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Madoff Ruling: More Reason Not to Trust Wall Street or Washington

Posted by Larry Doyle on March 1, 2010 1:03 PM |

On the heels of my commentary this morning addressing why Harry Markopolos feels America’s citizens should not trust the government, we receive more fuel for the fire.

The timing of this release is truly uncanny:

MADOFF JUDGE’S RULING REDUCES PROTECTIONS AGAINST PONZI SCHEMES FOR ALL SECURITIES INVESTORS

Judge rules SIPC does not have to insure every account up to $500,000, shifts burden of Madoff losses to American taxpayer.

New York, NY – A federal bankruptcy Judge ruled Monday that the Securities Investor Protection Corporation (SIPC) can avoid its statutory obligation to replace up to $500,000 in securities of thousands of Madoff victims in a decision that dramatically reduces protections against fraud for every American investor, according to lawyers and investment experts. Judge Burton Lifland found that SIPC can ignore 40 years of legal precedent stating that SIPC must determine reimbursements based on an investor’s final statement, essentially letting Wall Street off the hook at the expense of Main Street investors and taxpayers.

“Unless and until this decision is reversed, no American who invests in the stock market with the hope of retiring on his savings, has any protection against a dishonest broker,” said Helen Davis Chaitman, Esq., attorney for hundreds of Madoff victims. “If we learned anything in the last two years, it was that Wall Street will manipulate the law to enrich itself at the expense of every honest, hard-working American taxpayer. Now we know that no American can rely on SIPC insurance.”

Briefs filed by numerous firms representing investors demonstrate that Judge Lifland’s decision departed from 38 years of SIPC’s practice, its regulations, and court decisions upholding the principle that, when an SEC-regulated broker/dealer defrauds a customer, the customer’s account is insured for up to $500,000 based upon the customer’s last statement. Judge Lifland held that, where a customer is the victim of a Ponzi scheme, the insurance can instead be based on the customer’s net investment over the life of the account (the amount deposited minus the amount withdrawn). Thus, all investors now have no insurance for the appreciation in the investment, even if the investment spanned a 30-year period, Chaitman warned.

“This is no different than a court-sanctioned breach by the FDIC of its insurance obligations to bank depositors. Imagine if bank depositors were told by the FDIC that they are insured only for the amount they invested and not for any of the interest they allowed to accumulate in their accounts over a period of 20-30 years,” Chaitman said. “Now it is up to Congress to rectify the law, or abandon the concept of investor protection.”

Tuesday’s decision also allows SIPC, which is made up of Wall Street investment firms, to transfer the burden of Madoff losses to the American taxpayer. Although SIPC is required under law to insure up to $500,000 of each investor’s account, Judge Lifland’s decision allows SIPC to escape liability to the vast majority of Madoff victims, who will then have a theft loss under the Internal Revenue Code. This theft loss entitles them to a tax credit, forcing the IRS to refund $166,500 for every $500,000 that SIPC refuses to pay.

“SIPC, as the representative of Wall Street, has avoided its obligation to pay SIPC insurance and instead shifted the payments to the U.S. Treasury – the pockets of the American people,” Chaitman said. “Judge Lifland’s decision today is another example of Wall Street manipulating the law to enrich itself at the expense of Main Street, even though it is one of SIPC’s own members who stole the investors’ money.”

SIPA was enacted in 1970 in order to instill public confidence in the capital markets by insuring customer investments in the event that a broker is dishonest and either steals the securities or never purchases them. Wall Street supported the enactment of SIPA, even though it was required to fund the insurance, because it would profit by being allowed to hold investors’ securities in “street name” (in the broker’s own name). SIPC insurance was intended to give investors protection against a broker who stole or never bought their street name securities. Holding securities in street name gave Wall Street a new source of billions of dollars of income because brokerage firms could use “street name” securities as their own property, even though they are holding them “in trust” for their customers. In 1978, the level of insurance was increased to $500,000 per customer account.

Although SIPC has the authority to assess member firms ¼ of 1% of operating revenues, for the 19 years ending in 2008, Wall Street firms paid a mere $150 per year for SIPC insurance, even large houses like Goldman Sachs and Merrill Lynch. Congress repeatedly warned SIPC that it was grossly under-funded, but SIPC ignored those warnings and did nothing to increase its revenue. As a result, SIPC had assets of $1.7 billion when Madoff collapsed, but was faced with an exposure substantially higher. In order to avoid assessing its members (Wall Street) for the 19 years of practically free insurance, SIPC decided to default on its obligations, leaving investors and taxpayers holding the bag.

“The only way an investor can be protected against the fraud of his broker is for the investor to insist on having his securities registered in his own name. If an investor allows the broker to hold the securities in “street name” (that is, in the broker’s name), then the investor is gambling on the honesty of his broker,” Chaitman said.

Why did Judge Lifland rule in this manner?

I have no doubt that it was purely based upon the total dollar figures involved. This ruling also sets a precedent for future limited investor protection provided by SIPC against every other Ponzi scheme perpetrated on Wall Street.

This ruling truly increases the risks on Wall Street dramatically.

Wall Street owns Washington. This ruling is indicative that when the chips are down, Wall Street also owns and screws Main Street.

Navigate accordingly.

LD

  • Matt

    WOW Larry. My heart really goes out to the Madoff investors, as things just continue to get worse and worse for them, when it seems like things couldn’t get any worse. All Americans truly need to read and understand this ruling, especially if they are currently invested through or considering investing through a Broker/Dealer. WOW.

  • thewiseking

    When Madoff’s victims heard the news and got over their initial shock they were at first comforted by the SIPC seal on their statements. They were victims of fraud and theft who were failed by the SEC but it seemed their SIPC insurance would provide at least partial restitution.
    What they have come to realize however is that SIPC is not on their side. SIPC has proven to be an adversarial organization which despite having been created by Congress to protect “mom and pop” investors has been hijacked by private practice bankruptcy attornies who are directly incentivized to deny claims and to clawback and revictimize the victims while “preserving” the meager funds the wall street firms paid to provide insurance in the first place.

    Let’s face it: unless the SEC and SIPC are revamped NOBODY has got our backs.

  • Bill

    LD, maybe you can clarify it for me. I’ve commented on this
    before. I certainly have sympathy for the people who got caught up in the Madoff fraud. But I don’t understand why SIPC can be expected to reimburse Madoff investors for phantom profits that they “lost.” Understanding it gets a bit complicated because they may have paid income tax on those phantom profits. But they can get a refund on at least some of that by amending their returns. To require SIPC to pay the phantom profits would basically be insurance against being defrauded out of your profits in a Ponzi scheme, at least up to $500K, which would be a real case of moral hazard. So far as this Chaitman’s analogy to FDIC, if she really believes what she is saying, I wouldn’t want her for a lawyer. The FDIC insurance is $250K max–principal and interest. It has never covered interest beyond its cap. That is, back in the day when the limit was $100K, if you had a $100K CD, and the bank went under, and you had unpaid interest accrued of, say $2,000, you were out the $2,000.

  • LD

    Bill,

    In my opinion, the industry has been keen to promote the presence of SIPC coverage to protect investors who left their securities in street name. That coverage was always promoted as being based on the last customer statement.

    The phantom profit puts the burden on the regulators to root out and expose Ponzi schemes being perpetrated within broker-dealers. The fact that the SEC and FINRA did not perform is now exacerbated by the fact that SIPC is changing how it defines its exposure.

    Perhaps SIPC should or could change how it defines its exposure on a going forward basis, but to do so retroactively strikes me as an injustice.

    For those who were aware of the scam, regulators and/or prosecutors should try to make a case as to those investors’ complicity. Is that a stretch?

    The fact is, Wall Street as an industry should have been paying much more in SIPC premiums while also promoting self-policing.

    In my opinion, this ruling today only puts investors in a more precarious position.

  • Arvin

    Who is running the scam. Madoff did, now Picard and SIPC are.
    Everyone is greedy – the investors wanted their final statement value BUT let go gentle – as an example.
    Say person X had NO money and 20 years ago was given 1 million dollars tax free. In year one, at 15% return, “X” would have earned $150,000, which was reported to the IRS and “X” would have paid $50,000 in taxes. The taxes would have increased each year had person “X” onbly taken out that necessary for taxes and let the rest accumulate (basis).
    To keep things simple, person “X” withdrew ONLY for taxes in 20 years 1 million and put in 1 million to start. The winner – the IRS. Picard’s rule says “X” put in 1 million and took out 1 million (even) to pay taxes and not a penny for himself, yet he now is at ZERO- and is not eligible for SIPC.
    How could a judge and many brilliant lawyers opposing the judge not see such a sham.
    In addition, by denying the SIPC to that person “X”, he at the age of 94, tried to commit suicide and finally died broke and as a broken spirit.
    The judge was wrong in siding with the trustee. The trustee not only took away the average person’s SIPC insurance but took their lives.
    A simple formula is money in plus taxes paid on that money minus money out (in the above case – taxes) = final.
    Can’t the brilliant lawyers and judge see that as a solution.

  • Randy

    Investors have always been in a precarious position, it is just that they never before fully realized they were depending upon outright lies by Wall St. and the Government in making those investment decisions. Whenever it comes down to a serious amount of money, just who did we think was going to get screwed? Surely we didn’t believe the big money interests would punish themselves, did we?

    Is this really much different than Obama and team deciding to rehabilitate their big corporate brethern by totally ignoring the legal and financial rights of secured creditors? It just sounds like more of the same to me.

    The system is badly broken clear across the board and we are clearly not on the winning side, nor were we ever meant to be. To think otherwise has been proven over and over again to be pure folly.

    Also, lest any of us begin to feel even the tiniest bit smug as we listen to the precarious news regarding those “spendthrift” Greeks way over there across the ocean and other European countries they so unflatteringly refer to as PIGS, please realize that this is little more than a temporary distraction compared to what is happening right here in the good old U.S. of A. It is easy to be distracted by things from afar and lose sight of what is happening under our very noses.

    Do any of us really believe that our elected representatives are somehow going to miraculously save our precious Social Security and Medicare entitlements so that when most of us finally qualify for and need it, it will be there to keep us off the streets and healthy? Come on, we can’t even hold onto our access to natural health supplements as big money interests and politicians like McCain push new legislation to give the corrupt FDA even more power to eliminate that access in favor of the poisonous products of the FDA’s corporate benefactors in the pharmaceutical industry. Are most of us still asleep or are we finally beginning to wake up to what is really going right here and right now?

    Even today you can read where they have allowed (for a second time) a single Republican senator (just in case any of us thought the Republicans were any better than the Democrats) to hold off approval of the extension of the Unemployment Benefits so desperately needed by many hundreds of thousands of American citizens who struggle daily to avoid being thrown into the streets along with their families, while jobs continue to disappear at an alarming rate.

    Come to think of it, whom amongst us truly believes that a majority of those jobs are actually coming back any time soon, if ever? IMHO those who still hold to that belief are destined to be sorely disappointed.

    The divide between the “haves” and the “have-nots” appears to be accelerating and it appears that the laws on the books which we thought were designed to help the average citizen will be manipulated and used against us at turn after desperate turn.

    Will we ever do more than share our combined disgust in hushed tones with our neighbors or worse yet anonymously over tiny gatherins on the Internet? When will we finally organize and speak as one? Are we going to let only a few brave souls such as “ea Partiers” or whomever stand out there all alone and watch them get co-opted and eventually discredited and broken apart by Wall St and D.C. money interests?

    In the final analysis, blogging is great and I think absolutely necessary, but it is only a tiny first step and we can’t just leave things at that. Indeed, misery does love company (even online)but are we seeking to protect our way of life here or are we going to be content with just a little nice group therapy amongst ourselves? You will each have to decide that one for yourselves, but I wouldn’t tarry too long in making that decision.

  • Randy

    Please forgive the typos such as “ea Partiers” for Tea Partiers and so on. Apparently when I get hot under the collar, my grammar, punctuation and typing suffer miserably. My apologies to the readers.

    • LD

      Randy,

      Thanks for the passion and the truth. America needs it!!

  • Bill

    LD, I read the bankruptcy court opinion sections germane to this dicussion. My opinion is unchanged, and I agree with the decision.
    First, the opinion points out that if the last statement method is employed, those who actually profited from the scam through withdrawals funded by the money of later investors would stand to profit even more, again at the expense of later investors. There is a finite pot of money and to allow any recovery based on other than how much you put in, minus how much you took out (the net investment method), would enrich those who already profited at the expense of those with a net loss–an incongruous result.

    The issue extends beyond SIPC’s responsibility, as that is only part of the equation; the other is the pot of money the Trustee recovers through liquidation of Madoff assets and recoupment of preferences, fraudulent transfers, etc. To the extent that is insufficient to satisfy claims, the SIPC coverage comes into play. For the net winners to qualify for SIPC coverage means that they will of necessity recover more from the Madoff pot than net losers. Those are practical effects of utilizing last statement as the basis for claims.

    Beyond that the law as stated in the opinion (and I can only conclude the judge accurately stated same) accords with the court’s decision. The opinion discussed the Securities Investors Protection Act, which established SIPC, in particular the definition of net equity, upon which the case turns. This is defined to include securities, which in the Madoff case there were no securities as such.

    This is also not the first time that the net investment method has been employed to adjudicate claims arising out of a securities Ponzi scheme. The opinion discusses at length In re New Times Secs. Servs., Inc., 371 F.3d 68(2d Cir. 2004) and New Times Secs. Servs., 463 F.3d 125, 130 (2d Cir. 2006)–New Times I and New Times II, in which net investment was employed rather than last statement balance as to one set of investors in a fraud. The last statement balance was employed as to another set in New Times, but the court distinguishes those investors from those in the Madoff case. Another case from Florida is also cited in which the net investment method was employed rather than last statement balance.

    This is of necessity a brief synopsis of the case, which may be found at http://www.nysb.uscourts.gov/. Click on Judge Lifland, and you will see the link to the decision. It’s about 24 pages; the rest is superfluous matter.

    As to inadequacy of SIPC premiums by investment houses, such as Goldman Sachs, that is truly outrageous.

  • Bill

    One more point on the ruling. I better understand, I think, the point Chenowith was trying to make about FDIC insurance. I suppose she was saying if you put $50K into a bank and thought you had $75K with accrued interest, when in fact the interest had never been credited, and your statement was false, under the court’s logic the FDIC would only owe $50K. However, the opinion dismisses the FDIC comparison with the observation FDIC is a different statutory scheme with different defintions and coverages. SIPC does not provide insurance, as does FDIC.

    • LD

      Bill,

      First and foremost, I commend you for taking the time to read the opinion and develop this informed response. If there is confusion in how SIPC handles claims I do believe then that SIPC and regulators should be wildly expressive in promoting what is and what is not covered so this confusion does not develop.

      Perhaps the industry does not want SIPC to be so explicit.

      I thank you fr your effort.

      • Bill

        LD, both sides cited the New Times case. The 2d Circuit did allow last statement balance as the measure of loss for certain investors whose funds were to be invested in mutual funds but in fact never were. Net investment method was applied to those who had “invested” in certain money market funds. In both cases the funds were never actually invested. I’d have to read New Times to better discern the basis for the distinction between the NT mutual fund investors and Madoff, but I’m inferring in NT there probably wasn’t the in and out, early and late investors, and the disparity in treatment that would occur with application of last statement balance in Madoff. But, yeah, SIPC coverage needs to be clarified.

  • Richard Friedman

    Larry,

    As always you have an excellent understanding of the issues. However, on the matter of the tax issue, your presentation is a bit misleading. It is first of all true, that the less SIPC pays an investor/taxpayer, the larger the loss and the larger the refund due back the taxpayer. However, it is a deduction, not a tax credit, and the amount of the resulting tax refund depends upon a number of factors, foremost the amount of income a taxpayer has been reporting for the last few years.

    In the case of a “Sr. citizen” on a fixed income consisting of mostly social security and Madoff “earnings” that person who might have lost (for example) $2 million can only offset it against his taxable income for the last five years, and going forward twenty. In a lower tax bracket, the refund could not only be substantially less than the amount of the $166,500 you cited (I guess you were figuring 33.33% tax bracket) but it might take many years into the future (if the person should live so long) to see the rest of it come back. In other words, there is no tax credit, no “automatic” refund check of $166,500 that people might assume that Madoff investors just file for and receive.

    You are correct in concept, but wrong in application, but not so wrong in trying to “keep it simple.”

    Thank you for another great post on this matter, tax credits aside.

    • LD

      Richard,

      Actually you are reading the lawyer’s (Helen Davis Chaitman) statement above as being mine.

      I am certainly no lawyer nor an accountant. I do have a fair understanding of markets and the economy, although I’m sure there are plenty far more astute on both those topics as well.

      I do know that SIPC and Wall Street abused those investors in Madoff who thought they had protection when in fact they were not truly protected at all.

      Thanks for your insights.






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