I
suspect, in this connection, that good old Bernie is sitting in his cell
laughing at us. For in various
statements that we need not get into or parse here, he practically told us what
he had been doing. But with only one guy
as an exception, for over 3 - years nobody seems to have caught on to what he
was saying -- he had hidden the truth in plain sight, if you ask me -- and
instead everyone was talking about a Ponzi scheme in which there were no
transactions and no profits or earnings.
Calling
Madoff's scam a Ponzi scheme has certain huge advantages for SIPC and the
trustee, of course, some of which I will discuss below. Because they will wish to retain these huge
advantages, they are quite likely to reply that I am wrong -- that Madoff was
running a Ponzi scheme because there were no purchases or sales of securities
for the investment advisory arm of
the business, the arm that investor victims were "associated with." The purchases and sales, they will say, were rather
for the proprietary trading arm (and the market making arm) of the business,
arms the investor victims were not
associated with. But this excuse does
not wash. Consider, if you will, a big
law firm which is a partnership and has many different sections, a tax section,
a securities section, an antitrust section, a banking section, a bankruptcy
section, and so on. The work in each section
is significantly different and separate, the clients are different, the lawyers
are different, may be in separate cities and may not even know each other. But if the tax section does something illegal
or unethical, the whole firm, including every section, will be hammered --
every lawyer, no matter his or her section, will have to pay. Or take a huge company which, in a single
corporation, makes a variety of drug products, with manufacture of different
products being in different plants, with different scientists for different
products, etc. If one of those drugs
culpably causes injury, the whole company
will be liable, not just the people or plants associated with the culpable
product.
Or
look at it somewhat in reverse. Suppose
a parent corporation which manufactures products X and Y creates a subsidiary
corporation to manufacture product Z, which causes injury. If the injured party sues the parent corporation,
the latter will say that he can't sue it,
because Z was made by a different corporation, its subsidiary. Will this defense work? It depends.
Courts will look at who sets policy for the subsidiary. Who are its directors, executives and
employees? Do the two corporations use
the same plants and sales force? And so
forth. The more that the two
corporations use the same policies, offices, officers, plants and so on, the
more likely it is that the parent will be held responsible for the misconduct
of the subsidiary. The corporate veil
will be pierced, as they say.
Now
let's look at the Madoff situation.
Madoff did not even have separate corporations for his three business
arms. It was all just one entity, so
there is not even any corporate veil to be pierced. Bernie Madoff owned everything. He controlled everything. He set all
policies. The three arms were run in
tandem, with Bernie's investment advisory arm being used to finance the other
arms. The whole business was Bernie
Madoff, plain and simple. As he used to
tell people, it was his name on the door. So there is no way that it is legally proper
to say that one can ignore the fact that the very securities Madoff told people
he would buy were in fact bought, or can correspondingly say that there was a
Ponzi scheme because the securities weren't bought by the investment advisory
section of the integrated business but by the proprietary trading arm to which
investors gave the money that Madoff transferred over to the proprietary arm's
bank account.
Let
me turn now to the question you've all been waiting for. What difference does it make whether Madoff
was a Ponzi scheme or was, rather, a different kind of fraud, a fraud in which
he simply bought for himself the securities that he falsely told investors he
was buying for them? I believe that for
SIPC, the Trustee, his lawyers and victims, it makes a huge difference whether Madoff was or was not a Ponzi scheme.
To
begin with, take the concept of net equity.
Without refighting the battle in which courts have found for the Trustee
and SIPC and have, if I may be so crude, screwed innocent investors, SIPC and
the Trustee have argued from day one, and have gotten the courts' agreement,
that investors' so called net equity is not measured by the amounts shown owing
to them on their last monthly account statement (the final statement method),
but is instead the far smaller amount
calculated by subtracting the amounts an investor physically put into Madoff
from amounts he physically took out of Madoff.
Investors got no credit for the amount of earnings shown on these
account statements. This method is
called the cash-in/cash-out method (CICO), has been used in only two or three
percent of SIPC's cases -- the rest all measured an investor's net equity by
what is shown on his account statement -- and has been used, as I understand
it, only where there have been Ponzi schemes.
The CICO method, by greatly reducing an investor's net equity, results
in investors, especially small ones whom Congress enacted the Securities
Investor Protection Act specifically to protect, getting greatly reduced or no
recompense from the SIPC insurance fund.
The fund allows an
investor to get up to $500,000, if his net equity is that high. But many investors -- even thousands perhaps,
especially small ones who are suffering great hardship -- have ended up with
tremendously reduced net equity or no net
equity, and accordingly with greatly reduced or no payments from the SIPC fund,
because SIPC and the Trustee have measured net equity by the CICO method rather
than by the standard final statement method used 97 or 98 percent of the
time. SIPC and the Trustee say it is
proper to use the CICO method because Madoff was a Ponzi scheme in which there
were no purchases or sales of securities, no transactions in securities. But there were
purchases or sales of promised securities, there were transactions in promised securities, apparently in the many,
many billions of dollars. It's just
that, instead of giving the victims ownership of the securities, as he was
legally obligated to do, Madoff kept the ownership for himself. To reemphasize the obvious, the fact that
Madoff illegally kept for himself the ownership of securities in which he was
conducting billions and billions of dollars worth of transactions does not mean
that there were no transactions. (Nor,
of course, did keeping the ownership for himself relieve him of any duty, as
the holder of discretionary customer accounts, to allocate trades to the
customers before trading for his own account.)
Make
no mistake about it: the vast reduction
or elimination of payments to victims from the SIPC fund, and the consequent
savings to the fund, were matters of enormous consequence not just to thousands
of small, often elderly victims in their 60s, 70s and 80s who found their
savings depleted and often had to scramble to live, but also to SIPC and its
managers (who make up to or more than $750,000 per year). One estimates that the savings to the SIPC
fund were between one billion and 2.5 billion dollars per year. (Once again the precisely accurate
information is in the hands of SIPC, although the numbers may be calculable (I really don't know) from complicated
information released by SIPC in answer to a Congressman's questions.) There was deep concern in SIPC that, had the
final statement method of determining net equity been used, with consequent far greater payments to victims from the
SIPC fund, the fund would have gone broke.
In order to save the fund, SIPC -- which had refused to increase the
size of its fund when leading federal legislators urged it to do so in the
early-mid 2000s lest the fund prove incapable of handling a major disaster -- would
have had to levy assessments upon members of the financial services industry
(who for years had been paying only $150 per year even if they were Goldman
Sachs or Morgan Stanley), or drawn down upon a huge private line of credit that
SIPC then had (but soon ceased renewing), or ask Congress for more money. SIPC did not want to do any of these things,
especially, one assumes, because it would have looked very bad if it had been
necessary to do them in order to save the fund:
the necessity would have cast great doubt on the competency of
management (which had, as said, refused a few years earlier to increase the
size of the fund upon congressional urging, lest the fund prove inadequate if
there were a major financial disaster -- as occurred with Madoff). Very likely, heads would have rolled at
SIPC: managers making half a million or
750,000 dollars per year -- which is still good money even in the profligate
Washington, D.C. area -- would have lost their jobs. The way to save the fund without assessing
and aggravating the financial services industry which supports SIPC and its
fund, without drawing down the then existing line of credit, and without asking
Congress for more money, was to use the CICO method of determining net equity
-- the method which arguably could be used if there were a Ponzi scheme but not
if there weren't -- and to thereby vastly reduce or eliminate payments from the
fund. So CICO was used on the theory that there was a Ponzi scheme even though Madoff was buying and selling
billions upon billions of dollars of the very securities he told investors he
would buy, payments from the fund thereby were dramatically reduced, and
the fund and management's lucrative jobs were saved.
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