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General News    H3'ed 4/21/09

Feeder Funds And The SIPC

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Message Lawrence Velvel
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April 21, 2009

 

Re:  Feeder Funds And The SIPC.

 

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            I’m probably missing something, in fact I’m probably missing a lot, but as far as I know there has been little in the way of official release of certain crucial numbers related to the Madoff scam.  The government has said that $65 billion was lost; I presume that $65 billion is the collective total shown on the November 30, 2008 statements, and it therefore is the number I shall use here for the total loss.  It has been estimated at various times, if memory serves, that there were either 8,000 accounts or 13,000 accounts. But these would seem to be the number of accounts listed with Madoff, and, since a feeder fund was but one account, these numbers do not include any of the persons who invested through the feeder funds.  It has also been estimated -- with what accuracy I have no idea -- that if you were to count all the people who invested through feeder funds, pension funds, etc., there are 50,000 people who lost money with Madoff.

 

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            The numbers -- which we generally cannot know for sure at present because of silence by those who may know them -- are especially important with regard to restitution from SIPC (as well as certain other modes of restitution). For the numbers can tell us what the chances of recovery from SIPC actually are.

 

            In this connection, though I personally am a direct investor, I am one of those who have never understood the morality or the decency of denying SIPC recovery to those who invested through feeder funds.  In this regard, I once pointed out on a MadoffSurvivors Steering Committee phone call (or Advisory Committee phone call or a whatever-it-is-now-called phone call) that the SIPA’s use of the word “customer,” the word which is the basis of excluding feeder fund investors from obtaining SIPC recoveries, does not itself exclude investors through feeder funds from being customers. There is nothing ex cathedra or from on high about it.  Rather, the definition of customer that causes feeder fund investors to be excluded from individual recoveries is judge made law, law made decades ago by courts in accordance with arguments put forth by SIPA.  This point was met on the phone call with a degree of hostility and scorn on the part of one individual that was startling if not shocking.  (As I understand it, the individual claimed -- wrongly -- that the definition of customer which excluded feeder fund investors was from the statute rather than from judicial rulings.)  It was in part this person’s continuing vitriol (not to mention other, related conduct that the Advisory Committee knows of very well) that caused me to resign from the Advisory (or Steering) Committee about two weeks ago. But the fact nonetheless is that the definition of “customer” which excludes feeder fund investors is not in the SIPA statute, but goes back, as near as I can tell, to the 2d Circuit court of appeals opinion in early 1976 in SIPC v. Morgan, Kennedy & Co.  This was before there were feeder funds, as far as I know, although at the time there were smaller collective groups of defacto or dejure investors such as the 108 person profit-sharing plan involved in the Morgan, Kennedy  case itself.  Of course, even though the Morgan, Kennedy interpretation of customer is not suitable to current conditions, its age -- 33 years -- may make it “undislodgeable” so to speak.

 

            Recently, however, to judge by the traffic on MadoffSurvivors, some investors through feeder funds, who claim -- perhaps rightly (probably rightly?) -- to be the large majority of people who lost money, are beginning to rebel against the focus (as I and others see it) mainly on direct investors, with associated lack of focus on feeder fund investors.  There are feeder fund investors who seem no longer to accept the argument that the group must focus on what its leaders regard as more doable - - e.g., getting rid of Picard’s unjustifiable definition of net equity, and raising the SIPC recovery to $1.6 million, all for direct investors, instead of trying to get SIPC recovery for in direct investors who invested through feeder funds.

 

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            Now, it may be that certain numbers will make it insuperably difficult to have the definition of “customer” changed to include investors through feeder funds.  (I shall discuss these numbers below.)  But if this is true, it should reinforce in people’s minds, especially people who were feeder fund investors, the vast importance of seeking other forms of restitution, especially restitution through taxes. The IRS’ recently announced “safe harbor” provisions for theft deduction exclude feeder fund investors because they are not so-called “qualified investors.”  This is an outrage.  As adequate as the IRS’ recent revenue ruling and procedure may be for some people (especially the very wealthy who will obtain deductions worth scores of millions or more), it is vastly inadequate for others, and people should work on getting them changed to include feeder fund investors.  People should also get behind the efforts of Steve Breitstone to obtain a change in the tax law that would allow persons to get refunds of taxes paid on phantom income going back to 1995 or 1992 (when the SEC assured people -- wrongly -- that the deal was on the up and up, that there was no fraud, no Ponzi scheme).  A combination of making theft deductions available to feeder fund investors who paid taxes, plus tax refunds for all defrauded investors going back to 1995 or 1992, would go far towards providing adequate though not full restitution for many who for years paid the IRS taxes to which it had no right and which resulted from a scam that the IRS itself seems to have furthered in 2004 by approving of Madoff as a non-bank custodian for IRAs in violation of the IRS’ own regulations.

 

            Of course, though people should focus on getting legislative corrections of the IRS’ inadequate recent tax guidance and on obtaining legislation allowing refunds, this won’t help those who did not pay taxes:  charities, IRAs, pension plans, etc.  To help them, something else is needed:  either recovery through SIPC, which would leave many of them vastly short of adequate restitution for the governmental derelictions committed by the SEC and, apparently, the IRS too, or recovery through a plan that I think better than anything currently in focus.  The plan in mind would cover all investors of any type, would enable them to obtain roughly the same annual income as before though they would have to wait several years to recover principal, and would cost the government less money for many years than anything else that people currently have in mind. 

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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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