Investors in Bernard L. Madoff's giant $50 billion self-declared Ponzi scheme may have a lot more to lose than they think.
Those who redeemed all or part of their investments in Madoff's investment advisory business could be forced to return the money if it is found they had an inkling fraud was taking place. An investor can only keep money that was withdrawn if it was done in good faith.
"If the person requested the redemption and got it because they thought the fund was going under, it was not taken in good faith," says Stephen J. Nelson, a corporate attorney and partner at the Nelson Law Firm LLC.
"There will be some effort to claw money back from investors who redeemed at least in the last two or three years," he says. "The doctrine the plaintiffs will use to do that is fraudulent conveyance. But how the facts will shake out, no one knows."
Lawyers will be looking at who got money and who didn't to figure out if money that was transferred was done so fraudulently. "It appears that there were no profits, so investors might have gotten back money they weren't entitled to. It could have been someone else's money," says Nelson. "My guess is that this will end up in the bankruptcy court."
There may be precedent from Samuel Israel III's Bayou Group, which operated hedge funds that turned out to be a massive $400 million Ponzi scheme. In April, Israel was sentenced to a 20-year prison term.
Investors in the Bayou Fund may be forced to return redemptions made from the fund. A bankruptcy court in the Southern District of New York in October found that some investors were paid fictitious profits during a time when the Bayou Fund was insolvent.
"The Bayou Fund investors who did not elect to exchange were redeemed at inflated values, thereby further fraudulently diminishing the remaining Bayou Fund assets to the disadvantage of those investors who did exchange," according to the decision.
The possibility of returning redemptions isn't the only bad news for Madoff investors. Those who paid income taxes on phantom earnings they were led to believe they received from their investment at Madoff's advisory firm might not get back what they paid if too much time has passed.
Tax returns can, in most cases, only be amended within three years of the date of the original return.
"After the statute of limitations has passed on the filing of a tax return, it is no longer possible to amend it," says Mary Ann Mayo, a partner at the Nelson Law Firm LLC who specializes in taxation issues. "It would be possible to claim as part of your damages against Madoff the taxes you had to pay because of the bad income statements they gave investors. If they gave you a false income statement and you paid taxes based on it, that would be part of your damages."
There will be no getting that money back at a certain point except from the people who defrauded you in the first place, she adds.
The U.S. Attorney's Office filed a criminal complaint for securities fraud against Madoff on Dec. 11. In the complaint, Theodore Cacioppi, a special agent with the Federal Bureau of Investigation, said Madoff admitted there was no innocent explanation for the alleged fraud.
Madoff explained he had decided it could not go on and he expected to go to jail. Madoff allegedly told two senior employees of his firm--believe to be his sons, Mark and Andrew--that his investment advisory business was a fraud. Madoff stated he was "finished' and he had "absolutely nothing," that "it's all just one big lie," and that it was "basically a giant Ponzi scheme."
For years, it is believed Madoff was paying returns to certain investors. Madoff said his business was insolvent and that it had been for years. He stated that he estimated the losses from this fraud to be at least $50 billion.
The Securities and Exchange Commission also filed securities fraud charges against Madoff and his investment firm, Bernard L. Madoff Investment Securities LLC, for a multibillion-dollar Ponzi scheme that he perpetrated on advisory clients of his firm.
The SEC is currently seeking emergency relief for investors, including an asset freeze and the appointment of a receiver for the firm.
"Our complaint alleges a stunning fraud that appears to be of epic proportions," says Andrew M. Calamari, associate director of enforcement in the SEC's New York Regional Office.
The alleged fraud is massive, both in terms of scope and duration, adds Linda Chatman Thomsen, director of the SEC's Division of Enforcement. "We are moving quickly and decisively to stop the fraud and protect remaining assets for investors, and we are working closely with the criminal authorities to hold Mr. Madoff accountable."
Madoff founded the firm in 1960 and has been a prominent member of the securities industry throughout his career. Madoff served as vice chairman of the NASD, as a member of its board of governors and as chairman of its New York region. He was also a member of NASDAQ Stock Market's board of governors and its executive committee and served as chairman of its trading committee.
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