Madoff Ponzi Scheme, Five Years Later
It was the first week of December, 2008, and Bernard Madoff's world was in turmoil. Financial juggernaut Lehman Brothers had just filed for bankruptcy protection in what would be the largest corporate bankruptcy in history, and financial markets were in a tailspin. Investors were making withdrawal requests from his investment firm, Bernard L. Madoff Investment Securities (BLMIS), at an increasing pace.
On Wednesday December 10th, with an appointment already scheduled with a top criminal defense lawyer, an argument arose between Madoff and his sons about the "premature" nature of bonuses he was planning to distribute that week. It escalated into Madoff's confession to his sons and wife, Ruth, that there was "absolutely nothing left" and that his decades-long business was nothing more than a "giant Ponzi scheme." While Madoff and his wife attended the firm's Christmas party that evening, the next day, December 11th 2008, is a day seared into the memory of many. After a morning visit from the FBI, Madoff was arrested on suspicion of committing the largest Ponzi scheme in history. BLMIS was subsequently swarmed by authorities, and the firm's assets were later frozen. The world, as known by those connected to Bernard Madoff, was about to change.
Five years later, Madoff's Ponzi scheme remains the largest Ponzi scheme in history, taking tens of billions of dollars from thousands of victims and resulting in total losses of at least $17 billion. The numbers were truly staggering - indeed, the losses from the second, third, and fourth-largest Ponzi schemes collectively account for about 60% of the estimated cash losses in Madoff's scheme. While Charles Ponzi's namesake scheme had given the fraud its name back in the 1920's, Madoff's arrest quickly transformed "Ponzi scheme" into a household word. Investors began to question whether their financial advisor was "just another Madoff," and many would see their worst fears come true: the failure of BLMIS would mark the beginning of a multi-year period in which hundreds of Ponzi schemes were exposed.
Five years later, many questions remain unanswered. After Madoff's guilty plea and subsequent 150-year sentence, authorities sought to determine whether his claims that he acted alone were, in fact, accurate. The trustee appointed to oversee the liquidation of BLMIS, Irving Picard, has filed thousands of lawsuits seeking to increase the pot of money available to victims; to date, over $9 billion has been recovered. Regulators have sought to enact sweeping reforms to ensure another Madoff could not escape detection for decades. And Madoff's victims, after learning that some or all of their life savings had simply disappeared, have been forced to adapt to a new normal.
Recovery Efforts
On December 15, 2008, Irving Picard was appointed as the trustee tasked with sifting through the aftermath of BLMIS's shutdown and recouping assets for eventual distribution to victims. This began with winding down Madoff's business units, including a proprietary trading unit, broker dealer, and securities company. After securing Madoff's assets, Picard embarked on the monumental task of reconstructing Madoff's operations to understand the depth of the fraud and pinpoint investor gains and losses. After enacting a claims process for victims to submit their losses, Picard would ultimately approve approximately 2,500 claims while denying over 13,000 claims.
The majority of recovery efforts focused on "clawing back" funds from investors that were fortunate enough to receive distributions exceeding their principal investment. Picard ultimately filed hundreds of these proceedings, better known as "clawback suits," seeking the return of billions of dollars in "false profits." Thus far, Picard has recovered billions of dollars from the clawback lawsuits, including $5 billion alone from a suit filed against Jeffrey Picower, a longtime Madoff investor and acquaintance. After Picower's death in late 2009, it was announced that his estate would return $5 billion to Picard and an additional $2.2 billion to federal authorities. Many clawback suits remain pending.
In addition to clawback lawsuits, Picard also filed lawsuits against many of the financial institutions that did business with Madoff, including banking behemoths JP Morgan, HSBC, and UBS. Unlike the clawback suits that sought the return of false profits and didn't typically involve allegations of complicity or knowledge of Madoff's fraud, Picard claimed that the named financial institutions were "willfully blind" to Madoff's fraud despite becoming aware of numerous associated red flags. Picard sought $19 billion from JP Morgan alone, alleging the bank was "at the very center" of Madoff's fraud, had earned nearly half-a-billion dollars in fees, and had even quietly withdrawn over $250 million from Madoff's funds in late 2008 just before the scheme collapsed. However, a federal district court issued rulings prohibiting Picard from pursuing his claims, and a federal appellate court later agreed. Picard has since asked the Supreme Court to overturn that ruling.
To date, Picard has made three distributions totaling over $5.4 billion to victims with approved claims. Additionally, over $4 billion remains available for future distributions after resolution of various legal appeals. Federal authorities also recently announced that an additional sum of approximately $2.35 billion, representing the remainder of Picower's returned funds and other actions including forfeiture, would soon be available for victims. While the recovery process may not have proceeded as quickly as some victims may have hoped, it appears very likely that their total recovery will be significant.
Criminal Investigation
Despite Madoff's insistence that he acted alone, authorities were convinced that others were complicit in assisting and prolonging his fraud. In the ensuing investigation, authorities brought criminal charges against 15 individuals, including Madoff's inner circle, accountants, and traders. Of these 15 individuals, nine have pleaded guilty to various charges and have agreed to assist the government in building cases against former co-workers.
Frank DiPascali, Madoff's top lieutenant and one of the longest serving BLMIS employees, has played a pivotal role in these efforts, as he faces a possible sentence that could exceed 100 years. Last week, DiPascali served as the prosecution's star witness as he testified against five former co-workers accusing of knowingly aiding Madoff. Those five have maintained their innocence and claimed that they, too, were duped by Madoff. A verdict is not expected for several months.
The significance of the five-year anniversary of Madoff's fraud also carries criminal ramifications: many charges - including securities fraud, mail fraud, and wire fraud - carry a five-year statute of limitations. It is unknown whether any more individuals will be charged.
Regulatory Changes
In the wake of Madoff, a slew of reforms were proposed at the Securities and Exchange Commission, which was criticized for missing several opportunities to discover Madoff's scheme. This included greater transparency and coordination between regional offices, the creation of a central division to handle tips and market intelligence, a greater emphasis on encouraging whistleblowers to come forward, independent custody requirements, and improved fraud detection procedures.
Recently, the SEC adopted requirements that brokers holding investor assets file quarterly reports explaining how they maintain customer assets and detailing their compliance efforts. To understand the significant of these specific reforms, one need look no further than Madoff himself, who stated in a recent interview that his fraud was able to last so long because auditors failed to verify the existence of BLMIS assets at depository trusts.
These efforts have already begun to bear fruit. Enforcement has become a priority, and in 2011 and 2012 the SEC filed a record number of enforcement actions against investment advisors and investment companies. These efforts resulted in nearly $6 billion in court-ordered penalties and disgorgement.
Jordan Maglich is a Florida attorney whose practice focuses on securities and financial services litigation. Follow him on Twitter at @Ponzitracker.
For a detailed account of Madoff's fraud, read Diana B. Henriques' book, The Wizard of Lies, available at Amazon.