There will also be very important questions raised in litigation as to why the IRS' program of approval of non bank custodians did not expose the Ponzi scheme. This is a remarkable and potentially highly explosive point. Madoff was approved by the IRS in 2004 -- in the midst of Markopolos' revelations to the SEC -- to be one of only about 260 non-bank custodians for IRAs and pension funds throughout the entire United States. How did that happen -- i.e., how could Madoff possibly have been approved by the IRS in 2004 -- especially since the IRS has claimed, since 1984, the right to inspect the books and records of non bank custodians? Such inspection of Madoff would have shown that Madoff was in major violation of the IRS' own governing regulations and would have blown open the Ponzi scheme. It would have shown, directly contrary to governing IRS regulations, that Madoff himself owned 90 to 100 percent of the business rather than the maximally allowable 50 percent designed to insure corporate continuity, had no trust department, had no vault for customers' securities (and indeed had no securities being held for customers), did not keep fiduciary IRA records separate from other records, and had been acting as an illegal non-approved custodian of IRAs and pension funds for decades. It would inevitably have shown that Madoff was acting illegally under the IRS' own rules and was not doing what he claimed to be doing. It would have exposed the Ponzi scheme.
Yet the IRS approved Madoff, contrary to Congress' specific intent that it act in a fiduciary capacity in overseeing non-bank custodians of IRAs and pension funds. Does the IRS, contrary to Congress' intent that it exercise careful fiduciary oversight, simply approve companies to be non bank custodians without looking at their books and records to insure they are legitimate and that the owners of IRAs and other accounts are protected? Did the IRS look at Madoff's books and records and, like the SEC, the NASD and FINRA, negligently miss the Ponzi scheme? Whatever the IRS failed to do, its negligence (or worse?) is bound to be explosive. For the nation's tax collector to have been the facilitator of a Ponzi scheme, as appears to have occurred here, will necessarily be regarded as awful. (I note that one Congressman already has written to the IRS about this situation although it was disclosed (by me) less than two weeks ago.)
These questions, as said, are sure to be raised in litigation. Another question that will be raised is this. There are tax lawyers who claim the IRS has a program which matches corporate reports of dividends and interest paid against taxpayers' reports of dividends and interest received. We have been unable to locate information on such a program. But if it does exist, how could it have failed to expose Madoff's Ponzi scheme, since the reports of dividends and interest paid by companies would have had to be far smaller than the reports of dividends and interest received by taxpayers because Madoff was making up the latter out of whole cloth? Since the program of matching, if it exists, is largely shrouded in obscurity, people outside the IRS cannot know how it works or its capabilities; thus the question of why (if it exists) it didn't catch Madoff will surely be raised in litigation.
There will also be extensive litigation against FINRA. It and its predecessor, the NASD, inspected Madoff every two years since 1962. Yet it never uncovered the largest Ponzi scheme in the history of the world. How could this possibly be? This question, and FINRA's liability for negligence or worse to every single victim of Madoff, will be the subject of lengthy litigation.
The entire process of ironing out all these questions, relating to governmental and quasi governmental agencies, in a variety of forums is bound to take a decade or so, while those who are not highly wealthy suffer immensely and the process becomes, as it is already becoming, mainly a lawyers' relief act.
Surely there must be a better way than a decade of widespread hassling and litigation.
There in fact is a better way. It is a way that, at one and the same time, will enable deeply injured people to obtain enough income to live on, while costing the government far less for several years than the provision of tax relief would. It would also, though large in absolute number, be a drop in the bucket compared to the trillions being spent in bailouts. I hope, as said, that you will look upon it with favor.
The idea I have in mind, even though it is simplicity itself, will greatly assist direct investors, feeder fund investors, IRA investors, pension fund investors, charities -- everyone. It will nullify the need for tax refunds. It will nullify the need for tax deductions. It will nullify the need for SIPC payments. Rather than provide any of these, the government would instead provide victims with government bonds whose principal is not payable for ten years, and whose interest rate, payable annually, would be seven percent tax free. To satisfy the principle of legitimate expectations, the bonds' principal would be the amount shown in an investor's final, November 30, 2008 statement (minus amounts already obtained in tax refunds or from SIPC). All private or other litigation rights against potentially culpable parties would be transferred to the government, which is best situated to and can pursue them in court through the Department of Justice if it wishes, and may be able to recover immense amounts by doing so. (The SIPC trustee has already filed suits seeking ten billion dollars or so.) The victims, however, will simply get bonds whose principal will come due in ten years, with interest payable annually.
This is simple, clean, direct and would achieve crucial goals. Let us start with victims. Whether they were direct investors or investors through feeder funds, many of them, who are now wiped out, were literally living off of their Madoff earnings, which they would take out every year for living expenses. In recent years Madoff claimed to be earning, roughly speaking, about ten to twelve percent taxable, about eight or nine percent after taxes. Victims, whether direct investors or feeder fund investors, will continue to get roughly similar amounts (a bit less actually) under the bond proposal, but enough to live on.
Pension funds and charities will be able to continue to obtain money tax free, just as before. Partnerships and trusts will likewise receive the same treatment as before.
For those who do not want to hold on to their government bonds for ten years, there is likely to develop -- there almost surely will develop -- a secondary market, an over the counter market, on which the bonds can be sold, depending on the situation, for their appropriately discounted value or their appropriately higher-than-face-value value.
As for the government, it will make out reasonably well in comparison with the situation otherwise. The government has estimated the amount of loss shown in statements from Madoff at being $65 billion. It was also estimated early on that the government might have to pay out a total of 20 billion or more in tax refunds and SIPC recovery, though this estimate may now be far different. (If the government itself has made knowledgeable estimates that are different, it has not disclosed them to the public or Congress). Under the bond proposal, at 7 percent tax free, the government, for ten years, will pay out only $4.55 billion a year (seven percent of $65 billion). It will not pay out a total of the previously estimated $20 billion until the fifth year -- not until then will the total interest reach $20 billion. The principal of $65 billion will not be paid by the government for ten years and, if my understanding is correct, is only the same amount the FDIC expects to pay out in the next five years due to bank closings . And each year the government will pay out in interest an amount that, very roughly, is only about one-tenth of one percent of the total of ten trillion dollars (or even more) which it is now estimated the government will provide, as an investor, lender, and/or insurer, to the financial oligarchs who caused the current economic meltdown.
The present value to the investors of receiving a collective total of $4.55 billion per year for ten years at a rate of seven percent is approximately $32 billion. Also, the present value to the investors of $65 billion in principal to be received in ten years, calculated at a discount rate of seven percent, is $33 billion. So investors receive a total present value of about $65 billion. This total present value of $65 billion "replaces" the present value possessed by the investors on December 10th (the day before the fraud was disclosed). On December 10th investors had accounts worth $65 billion plus, assuming an after tax "return" from Madoff of eight percent, another $5.2 billion per year every year for the next ten years, or a present value of $36.5 billion, for a total present value on December 10th of $101.5 billion. So the total present value on December 10th of $101.5 billion ($65 billion plus $36.5 billion) would be replaced by present value of $65 billion ($32 billion plus $35 billion). Accordingly, investors are much less well off under the bond proposal than they expectably would have been had Madoff been for real. Yet they will be able to live.
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In conclusion, I would be very grateful if you were to look with favor upon the proposal discussed here, and were to pass on the idea to persons who are high level decisionmakers. As is evident, the proposal has many advantages. It will provide wiped-out investors with annual monies on which to live. It will cost the government less for many years than likely will otherwise be the cost in tax deductions, tax refunds and possible government financing of SIPC payments. It will provide restitution for the governmental conduct which helped cause the disaster -- the incredible SEC statement of December 1992, the phenomenal SEC negligence, or worse, of 2000-2008, and IRS actions or inactions that allowed Madoff to become a non bank custodian. It will end all private litigation, leaving only litigation that the government chooses to pursue. It will help restore confidence in the securities markets, confidence essential to recovery from the current economic meltdown. It will show that the people who caused the meltdown, and who in one way or another are receiving an estimated ten trillion dollars or more in bailout monies, are not the only ones whom the government will assist. And it is the moral thing to do.
Finally, let me say that I greatly appreciate your willingness to take the time to consider this, and, as said, hope that will look upon it with favor.
