If
there is a Ponzi scheme, however, the situation is altered to the Trustee's
benefit in a crucial way. It is
automatically assumed that the broker
-- Madoff -- gave money to the victims in order to hide the existence of a
fraud. (This is the so-called Ponzi
presumption.) The Trustee is then
relieved of the oft-difficult task of proving that the fraudster -- here Madoff
-- gave money to the victims for the specific purpose of hiding the fraud. This is presumed.
So
. . . to call Madoff a Ponzi scheme has important ramifications benefitting the
Trustee in his clawback work for SIPC (and benefitting SIPC too in various
ways). For to claw back, the Trustee
does not have to prove the fraudster was acting with the purpose of hiding his
Ponzi scheme when he gave the investor the money requested by the
investor. The Trustee is relieved of
bearing this oft difficult burden of proof -- a burden he might not be able to
meet -- and the illicit purpose is instead presumed in his favor.
(I note that, in the
absence of the Ponzi presumption, one of the many factors that can be looked at
to determine if hiding the existence of a fraud was the fraudster's purpose in
transferring money to the victim is whether the fraudster was insolvent when he
gave the victim the money. Was Madoff insolvent when he honored
requested withdrawals, or did he instead own enough in securities and
associated cash to pay back the monies he had taken in (about $17 billion at
the end) or to pay back the vastly greater amounts that victims' account
statements showed he owed them (about $64 billion at the end)? And which of these was the true measure of
insolvency in this particular case? (Or
is neither the measure of insolvency here because, I have been told (I presume correctly but don't really know),
that by law a broker need not have on hand enough securities and cash to cover
the full value of customers' accounts (like, I suppose, a bank's reserves are
only a fraction of the deposits owing to bank customers)? Also, in a related vein, when did Madoff's
indebtedness to investors become so much greater than his assets that it became
clear he could never repay his entire debt, so that at that point his scam
conceivably could be thought to have become a partial Ponzi scheme (if there
can be a partial Ponzi scheme)? These are all questions to which we do not
know the answer (at least I do not),
and it is hard to believe that Madoff ever had $64 billion in securities and
associated cash, though it is not so hard to believe he had $17 billion (or at
least around $10 billion). But who knows what the situation was or what all the
factors are that could bear on it? All
that one knows for sure is that, by labeling Madoff a Ponzi scheme, and by
getting courts to agree to this (mistaken) view, the Trustee was relieved of
any possible need to prove that Madoff had the requisite illicit intent when he
transferred to an investor the money that the Trustee now wants to claw back.)
Also,
to reiterate, by calling Madoff a Ponzi scheme, the Trustee is enabled to claw
back any monies an investor took out over and above the amounts he put in. For, according to the Trustee, such monies
cannot be earnings accruing to the investor, since there were no transactions and thus no earnings.
The Trustee thus need not prove that
the monies taken out over and above principal were not earnings -- they are presumed not to be earnings.
But
what is the truth about earnings? Were there earnings, because of
appreciation in, and dividends and interest paid on, the securities Madoff
bought and sold for his own account
with the monies provided by investors, instead of buying and selling the
securities for his investors' accounts
as he should have -- securities which in law, although not on Madoff's internal
books, apparently belong to the investors?
Only the Trustee and SIPC know if there were such earnings, and they are
not saying, but instead are simply benefitting from the fact that, in a Ponzi
scheme, it is as sumed there were no
earnings and the Trustee therefore need not show
there were not sufficient earnings so that monies taken out by investors, over
and above the principal they put in, were
not earnings but simply other people's money as the Trustee claims.
Let
me now turn to the unintentionally somewhat humorous story of how I came to
realizations discussed above, and to a question that has been put to me by
laymen with whom I have discussed them, to wit, what is the responsibility
before the law, if any, of the Trustee (and his minions, and SIPC) for the long
prevalent belief that Madoff was a Ponzi scheme, a belief which they
continuously propounded and, I think, caused to be the accepted wisdom.
Like
everyone else I know, except the lawyer named David Bernfeld, I myself long
accepted and thought that Madoff was a Ponzi scheme. Even though I had read and noted the
statements quoted above from the SIPC report relating to the two computers
called House 17 and House 5, the statements, and their full meaning, had not
penetrated my thick skull any more than they had penetrated others. About three weeks ago, however, I was again discussing
aspects of Madoff with Bernfeld and another individual. Bernfeld made some comments that struck me --
they must have had to do with the fact that Madoff used the monies he took in
to float the rest of his business, and later that day I mentioned Bernfeld's
comments to my wife. Her response
stopped me cold, absolutely cold, and got me to thinking. Her response was something like this: "Of course, she said, "Madoff is a smart
guy. He wasn't going to do something
that would necessarily fail." The
implicit assumption underlying her remark, she confirmed, is that a Ponzi
scheme always fails in the end. None of
us have heard of one that succeeded -- although if there is one that succeeded,
of course we've never heard of it,
since one hears of Ponzi schemes only when they are uncovered, usually after
failure. To put her underlying
assumption a different way, Madoff probably did not initially intend to start a
Ponzi scheme, because such a scheme is inevitably destined to fail one day,
with disastrous consequences for its perpetrator. (If I remember correctly, after Madoff was
caught, the telly showed a video of him at some meeting or conference, telling
the attendees something to the effect that he thought Ponzi schemes resulted
from persons starting some financial arrangement that ultimately got away from
them and became a Ponzi scheme.)
Well,
if Madoff, as my wife said, is a smart guy who would not have intentionally
started something destined to fail -- a Ponzi scheme -- what had he intended to do? The answer was obvious. Initially expecting his business to be
profitable, he was using investors' money to float his proprietary trading in
the very securities he told the investors he was buying for them and, to some
extent, to float his market making operation, too. Indeed the fact that he was dealing for his
own account in the securities he told investors he was buying for them was
probably one of the reasons he knew so much about the securities that he
apparently could judge whether the prices for the securities shown on the
account statements sent to customers made sense. It was also, probably, one of the reasons --
although only one of them -- why
nobody in his firm thought boo about what he was doing. For the most part, all that they could see
was that, as expected, the
proprietary trading (and market making) arms of his firm were buying and
selling Fortune 100 securities. And it
enabled Madoff to parade himself before the world as what one suspects his
ambition and psyche demanded that he be:
a brilliant and enormously successful Wall Street investor.
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