It may feel like the Bernard Madoff case has been with us for years, but it was only Dec. 11, 2008, when news broke that the supposed Wall Street titan and former chairman of Nasdaq had been arrested for running a Ponzi scheme of unimaginable size.
According to a complaint filed that day by the Securities and Exchange Commission, Madoff informed two senior employees (his sons) that his investment advisory business was a fraud, that he was “finished,” that he had “absolutely nothing,” that “it’s all just one big lie,” and that it was “basically, a giant Ponzi scheme.” Madoff reportedly admitted in this conversation that his firm was insolvent and had been for years, and that he estimated the losses from this fraud were at least $50 billion.
The massive size of the alleged Madoff scheme, and some of the stunning details that have since emerged, have had a seismic effect in the investment community as well as the legal and regulatory worlds. The list of areas affected by the Madoff case is remarkably long: class-action and individual litigation, SEC enforcement, criminal enforcement, legislative action, bankruptcy law, auditing and insurance, to name just a few. To that end, here is a 360-degree view of the implications so far, and the thousand ships of challenge the case has launched.
Securities and Exchange Commission. The Madoff case’s consequence for the SEC could be the subject of a lengthy article on its own:
- Enforcement action. The complaint against Madoff alleges “a stunning fraud that appears to be of epic proportions.” The SEC states that of the more than $17 billion in assets under management by Madoff’s firm at the start of 2008, essentially all of that appears to be missing.
- Receivership. The court handling the SEC’s case appointed a receiver for Madoff’s business and set a Dec. 31 deadline for Madoff to provide the agency with a written account of all his assets held for his “direct or indirect benefit,” with descriptions of “the source, amount, disposition, and current location of each.” He reportedly has provided that list, but the details have not yet been disclosed.
- Internal investigations. On Dec. 16, SEC Chairman Christopher Cox made a startling announcement that “credible and specific allegations” about Madoff’s possible fraud dated back to at least 1999, “but were never recommended to the Commission for action.” Cox requested that the agency’s inspector general, David Kotz, launch a review of the past allegations about Madoff and the reasons why nobody at the SEC found them credible enough to explore for so long.
- Lawsuits. On Dec. 22, an investor who lost nearly $2 million investing with Madoff filed a claim against the SEC alleging that the agency was negligent in failing to detect Madoff’s alleged fraud, and seeking $1.7 million in damages. Legal experts, however, say the claim is likely doomed by the SEC’s defense of sovereign immunity.
Department of Justice. On the same day that the SEC filed its case, the Justice Department also filed a criminal complaint against Madoff in New York charging him with securities fraud. According to the sworn statement of an FBI agent in the complaint, the FBI interviewed Madoff on Dec. 11 to inquire whether there was an innocent explanation for the statements he allegedly made to his senior employees that his operation was just a “big Ponzi scheme.” Madoff’s point-blank response: “There is no innocent explanation.”
Class-action litigation. At least seven federal class-action lawsuits have been filed, against a range of different types of defendants. Madoff himself and his firm have been named as defendants, of course, but so have several of the so-called “feeder funds” that gathered and directed investor capital to Madoff and his firm (as well as the individuals running those funds and corporations affiliated with those funds). Auditors for the feeder funds, such as BDO Seidman and Ernst & Young, have also been sued for allegedly grossly negligent audits. At least one class action has been filed in state court, as well.
Individual litigation. Although most of these cases have yet to be filed, several law firms have announced that they now represent scores of Madoff investors who have retained the firms to represent them in individual cases. By late December 2008, the Milberg law firm had reportedly gained more than 100 Madoff investors as clients, and the firm believed the group could reach 150 investors in a matter of weeks.
And plaintiff law firms were not the only law firms offering their services in connection with the Madoff litigation. By the end of December, nine law firms had established “Madoff practice groups,” including large defense firms such as Duane Morris, Holland & Knight, Greenberg Traurig, and Nixon Peabody.
Congress. Lawmakers were irate over the SEC’s admission that it had failed to pursue credible leads that Madoff was running a Ponzi scheme. On New Year’s Eve, the House Financial Services Committee announced that it would hear testimony in January on the Madoff case and the need for regulatory reform. The committee planned to call witnesses including SEC Inspector General Kotz and Stephen Harbeck, head of the Securities Investor Protection Corp.
Securities Investor Protection Corp. The SIPC was created by Congress in 1970 to replace customer cash and securities in brokerage accounts in situations including the theft of customer assets. But the legal limits on amounts covered make it clear the SIPC was not designed to handle a $50 billion fraud. On Dec. 23, a federal bankruptcy judge approved the SIPC’s liquidation plan in the Madoff case where Madoff victims are eligible for maximum compensation of $500,000 worth of securities, with no more than $100,000 of that amount in the form of cash.
Bankruptcy. The SIPC’s actions are not technically bankruptcy cases, but the Securities Investor Protection Act provides that the liquidation of a failed securities business is conducted as if it were a Chapter 7 bankruptcy case. That has prompted many observers to compare the Madoff case to the collapse of the Bayou Funds in 2005, which also involved a complex Ponzi scheme. Most of the assets recovered in the Bayou matter were obtained through the pursuit of “fraudulent conveyance” claims against investors that had redeemed some or all of their money before bankruptcy proceedings started. Accordingly, some Madoff investors who were fortunate enough to withdraw their funds before the alleged fraud was disclosed in December could be forced to return that money under these “clawback” procedures.
Other disputes will also arise in the bankruptcy proceedings. Already, the trustee appointed by the SIPC to supervise the liquidation of Madoff’s business has been sued by a family that claims that it sent Bernard Madoff $10 million just six days before he was arrested and charged with running the Ponzi scheme. Rosenman Family Corp. claims that the Madoff trustee has no claim to the $10 million because Madoff told the Rosenmans that the fund was closed until Jan. 1, 2009, but that Rosenman could wire money before that date into a Madoff firm account, which he did. The trustee maintains that the $10 million is property of the firm’s estate.
International. Victims from around the world have emerged over the past few weeks, including reports of huge losses by Banco Santander (Spain, $2.87 billion); Bank Medici (Austria, $2.1 billion); and Fortis (Holland, $1.35 billion); significant losses have also been reported by institutions in Japan, Britain, Korea, Switzerland, and Belgium. These losses have led to harsh criticism of the U.S. regulatory system from people such as Nicola Horlick, fund manager of the Bramdean Alternatives fund in Britain. Horlick, whose fund reportedly invested an estimated $30.4 million with Madoff, was quoted as saying that “[i]t is astonishing that this apparent fraud seems to have been continuing for so long, possibly for decades. The allegations appear to point to a systemic failure of the regulatory and securities markets regime in the U.S.”
All of this and more occurred in the three holiday-shortened weeks between the time Madoff was arrested on Dec. 11 and the end of 2008. But the Madoff story is just beginning, and will no doubt continue to expand and be driven into other areas in 2009 by investors determined to recover as much of their funds as possible.
Originally published in Compliance Week. Reprinted with permission. © 2009 Financial Media Holdings Group, Inc. All Rights Reserved. Compliance Week can be found at http://www.complianceweek.com. Call (888) 519-9200 for more information.