Securities Law Blog

I have seen a lot over the years—but this massive Madoff securities fraud story just gets better every day. As reported by MSNBC, an investor is suing the Madoff Trustee—under the theory that his money was given to Madoff so late in the game, that it was not “invested”, and should not be considered part of the Madoff estate. Sounds like a good argument to me—and an important one. Here is the MSNBC story:

A private New York company has sued the trustee who is liquidating accused fraudster Bernard Madoff's firm for the return of $10 million it invested six days before Madoff was arrested.

According to the complaint dated Jan. 1 by Rosenman Family LLC, its managing member, Martin Rosenman, talked to Madoff on the phone on Dec. 3 about investing in his investment advisory fund.

Madoff told Rosenman the fund was closed until Jan. 1, 2009, but he could wire money to an account where it would be held, the complaint in U.S. Bankruptcy Court in Manhattan said.

It said that the family transferred $10 million to a JPMorgan Chase account on Dec. 5.

Madoff was arrested and charged with securities fraud on Dec. 11 and is currently under house arrest.

Authorities have said in court documents that Madoff confessed to running a Ponzi scheme for years that had losses of $50 billion in what would be Wall Street's largest fraud. A Ponzi scheme is one in which early investors are paid off with the money of new clients.

"Family seeks a mandatory injunction requiring Chase to turn over $10 million," the complaint in bankruptcy court said.

"Family demands judgment that the funds deposited by Family in the Chase Account on December 5, 2008 are not property of the debtor's estate and the debtor has no interest in these funds."

The investment adviser's firm, Bernard L. Madoff Investment Securities LLC, is being liquidated under court-appointed trustee Irving Picard, a lawyer.

Rosenman, who is also president of the Stuyvesant Fuel Service Corp in New York, sued Picard and JP Morgan Chase Bank for recovery of his money.

A lawyer for Picard declined to comment. A representative of the bank was not immediately available for comment.

The complaint said that Rosenman had neither invested nor conducted business with Madoff or his firm before the Dec. 3 phone conversation.

This investor knows that the Madoff Trustee has only one duty—and that is to gather any and all Madoff assets, and put them into a big pot of money. Out of that pot, the Trustee (and his law firm) get paid first (naturally). The remaining assets are then carved up and returned to investors. How that will happen in this case is beyond me. Madoff’s statements were fraudulent. Maybe he kept a set of books someplace that showed what the true investment amounts were—that would be a start I guess. But here is why the Rosenman situation interests me—and why it is “man bites dog”—Rosenman has decided that a good offense against the trustee is what will carry the day here. It is essential that he (Rosenman) keeps his money out of the Trustee’s hands. It is his only chance to see any meaningful part of it before it goes into that big pot of money and gets divided up among other Madoff victims. If you are a Madoff victim, the Trustee is not your friend. Yes, he may be in charge of distributing some assets to you at the end of a long and expensive process in which his law firm will reap tens of millions of dollars for themselves. BUT—as part of marshalling assets he becomes, like the shark in “Jaws”, a killing machine. His tool is called a “clawback”. His prey is YOU. Imagine Madoff ran you over in a car when he stole your money. Well, the trustee has just gotten in that car, and backed it up and is ready to run over you again. The Trustee’s duty will now be to sue any Madoff investor who received any payments from Madoff—and to seize those payments—even if they were a return of principal-- and throw them into that big pot of money I keep talking about so that it can be distributed to all the other victims.

The Trustee has already asked the judge assigned to the case for broad authority to gather documents and subpoena witnesses about the Madoff situation. That is simply a prelude to the Trustee applying the coup de grace to investors—taking whatever money they have left. As reported by Bloomberg, the Trustee is about to go hunting Madoff investors:


Dec. 23 (Bloomberg) -- Like some of Bernard Madoff’s clients, a Florida restaurant owner was lucky enough to withdraw part of his investment before the money manager allegedly confessed to a $50 billion Ponzi scheme. Now he’s worried he might be asked to give it back.

The 53-year-old investor, who asked not to be identified to protect his stake, took out about $600,000 this year from his $1.5 million account, using some of it to pay down a mortgage. He and other Madoff clients who withdrew funds as long as six years ago may be sued on behalf of other victims to return profits and even principal, securities and bankruptcy lawyers say.

“Right now there are Madoff winners and Madoff losers,” said Lynn LoPucki, who teaches bankruptcy law at Harvard University. “Before this is over there will be nothing but Madoff losers.”

Clients of Madoff had about $36 billion with his firm, according to a Bloomberg tally that may include some double counting. Before his arrest on Dec. 11, Madoff, 70, confessed to employees that his “giant Ponzi scheme” may have cost as much as $50 billion, according to an FBI complaint. His misconduct may have stretched back to at least the 1970s, two people familiar with the government’s inquiry of Madoff said last week.

The Florida investor, who first gave his money to Madoff five years ago, said he had no hint of fraud and would go to jail rather than give up the amount he took out.
Irving Picard, the trustee appointed to liquidate Madoff’s brokerage, Bernard L. Madoff Investment Securities LLC, holds the fate of the restaurant owner and other investors in his hands.
Enough Funds Left?

Picard, who didn’t return a call seeking comment on plans to sue victims to recover funds, said in a court filing yesterday that “there has not been any showing or determination that there are sufficient funds” to satisfy victim claims.

A so-called clawback of paid-out funds in the Madoff liquidation could result in lawsuits against investors such as charities, hedge funds and individuals who redeemed profits and took out principal. Nonprofit institutions such as the Carl and Ruth Shapiro Family Foundation, a foundation controlled by Democratic U.S. Senator Frank Lautenberg of New Jersey, and Yeshiva University relied on funding from Madoff investments.

Lawyers and representatives of the Shapiro and Lautenberg foundations didn’t return calls seeking comment. In a statement, Rick Matthews, a Yeshiva University spokesman, said, “Our lawyers and accountants are in the process of an investigation.”

‘Further Risk’
“Charities are looking at their legal options as regarding their right to recoup money,” said Mark Charendoff, president of the New York-based Jewish Funders Network, whose 1,000 members fund Jewish causes and are assessing losses from Madoff investments. “I don’t know that they’ve been focused on or are aware that they may in fact be at further risk of loss.”
Bankruptcy laws authorize a trustee like Picard to recover money that was distributed as part of a fraud and share it among the victims, LoPucki said.

“The purpose of these laws is to balance the losses among the various investors, but how that balance is supposed to be struck is not clear,” LoPucki said.

Under New York state law, which can be invoked for Madoff recoveries, a trustee can seek redemptions going back six years, said Tracy Klestadt, a New York bankruptcy lawyer.

In a similar case, U.S. Bankruptcy Judge Adlai Hardin in White Plains, New York, ordered investors of defunct hedge-fund manager Bayou Group LLC in October to disgorge profits they’d taken out. Investors were required to pay back any gains they’d redeemed involving “fictitious profits.” Before the fraud was discovered, Bayou paid out more than $135 million, according to court papers.

‘Good Faith’ Rule
Hardin also ruled some investors would have to hand back their principal. Only investors who acted in “good faith” -- a legal standard that makes investors prove they didn’t have knowledge or suspicion of fraud -- could protect their initial stake, Hardin ruled. He said investors could show they had good faith if they didn’t see any “red flags” when they withdrew the funds.
That decision could be a guide for Picard, Klestadt said.

The Bayou decision set a high bar for investors who hope to protect their principal, said Carole Neville, a lawyer representing Bayou investors.

“What the Bayou case holds at the moment, is, if you had any reason to feel uncomfortable about your investment and took your money out, you don’t have good faith,” Neville said.

‘Almost Impossible’ Standard
“On the surface it seems a standard that’s almost impossible for people to meet,” said Robert Crane, president of New York’s JEHT Foundation, a group dedicated to criminal justice matters that relied on donors who invested with Madoff and said it’s closing in January.
Seeking money from investors who say they were defrauded can result in protracted litigation. In the Bayou case, which is being appealed, $20 million of the $33 million recovered from redeeming investors went to pay legal fees, Neville said…

Bankruptcy trustees “spend huge amounts of money trying to get money from some investors and give it back to other investors,” LoPucki said. “The incentive of the trustee and [his] lawyers is to churn, to bring lots of cases, spend lots of time and charge lots of fees.”

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