Five years since his arrest, Bernie Madoff is still big news. In New York City last month, five former employees of Bernard L Madoff Investment Securities (“BLMIS”) were tried on criminal charges, the first criminal trial to date stemming from Madoff’s massive fraud. The testimony of Madoff’s former deputy, Frank DiPascali, was headline fodder for the tabloids, which featured tales of a vain Madoff complaining that a drawing in the Wall Street Journal made his cheeks look chubby; eleventh-hour cheques being written to favoured clients just before Madoff’s scheme surfaced; and a weeping Madoff plotting to orchestrate the final details of his business.

In a recent jailhouse interview, Madoff tried to deflect responsibility away from himself, saying that he felt 'trapped' into the scheme by others and that his investors should have done more homework before investing with him.

Amid the juicy gossip, there has been good news for Madoff victims.  First, there was the announcement that the Madoff Victim Fund (MVF) will begin accepting claims and making payouts to many victims who were shut out of recovery in the BLMIS bankruptcy proceedings.  Next came the news that JP Morgan Chase is close to agreeing on a ten-figure settlement with federal prosecutors in Manhattan and regulators in Washington, expanding the pool of funds available to compensate investors.  These are significant developments for Madoff victims.

Recovering losses from Madoff’s fraud

Before his arrest in December 2008, Bernie Madoff was a controversial figure on Wall Street but few knew of him outside the world of finance.  The revelation that he was operating a multi-billion-dollar Ponzi scheme made him a household name and instantly wiped away billions of dollars in wealth.  It is estimated that the BLMIS fraud cost investors approximately $17.5 billion in invested principal and revealed that many billions of dollars of supposed investment earnings were nothing more than fictitious profits.

In the five years since, investors have had to tread a long and hard road to retrieve even a portion of their profits.  The trustee of the BLMIS bankruptcy estate, Irving H Picard, has collected more than $9 billion and continues to seek out additional monies through claw-back litigation.  Although the bankruptcy estate has offered compensation to many Madoff victims, others have been unable to collect from the trustee.  For instance, the trustee has disallowed claims from the many thousands of investors whose money was indirectly invested with BLMIS through feeder funds, investment partnerships, bank co-mingled funds, family trusts and other pooled investment accounts.  This approach to administering the bankruptcy estate was affirmed by the Second Circuit Court of Appeals, which held that indirect investors were not BLMIS 'customers' under the Securities Investor Protection Act (SIPA) and thus could not pursue SIPA claims of their own.  In re Bernard L. Madoff Investment Securities LLC, 708 F.3d 422 (2013), other investors had their claims denied in the bankruptcy proceeding because their money was invested in a common account that withdrew more from BLMIS than it invested, even though the individual investor never made any withdrawals.

For these indirect investors, the recent announcement that the MVF was beginning to accept claims is excellent news.  The MVF currently has approximately $2.35 billion, which will provide compensation to Madoff victims, even if their investment in BLMIS was through a feeder fund or other conduit.  This is money that prosecutors have recovered from various civil and criminal forfeiture actions, including $2.2 billion from the estate of deceased Madoff investor Jeffry Picower, as well as funds from Bernard L Madoff, Peter B Madoff and their fellow conspirators.  The settlement in the works with JP Morgan Chase could expand the MVF’s assets, making yet more money available to victims of Madoff’s fraud.

The MVF is administered by a Special Master, Richard C Breeden, a former Chairman of the Securities and Exchange Commission, and is separate from and independent of the BLMIS estate. The MVF will attempt to look to the economic reality of an investor’s loss, rather than the formalities of whether an investor’s money was placed into BLMIS directly or indirectly. This is welcome news for the thousands of investors whose bankruptcy and Securities Investor Protection Corporation claims were denied, many of whom lost money when their investment vehicles, which had large stakes in BLMIS, plummeted in value following the revelation of Madoff’s fraud.

Calculating recovery
Like the bankruptcy trustee, the Special Master will only pay claims to investors who invested more money into Madoff securities than they withdrew—the 'net losers.'  This 'cash-in, cash-out' principle requires a claimant to show how much cash he or she invested in BLMIS (whether directly or indirectly), how much he or she withdrew, and how much he or she has received from other sources (e.g., from the BLMIS bankruptcy estate or class action recovery).  'Net winners' (those who obtained more money from BLMIS than they put in) will not be eligible to recover from the MVF, regardless of how much the purported value of their investment in BLMIS declined after the fraud was uncovered.  The MVF will not compensate investors for the time value of money or any opportunity cost incurred as a result of investing with BLMIS.  Investors are only entitled to claim the money actually invested with BLMIS.

The MVF will calculate the losses sustained by each individual.  Therefore, even if investors in a single fund withdrew more from BLMIS than the fund had invested, any investor who personally put in more than he or she took out can make a claim on that amount to the MVF.  The MVF will, however, consider whether several investors have a “unity of interest” such that their accounts should be consolidated for the purpose of determining whether the investors are net winners or net losers.  A claim must disclose all of the claimant’s investments in and withdrawals from BLMIS, even if the claimant had different accounts over different periods.

Filing claims

To recover funds from the MVF, investors must send their claims to the Special Master (or have a claim filed on their behalf) and list their losses.  Forms are available on the MVF website, which is at www.madoffvictimfund.com.  Investors must be able to present documents that show how much they invested, how much they withdrew, and how much they have already received from other sources.  A claimant who invested indirectly with BLMIS has to 'document' each transaction along the chain, showing the release of his or her own funds to BLMIS.  Furthermore, claimants must be able to demonstrate that the money was theirs and not invested on someone else’s behalf.  

The burden of proving loss is on the claimants, so they must be sure to 'document' all transactions related to their BLMIS investments carefully.  The documents might include investment statements, K-1s, bank statements, tax returns, copies of cheques or wire payment slips and investment intermediary payout reports.  This may be relatively straightforward for direct investors, but a more daunting process for investors who invested in funds that invested in other funds that invested with Madoff.

Pooled investment vehicles may file claims on behalf of their underlying investors, although they are not required to do so.  The investor in question cannot necessarily rely on the intermediary through which he or she invested to file a claim on his or her behalf.  Nevertheless, pooled investment vehicles probably have better records than investors about where this-or-that investor's cash flowed.  Even when a pooled investment vehicle makes a claim, payment generally will be made directly to the investors, not to the conduit.  Such pooled investment vehicles can only recover money they invested in BLMIS securities on their own behalf, not money invested for others.  Pooled investment vehicles cannot submit omnibus claims on behalf of aggregated groups of investors.  In all cases, the identity and address of the ultimate investor must be provided to the MVF.

Claims can be made now.  All claims must be received by the Special Master no later than February 28, 2014.  The Special Master has warned claimants not to delay – the process of collecting documentation to support a claim can be time-consuming.

Payments

The payment process has not yet been settled on, but the Special Master has given potential claimants some inkling of his intentions.  He has said that he expects to make an initial round of payments to ensure that all victims have recovered a certain (and, as yet, undetermined) percentage of their losses before making any payments to victims who have already recovered a proportion of their losses that exceeds that.  Anyone who has already received pay-outs from other sources can expect to wait in the queue behind those who have yet to receive any compensation.  Even so, investors whose monetary losses from BLMIS have not been fully compensated are eligible to recover money from the MVF and should consider making claims.  The Special Master has given no indication of when payments will begin.

* James Masella is a partner, and Jeremy A Weinberg is an associate, of Patterson Belknap Webb & Tyler LLP.  Messrs Masella and Weinberg represent high-net-worth sufferers from the failure of BLMIS. They can be contacted at JMasella@pbwt.com or 212-336-2246.