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General News    H3'ed 6/18/10

MADOFF: THE LIABILITY OF THE SEC, FINRA,LARGE BANKS AND FUNDS, AND ACCOUNTANTS

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Message Lawrence Velvel

In all of the foregoing examples, the situation would have been far different if the funds, banks, etc. had done due diligence and had not invested in Madoff to reap rich commissions from a fraud. Had large numbers of Wall Street institutions refused to invest in Madoff, instead of only a few refusing, the word would have started to get around. Far more reporters than only Erin Arvedlund and Michael Ocrant would have been investigating and writing about the situation. Had a large number of institutions complained to the SEC -- had 20 or 30 or 50 complained to it instead of it receiving complaints from only Harry Markopolos, whom it hated, and one hedge fund manager -- the SEC would have been forced into effective action instead of continuing with half-baked, grossly negligent efforts. Madoff would have been finished, I would estimate, by around 2000 or 2001, if not before. (Remember, Ivy Asset Management knew that his claims about using options was fraudulent as far back as 1997.) Thousands of people would have been saved billions of dollars plus personal agony.

There are those who think that much of Wall Street, maybe even most of it, knew that Madoff was a fraud. Yet very few Wall Streeters said anything about it to anyone, let alone to reporters or the SEC. The effect might be thought a conspiracy of silence and, in any event, allowed a huge fraud to grow to gigantic proportions, to the dire injury of at least thousands. Traditional interpretations of liability law which foster such a result -- which foster non liability to third parties -- would seem ipso facto undesirable if we want Wall Street and others to do the right thing. Instead, interpretations of law which would cause people to have to act, to have to do the right thing, when they feel they have good grounds for suspicion -- as by requiring them to at least notify the SEC as Markopolos did if they have reasonable suspicions and want to avoid suits for negligence -- would conversely seem quite desirable.

I do have to admit, though, that my view is premised on a deep belief that honesty, and conduct which promotes honesty, are crucially important, often to the exclusion of almost anything else. While the country seems slowly to be coming closer to this belief due to disasters caused by various forms of lack of honesty, the belief is not a universal one and, judging by some recent cases, it is not shared by the Supreme Court.

Finally, before leaving the subject of the liability of funds and banks, let me discuss one bank in particular, JP Morgan Chase. According to a major complaint, all the money going into and out of Madoff's Ponzi scheme went to and came from a single multi-billion dollar account in JP Morgan Chase, the so-called 703 account. (Initially, the account had been in Chase, but went to Morgan when it acquired Chase.) Morgan was earning hundreds of millions of dollars from this account, and is thought to have monitored it because it was one of Morgan's largest accounts. Morgan also had offered investors so-called structured investments in Madoff. At some point in the middle or late part of the decade beginning in 2000, Morgan is said to have become aware that Madoff was a fraud and to have subsequently pulled its structured investments out of Madoff. But even though it knew a fraud was occurring, Morgan continued to service the 703 account, which was being used to perpetrate the fraud, by putting into the account the checks and wire transfers received from Madoff victims and sending monies from the account to Madoff, his cronies, and his London operation. It seems to me that, by continuing to hold, service and make millions of dollars from the account being used to perpetrate a fraud that Morgan knew existed, and by enabling the fraud to continue while it made vast sums of money from the account, Morgan became a coconspirator with Madoff. Morgan is therefore liable to all Madoff investors: all of their monies went through the Morgan account, it dealt with all of them (as when they sent it money for Madoff or received Madoff money from it), and without the account, from which Morgan made a fortune, there could have been no Ponzi scheme.

But Morgan is liable to all for an additional, related reason as well. Regardless of exactly when Morgan actually realized a fraud was in progress, it and its predecessor holder of the accounts, Chase, should have known a fraud was going on many years before that. Morgan and Chase knew that the 703 account was used for Madoff's investment advisory business, but also knew that no money ever went out of the account to brokers or others who have to be paid for securities and options, and no money ever went into the account from brokers, option dealers, etc. to whom Madoff sold securities. Chase and Morgan knew, in short, or assuredly should have known, that the account showed no transactions of the kind required by the investment advisory business that the account supposedly was servicing. They thus knew or certainly should have known -- probably since at least the mid or late 1980s -- that a fraud was in progress. Indeed, since there were no monies from securities dealers or options dealers being deposited in the account, yet investors were receiving monies from it, they certainly should have known, if they did not in fact know, that the exact nature of the fraud was that it was a Ponzi scheme. How else but through the operation of a Ponzi scheme, after all, could Madoff be paying billions of dollars to investors if he was not engaging in securities transactions from which he was making money that would have come into the account?

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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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