were not ROI, but rather, the proceeds of a Ponzi scheme. Investigators believe that Madoff didn't invest the money, but rather that he he paid old investors out of the money that he collected from new clients. Madoff's  scheme was a giant financial chain letter.

This situation raises interesting ethical questions. One man quoted in the AP story came out ahead, even though Madoff held on to the final $1 million in his account. Should this guy be eligible for compensation under the new program that's being set up to help Madoff's victims? After all, he already profited from a crime by accepting money that Maddoff stole from his other clients. Yet, he did lose a million dollars through no fault of his own.

Here's a legal question for you guys. Is there any way that the authorities could come after Madoff "investors" in an attempt to retrieve the money? After all, these profits were the proceeds of a crime.

Comments

[alameda]

Seems like the right thing to do is allow investors to keep any money up to the amount of principal that they deposited and return the rest to the Feds.

[cfrost]

Considering the size of Madoff's pyramid scheme, no one can recoup a pound of his flesh. They'll just have to settle maybe for a Vienna sausage. Perhaps they can sue the people at the SEC who dropped the ball. Or perhaps they should try to sue the fuckhead free market fundamentalists who encouraged the SEC to lay around and scratch their asses when they should have been on the job.

[The Phantom]

I know two people who were taken in by Madoff.

They're not my favorite people and my heart is not broken.

[Ktesibios]

After the original Ponzi scheme collapsed, the bankruptcy receivers who were trying to sort out the ruins of Ponzi's finances went to court to compel investors who had been "lucky" enough to pull their money out in the original run on Ponzi's companyto return the money, holding that these were "voidable preferences" under bankruptcy law.

The litigation ultimately went all the way to the US Supreme Court, and the receivers prevailed. Madoff investors who pulled out shortly before the crash and who had reason to believe that Madoff was about to become insolvent might be on the hook for that reason.

In addition-

Attorney General Allen's office said that those who received payment from Ponzi prior to the crash could be forced to return the money received, to be shared among all creditors. This would be based on the theory that any money Ponzi paid out would be stolen property, and hence recoverable. This theory does not appear to have been pursued, and the only moneys recovered in this manner were those the receivers recovered as preferences under bankruptcy law.

Source

As in the original case, the only people who are likely to "profit" from the debacle will be the lawyers and accountants who are kept employed in trying to clear up the mess.

[cfrost]

There are apparently a few employee pension funds that are a part of the Madoff rubble. The pension fund managers may have been negligent, but there remain people who now have no pension funds. You don't make a bonfire with 50 billion dollars cash without leaving a few innocent people burnt.

[togolosh]

At least some investors in Madoff's schemes were aware that his returns were too good to be true but invested anyway in the belief that he was engaged in some run-off-the-mill type fraud like insider trading as opposed to the outright Ponzi scheme he was actually running. Unfortunately it's impossible to identify the sleazy investors and separate them from the dupes, but I take at least some measure of comfort in the knowledge that some fraction of the misery from this implosion is falling on people who well deserve it.

[RobNYNY]

State and federal bankruptcy law provides for funds to be returned to the bankruptcy estate if there were paid out for a certain period before the filing of the bankruptcy under doctrines of preference, constructive fraud and actual fraud. The periods range from 3 months to a year or more for preference and constructive fraud, though I don't know what the period is for actual fraud. The rules are complicated, but basically any innocent person can be required to return some money received for the three months before the bankruptcy (at least any part that represents earnings). However, I'm not an expert, and there are no doubt special provisions for bankrupt investment funds.

Here's something for the legal minded:

http://www.pwsp.com/content/portal/publications/2008/12/20081216184832468/Insolvency%20Restructuring%20Vol%201300%20No%201309%2012-18-08.pdf

It will be interesting to see how this is applied to second tier clients (like the clients of Fairfield Greenwich). Fairfield Greenwich is going to be sued by the bankrupty receiver to claw back money, and by its investors for money lost.

[RobNYNY]

Here's another link on preference payments.

http://www.thedeal.com/newsweekly/community/legal-battle-looms-for-madoff.php

[PhoenixRising]

Rob's links may cover this, but I think the applicable concept is called a 'clawback'. It's a provision in regulated investments to prevent investors from recovering what they put in if they are the first to figure out that the venture is going to fail; broadly, a clawback has a six year window for the investors who stick with the venture to compel the first rats off the ship to share in the losses.

I've now told you more than I know, so if there is someone who can 'splain clawbacks better, jump on in.

[rapier]

Your way behind the curve on this one Lindsay.As others have noted above those who got payouts can be made to return them.

The MSM has botched this story from the start because they are so ignorant of financial matters. Of course so is the general public. Most matters financial and monetary are incomprehensible to layman for reasons it might take several long books to explore.

What the hell, I'll try anyway. Money is so close, so intimate, so entwined with everything we do, everything we are, all our relationships with others that it's impossible to step back and see it for what it is. Well, not so good. How about this. Money is like culture which has been defined as all those tiny little signals we inculcate and use and see without thought. Like a simple gesture in one culture which signals friendship in another means I think your are an asshole. You've heard the stories.

Money today is debt. A debt is a liability. Every dollar in your pocket represents, no is, a liability of the US Treasury. Confused? Of course. It takes almost superhuman effort for some people to really understand this. I can't help. You have to study. Read Galbraith's Money perhaps. Remember this if you remember anything. Money is an abstraction. Even gold money is an abstraction. Stone age cultures saw no more value in gold than in dirt. Diamonds littered the beach Cecil Rhodes found. Gold dust twinkled in the sands on Nome's beach. It was only an idea, a concept, which gave them value. Modern money is several layers of abstraction deeper. Still, it's all an abstraction.

Money used to be gold or silver. Then paper money was invented and in modern times lead by the Bank of England was backed by gold or silver. US paper money went through several iterations and eventually was nominally backed by gold until 1971. Then all currencies were simply backed by.......... nothing. Confidence. Espressed as the exchange rate with other currencies, which is often manipulated.

Bernie's reported $50 billion was ephemeral. Some of the money was lost by picking losers in the market and the rest was lost paying withdrawals and the rest went to fees. Fees to the ones who steered the money to him, the rest he took. However to get a bit philosophical, all the prices, the so called 'values' of financial assets he supposedly owned were quite ephemeral as well. If they had been worth $50 billion a year ago they well could be worth only $25 billion today. And remember those billions, those dollars, are not solid either. They are an abstraction.

The inflation in the price of assets has been the be all and end all of our political economy for over 30 years. That inflation was achieved by multiplying the amount of money and keeping that money mostly within the financial system so the asset prices could continue to rise. The rising prices brought in ever more money in a virtuous circle. Those high prices however were always called 'values'. "The value of stock rose" we heard a billion times. Value being a loaded term. A term of art. There is only price. Now those prices are deflating. They will continue to deflate for a long long long time.

Everything you thought you knew about money is soon to be gone with the wind.

I will recommend this site.

http://theautomaticearth.blogspot.com/

[Lindsay Beyerstein]

Rapier, I'm comfortable with the idea that money is an abstraction. That much is self-evident. What else could it be?

However, I gather that Madoff's scam was primarily a Ponzi scheme. The problem was that he DIDN'T have assets that could be said to be worth $50 billion today or $25 billion tomorrow--because he mostly didn't acquire assets. He just robbed Peter to pay Paul until he couldn't.

He took in $X billion from investors over the years. The problem was that Madoff didn't invest most of that money in anything. Instead, he took money from newer investors and used it to pay "returns" to previous investors. As long as there was a steady stream of new marks ("investors") handing over money to Madoff, he could keep all the balls in the air.

[Daniel]

The more recently one redeemed their money, the more likely they will have to pay some back. That's the way the law works in such cases.

The more interesting and important question is whether the Obama administration and Justice Department (Bush's has already dropped the ball on this) will demand that Wall Streeters - all Wall Streeters, from the obscenely paid Robert Rubin, Rahm Emanuel, Hank Paulson, Franklin Raines, Jamie Gorelick......to the little shit traders recently sprung from Ivy schools - will pay back to the United States treasury the tens of billions of dollars of "bonus" that were fraudulently conveyed to them over the past 5 years under the bogus guise of legitimate compensation.

For at least the past 5 years and going back further Wall Street was a sham, a sordid bacchanal, a dead-beat casino. There was very little legitimate activity going on down there. And these bastards fraudulently conveyed the U.S. taxpayer-guaranteed money out the front door under the guise of "compensation". I say bull. Go after these people. All of them. The American people demand justice on this. They should be pursued, hounded and ruined for what they have done to millions of Americans and others who may very well face an economic depression.

But, don't hold your breath waiting for the Obama administration to act, because, yes, most Wall Streeters are in fact Democrats, and they give a lot of money to Democrat politicians, and that money was paid as protection, and they will be protected. Watch. So the scam will continue. Same old, same old. Yep. Don't hold your breath.

[Greg Abbott]

We have our own investment fraud Ponzi scheme that blew up here in Minnesota as well, the Tom Petters case. http://www.startribune.com/local/37273289.html It's only $2 billion or so, Petters was small potatoes compared to Madoff.

Both cases strike me as somewhat "mild" Ponzi schemes, that collapsed only because of the overall market collapse. Presumably they were using new investor money to maintain the appearance of higher-than-normal, but not astronomical returns, for their investor/victims. The 40 percent drop in the market made it impossible for them to cover their tracks anymore.