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Greater And Lesser Potpourri Regarding Madoff, Starting With The IRS And Then Moving To Other Matters.Part 1

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Headlined to H3 9/1/09

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<Fairfield family of funds, and unlike JP Morgan, Chase -- so many investors left all their money with Madoff until December 11th.

In addition to the loss of all principal put into Madoff, and not withdrawn, after early 2004, the losses include all appreciation on that principal since 2004. In terms of this case, those losses are called the appreciation shown on account statements from Madoff, and are in the mucho billions, although once again only Picard and the government know their amount. And, even if one follows Picard and says these were not truly losses because the appreciation was phony and losses therefore should not be measured by the legitimate expectations shown on the statements of November 30th, losses still exist in the billions of dollars because of what the economists call opportunity costs. Which is to say that, had the money not been invested in Madoff, it would likely have been invested elsewhere and earned interest and appreciation. (Since so many Madoff investors were essentially conservative investors, their market losses of principal in 2008-09 might not have been too bad because they might have been heavily in Treasuries or bonds that maintained their value. As well, any partial losses of principal would have been partially recouped in recent months and might be still further recouped in future. And, in any event, interest was lost -- my understanding is that a New York law sometimes sets interest in pertinent cases at nine percent -- that's a hell of a chunk of change over the years. Even interest at three to five percent would be a major chunk of money.)

Taxes were also lost. Take the question of federal income taxes paid on phony profits since 2004. According to the rules followed, or imposed, by the IRS, refunds can be obtained for those taxes for only three or five years, depending on the taxpayer's circumstances. (I think I am right about five years.) So, as I understand it, according to the IRS, refunds can be obtained only for taxes paid on phantom profits from 2005 onward or 2003 onward. But suppose the IRS had exposed the scam in 2004. In that case, not only would one not have paid income taxes in phony profits from 2004 onward, but, even according to the IRS, refunds would have been obtainable for the years 2001-2003 or 1999-2003 -- refunds of doubtlessly billions of dollars which are not available now according to the IRS.

In addition, theft deductions could have been carried back for earlier years than are now available had the IRS blown the whistle on Madoff in 2004, and there are people who would not have paid huge sums in estate taxes from 2004 onward because large chunks of the supposed estate would have been known not to exist.

So, as said, the amount of tax money that was lost by investors, due to the IRS' failure to catch and expose Madoff in 2004, must be gigantic even if not currently known to the public. Also, what this additionally means is that not only are losses since 1992 partially attributable to one government agency, the SEC, because of its moral and criminal incompetence then and later and because its unbelievable 1992 public statement that there was no fraud made it a co-cause with Madoff of sucking people into his scam, but a second government agency, the IRS, is partly responsible for all losses since 2004 because its malfeasance enabled Madoff to successfully continue his scam from then until nearly the end of 2008. And the fact that two government agencies, not just one, bear heavy responsibility for the success of the scam and the losses of investors makes it even more appropriate for the government to take action to relieve their plight, which it has not yet done for the most part. (Nor -- with only one exception that I know of (a complaint filed against FINRA which assails it for general incompetence or worse with regard to far more than Madoff) -- has anyone really considered in this regard that the malfeasance and incompetence of a body set up by a federal statute, FINRA, also was a contributing factor to the success of the scam from the very beginning of the fraud, whenever that was. Except for the one complaint which attacks it for a wide variety of failures in addition to its failure in Madoff, FINRA has thus far gotten pretty much a free pass in the Madoff disaster. It bears heavy responsibility, however, and most certainly should not get a free pass.

One must add that, even though the IRS bears responsibility for extensive losses, and a fellow government agency bears responsibility for all losses since 1992, the government -- the IRS -- wants to keep the lion's share, in years, of the taxes which were paid to it but should not have been because they were paid on phantom income, on phony income -- on money the government does not even have the constitutional authority to tax because its constitutional power is only to tax real income, not phantom income. The IRS is allowing people to recover refunds for only three or five years, and, if people wish to use its safe harbor provision for theft deductions, they have to give up the right to assert various doctrines that would allow them to obtain refunds of income taxes paid before that, e.g., refunds on taxes wrongly paid at least back to the early 1990s when the scam is known to have already been in operation. So not only is the IRS one of the causes of investors' losses, but it demands to keep more than a decade of taxes that should never have been paid (and it does so though it reserves the right to collect back to infinity if the shoe is on the other foot).

Given all these matters relating to the IRS -- given its malfeasant use of a paper-review-only process when approving Madoff, given this incredible misuse of a process designed for private letter rulings in which the goal is not to prevent fraud, given the IRS' consequent flouting of Congress' intent that it effectively enforce fiduciary standards to protect IRAs, given its consequent responsibility for the last four and one half years of the Madoff scam, given the possibility that the case is a canary in the coal mine -- given all this, the question arises of why did Doug Shulman have a letter written to me that disclosed how the IRS (malfeasantly) goes about approving non-bank custodians. The question is fascinating though one cannot presently know its answer. There are all kinds of possible speculations, with mine presupposing that Shulman and/or other high IRS officials saw the letter before it went out -- which seems to me likely when the matter is of such importance as the matter addressed in the letter of August 21st from Hulteng. My supposition that Shulman and other high officials saw the letter could be wrong, of course, and, if it is wrong, maybe they just didn't realize that the game was explosive and thus gave my letter to Hulteng's office to answer without the top guys like Shulman vetting the answer before it went out. But let us assume my speculation that the letter was vetted is correct. Why was the letter sent out?

My speculation begins with the fact that Shulman, as far as I know, is reputed to be a good guy. I am prone to believe this reputation on the theory that apples don't fall far from trees. My wife and I have known his parents for 50 years (his mother and my wife roomed together in Ann Arbor one semester and his father was my classmate there in law school), they are good people, and it is therefore likely their son is too. Further to the point, he was nice enough to personally call me (unexpectedly) to tell me why he would be unable to write a response to a letter (not discussed in this post) that I sent him on March 3, 2009. Being a good person might well cause someone to be sympathetic to the disaster that has befallen so many Madoff victims and to therefore think that, even if privacy rules preclude discussion of Madoff's case in particular, and even if that would justify a refusal to set forth any kind of answer to my inquiry (just as the IRS refused to answer my previous FOIA request), a response that at least sets forth the general process should be sent to an inquiry from a victim about how did the IRS come to approve Madoff.

There is also the possibility that, realizing how badly so many people have been hurt, Shulman, being a good guy, decided to give me information that did not on the surface seem damaging to the IRS, but which he knew might nonetheless be used by victims in efforts to recoup. Possibly knowing this, perhaps he even decided to give out the information as a vehicle for attempting to circumvent those in the IRS, or Treasury, or higher who don't want to do anything to help Madoff's victims. These latter speculations will be regarded as Machiavellian (though we all know it's how Washington works). But they are not impossible, although one must keep in mind that they are only speculations.

Finally, before turning from the question of the IRS to another piece of this potpourri, let me say one last thing; let me echo a point I once made previously in a posting on a different subject. If readers do not remember anything else written in this post or in its continuations, I beseech them to remember this: the IRS now appears to have surely admitted, in the letter of August 21st, that its review of Madoff was a paper-only-review -- was a review that was an open invitation for any liar, any Madoff, to receive IRS approval as a non-bank custodian by means of egregious fraudulent misstatements, and to thereby receive aid from the IRS in defrauding victims. The IRS has admitted that it did no on the ground review and inspection, used a process that destroyed Congress' powerfully expressed intent that it effectively impose and carry out fiduciary rules, and, for all we know, may have approved other fraudsters as well as Madoff. This is all crucial because (i) astounding, perhaps even criminal, government malfeasance was a major contributing cause to the huge losses suffered by Madoff victims; (ii) the government's incredible and even criminal malfeasance is a major reason why the government should provide restitution to Madoff victims -- regardless of what it does in other cases; (iii) the mass media seem not to care a whit so far about what the IRS did -- although legislators or their aides are sometimes astonished when they hear about it; and (iv) it is crucial, at least in my judgment, that the victims make a continuous major point of the malfeasance of both the SEC and the IRS if they, the victims, are to receive appropriate restitution to any significant degree.*

* * * * *

To Be Continued If Possible.

April 17, 2009

Re: Was The IRS As Culpable As The SEC In The Madoff Scam?

This posting raises the question whether the IRS may be as culpable as the SEC and FINRA for the continued success of Madoff's Ponzi scheme. If the possibility raised here turns out to be true, as I suspect will be the case, this would be a disaster for the country. For it would mean that what is perhaps the one agency which above all others must be kept competent and clean as a whistle, the agency that collects taxes, was instead a witting or unwitting facilitator of the worst kind of fraud. The consequences of this might accurately be called incalculable.

It is unknown to most people that, as part of its extensive authority over pension plans of all types, the IRS has the authority to approve so called non-bank custodians for IRAs and various other kinds of accounts (e.g., medical health plans). This goes back to the Employment Retirement Income Security Act of 1974. Congress, greatly concerned over many aspects of pension plans -- it wanted them, for example, to vest and be portable -- passed the 1974 act because

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Lawrence R. Velvel is a cofounder and the Dean of the Massachusetts School of Law, and is the founder of the American College of History and Legal Studies.
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