For one set of New Times victims, those who thought their stolen money had been used to buy brand-name mutual funds, SIPC honoured the final account statements—whose balances, unlike those in the Madoff accounts, accurately tracked the real-world fluctuations in the prices of the listed mutual fund shares, going up and down with the market tide. That decision was never challenged on appeal.
But the court upheld SIPC’s refusal to honour the final account statements of another set of New Times victims who had purchased high-yielding securities that were actually invented out of whole cloth by the Ponzi schemer. “Treating . . . fictitious paper profits as within the ambit of the customers’ ‘legitimate expectations’ would lead to the absurdity of ‘duped’ investors reaping windfalls as a result of fraudulent promises made on fake securities,” the court decided.
So which aspect of the New Times rulings applied? The blue-chip stocks the Madoff customers thought they owned were obviously more akin to the real mutual funds than to the make-believe securities in the New Times case. But the values Madoff attributed to those stocks more resembled the unattainable fantasy values of the fictional New Times securities than the accurate up-and-down prices of the mutual funds. So it was a stretch to say that the rulings in New Times were crystal clear in favour of Chaitman’s position—or, indeed, crystal clear about anything.
There were other court decisions that flatly contradicted her—In re Old Naples Securities, for example. In that case, decided in Florida in 2002, the court had acknowledged that “there is very little case law on point for determining what constitutes a customer’s net equity in a situation such as this,” another small Ponzi scheme being liquidated by SIPC. But the court nevertheless decided that letting the victims “recover not only their initial capital investment but also the phony ‘interest’ they received . . . is illogical.”
So Chaitman also grounded her arguments against Picard on her reading of the 1970 law that created SIPC and the comments that lawmakers had made about their intentions. As she saw it, SIPC was an insurance programme, created to restore investor confidence after the collapse of the wild go-go markets of the 1960s. Investor confidence could be maintained only if SIPC honoured customers’ “legitimate expectations”. In this case, she argued, those legitimate expectations were based on the final statements they received just before Madoff’s magic kingdom went up in smoke.
Again, this was not an undisputed thesis. The SIPC statute itself did not clearly address how a trustee should calculate net equity in a Ponzi scheme; nor did it flatly require the trustee to honour customers’ final account statements, regardless of the circumstances. It did, however, define “net equity” in a convoluted way that might support Chaitman’s position. It said the term meant “the sum which would have been owed by the [brokerage firm] if the [firm] had liquidated . . . all securities positions” of the customer, after subtracting any money the customer still owed the firm for those securities.
Irving Picard’s response was that, for years, Madoff’s victims had been paying for the “securities positions” shown on their account statements with play money—with the phoney profits credited to them by Madoff. They had not actually given Madoff any real money with which to pay for the securities shown on their statements—except for the various cash payments they made, for which Picard was giving them credit.
Some previous legal rulings challenged Picard’s reading of that portion of the statute, and it was certainly an issue that needed clarification from the courts or from Congress. However, it was not true to say that his definition of net equity was “invented”, or that his position was indefensible or in clear contradiction of the law and prior court rulings.
But this is what Helen Chaitman did say—repeatedly, eloquently, widely, in any forum available to her. For her, this was not a topic about which reasonable people could disagree; this was not even a topic desperately in need of judicial clarification. She argued that she was correctly defining net equity and that Picard was deliberately ignoring the law to shortchange victims and protect SIPC and its Wall Street masters.
Her clients and admirers did not doubt her for a moment. For the tragically mischaracterized “net winners”, who were denied any SIPC payment under Picard’s analysis, she was a beacon of hope for a better outcome. They trusted her completely.
Chaitman’s unequivocal opinions were amplified in the echo chamber of the Internet by an increasingly visible blog created and nurtured by another outspoken Madoff victim and Picard critic, a law school dean named Lawrence R. Velvel.
Like Chaitman, Velvel had been steered to Madoff by a trusted friend and had seen his retirement nest egg crushed in the Ponzi scheme’s collapse. But his CV clearly suggested he would be an implacable foe of SIPC from day one—he was a self-defined radical, and had been since the antiwar movement of the 1960s. He also was a cofounder in 1988 of the Massachusetts School of Law in Andover, a small low-cost law school whose mission was to serve working-class students.
Velvel looked like a genial gnome, short and stocky with a chin-circling white beard and owlish spectacles. When aroused, however, he could employ his words like a blowtorch.
In his view, justice had to incorporate “the simple dictates of humanity,” or it was not justice. This meant that the only just definition of net equity was one that provided SIPC money to Madoff victims who otherwise “will have to continue living on welfare or dumpster diving.” If destitution was the result of Picard’s net equity formula—as it would be for some as-yet-unknown number of victims—then Picard’s formula could not possibly be just.
Chaitman and Velvel became two of the most visible champions of the unlucky “net winners”. Their analysis of the New Times case was passed back and forth by e-mails and supplied to reporters as infallible doctrine. A few of their angriest supporters berated anyone—in the media or on victim chat sites—who did not agree with them.
It seemed impossible for them to shake free of the Wall Street vocabulary that Madoff had used to disguise his crime. His victims were “clients” who had been making “investments”. He had been generating “profits”, and they had been withdrawing them as “investment income”—even paying taxes on it, for heaven’s sake. Thanks to those “profits”, they still had money in their accounts when Madoff confessed. And that final account balance was the measure of what they had lost in Madoff’s fraud, plain and simple.
But Irving Picard and David Sheehan did not see “investments” and “profits” and “account balances”. Instead, they saw crimes and lies and stolen loot. In their view, Madoff was simply a thief. He had ridden into town and swindled everybody. Some people had been lucky enough to ask for their money back before he rode off into the sunset. He had given it back to them purely to forestall the cries of “Stop! Thief!” that would have broken out if he had refused. At the end of the day, those victims had dodged the bullet—they had narrowly avoided being robbed.
Other victims, the unlucky ones, had not retrieved a penny before Madoff galloped away. In their case, the bullet had hit home, the robbery had been consummated. As Picard and his posse saw it, any loot left in the crook’s saddlebags when he was finally captured clearly belonged to those unlucky victims, to the thousands of “net losers”, and to no one else.
But the net winners did not feel lucky. They felt as if they had been robbed, too—robbed of the wealth they thought they had. They felt betrayed by Madoff and by the SEC—and they were right; they had been tragically betrayed. But so had the “net losers”, and at much greater cost, at least in terms of out-of-pocket cash. So the “lucky net winners” were not lucky and they were not winners. They simply were not eligible for immediate relief, under Picard’s calculations, no matter how genuinely needy some of them might have been.
Picard’s job, as the courts had long interpreted it, was to try to get all the innocent Madoff victims into the same boat, a boat whose occupants had sacrificed all their fictional profits but recovered all of the cash they orig
inally invested. On the day Madoff was arrested, the net winners had already gotten all their cash back and the net losers had not. The net losers had never received any fictional profits, and the net winners had.
Madoff had robbed Peter to pay Paul; the only way to fix that was to take money back from Paul to repay Peter. Even if the trustee could find a way to repay Peter from some other source of money, Paul would still be better off than Peter because he had his fictional profits and Peter didn’t. Unless everyone, somehow, could recover the full amount shown on their final account statements, the net losers would inevitably be treated worse than the net winners, which could not possibly be fair.
Was there a moment immediately after Madoff’s arrest when a different approach could have been applied to helping the neediest casualties of his crime?
The justice available through the bankruptcy court was blind. It would treat wealthy “net winners” such as the New York Mets’ owners the same as nearly impoverished “net winners” such as retired school-teachers or a struggling freelance writer. It would treat all “net losers” the same, whether they were rich hedge funds in the Caribbean or a retired small-town mayor in New Jersey. And this brand of justice was not only blind but slow, far too slow to deliver emergency relief.
There was a template for a different approach. After the 9/11 terrorist attacks, the US Congress recognized that the court system—the forum that would have to deal with lawsuits by victims’ families against the airlines, the airports, and the Port Authority of New York and New Jersey—was a ruinous option. Thousands of breadwinners had been killed, and their families needed immediate relief, fairly distributed. So Congress created a victim compensation fund, whose special master was empowered to tailor compensation awards to reflect both justice and mercy, with financing from Congress—in exchange for an agreement not to sue the airlines or any other entity that could have been held negligent. The final distributions were made within two years and were generally considered fair.
More recently, when a massive oil spill inflicted enormous damage on the communities and businesses on the Gulf Coast of the US in the spring and summer of 2010, a similar approach was taken, with the same special master appointed to make fast-track decisions to distribute funds set aside by BP for damage claims. The effort got off to a rocky start after the special master promised quicker decisions than he could produce. But while going to court remained an option for those dissatisfied by his rulings, the concept was still generally viewed as a faster route to recovery than a long trip through the judicial system.
Of course, a special master for some sort of “Madoff Victim Restitution Fund” would have faced all the same problems that the SIPC trustee confronted: the criminal investigation, the possibility that some Madoff victims were actually accomplices, the unreliable or nonexistent records. Taxpayers willing to finance compensation to 9/11 widows and orphans would no doubt have balked at reimbursing wealthy offshore hedge funds, and the only deep pocket that could have played the role of BP in paying claims was SIPC itself, which was institutionally committed to the bankruptcy process.
Still, some sort of global SIPC settlement or custom-tailored emergency relief for the neediest victims might have been possible if the SEC had immediately recognized the scale of financial devastation and had gotten the White House to persuade the Congress to enact a more creative response.
But the reality of late 2008 was that the SEC was hamstrung by its history with Madoff and caught in a leadership change as a new administration moved into the White House. A divided Congress already was wrestling with failing banks, faltering insurers, near-bankrupt car manufacturers, several endangered brokerage giants, a rising flood of home foreclosures, high levels of unemployment, and the paralysis afflicting most of the nation’s sources of consumer and business credit.
In the absence of a more creative and flexible option, the default position was a blind, slow, and bitterly adversarial SIPC liquidation in bankruptcy court.
Clawback lawsuits were an integral part of bankruptcy court liquidation. Typically, the cash withdrawn before a Ponzi scheme collapses is the primary asset a trustee can find to settle claims. With luck, there may be some untapped bank or brokerage accounts, or some costly toys and pretty houses that can be seized and sold. In essence, though, a Ponzi scheme is simply a liar’s bank account, with a stack of deposit slips at one end and a cheque book at the other. Its lifeblood is the money that flows in as “investments” and flows out again as “withdrawals”.
To recover the investors’ money that had flowed out, Picard needed to sue those who had withdrawn it, an obligation the net winners saw as a threat aimed directly at them, especially if they had taken out millions more than they originally invested. If Picard could be forced to acknowledge their final account statements as the basis for their claims, then they would still be owed money by the estate regardless of how much they had withdrawn. This would mean they would not be vulnerable to clawback lawsuits at all and, in turn, the recovery of many of the billions of dollars Picard had gone to court to claim would be impossible.
Picard’s bedrock assumption was that there was a limited amount of money available to satisfy the claims of Madoff’s victims. As he saw it, the net winners had already gotten back 100 percent of every dollar they had given Madoff. But, even on his optimistic days, he feared that net losers would get back just twenty cents on the dollar—maybe thirty cents if David Sheehan got very lucky with the big-ticket clawback lawsuits.
If that limited pool of cash were reduced by the invalidation of most clawback lawsuits and then had to be shared with every Madoff customer based on the final account balances, the payout could be pennies on the dollar, at best.
But what if the assets weren’t limited? What if the saddlebags retrieved by the posse were bottomless? What if someone—such as SIPC or the SEC—somehow came up with the full $64.8 billion necessary to pay 100 percent of everyone’s final account balance?
By law, SIPC could turn to Wall Street for the cash, and the SEC could get money from the US Treasury. Perhaps that approach might have seemed fair to many Madoff victims—that the fat cats on Wall Street should deliver the fictional profits that Madoff had promised them, with something chipped in by the negligent regulators who had allowed this disaster to happen.
The debate over compensation escalated. Why rescue just the Madoff victims? Literally dozens of Ponzi schemes had fallen apart or were shut down in 2008 and the first half of 2009. And what about the legitimate profits the rest of America had lost in the same market meltdown that caused Madoff to implode? Why should the fictional profits promised by a crook magically reappear in people’s bank accounts, while the reality-based profits created through honest trades by the rest of America just vanished? If Wall Street and the SEC were going to make Madoff’s victims whole, why not make everyone whole?
It was going to be that kind of war, and the first shot was fired on June 5, 2009.
On that day, the small law firm of Lax & Neville filed a class-action suit against Picard on behalf of plaintiffs whose claims he had rejected. One plaintiff was a seventy-six-year-old New Yorker named Allan Goldstein, who had been one of the victims to testify before Congress soon after Madoff’s arrest.
He had been an eloquent spokesman in his congressional testimony.
“I am a human face on this tragedy,” he told Congress’s House Financial Services Committee on January 5. “I speak not only for myself but for the many people who have also lost everything because of this Ponzi scheme.”
In a hardworking life, he had accumulated $4.2 million in retirement savings, all of it invested with Madoff. During twenty-one years of booming bull markets, Madoff had paid him steady annual returns ranging from 8 percent to 12 percent. “I was willing to forgo outsized gains in boom years in favour of greater security,” he said. “We entrusted Mr Madoff with all we had, and now everything that I worked for over a 50-year career is gone.”
Since the collapse, he had
cashed in his life insurance to pay his mortgage, was trying to sell his home in a dismal market, and feared he would be forced into foreclosure. “At this stage of our lives, I never could have envisioned the financial devastation that we are now suffering,” he added. “In the blink of an eye, savings that I had struggled my entire lifetime to earn have vanished. . . . I sit before you today a broken man.”
He urged Congress to set up a restitution fund and enact some sort of emergency legislation that would allow SIPC to “loosen the standards” and distribute money more quickly. He concluded, “We are not trust funds, hedge funds or banks. We are ordinary people who were victims of an incomprehensible crime and who have had their lives turned upside down. We are turning to you, our only hope, for relief we so desperately need.”
But no emergency legislation or restitution fund was enacted by Congress; nor was either even considered. Appeals to the SEC did not produce any change in SIPC’s policies, either. Privately, regulators might fume about how poorly SIPC was handling its escalating public relations problem. But the SEC had gigantic public relations problems of its own, and it did not commit itself in the net equity battle at all until just before it was required to do so in court.
The Lax & Neville lawsuit was followed almost immediately by a similar complaint by Helen Chaitman. She argued that Picard was wrong and conflicted, that clawback lawsuits were simply immoral, and that both clawbacks and Picard had to be eliminated from the Madoff claims process if the victims were ever to find justice.
Spurred by their tireless advocates, the “net winners” became more organized. In letters to the editor, Internet postings, media interviews, and letters to Congress and the courts, they honed their arguments against Picard’s “cash in, cash out” approach. Some of them set up advocacy groups, forming alliances with other fraud-victim groups and lobbying Congress for legislative action to force Picard and SIPC to recognize their claims.
Bernie Madoff, The Wizard of Lies Page 34