Securities Law Blog

A top aide to disgraced money manager Bernard Madoff had employees generate trading tickets, thought to be fake, in order to dupe investors into thinking their returns were legitimate, the Wall Street Journal reported Monday.

According to Journal reporter Amir Efrati, Annette Bongiorno directed two assistants to research daily stock prices, at times dating back several months, and to use the information to produce trading tickets that would reflect the returns that Madoff had become famous for.

"This is how it was done – there were all these thousands and thousands of trade confirmations purporting to sort of signify that there were trades that occurred and we know now that, obviously, there weren't trades at least for 13 years and probably a lot longer than that – maybe decades," Efrati told CBS News.

Irving Picard, the court-appointed trustee charged with sorting out the Madoff mess, indicated last month that there was "no evidence to indicate securities were purchased for customer accounts."

Madoff is scheduled to appear in federal court Thursday and is expected to plead guilty to charges that range from securities fraud to money laundering, reports the Journal. U.S. District Judge Denny Chin invited victims of Madoff's alleged $50 billion ponzi scheme to the hearing – the very same people who got bogus client statements in the mail each month.

"For the most part, the people who got these statements had no reason to believe anything was wrong," said Efrati. "They showed these statements to their accountants, their accountants signed off on them."

But looking back at the paper trail, Efrati said that it was possible to detect that something was amiss.

"They say that the statements didn't make sense at the time and that you could, by scrutinizing client statements that were going out every month, deduce that something was wrong."

The two assistants, Semone Anderson and Winnie Jackson, offered information on the alleged fake tickets to the U.S. attorney's office in what is called a proffer agreement, which protect informants from having their statements used against them as long as they are truthful, reports the Journal.

The SEC charged Sunwest Management Inc. yesterday with securities fraud. The SEC alleges that Sunwest, which operates hundreds of retirement homes across the United States, lied to investors about its operations and concealed the risks of the investments, exposing investors to massive losses when the economic downturn triggered Sunwest's collapse. According to the SEC's complaint, Sunwest raised at least $300 million from more than 1,300 investors nationwide by promising a steady income stream and touting its success in running the properties. It is expected that lawyers representing defrauded investors will file FINRA arbitrations against the broker-dealers and registered representatives who recommended TIC interests in Sunwest properties.

The complete text of the SEC press release regarding the Sunwest filings follows:

SEC Charges Operators of Multi-Billion Dollar Real Estate Enterprise With Fraud

FOR IMMEDIATE RELEASE
2009-38

Washington, D.C., March 2, 2009 — The Securities and Exchange Commission today charged Oregon-based Sunwest Management Inc. with securities fraud and is seeking an emergency court order freezing its assets. The SEC alleges that Sunwest, which operates hundreds of retirement homes across the United States, lied to investors about its operations and concealed the risks of the investments, exposing investors to massive losses when the economic downturn triggered Sunwest's collapse.

According to the SEC's complaint, Sunwest raised at least $300 million from more than 1,300 investors nationwide by promising a steady income stream and touting its success in running the properties.

"Investors are entitled to accurate information about the securities they are buying and the risks involved," said Marc J. Fagel, Regional Director of the SEC's San Francisco Regional Office. "This is a tragic example of investors being defrauded out of millions of dollars because they were far more exposed to a downturn in the real estate market than they had been led to believe."

The SEC's complaint, filed today in federal district court in Eugene, Ore., charges Sunwest, its former President and CEO Jon M. Harder of Salem, Ore., and several related entities with securities fraud. According to the complaint, Sunwest, which operates more than 200 retirement homes at one point valued at $2 billion, told investors that they would be investing in a particular property. Investors were told that the property would generate sufficient profits to pay annual returns of around 10 percent, and that Sunwest had a track record of never missing a payment. Between 2006 and 2008, Sunwest raised more than $300 million from investors, which was used for the down payments on approximately 100 retirement homes, with the balance financed by institutional lenders and banks.

The SEC alleges that at least half of the properties had lost money, and Sunwest concealed this information from investors by commingling all of its finances and making investor payments from this pot of cash. The SEC further alleges that investor returns came not just from these commingled assets, but from mortgage refinancings as well as loans from Harder. According to the SEC's complaint, Sunwest concealed its precarious financial position and the risks it posed to investors by failing to disclose that Sunwest was being run as a single massive enterprise with its fortunes tied to the success of hundreds of properties and contingent on future financing ability. When the recent credit crisis derailed Sunwest's ability to continue to refinance the properties, payments to investors ceased and many of them stood to lose their entire investments.

The SEC further alleges that, even after Sunwest encountered difficulties refinancing properties and lenders began foreclosing, the defendants continued raising money from investors. Sunwest obtained millions more in investments up through June 2008, continuing to misrepresent that the money was designated for a specific property when, according to the SEC, it was being used to prop up the failing business.

The SEC's complaint alleges that Harder, Sunwest, and related entities Canyon Creek Development Inc. and Canyon Creek Financial LLC, violated the antifraud provisions of the federal securities laws, and seeks relief including disgorgement and civil monetary penalties. The SEC's complaint also seeks disgorgement from several relief defendants, including Sunwest Chief Operating Officer Darryl E. Fisher, General Counsel J. Wallace Gutzler, and Chief Restructuring Officer Hamstreet & Associates and its principal Clyde Hamstreet, as well as Harder's wife and several entities he controls.

Friday February 20, 2009 was an important date in the life of this case. That was the date of the First Meeting of Creditors in New York City in the Madoff bankruptcy. Many investors attended in person-and were able to ask some pointed questions of the Trustee Irving Picard, and his cadre of attorneys. While much information came out at the hearing, here are some of the most important developments to my eye:

1. Fraudster Madoff Made No Trades: Picard reported that there is no evidence in the 7000 plus documents that his staff (including scores of forensic accountants I am told) has reviewed that ANY securities were ever purchased for Madoff clients. This is significant because SIPC covers limited cash ($100,000) deposits in a securities account. In my mind, if there were never securities purchased, then all you are left with in a SIPC claim is the claim for your stolen cash balances. But that will develop with time—securities recovery is capped at $500,000, cash at $100,000--but that is not additive-the total amount is $500,000.

2. The Clawback is Coming: David Sheehan, one of Picard’s attorneys confirmed that Picard fully intends to clawback funds paid out to them in excess of amounts deposited. (He has 2 years to bring any clawback actions). However, according to the New York Times, the Trustee said that “it would not be practical to seek clawbacks of small amounts from customers of limited means”.

Bloomberg reported thusly:

"He said the trustee would seek to recover money that investors withdrew over the amount they put in. “We will be seeking to recover false profits from people who received them in substantial amounts over the years,” Sheehan said.

Picard said he would not pay out a SIPC claim if he has a potential clawback claim against the investor. Dozens of investors asked Picard questions about the possibility of clawbacks.

“These clawbacks are making criminals out of innocent people,” a woman from the audience said.

Sheehan later said clawbacks would be determined on a case- by-case basis, taking into account such factors as the size of the investment, the time period over which any money was invested, the investor’s relationship with Madoff or other insiders and a review of account statements".

I heard some statistics today on the clawback in the Bayou Capital case. About 135 clawback cases were filed. Of that number, investors in 95 fought the clawback. All but 30 of those settled for a lesser amount that was being sought in the clawback. If the 30 that fought the clawback, there were a few--less than 10--that actually prevailed. But there is no doubt that fighting the clawback is an uphill battle.

3. What is The Amount of my Tax Loss/Investment?: Like so many other things in this case—we have more questions than answers. The IRS won’t give guidance. The Trustee won’t give guidance. If you invested $200,000 years ago, and have a statement that showed you had $1 million in the account, what are your losses? I think that the Trustee will take the position that the loss is $200,000—given his comment above. Simply put, if you took out more than you put in-then Picard will NOT pay out a SIPC claim-and may come after you for the distribution. (See also the article in the Boston Globe on this on 2/21/09). This is especially true since there was no trading activity (at least for the past 13 years). Regardless of what the Madoff statements may have said—the reality was that the account was never worth more than the $200,000 that went in when the account was opened. I am not a tax lawyer-but I would strongly urge you to speak to one, or to your CPA.

The timing and size of tax losses will be a huge issue in this case. Are they theft losses-such as can be used to offset current ordinary income? Do you have the right to amend your returns to reverse capital gains taxes that you may have paid on non-existent "profits"? What, if any, impact does the filing of a SIPC claim form have on the tax situation? Many tax lawyers (of which I am not one) have been advocating filing for a theft loss deduction–in full—for the 2008 tax year. But that still doesn’t address the amount that you should seek in such an IRS filing. Again-speak to your CPA or tax counsel. Believe me-they won’t be able to answer the question either—but it is important to get them on notice that you have an IRS Madoff-related issue asap! The IRS will have to give guidance sooner or later. I do know that there have been other Ponzi cases where the losses have been treated as theft losses. See, Berado v. Comm’r T.C. Memo 1987-433; Jensen v. Comm’r T.C. Memo 1993-393

4. Madoff’s Helpers: It is clear to me that 7000 boxes of documents of non-existent trades means that Madoff had help—a lot of it. This is not a one man case of embezzlement from an account. This took a lot of effort. You should keep an eye on the website for Conde Nast Portfolio Magazine. The print version of the March Issue is out now and there is even more online content available. Portfolio has many folks on this story-and there is a good amount of information. I was interviewed for the stories-specifically about the rights and responsibilities of some of the Madoff staff. I expect that we will hear more from that shortly. That is significant to victims only if it provides them someone to sue-which is unlikley to yield much more funds for a potential recovery given the number of investors

5. No SIPC for Feeders: SIPC will cover only the direct investors with Madoff. Anyone who invested through a feeder fund will not recover from SIPC. The feeder fund will have the SIPC claim, not the investors in that fund. I was told today by sources close to Picard that he has "very good" records on the Madoff accounts and will be able to demonstrate "to the penny" all amounts flowing into and out of the accounts over the last 6 years.

In the midst of all the horrible economic news of the last few months—Madoff, Stanford, the plummeting economy in general and financials in particular—the Auction Rate Securities (ARS) woes seem to have fallen off the media radar screen. If you recall, in 2008, many firms reached regulatory settlements of many millions of dollars to help make clients liquid in a suddenly illiquid world. The litigation is now catching up with the prior regulatory ARS settlements.

As Dan Jamieson writes in the current issue of Investment News more litigation is likely:

Despite having settled regulatory actions involving auction rate securities, the big Wall Street firms aren't out of the woods yet.

Citigroup Inc., Merrill Lynch & Co. Inc. and UBS Financial Services Inc., all of New York, and St. Louis-based Wachovia Securities LLC are facing a number of individual lawsuits from institutional investors who still have huge sums locked up in the illiquid securities.

What's more, last month, the first so-called downstream brokerage firm case was filed, when Amegy Bank NA of Houston and its broker-dealer affiliate Amegy Investments Inc. filed an arbitration claim against Merrill Lynch.

Amegy claims it purchased more than $240 million of ARS from Merrill, which it said it then sold to its clients. Amegy's suit seeks rescission of the remaining $140 million that its clients still hold, plus unspecified damages.

In a statement, Merrill Lynch spokesman Mark Herr said the suit has no merit.
The downstream firms, as well as institutional and wealthier individual investors, weren't part of the ARS buyback agreements announced last year. Those settlements with regulators cover only retail investors at the major firms.

The underwriting firms "got regulators to believe [that the ARS mess was] a point-of-sale problem" rather than fraud by the underwriters, said an executive with a regional firm who asked not to be identified.

The market for ARS froze a year ago after all the major underwriters stopped supporting auctions for the securities.

More claims from downstream firms are coming, said Paul Yetter, a partner at Yetter Warden & Coleman LLP in Houston, which represents Amegy Bank.

He said he has more such cases but could not yet comment on those claims.

"It wouldn't surprise me if other [downstream firms] took action like this, especially if Amegy is able to get some traction ... and get money back for its clients," said Michael Decker, co-chief executive of the Regional Bond Dealers Association in Alexandria, Va.

He estimated that $30 billion to $40 billion worth of ARS are still held by downstream firms.
The major firms are "leaving innocent [investors and downstream firms] with no other option" but to sue, Mr. Yetter said.

And that's what they're doing. Some of the claims filed so far:

• American Eagle Outfitters Inc., a Pittsburgh-based specialty retailer, this month filed a lawsuit in federal court seeking to force Citigroup to take back the $258 million worth of illiquid ARS the bank sold to it.

• Another suit against Citigroup, filed in federal court in November by Hutchinson (Minn.) Technology Inc., is pending in arbitration.

  Hutchinson said it is stuck with $31 million of ARS it bought from Citigroup.

  A separate claim against UBS by Hutchinson Technology for rescission of $70 million of ARS was settled in December, with UBS providing a no-net-cost $59.5 million line of credit.

• A federal lawsuit filed against UBS by Plug Power Inc. was settled in December, with UBS providing a no-net-cost line of $62.9 million, equal to the value of Plug Power's frozen ARS, according to an SEC filing by the Latham, N.Y.-based energy company. UBS also agreed to repurchase the securities at any time from June 30, 2010, to July 2, 2012.
• In December, Hanna Steel Corp., a Fairfield, Ala.-based tube manufacturer, sued Charlotte, N.C.-based Wachovia Corp. and its broker-dealer units in federal court seeking rescission of $12.9 million worth of ARS.
• TGS-NOPEC Geophysical Co. ASA of Asker, Norway, filed an arbitration in November against Merrill
  Lynch seeking the repurchase of $64.5 million in frozen ARS.

Citigroup spokeswoman Danielle Romero-Apsilos declined to comment.

UBS and Wachovia had not responded to questions by press time.

The fights among the heavyweight investors and Wall Street firms could get nasty.
Claimants of all stripes said the big underwriting firms knew by late 2007 that auction failures were imminent and were reducing their inventories, but never disclosed any impending problems to their
clients.

Lawsuits by institutional clients cite many of the charges previously made by regulators.
But unlike many retail investors, some institutional clients say they had warning of ARS problems and specifically raised concerns late last year with their brokerage firms but got reassurance that all was well.

Several claim that their brokers violated written investment policy statements for cash reserves that prohibited investments in long-term securities or anything with limited liquidity.
Amegy Bank's claim says it "bought the securities from Merrill at the same informational disadvantage as Merrill's direct retail customers."

Mr. Herr begs to differ.

"Amegy began selling ARS it purchased from Merrill Lynch in 2004, and it is unfathomable that it would now claim that when it sold these products to its clients, it didn't know or understand what it was selling," the Merrill spokesman said in his statement. "It appears Amegy failed to do even the most routine due diligence."

Amegy's claim said it performed an exhaustive analysis of the credit quality of ARS in the summer and fall of 2007, "but no amount of research or analysis could have led Amegy to learn of Merrill's deceptive marketing and support of the ARS market."

Mr. Herr said Merrill Lynch did disclose its role in the auction process and informed purchasers that auctions could fail.

This post is a direct result of speaking with many former Madoff investors over the past week or so. First, I would like to thank each of you for sharing your stories with me. You are, collectively, as gracious and honest a group of individuals one would ever want to meet. I am just sorry our paths have crossed over such a painful matter. I also thank you for your kind words about our blog-and I am glad that it provides you with some guidance in these trying and difficult times. I will continue to try to keep it as current and informative as possible. This particular post is based entirely on your suggestions.

First, here is the link to the Madoff Trustee website that some of you requested. This should be your first line of information-gathering. It is http://www.madofftrustee.com/index.html.

Second, I know many of you have clawback-related questions. The Wall Street Journal has an article on what they believe to be the beginning of the clawback process today, and their blog reports it as follows (note that the hyperlinks within the blog are likely inactive):

February 17, 2009, 9:04 am
With Spate of Filings, Madoff Trustee Kicks off ‘Clawback’ Party
Posted by Ashby Jones

Let the clawback party begin.

Irv Picard (pictured, left), the trustee in charge of liquidating the assets of Bernard Madoff’s investment firm, has begun sending subpoenas to brokerage firms that may have facilitated trades in Madoff’s operation. Click here for the WSJ story; here and here for earlier posts on the clawback conundrum.

Some legal experts think the filings could show that Picard is starting the process of retrieving money Madoff’s firm paid out to various firms or investors in the days before his arrest for operating an alleged Ponzi scheme.

The filings, made in federal bankruptcy court in New York late Monday night, included documents showing that Picard had subpoenaed, among others, Timber Hill LLC, a Greenwich, Conn.-based market maker; Knight Capital Group Inc., a capital markets firm in Jersey City, N.J.; and PEAK6 Investments LP, a market-making firm in Chicago. None of the subpoenaed firms could be reached for comment.
None of the companies has previously been identified as a “feeder firm,” or an entity that helped connect investors with Madoff. Instead, the firms sent subpoenas were more likely brokerage operations through which Madoff sold securities in order to meet redemption requests from investors. Representatives for Mr. Picard didn’t return calls for comment.

Since shortly after Madoff’s alleged Ponzi scheme was revealed, some investors say they have feared they would be subjected to so-called clawbacks of money they had recently withdrawn, after losing in some cases millions of dollars. Such clawback provisions are based on the logic that the redemptions were paid using other investors’ money.

+++++++++++++++++++++++++++

I would like to think that the WSJ has it wrong-and that there are other reasons behind the Trustee’s subpoenas. Indeed, I find it hard to believe that there wouldn’t be other reasons for those subpoenas. For example, maybe the Trustee is merely looking for additional Bernie Madoff personl assets. If the Trustee was truly looking for transfer by investors—then he wouldn’t have limited it to just a few entities—he would have subpoenaed every brokerage firm on the street trying to catch Madoff investors’ asset transfers. I continue to be hopeful that the clawback doesn’t happen.