Judge Rules Madoff Victims Can't Recover Fictitious Profits

Bankruptcy court confirms that Madoff’s trustee has no responsibility to make good on the arch-fraudster’s outrageous claims.

Bernard Madoff conjured up whatever investment performance numbers would keep his clients happy, but according to a Manhattan judge, his estate is not liable for the roughly $45 billion he ended up creating out of thin air.

“The trustee is not obligated to step into the shoes of the defrauder or treat the customer statements as reflections of reality,” observes Dennis Jacobs, head judge of the U.S. Second District Court of Appeals.

Last week we wrote about how one angry couple was suing high-end Philadelphia law firm Duane Morris for moving some of their cash into a Madoff feeder fund.

Their case looks a little weaker now that Judge Jacobs has ruled that Madoff’s trustee, Irving Picard, only needs to come up with enough cash to cover the $20 billion or so clients actually invested in the scheme.

“Fictitious” returns are exempt, even though they showed up on his victims’ quarterly statements.

The news is considered a win for Picard, who was already working overtime to make sure nobody lost real capital, much less make good on Madoff’s promises.

But for investors who thought they were entitled to every fictitious cent they were promised, it’s a harsh return to reality.

Completely divorced from the truth

Those investors were the reason Jacobs was hearing the case in the first place.

Picard has spent the last few years fighting to recover enough cash to repay all the investors what they originally sank into the scheme.

Since Madoff never actually put that money to work -- except on his own behalf -- there was never any way it could have generated a single cent of returns for anyone.

Unfortunately, hundreds of his clients still think they’re entitled to that fake money, or at least to have it taken into account as part of their split of Madoff’s still-liquidating estate.

They sued to get Picard to honor their December 2008 account balances instead of taking a “cash in, cash out” accounting approach, and when a local bankruptcy court ruled in his favor, they appealed.

Now that Jacobs has disappointed them again, they’ll probably take their case all the way to the Supreme Court.

How far can regulators protect investors?

The disgruntled clients’ lawyers claim that people lost their life savings. In theory, they’ll get as much of their principal back as Picard can scrape up.

But Madoff’s accounts go back to the 1960s, so many of his oldest surviving clients have now been retired and living off their accounts for decades.

While Picard may not be pursuing “clawback” lawsuits to recover Ponzi money from these clients, the SEC has refused to honor their insurance claims, arguing that they already spent the money they were entitled to receive.

That leaves smaller Madoff investors out in the cold, but it’s unclear what they expect Picard or the SEC to do.

The Securities Industry Protection Corporation (SIPC) has already sent Picard $786 million to distribute to Madoff clients.

And besides, even if the number on the account statement had any relevance to reality in a situation like this, giving investors a claim on it would set an ominous precedent.

After all, account balances go up and down all the time depending on the market. When the value of the account goes up, investors gain money. When it goes down, they lose. It’s that simple.

The value of Madoff’s accounts dropped to zero after his scam went public and he went to jail. Trying to collect on his last client statements is like trying to cash in stocks at last month’s prices.

Similar logic might apply in other market fraud scenarios. If they get their principal back, exactly how much money are they out on that account?

Since that money was already in cash, the opportunity cost is pretty close to zero -- and now any fictitious returns Madoff promised them have evaporated.

Arbitrarily distributed returns

And there’s a problem with using his statements as a basis for how big a share of his estate a given investor is entitled to receive: Madoff made up his returns on the spot to keep his victims happy.

“The profits recorded over time on the customer statements were arbitrarily and unequally distributed among customers,” Judge Jacobs notes.

Multiply those fake returns by decades, and you have a situation where anything goes.

“The books and records reveal that the last statements are a fiction,” Picard told the court.

If so, then there’s not much obvious justification for those same clients suing for anything but what they put into Madoff’s funds. They might feel cheated, but there’s just no way to know what they deserve -- and in any event, there’s just no money to collect.

Meanwhile, Picard is busy suing just about everyone to try to generate more cash to pay the claims that everyone can agree are valid.

“This does the greatest good for the greatest number of Madoff victims,” says Orlan Johnson, SIPC chairman. “We look forward to getting funds to Bernard Madoff customers as soon as possible.”

It might not be fair, but the market is not always fair.

Scott Martin, senior editor, The Trust Advisor Blog. Jerry Cooper and Steven Maimes contributed to the research.



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