The curious case of the Madoff clawbacks

Posted by on October 22, 2009 in Misc.

Imagine you invested in a mutual fund several years ago. You received dividends and, on sale, capital gains. Not soon after the sale of your units, the mutual fund is put into receivership or goes bankrupt. A few months after that, you receive a letter from the receiver or trustee asking for your profits back to help compensate the existing investors.

Hardly seems fair doesn’t it?

Yet, this is what is happening in the aftermath of the Madoff ponzi scheme being exposed.

The Securities Investor Protection Corp (SIPC) is a not for profit corporation which protects investors if broker-dealers fails. It has jurisdiction of the Madoff matters. Under Securities Investor Protection Corp. v. Bernard L. Madoff Investment Securities LLC, 08-01789, U.S. Bankruptcy Court, Southern District of New York (Manhattan), the liquidator appointed by SIPC has begun clawback lawsuits against investors who made a profit from “investing” with Madoff.

Yesterday, it was revealed the owners of the New York Mets baseball club made a profit through the scheme and speculation is that SIPC will also initiate a suit against the owners (whatever the profits, it sure didn’t buy defense or pitching this season).

A clawback suit is analogous to fraudulent conveyance in which individuals are paid out of order to defeat certain classes of creditors (think of  a parent who sells their house to their adult child for $1 to avoid a tax judgement). If proven liable, the typical remedy is to rollback the transaction or, in this case, the return of profits.

The particular issue in the Madoff case is that the liquidator can reach back 6 years and the clawback suits have been initiated against insiders who allegedly knew it was a fraud and cashed out (the intention of these kinds of laws and, if proven true, a just decision), persons who allege they knew nothing about the fraud and where fortunate in their timing (giving rise to some type of  good faith dealing defense) and charities (who have a moral defense at the very least). As I understand it, no allegations have been proven.

The liquidator is in a very tough position. If he does not initate clawback suits, he will expose himself to charges that he did not carry out his fiduciary duties. By initiating suit, he’s now subject to charges he’s being overly broad in the application of the law and costing innocent people time and lawyer’s fees to defend themselves. Of course, he’s been sued too.

Some have questioned if ponzi scheme victims should be compensated for their losses. If you believe they should, should it come from  the unknowing “winners”  (those in on it and cashed out should return money if proven to be so)? You could construct a university level ethics course on the Madoff moral quagmire as it pertains to compensating its victims.

All I know is that some lawyer is going to retire on this matter alone.

Anyone care to share any thoughts about this?

2 Comments on The curious case of the Madoff clawbacks

By Pedro on October 22, 2009 at 9:25 am

Question is are we sure, beyond any reasonable doubt, this people didn’t have any inside information to got a profit from Madoff? If they knew they should be prosecuted but if they did it without knowing the fraud, they should keep their earnings.

By Canadian Capitalist on October 22, 2009 at 11:33 am

As a lay person when it comes to law, it seems to me that it is fair to ask investors who profited from a pyramid scheme to pay back the profits, irrespective of whether they had knowledge of the scam or not. And they should count themselves among the lucky ones who got their entire ‘investment’ back.

The reason I feel it is fair is because their ‘profits’ came at the expense of other investors’ capital in what turned out to be scam. It is only right that it is given back.

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