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Just how risky should it have been to invest with Bernard Madoff?

MadoffSuppose you put $10,000 into an account with an investment advisor who promises to double your money every year. Two years later your account statement says you've got $33,000, so you happily withdraw $5,000. It seems too good to be true, and that's what it turns out to be. When you try to withdraw  $10,000 more, your advisor sends you a check that bounces. The next thing you know, he's being led off in handcuffs by the feds for running a Ponzi scheme.

Under the Securities Investor Protection Act of 1970, you're protected for up to $500,000 in losses at the hands of unscrupulous investment professionals. The act creates a fund to reimburse investors, and fills it by taxing registered securities brokers and dealers. So, under our imaginary Ponzi scheme, how much should you be entitled to recover? Just the $10,000 you invested, or the full $28,000 shown on your account statement, even though it's a mythical number that your advisor concocted to conceal his fraud?

How about $5,000 -- the amount of cash you paid in minus the amount you withdrew?

That's the formula the Securities Investor Protection Corp., which administers the aforementioned fund, is using for investors in Bernard L. Madoff's epic sham. According to Ron Stein, president of Network for Investor Action and Protection, the SIPC's cash-in-minus-cash-out approach has led it to reduce or deny reimbursements to more than two-thirds of the Madoff investors who've filed claims. That's why Stein's group is backing HR 757, a bill by Rep. Scott Garrett (R-N.J.). HR 757 would force the SIPC to make reimbursements based on investors' account statements, not on their actual investments -- even if those statements aren't worth the paper they're printed on because the ostensible returns they reported never existed.

This strikes me as an overreach, but Stein offers several arguments in favor of the bill. His main assertion is that securities insurance should work the same way bank deposit insurance does. When a bank goes belly up, its customers are insured for up to $250,000 per account, including the interest the bank purported to pay even when it was insolvent.

Of course, bank deposits are supposed to be safe, and securities are inherently risky. Beyond that, the rationales for the two insurance programs are fundamentally different.

Congress started insuring bank deposits to guard against panic-fueled runs that would ruin otherwise healthy institutions. The rationale behind the investor insurance fund, Stein said, was to help Wall Street make the leap into electronic trading. The protection offered by the fund helped convince investors that they could trust the statements they received from their investment advisors and broker-dealers, rather than demanding physical copies of certificates. If investors were later denied the shares they thought they owned, the fund would reimburse them regardless of why it happened.

Garrett's bill would also stop trustees liquidating an investment company from trying to recover assets that the company had transferred to individual investors before its checks started bouncing. In the Madoff case, Stein said, "at least 1,000 claims have been filed against innocent victims" -- investors who withdrew money from their accounts with no knowledge of the sham.

It wasn't their fault that Madoff got away with so much for so long, Stein said; the blame belongs with the Securities and Exchange Commission and a securities industry self-regulatory body for repeatedly giving Madoff a pass. When they enacted the Securities Investor Protection Act, lawmakers knew that  Ponzi schemes could lead investors to seek reimbursement for exaggerated losses, Stein said. But such reimbursements were OK, he said, because they counted on "vigorous oversight" by regulators to minimize the impact.

I understand the argument, and can see why the SIPC's approach in the Madoff case might alarm some investors. Nevertheless, Garrett's bill would let people recover losses based on ginned-up results and fictitious account statements.

Regardless of what Madoff was telling them, the folks who put their cash in his hands lost money the minute he switched from investing to inventing. And the lucky ones who converted some of those fictitious gains into cash before Madoff's con was discovered didn't earn the money. They were just taking it from some other poor sap, albeit unwittingly. (The trustee liquidating Madoff's firm argues that a number of Madoff's customers weren't so innocent; Garrett's bill wouldn't provide any protection for those who knew their advisor or broker-dealer was "involved in fraudulent activity").

I'm not worried about investors being spooked by the SIPC. They should be spooked by regulators' failure to detect fraud even when it's done on a multibillion-dollar scale. One of the larger lessons of Wall Street's collapse in 2008-09 is that bad things happen when investors take an uncritical approach to the assets they buy. When risk assessment goes out the window, things don't end well.

SIPC should protect investors when they're suckered by a con man, but should it go so far as to guarantee them returns on their principal? If they bet on a fake horse, should they be able to collect winnings? I don't think so. Do you?

ALSO:

A warning to Wall Street

Raj Rajaratnam: The feeble defense of an insecure billionaire

-- Jon Healey

Photo: Bernard Madoff leaving court in 2009. Credit: David Karp / Associated Press

 

Comments () | Archives (23)

The comments to this entry are closed.

Fictitious Claims

What everyone seems to be missing is that Madoff did execute the trades that are indicated on his customer's statements. People were robbed and victimized, but not in the manner espoused by the SIPC. The entirety of the securities were very real and certainly stolen. These were not fictitious trades. "Believe half of what you see and none of what you hear". I'm just wondering when the truth will actually come out. It will rock Wall Street, but maybe that's what Wall Street needs.

Robert Henderson

Your comment is well written, just totally inaccurate. Please research -
When you personally invest through a company such as Goldman or Fidelity, how do you know you are not be conned when you get monthly statements.
These investments were made in real companies and not ficititious ones. The average investor in Madoff had no clue AND those gains were report by Madoff as STCG, 1099-DIV and 1099-INT to the IRS. Taxes were paid on those "earned reported gains" and taken into account by IRS but not by the cash in/cash out formula "invented" by the Trustee.
Your final statement: SIPC should protect investors when they're suckered by a con man, but should it go so far as to guarantee them returns on their principal? If they bet on a fake horse, should they be able to collect winnings? I don't think so. Do you?

SIPC is being suckered currently and paying without question, the Trustee over $150 million for his fictitious or non documented expenses, The Trustee is the fake horse for the innocent investors who have been denied of SIPC and any future recoveries by the Trustee. The Trustee has hurt terribly the innocent by his formula. The Trustee and his company should be taken off the case and all monies received to date should be returned.

Jack Gracin

Hey Jon...What would your answer be to your question above if you were one of the innocent victims/survivors who had Madoff, Schwab, Fidelity, or any other brokerage house steal their money in a ponzi scheme. Wouldn't you say that the value of your account was the value in the last month you received a statement before the crime was discovered? Of course you would. The 1970 law does not say, fraud except in the case of a ponzi scheme. It simply states fraud.

Also, you should do a little bit of homework and start talking about the innocent victims who are being tortured for over 2 1/2 years now. Sure, there were several hundred accounts that received over 100% returns and those are the people The Picard should be suing. But, people who received 8-11%? Come one. Get real. None of those people thought they were getting amazing returns. What about the mutual funds in 98-01? Weren't those giving up returns in the double digits?

And finally, maybe you should report that The Picard isn't giving credit to any accounts in Madoff from the massive amount of interest that Madoff was making from Chase and other accounts. He won't even allow the public to view his time records or bills. What's up with that? Why aren't you reporting the crap that The Picard is forcing on people? And, when is someone going to investigate The Lifland judge who seems to not give a damn about anyone except giving The Picard a rubber stamp on everything he has ever asked for including changing the rules that the victims can be sued under! Did you know that Madoff victims being sued HAVE TO go through mandatory mediation before entering a court room? How can The Picard get away with making changes to the system that is supposed to protect innocent investors while he and his firm continue to live in the lap of luxury?

Take that and stick it in your coffee.

Tex

Here’s someone worse than Madoff. Read this link and pass it on to everyone you know, so they don’t get scammed:http://texsquixtarblog.blogspot.com/2009/04/who-is-worse-bernie-madoff-or-rich.html

Louis L. Straney

While I agree that the Trustee's methodology for distribution of funds narrowed the investor pool, I believe that your comment that SIPC was created to protect investors "at the hands of unscrupulous investment professionals" is a mischaracterization of SIPC's statutory mandate. From the SIPC web site, it is clear that the fund was not created to indemnify against fraud or "unscrupulous professionals".

For forty years, SIPC has exercised it's specific mandate for brokerage firms facing insolvency - not fraud. With Madoff victims, as in the past, SIPC is confined to a money-in, money-out recovery formula. Taking the argument that SIPC should use the November 2008 client statement as a benchmark begs the question of "what if the final statements reflected $6 trillion instead of $60 million in client assets?". Under the final statement theory, SIPC would be liable for $6 trillion in losses. Like SIPC, I don't know of any insurance companies willing to indemnify against fraud.

In terms of expanding the pool of SIPC assets, since it is funded by its members, any increase in member contributions would be a business expense that would eventually get passed along to stakeholders and customers. How do you think consumers and investors would react to a SIPC surcharge added to each trade confirmation or monthly statement? I suspect that like SIPC and other insurance companies, investors are unwilling to underwrite fraud insurance.

Unfortunately, the myth that everyone should invest in American enterprise is misguided. There is inherent risk in all financial markets. That element of risk, in theory, provides a return above riskless options. Investment vehicles have yet to be created that provide premium returns with guarantees against misconduct. Investors uncomfortable with that notion should limit their experience to savings accounts.

While the loss of investor funds at the hand of Madoff is tragic, rather than singling out any agency adhering to its statutory mandate, I suggest that the public must accept that agencies cannot create legislation, they can only enforce the laws initiated by Congress. Indeed the financial crimes that permitted Madoff and others to victimize millions of investors screams for reform. However, the responsibility rests with those who make the laws and those who elect the lawmakers.

[From the SIPC site:]
"Why Was SIPC Created?
"SIPC is an important part of the overall system of investor protection in the United States. While a number of federal, self-regulatory and state securities agencies deal with cases of investment fraud, SIPC's focus is both different and narrow: Restoring funds to investors with assets in the hands of bankrupt and otherwise financially troubled brokerage firms. The Securities Investor Protection Corporation was not chartered by Congress to combat fraud. "

[Editor's note: Louis Straney is the author of three books on securities fraud, including the forthcoming "Investor's Guide to Loss Recovery: Rights, Mediation, Arbitration and Other Strategies"]

Teresa Trujillo

The government can't--nor should it--insure private risk in the financial markets. This is just another way to insure that the wealthy don't have to assume risk to make money.

To believe that the government is responsible for every private market tragedy, act of God or nature, and human greed--is a false promise of security in an inherently dangerous world.

This is another piece of bad legislation with a HUGE public financial burden attached to it.

Madoff's scam was a creative way to separate the greedy from their money. The old adage--if it sounds too good to be true, it probably is--is wisdom that went unheard by a group of investors that believed a crook. They are entitled to see him in prison, but nothing more.

Madoff Victim

The author of this story misses the point on several levels. 1) The purpose of SIPC insurance was a mandate by Congress so that brokers would no longer have to deliver certificates for each stock bought or sold. In exchange for not receiving the certificate, customers of SIPC broker / dealers were allowed to rely on their final statement from a belly up broker, "EVEN IF THE STOCKS WERE NEVER PURCHASED." Those are the Congress's words, as written in the Securities Investor Protection Act of 1970 and amended in 1978. If a customer cannot rely on a statement from a SIPC broker / dealer, and they don't get certificates from that broker / dealer, then WHAT can they rely upon as accurate? The insurance is to insure the broker / dealer as reliable, not how or why he went belly up. 2) One of the things that the Trustee is hiding by blocking discovery by the victims is that securities WERE purchased with the funds of the victims. Unfortunately, those securities were given to the other brokerage firms on Wall Street that cleared their trades through Madoff's brokerage arm. It's fact that the brokerage arm was losing money and was propped up by funds co-mingled from the investment arm. That means that MY money bought stocks for a customer of Merrill Lynch or Pru Bache because Madoff was short the funds to cover. All monies from both divisions were kept in co-mingled accounts. At the end of the day, if the Trustee is going to claw back from customers, he also needs to claw back from those Wall Street firms who traded through Madoff's brokerage arm in the final 90 days. Why should my money support the transactions of Wall Street customers who don't get sued, while I do get sued for return of MY OWN MONEY (INCLUDING MY INITIAL INVESTMENT)?
I find it telling that the author of this story starts by using an example of someone being promised that their money would double every year. All the victims I know earned 10% a year. At 10%, money doubles every 7.2 years. This was the case even in times when investing in the Dow index would have returned more.
If I can't get stock certificates and I can't rely on the statements that a SIPC insured broker / dealer issues, stating what I own, it would seem that the entire financial system could one day turn out to be a fraud.

subiaco10

Madoff was one of the heads of NASDAQ......soooo much deep, well placed corruption then and now. Why would you choose to invest in Vegas Meets Wall Street??

Mike

Another give-away to the rich, complements of our wonderful GOP. Not surprised one bit.

Timothy Murray

The Securities and Exchange Commission's, Securities Investors Protection Corporation's and their Trustee's absurd claims that investors cannot rely on their brokerage statements and trade confirmations is damaging our capital markets at a time when we should be reinforcing safety, healing from the failures of our regulatory systems and encouraging capital investment.

To allow broker-dealers to avail themselves the benefits, under SIPA, for the last 40 years, (no premiums were paid for 19 of those years) of holding customer securities in Street Name and later when fraud is committed, denying claims for SIPC advances under the same law that allowed a broker-dealer to hold these securities in their own name is ludicrous.

It was the illusions that the SEC was regulating, and that SIPC was insuring, at the same time allowing broker-dealers to hold customer securities in Street Name that created the Perfect Storm of fraud.

Ficitious Claims

To Madoff Victim......... AMEN

The trades were made. I hear over and over again how Madoff executed NO TRADES. The fact is that Madoff traded. There should not be an argument over whether SIPC should recognize the final statements as a basis for a claim. There should be an argument that the entire truth should be revealed. Why are Madoff investors not entitled to see the evidence. I've already seen it. There is no doubt that Madoff traded. There is no doubt that the securities on those final statements were very real and in the custody of Madoff for those customers.

gullible

Ficticious claims

You really need to get up to speed on this case.....He transacted NO TRADES...NONE! what the heck have you been smoking....oh, never mine, you must be his son......sorry for your blood line.....

klerg

Fictitious Claims, Madoff Victim, hang on just one second...

Harry Markopolos, a very smart man that Madoff victims hold up as a deity, has flat-out said that Madoff made no trades on behalf of victims. In fact, he testified to this in front of Congress.

Your argument is that Madoff took your money and funneled it to the legitimate arm of his business. I haven't researched this claim so I can't say that I know it to be true. But if it is true, it doesn't qualify you for SIPC protection.

Ficitious Claims

klerg......

My argument is that Madoff took customer's securities and used them for the purposes of his market making.

When a Fidelity or an AG Edwards or any one of the hundreds of brokers needed to buy shares of (let's say) GE for a client, they would have Madoff execute their trade. Madoff would sell them the shares. He would steal them from his customers accounts and sell them to the broker asking to buy them.

These customers literally had their shares stolen by Madoff and sold to the customers of the various brokerages that Madoff traded with. There was no legitimate side of his business. The supposed "legitmate" side of his business was funded with the customers money and securities. He could not have functioned as a market maker without borrowing (read stealing) the securites he purchased for his customers.

Therefore, the entire portfolio of securities that were shown on the customer's final statements were real. They were stolen and sold to other brokers. If you have your securities stolen, SIPC should step up to the plate.

As per gullible's comment, if you are gullible to believe that Madoff did "NO TRADES...NONE", then SIPC can get away with their argument and evade their obligations. This is why it is important to have full disclosure of the investigation. And this is also why SIPC will fight to not disclose anything.

klerg

Fictitious Claims:

I thought that Markolpolos' "reverse engineering" investigation demonstrated that Madoff made no trades on behalf of customers. Was Markopolos unclear about this or did he just not talk mention it?

And as far as your statement that "the entire portfolio of securities that were shown on the customer's final statements were real," there was that whole thing with that Fidelity money market fund that appeared on some customer statements, but didn't exist...Fidelity confirmed this. So are you sure that the entire portfolio was real? Considering the circumstances, doesn't it stand to reason that, at the very least, a big portion of the victim's statements were bogus?

Ficitious Claims

klerg:

Harry Markopolis tried to reverse engineer Madoff's strategy, but was unable to do so. It was this that led him to the red flags indicating that Madoff was a fraud. I don't think anyone is disagreeing that Madoff was indeed a crook. Markopolis was correct in that assumption.

Regarding Fidelity, Madoff indicated that his customer's held Fidelity Money Market instruments that were no longer in existence. I'm assuming in his criminal dealings that Madoff made up an amount of those money market funds so as to reconcile a customer's account with what their balance should have been.

So at the end of the day if someone showed that they had a $1,000,000 balance, if $999,000 were NYSE listed shares and the other $1,000 were some fictitious money market security, then that person had $999,000 of real securities stolen from them.

When I referred to Fidelity I was talking about the brokerage, not the money market instrument. Fidelity, the brokerage, would buy and sell NYSE listed securities from Madoff. Those securities were really Madoff's customer's securities and he had no right to steal and sell them to the various brokerages.

So in response to your question, I would say that it stands to reason that a VERY SMALL portion of the victim's securities were bogus. The Fidelity Money Market instruments were a mere fraction of a customer's statements.

James Li

If this proposed bill bars future trustees from going after individual investors who profited from the illegal schemes before the checks started bouncing, then future victims will likely be unable to recover much, if any, money.

The Jeffry M. Picower estate settled with the Madoff trustee for $7.2 billion rather than have to deal with a lawsuit. The same trustee is going after the Mets owners for $300 million. The direct investors who lost money are now in a decent position financially only because of the trustee's legal power to force people who profited from ill-gotten gains to disgorge their profits.

klerg

Ficitious Claims:

I dunno...it's a novel theory but it seems far-fetched to me. And if it's true, it would reverse many things that have gone on, including the Madoff victim tax break.

I think that Picard's info that's allegedly being withheld will be made publicly eventually and disprove this theory but I could be wrong...good luck!

Ficitious Claims

klerg......

That tax break is a bailout for Wall Street. Instead of having SIPC surcharge their members for any shortfall, the Wall Street firms passed the buck to the taxpayers.

If you or I bought stolen property from Madoff (let's say Madoff stole Fred Wilpon's Rolex and sold it to me cheap) even if I didn't know it were stolen I would have to give it back to Mr. Wilpon and then I would have a claim against Madoff. If Madoff has no money then it's me who is out the money.

Likewise, the brokerage houses should be forced to give back the stolen securities they purchased even though they might not have known they were stolen (that's another argument) Then those brolerage houses would have a claim against Madoff.

The problem with that is that those brokerages would have to go to their customers and tell them "Uh, Mr. Jones......you know those 1,000 of Microsoft we sold you? Well, you have to give them back. We screwed up and purchased stolen stocks for your account."

Then Mr. Jones would say, "But I paid $25,000 for those thousand shares."

And the broker would say, "Yes, but as a direct customer of ours you are entitled to file a SIPC claim and SIPC will go into the market and purchase those 1,000 shares for you."

So you see, it is in the best interests of SIPC to portray this as NO TRADES were done. So the investor gets screwed for the benefit of Wall Street. It's a charade.

klerg

Ficitious Claims...wait a minute...

I personally know Madoff victims that got that this tax break and don't work for Wall Street. It's not easy or possible for all victims to take advantage of it and it...the elderly, IRA/401(k)/403(b) investors, etc. But it's there.

Ficitious Claims

klerg.......

Yes, I'm in complete agreement with you. Instead of having the Wall Street firms and SIPC own up to their responsibilties, shortcomings and illegalities, the American Taxpayer is footing a huge chunk of the bill. By having the US Treasury refund all of this money via theft claims on people's tax returns, it is ultimately the US Taxpayer footing the bill.

If the securities were returned to their rightful owners then they could not file a theft claim and there would be no refund. SIPC has found a way to dump their obligations into the Taxpayer's lap. So, yes, by hiding the truth about the real trading that took place at Madoff, if you pay taxes, you're bailing out the obligations of the Wall Street firms and SIPC.

Leonel A Umana

You can not reimburse the victims of a Ponzi scheme with another Ponzi scheme. Asking for more than what was actually stolen from people, the taxpayer, from you is just greed. It is one thing for the taxpayer to help you get back on your feet after some one knock you over or pulling together to help each other, and it is quite another to expect that those taxpayer be knock over just to make you feel better. Rep. Scott Gareett is just scaming for political points.

Tim Bowman

Will the same law protect all of us who paid into Social Security all these years? The only difference between Social Security and Bernie Madoff is the former admits their Ponzi scheme will eventually go bust, but the government makes it not only legal, but also compulsory.


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