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It Appears That The Madoff Scam Was Not, Repeat Not, A Ponzi Scheme.

By       Message Lawrence Velvel     Permalink
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July 18, 2012

It Appears That The Madoff Scam

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Was Not, Repeat Not, A Ponzi Scheme.



From the time Bernie Madoff's fraud was uncovered in December 2008 until today, a period of over 3 - years, his scam has been regarded as a Ponzi scheme.   I know of only one person, a brilliant lawyer named David Bernfeld, who did not concede it was a Ponzi scheme, but nobody accepted his view.   Victims, (very importantly) the media, and courts all thought and said Madoff was a Ponzi scheme.   Of enormous importance the Trustee in the Madoff case, Irving Picard, and his chief lawyer, David Sheehan, regularly insisted it was a Ponzi scheme because, they said, there were no securities transactions, and accordingly there were no securities, and no earnings (and could not have been any earnings).   Crucial legal and factual consequences, some of which are mentioned below, flowed from the fact that the scam was regarded as a Ponzi scheme.

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But now it is beginning to look as if Madoff was not a Ponzi scheme.   It was a huge fraud to be sure, but not the species of fraud called a Ponzi scheme, with the consequences attendant upon that species of fraud.

As I have always understood matters (I think and hope correctly), in a Ponzi scheme the crook tells people that he will be investing their money in particular stocks or particular goods or what have you, and then fails to do so.   Instead he blows the money, uses it for other purposes, etc.   The key point, the central point, is that he does not purchase or acquire the investments that he told victims he would acquire in order to induce them to give him their money.   Along this line, in the Madoff case the Trustee has always insisted -- in court filings, in remarks, whenever and wherever -- that none of the securities that were shown in victims' monthly account statements -- none of the securities that Madoff inducingly told victims he would buy and sell for them -- were ever bought or sold.   There were, the Trustee and his lawyer have told victims, the courts and the world, no transactions in these securities.   Ergo, a Ponzi scheme.

But apparently there were purchases and sales of these securities -- untold and currently unknown billions of dollars of these purchases and sales.   On his books, however, Bernie Madoff did not, as he should have, credit the investor-victims with ownership of the billions of dollars in securities he was buying (and selling).   Instead, on his books he unlawfully kept ownership for himself.   There was a fraud alright, but the fraud was not the Ponzi fraud of failing to buy the very items the crook said he would buy.   The fraud, rather, was in failing to credit his investors with the ownership of the securities on Madoff's books, as should have been done, and instead keeping the securities for Madoff himself.   The securities, that is to say, were bought and sold for what was called the proprietary trading arm of Bernie Madoff's company, the arm which bought and sold securities, and attempted to thereby make a profit, for Bernie's company.   They may also have been bought for the market making arm of his business.   The monies given to Madoff by his investor victims was used not to purchase the promised securities for them, but instead to purchase those securities for Madoff himself -- for his own account, as it is said, and, when necessary, to support another arm of his business, the market making arm.   (The monies were also used to fund the Madoff family's extravagant life style.)   The account statements received every month by victims, and showing that they owned the securities, were a lie, a fraud.

It would be fair for the reader to ask at this point, "How do you know all this?   Can you be sure of it?"   Let me answer this way:   For reasons discussed below, and for other reasons too, we already know enough to be virtually positive that the foregoing is what occurred.   But we do not know enough to know certain of the details, e.g., what was the total value at any given time of the securities that Madoff purchased for his own account, and how closely did the value of these securities match up with the amounts of monies victims invested with him; how much of the money invested with him was used to support the market making arm of Madoff's business or the family's life style instead of being used to buy the securities for Madoff's own account that he fraudulently told victims were being bought for them; what amounts of profit or loss did Madoff make or suffer on the purchases and sales of securities for his own account.

Well, then, why do we not know these details over 3 - years after the Madoff scam was uncovered?   The answer (or answers) to that, I'm afraid, is (or are) pretty simple.   The only persons or organizations that have the information needed to flesh out the details are the Securities Investor Protection Corporation (SIPC) and its Trustee, Irving Picard (and his army of lawyers, workers, and acolytes).   In order for the rest of us to flesh out the details, we have to obtain what lawyers call "discovery" from SIPC and the Trustee.   That is, we have to obtain from SIPC and the Trustee, in law cases, the documents and information that will enable us to figure out the details.   I am assuming, of course, that SIPC and the Trustee will not give the information to us voluntarily, outside the four corners of law cases, because they benefit, and for years have benefitted, from us not knowing the details, as discussed later, and to date they have vigorously resisted any discovery of anything in law cases.

Also to this day, however, the lawyers arrayed against SIPC and the Trustee in law cases have basically not pushed for, or even sought, the needed discovery or any discovery.   There has been only one exception.   (Guess who that was?)   This writer, acting as his own lawyer, sought discovery on a number of issues in the Bankruptcy Court, sought to have the Second Circuit require requested discovery, and then told the Supreme Court that the absence of discovery was an important reason to hear the Second Circuit's ruling on net equity.   In the Second Circuit and the Supreme Court a small number of other lawyers at least mentioned the absence of discovery, after totally ignoring it in the Bankruptcy Court, but there has been only one person really pushing for it.   That person -- me -- lost in every court, with SIPC and the Trustee vigorously, even stridently, and on one or two occasions even falsely, resisting discovery and telling the courts, ultimately with the support of the SEC and the sainted Solicitor General's Office of the Department of Justice, that discovery was unnecessary or unneeded or what have you.

So . . . . when you get right down to the truth, the reason we cannot yet know all the details we would like to know about what Madoff did, the reason we cannot know the full truth of what happened, is that the Trustee and SIPC, supported by the courts and by the Solicitor General, have not provided, and have strongly resisted providing, the information needed to determine the full truth.   We know enough anyway to be pretty certain of the broad outline of what happened, but not enough to know certain relevant details.

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   But we do know that Madoff Securities was a single corporation that was internally divided into an investment advisory arm, a market making arm, and a proprietary trading arm.   We also know that Bernie Madoff ran and had sole control over the whole shooting match -- over the entire business and all of its operations, including all three of its arms.   Also, persons who traded for Madoff apparently have said that the securities in which Madoff traded for his own account were generally the same securities that appeared in investors' monthly statements as the securities he allegedly was buying and selling for them.   And we know that every year Bernie Madoff transferred scores of millions of dollars from the so-called 703 Account at Chase Bank, the account in which he put monies received from investors, into the so-called Madoff 621 account at The Bank of New York, the primary bank account for the proprietary trading and market making arms of Madoff's business.  

This last point was told to us by SIPC itself at page 20, and in a table on page 20, of a January 24, 2011 letter SIPC sent to a Congressman in answer to questions he asked SIPC.   The letter thus said:   "The table below includes amounts transferred directly or indirectly from the Madoff 703 Account at Chase Bank, the primary bank account used by House 17 (the investment advisory business), to the Madoff 621 Account at The Bank of New York, the primary bank account used by House 5 (the proprietary trading and market making business)."   The table referred to shows almost $734 million being transferred from 2000 to 2008 from the investment advisory bank account (Chase 703) to the proprietary trading and market making bank account (Bank of New York 621).  

SIPC further said, on the next page of its letter (page 21), that "the funds transferred from House 17 [the investment advisory business] were recorded by House 5 [the proprietary trading and market making businesses] as revenue" for the latter and "represented a substantial part of House 5's liquidity.   Without these funds from the IA [investment advisory] business, House 5 would have incurred annual net losses . . . ."   In other words, SIPC itself has told us that the monies Madoff took in from victims/investors in his IA business were used to prop up and support his market making and proprietary trading businesses, the latter of which deals in the purchase of securities for his own account.   As indicated, we do not know the total amount of such securities he owned at any given time, though the collective amount of securities and associated cash he had in any given year must have usually been hundreds of millions or billions of dollars more than the amount of monies transferred from Chase 703 to Bank of New York 621 during that year, since the collective securities and cash included stocks and cash from all prior years.   But, as previously indicated, we do know that Madoff was taking money from the investment advisory business account (Chase 703) to support the proprietary trading arm of the business which bought and sold securities for Madoff himself and to support his market making.

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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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