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OpEdNews Op Eds    H3'ed 4/17/09

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

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Message Lawrence Velvel
 

            It has been widely believed, of course, that Madoff’s firm refused to handle IRA accounts itself -- that, if one desired an IRA account, one had to work through FISERV or its predecessors (like Retirement Accounts Incorporated).  Lately, however, we are beginning to hear of people who say they had an IRA account directly with Madoff, not through FISERV.  And, in any event, since FISERV and its predecessors never had in their custody any securities purchased by Madoff for customers (they couldn’t have had them, since Madoff never bought securities), Madoff was what I have heard referred to as a subcustodian for FISERV (at least he would have been a subcustodian had he actually bought securities for the accounts).  So, one way or another Madoff was a nonbank custodian -- or at least would have been had he bought securities instead of faking it.

 

            Alright, so here is a guy who comes to the IRS and says he wants to become an approved nonbank custodian of securities, and who gets approved by the IRS in 2004.  How did that happen?  Did the IRS simply ignore its own regulations?  For instance, did it ignore its own requirement that he not own more than fifty percent of the company?  Did it not check to see whether he had a separate trust division.  Did it not check to see whether securities were kept in an adequate vault and not commingled, and whether there was a permanent record of assets put into and taken out of the vault?  Did it not check to see whether fiduciary records were kept separate from other records? Did the IRS not examine Madoff’s books and records, as it had been claiming a right to do for two decades, since 1984? 

 

Had the IRS done these things to determine compliance with its own regulations regarding becoming an approved nonbank custodian for IRAs, had it done these things which it seems that it must not have done, it almost surely would have discovered Madoff was a fraud.  Madoff’s game almost surely would have been up.  The IRS would have found, for example, no vault with securities.  It would not have found any securities.  It would have found no separate trust division.  It would have found no books and records of the kind needed to be a nonbank custodian of IRAs.  It would have found that Bernie Madoff owned almost the whole damn business, not a “mere” 50 percent.

 

            But since the IRS approved Madoff as a nonbank custodian in 2004, it must not have done these things.  Its approval of Madoff, moreover, raises additional questions. Why did Madoff seek IRS approval in 2004?  What did he gain from it, especially since he was telling people that he would not accept IRA accounts (except through FISERV).  (Was he afraid of lawsuits for being a nonapproved nonbank subcustodian?)  And knowing in advance, as he must have, what the IRS regulations required, how did Madoff even dare to apply for approval as a nonbank custodian?  Was the fix in somehow?

 

            Or did the impetus for seeking approval from the IRS not come from Madoff, but from the IRS itself?  Did the IRS, for example, learn that Madoff was acting as an unapproved nonbank custodian of IRAs, tell him this is not permissible, and tell him to apply for approval?  And if this is what occurred, how did the IRS not know for 20 years that Madoff was acting as an unapproved nonbank custodian and how did the IRS approve Madoff despite his failure to follow its regulations?  Also, if the IRS learned he was acting as an unapproved nonbank custodian and told him to apply for approval, then the IRS had to have known or at least have suspected that he had been acting as an unapproved nonbank custodian for years, yet all it did, apparently, was to require him to submit a few pieces of paper whose veracity it did not check, and it then approved him without even looking at his books and records apparently?  (Just as the SEC, after finding out in 2006-2007 that he had been acting as an unregistered investment adviser for years, did nothing except require him to register.)

 

            One bottom line on all this is that there seems to be a plausible case – maybe even an overwhelming case -- that the SEC is not the only government agency deeply at fault here.  The IRS may also be deeply at fault.  If so, the losses sustained by the thousands of small people, often in their 60s, 70s and 80s, who have been wiped out, who are having to sell their homes, who are trying to find even the most menial work in order to live, are due not just to the fault of one government agency (as well as to Madoff himself), but to the fault of two government agencies (as well as Madoff).  This would make only the more compelling than it already is the case for extensive governmental restitution to compensate for the extensive governmental fault that wreaked disaster here. 

 

            Indeed, not only would the case for governmental restitution be even stronger than it already is, but the IRS’ restitutionary action to date will look even less generous than some of us already recognize to be the unhappy fact. When the IRS came out with its new revenue ruling and its safe harbor procedure, there was widespread approbation, a widespread feeling that it had been generous. This was in significant part due to sheer relief that the IRS would do something, and in part due to the traditional American unwillingness and inability to look facts in the face and to recognize what is right in front of one’s nose.  For those of us of a certain age, this American unwillingness and inability have repeatedly been thrust in front of us since at least 1965 and the start of truly heavy American participation in the Viet Nam war.  It was manifest in Viet Nam, in Nixon’s and Kissinger’s enlargements of that war, in Iraq, in the promotion of stock market and real estate bubbles (and in adjustable rate mortgages and their packaging, which fueled a bubble) that common sense and economics warned couldn’t last, in the still continuing unwillingness to look torture and its perpetrators in the face, in the belief, starting with Reagan, that greed can serve as a philosophy of life, in the failure to recognize, as people like Andrew Bacevich and Robert Kaiser have now started to write in marvelous books, that our public life is thoroughly and almost uniformly corrupt at the federal level (and often below that too).  Paul Krugman has often made clear the American unwillingness to recognize reality, the drastic failure of intelligence in a democracy whose health requires intelligence.

 

            So it was with the general reaction to the IRS’ action regarding Madoff.  Largely lost in the handclapping for the IRS was recognition that its safe harbor procedure was the result of intense, immediate, behind the scenes lobbying by the superrich who were heavy donors to the Democratic party and who would benefit to the tune of deductions worth many score and even hundreds of millions of dollars, while small people (especially those who are older) who had had to take money out of Madoff every year to pay basic living expenses as well as to pay the tax on their very Madoff income itself would receive very little benefit and would instead continue to be subject to their “new- found inability” to afford food and shelter. 

 

Largely lost was that the IRS’ tax relief, designed to greatly benefit the superrich while the small man and woman got screwed, did not provide any restitution for people who invested through IRAs, through pension funds, through feeder funds -- these emphatically were not the private investment vehicles of the superrich Democratic donors who strongly pressed behind the scenes for the IRS’ action. 

 

Largely lost in the unconsidered gratitude and approbation was that, to take advantage of the IRS’ safe harbor theft deduction provision, one had to agree to give up all claims to refunds of taxes paid on phantom income -- on taxes that the government never had any right to -- neither under the constitution nor the statutes -- because there was no income, but which the government now was going to keep anyway. 

 

Largely lost was that, if one were to use the safe harbor provisions -- as many would out of sheer desperation to get something back quickly in order to be able to pay everyday living expenses, at least for awhile -- one was required to give up the right to use legal doctrines that, if pressed in court, could conceivably result in refunds of taxes unconscionably being kept by the government:  to give up the right to assert the claim of right doctrine, the equitable tolling doctrine, the equitable estoppel doctrine, the negative tax benefit doctrine. 

 

All of this was lost in the cheers, cheers resulting from the typically American refusal to look facts in the face and possibly resulting here as well from an analog to what I believe is called the Stockholm syndrome.

 

            And on top of all that, now it begins to look as if the IRS, which has done so little to help the small man and woman while kowtowing to the superrich who are heavy donors to the Democratic Party, may itself be one of the causes of the disaster, just like the SEC and Madoff himself.  For it looks like the IRS, by ignoring Congress’ desire that it safeguard those who had IRAs, and by ignoring its own regulations on the subject as well, approved of Madoff as a nonbank custodian of IRAs when, had it carried out Congress’ desire and its own regulations, it would have discovered and thereby caused a stop to be put to the fraud which was occurring.  And beyond this, for at least 20 years the IRS somehow ignored and/or did not learn that Madoff was acting as an unapproved nonbank custodian although, had it not ignored and/or failed to learn of this, and had it followed Congress’ wishes and its own regulations, it would have rung the bell on Madoff in the 1980s or 1990s.

 

            Does it not go without saying that the IRS’ actions and inactions need to be extensively investigated by Congress, by the media, by Madoff investors, by litigants, by the FBI? 

 

            And there is one other point, too, one that might be called earth shaking in its implication.  If the IRS acted with the extreme negligence and incompetence, if not complicity, that seems all too possible here with regard to Madoff, did it do the same with regard to other Ponzi schemes or frauds in which companies might have sought to elide suspicion by becoming an approved nonbank custodian?  Almost daily, it seems, we hear of more frauds and more Ponzi schemes.  Did the perpetrators of those frauds likewise seek and obtain IRS approval to shield themselves from suspicion?  The thought is almost too terrible to contemplate.  But it cannot be ignored.  Just how many Ponzi schemes and frauds, if any in addition to Madoff, may have hidden behind some form of negligent or complicitous IRS approval?* 

  


* This posting represents the personal views of Lawrence R. Velvel.  If you wish to comment on the post, on the general topic of the post, or on the comments of others, you can, if you wish, post your comment on my website, VelvelOnNationalAffairs.com.  All comments, of course, represent the views of their writers, not the views of Lawrence R. Velvel or of the Massachusetts School of Law.  If you wish your comment to remain private, you can email me at Velvel@VelvelOnNationalAffairs.com.   

VelvelOnNationalAffairs is now available as a podcast.  To subscribe please visit VelvelOnNationalAffairs.com, and click on the link on the top left corner of the page.   The podcasts can also be found on iTunes or at www.lrvelvel.libsyn.com 

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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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