Net Equity or Inequality?

Bloomberg

Commentary

While victims of Madoff's fraud cannot expect full restitution of their life savings, AIG's counter parties, including Goldman Sachs, JP Morgan Chase, Bank of America Merrill Lynch and foreign as well as American banks, are receiving 100% on their Credit Default Swaps. They paid a small amount over the past two years to hedge their bet on the American mortgage bubble, created by the fraudulent instruments called Collateralized Debt Obligations, and sustained by misguided rating agencies and oversight regulatory bodies. Now that the bubble burst, they won their bet with big payouts that far exceed their original payments. Where is the insurance company that delay and reduce payments? Where are the people to fight tooth-and-nail to claw back every possible penny from the insured, the counterparties? Do investment banks and hedge funds get special treatment, especially when it is billions of taxpayer money that are paid out?

Excerpts

The agency liquidating Bernard Madoff’s brokerage says the $2.6 billion it has on hand is enough to satisfy all legitimate claims by victims of the money manager’s $65 billion Ponzi scheme.

The Securities Investor Protection Corp. is using a formula that investors may challenge in court. The agency has the money in an industry-financed fund and from recovered assets to reimburse Madoff’s 5,000 customers to the maximum allowed by its charter, Stephen Harbeck, SIPC president, said in an interview.

The SIPC has $1.6 billion in a fund designed to reimburse customers as much as $500,000 on lost investments, plus $1 billion recovered by brokerage trustee Irving Picard from Madoff firm bank accounts and desk drawers, Harbeck said.

Prosecutors are seeking $170 billion in forfeitures from him, representing funds that flowed through his company. They have identified more than $100 million of his houses, cars, boats and jewelry they intend to seize.

Some Madoff investors are up in arms about SIPC’s decision, announced by Picard at a Feb. 20 creditors’ meeting, to limit victim claims to “net equity” -- cash invested minus sums taken out. That formula ignores profit reported on customer brokerage statements for the past 20 years, gains that were fictitious because Picard found no evidence Madoff had made any trades or profits going back decades.

‘Legitimately Expected’

Customers paid taxes on those phantom profits and “legitimately expected” that they owned the securities listed in official brokerage statements, said Helen Chaitman, a Madoff victim and lawyer with Phillips Nizer LLP who is advising 350 investors in the fraud without charge.

The Securities Investor Protection Act, passed in 1970 to safeguard investor accounts and maintain confidence in the market, encourages SIPC to honor customers’ “reasonable expectations” by compensating them for lost profit as well as principal, said Chaitman, other victims and legal experts.

In a similar case, involving a fraud at bankrupt New Times Securities Services Inc., a federal judge in New York, where Madoff’s firm is based, ordered SIPC in 2002 to pay $500,000 to customers whose statements reported nonexistent trades by actual mutual funds. An appeals court reversed that ruling in a 2004 precedent that Picard relies on.

“Picard is behaving like a true insurance representative,” said Chaitman, who said she lost her “entire retirement” by investing with Madoff. “SIPC is being creative about not having to pay people the money to which they’re entitled.”

Leading Precedent

In the New Times case, a federal district court said investors were entitled to maximum $500,000 payments from SIPC if statements reflected investments in genuine mutual funds, while customers whose records cited fictitious mutual funds were only entitled to $100,000, the SIPC limit for cash initially invested.

In its 2004 ruling, the federal appeals court disagreed, finding customers should get back money they invested and not “artificial” returns reported in “fictitious account statements.” It adopted an argument by the U.S. Securities and Exchange Commission, which exercises oversight, that SIPC would be “unacceptably exposed” if it had to pay customers “arbitrary amounts that necessarily have no relation to reality.”

Biondi said she understood SIPC protection as a form of insurance that covered her family partnership losses. “Now they’re going to deduct money from my claim,” she said.

“If you were to pay her based on fictitious, phony profits, there would be less money to distribute to someone who has lost principal,” Harbeck said.