Securities Law Blog

According to a published report in Investment News, a Florida Senate bill that would levy heavy penalties on agents and financial advisers who make fraudulent annuity sales has moved closer to becoming law. The Safeguard our Seniors Act, or SB 1372, on April 2, 2009 moved to Florida’s Policy and Steering Committee on Ways and Means, placing it a step away from a full Senate vote.

Under the bill’s original provisions, which would apply to consumers over age 65, surrender periods — the length of time the investor must hold the annuity — would have been cut to five years. It also set the maximum surrender fees, which investors must pay for exiting the product too soon, at 5% and reduced the fee 0% by the end of the fifth policy year. Additionally, the original bill also extended the free-look period to 60 days from the normal 14-day limit. In its new form, however, legislators have loosened the restrictions on the annuity sales, allowing for surrender charges to go as high as 10%, with the charge to fall by one percentage point each year, so that there is no surrender fee at the end of the 10th policy year.

Under the revised bill, the surrender fee changes don’t apply to accredited investors, defined as individuals with a net worth of greater than $1 million or with an annual income of more than $200,000 in each of the past two years, or $300,000 a year in joint income. The amended bill also cuts the free-look period to 30 days. The original bill also made “twisting” and “churning” annuities a third-degree felony punishable by up to five years in prison. The penalty has been expanded so as to cover fraudulent conduct in connection with the sales of all financial products. The American Council of Life Insurers in Washington, the Florida chapter of the Falls Church, Va.-based National Association of Insurance and Financial Advisors and the National Association for Fixed Annuities of Milwaukee had combined efforts to fight the early version of the bill. NAIFA-Florida had also asked state finance chief Alex Sink to consider a maximum 10-year surrender period and 10% surrender charge limit.

The Internal Revenue Service finally offered guidance this week to Ponzi scheme victims that it would allow them to claim a tax deduction related to the bulk of their losses-even losses related to ficticious profits carried on phony statements. The matter has been a point of debate and anxiety for many of the victims I have spoken to over the last few weeks, given the lack of clarity in the tax code about how it should be handled.

The plan, which applies to victims of all Ponzi schemes, is likely to provide major relief to victims of Mr. Madoff. It is also likely to provide clarity for victims as they prepare to file federal income tax returns by the April 15 deadline, and help the I.R.S. avoid an unwanted avalanche of amended returns from victims.

The commissioner of internal revenue, Douglas Shulman, announced the plan in testimony before a Senate Finance Committee hearing on Ponzi schemes, tax evasion and offshore banking fraud. Later, in a briefing, Mr. Shulman said that “clearly the Madoff case is tragic as so many people were victims of this fraud, but the case also raises a staggering array of tax issues.”

Under the plan, the I.R.S. will allow investors, including those who are suing Mr. Madoff, to claim a theft loss equal to 95 percent of their investments, minus any withdrawals, reinvested gains and payouts from SIPC. Investors who are suing third-parties involved in such a scheme, and who, as a result, may have some prospect of recovery, are permitted to claim a deduction equal to 75 percent of their investments.

Current theft loss rules typically allow losses to be carried back three years and forward 20 years, but the I.R.S plan will allow carrybacks of as many as five years, generally if the loss is for a small business with gross annual receipts of less than $15 million. Under the plan, investors must claim the loss as having happened in 2008.

For people who invested with Mr. Madoff through retirement plans, like 401(k)s and individual retirement plans, the picture is more complicated because such money was already invested on a tax-free basis. Mr. Shulman, the commissioner, said that generally, if the investment was deductible when it was made, such investors “can’t take a loss.”

When computing losses, investors are not permitted to include any taxes they paid on what turned out to be fictitious income.

But the plan affords relief to such investors by allowing them to include fictitious income in their loss computations — a measure that might allow them to recoup taxes paid. It also will keep scammed investors from “owing taxes on income that they never received,” said Senator Charles E. Schumer, Democrat of New York and a member of the Senate Finance Committee. Presumably, Investors will need to produce copies of the fraudulent statements to show Madoff's phony inflated account values.

People who invested with Mr. Madoff through so-called feeder funds that placed client money with him will also get relief. These funds will be allowed to claim the theft-loss deduction but will allot those losses proportionally to individual investors.

The I.R.S. said it did not know how much money in taxes investors had paid in recent years on Madoff-related income. It said that investors who had already filed 2008 returns should file amended returns claiming the theft-loss deduction.

January 2009 echoes the trend started in December 2008—simply put, new filings are flooding FINRA. The statistics, courtesy of Securities Arbitration Commentator, are as follows: With 525 new submissions, the month of January 2009 doubled the filings reported in January 2008.

December 2008 was also the largest month for new filings for 2008, so the January 2009 figures show that the momentum of late 2008 is continuing. The biggest growth in cases occurred in the derivative sector, where 801 of the new cases in 2008 involved derivatives. Another 299 cases involved disputes related to auction rate securities (ARS). Auction rate securities disputes generated 26 of the 525 new January 2009 arbitration proceedings, which means that, despite the regulatory settlements and the class actions, new ARS claims continue to be filed in droves.

Product-wise and percentage-wise, the most prominent growth in filings occurred with respect to variable annuities, with 11 new disputes submitted in January 2009. Mutual funds disputes account for the largest number of new cases: 121 of the 525 January submissions. Given state of the economy, it is safe to assume that this upswing will only continue.

The concerns of Madoff investors, many of whom are still coming to grips with devastating losses, are turning from “what have I lost” to “how do I keep what I have”. As I have written before in this space, Irving Picard, the Madoff Trustee, is evaluating his rights to “clawback” any money paid out to Madoff investors over the last few years. The most recent Madoff clawback related developments are the subject of an article today on Bloomberg.com, which is repeated below. I would also suggest that, if you are a Madoff investor possibly subject to clawback, that it may be worthwhile lobbying your US senator and congressperson now. There have been whispers of a movement afoot in Washington to prevent the clawback. How that happens, I don’t know. What I do know is that a clawback is a clawback—and the trustee can’t be selective about it. That is good for individual investors. It means that Mr. Picard would have to clawback money from many charities as well as individuals—and the powers in DC may have little appetite for letting that happen.

Madoff Investors Seek Exemption From July Claim Deadline

By Christopher Scinta

Feb. 11 (Bloomberg) -- Investors who may have to return cash withdrawn from Bernard L. Madoff Investment Securities LLC before it failed said they should be exempted by the bankrupt firm’s trustee from a July claim deadline.

Investors may have a claim against the Madoff firm if they are forced to return the funds, some customers said in a filing yesterday in U.S. Bankruptcy Court in Manhattan.

The Lucerne Foundation, Collingwood Enterprises and Douglas Rimsky want the deadline pushed back, according to court papers. While investors who withdrew money before Madoff Securities collapsed in December don’t have claims now, they could be entitled to a claim should Irving Picard, the trustee, sue them for the withdrawn funds. The trustee can seek a so-called clawback if he believes there was a preferential payment or fraudulent transfer.

“While we filed this motion on behalf of three of our clients that need this relief, we recognize that this is an issue of importance to hundreds, if not thousands of investors,” plaintiffs’ attorney Philip Bentley said in a phone interview. “We hope the court will enter an order that will resolve the dilemma facing a large number of Madoff investors.”

Since Picard hasn’t told investors how clawback claims would be handled, people who withdrew money before the firm imploded may be compelled to file documents before the July 2 deadline to preserve their claim. If they do, they may lose the right to a jury trial if Picard sues seeking return of the money.

Rimsky, reached at Lucerne Textiles Inc., declined to comment. Bentley declined to provide specifics about his clients’ investments. A hearing is scheduled for Feb. 24 before U.S. Bankruptcy Judge Burton Lifland.

$950 Million
Picard said Feb. 4 he has recovered about $946.4 million in cash and securities for customers of the bankrupt New York company, allegedly at the center of a $50 billion Ponzi scheme. Picard, appointed as part of the Securities Investor Protection Corp.’s supervision of the advisory firm, declined to comment.

Bernard Madoff was arrested by FBI agents in December and charged with securities fraud. Madoff, 70, hasn’t formally responded to the criminal charge, though on Feb. 9 he partially settled a parallel suit by the U.S. Securities and Exchange Commission. He said he wouldn’t challenge the SEC allegations when the judge in that case determines the penalty. Madoff didn’t admit or deny any wrongdoing in the settlement.

Creditors of his firm may file claims until July 2, though customers should submit their forms before March 4 to be paid “out of customer property,” according to Picard’s Web site.

On Feb. 5, Picard filed with the court a 162-page list of Madoff “customers” for the year before his Dec. 11 arrest after sending out claim forms to 8,000 customers in January. Legal experts estimate it may take several years for Picard to pay all the customers of the accused fraudster.

The SIPC case is Securities Investor Protection Corp. v. Bernard L. Madoff Investment Securities LLC, 08-01789, U.S. Bankruptcy Court, Southern District of New York (Manhattan).

To contact the reporter on this story: Christopher Scinta in New York bankruptcy court at scinta@bloomberg.net.

The New York Times reported Sunday that Mary Schapiro, the chief executive of the Financial Industry Regulatory Authority ("FINRA"), would like to see more protections for individual investors included in the planned overhaul of the regulation of the securities markets. Ms. Schapiro would like to ensure that consumers do not fall between the cracks in the current system. She expressed concern that consumers who buy annuities for retirement do not understand that these investments are regulated by the S.E.C., FINRA, state insurance regulators, or "some combination thereof." "We shouldn't leave it to the investor to figure it out," she adds. "We've left them in this never-never land of dramatically different protections, and that's one of the real shortcomings of the regulatory system." Ms. Schapiro also called for more regulatory oversight of mortgage brokers. "The amount of regulation required to offer someone a $500,000 mortgage," she says, "pales in comparison to what's needed to sell a $100 mutual fund." To addrss this, Ms. Schapiro says, mortgage brokers should be added to the groups that are more closely regulated, like stockbrokers and sellers of retirement products, like mutual funds, life insurance policies and annuities. Four important safeguards should be in place she says. "First, the person who sells the product should be licensed. Second, sales materials and advertising should not be misleading. Third, products can only be sold to a suitable investor in terms of objectives and risk tolerance. Fourth, disclosures should be complete and cover everything from risk to cost." None of these safeguards were in effect in the years leading up to the current mortgage crisis.

For more information on this subject contact securities attorneys, Michaels, Ward & Rabinovitz, LLP.