February 23, 2009Re: Of Markopolos And Madoff, New Times And Conventional Wisdom,
SIPC And Clawbacks, Equitable Estoppel And Declaratory Judgments.
The hearings before Congress on the Madoff scandal on February 4th put one in mind of some pertinent, hopefully salient, ideas.
There is, to begin with, Harry Markopolos’ claim that many people in the financial world -- dozens, maybe even hundreds -- either knew or suspected that Bernard Madoff was a fraud. Some, to whom Markopolos explained his ideas about Madoff in the course of his investigations, thereafter avoided investing with the man whom Markopolos chooses to call BM, an alphabetically correct appellation that likely is not based just on literal initials. Others figured it out for themselves for one reason or another. Some of these thought Madoff’s results could not be real, others worried because Madoff refused to give them information during the course of their due diligence examinations, still others suspected strongly that something illegal was going on -- the unlawful act of “front running,” for example -- but went ahead and invested anyway because there was money to be made.
Add to this widespread Wall Street knowledge two other factors: One is that Madoff, according to Markopolos, was in effect bribing investment managers to send him money. He did this by offering them an unheard of fee for doing so -- he gave them four percent annually of the amount of money they had sent him. Some investment managers, in addition, were charging their customers an additional one percent “management fee” annually -- for doing absolutely nothing -- plus 20 percent of the profits, again for doing nothing. At least one was, I gather, also arranging for bank loans enabling customers to invest 4 times what they could ordinarily invest -- to invest three dollars of loaned money, on which the customer paid interest -- for every one dollar of the customer’s own money. By arranging for this dangerous leverage -- the customer, who may have lost a fortune, now has to repay the bank 75 percent of what he invested in Madoff -- the investment manager quadrupled the amount he himself made in fees, since the customer was now investing, for example, $400,000 instead of $100,000.
But, though lots of Wall Streeters knew or suspected that Madoff was a fraud, plenty of Wall Streeters were making a boatload of money off of “BM,” and some of them suspected illegality, not a single one of the Wall Streeters went to the SEC. Not one (except, of course, Markopolos). Markopolos says this is due to the Wall Street code of silence. You don’t rat out the next guy. Instead you let him defraud the innocent. (Subprime mortgages, anyone?)
Now all of this is relevant to a question on which I expressed skepticism in a series of blogs posted in January. The question is whether the investment managers of funds, large banks, etc., may be liable to persons who didn’t invest with BM through them. That they are liable, for failure of due diligence or worse, to people who did invest through them, seems beyond doubt. But how about people who didn’t?
Until the February 4th hearing, my view was that there was no reasonable chance of legal liability to such people, regardless of the investment managers’ moral responsibility arising from having failed to blow the whistle on BM. The moral responsibility arises because, had enough of them -- not just Markopolos -- talked to the SEC, it might have felt compelled to act. This is, you know, much the same principle as the moral responsibility of nearly the entire German people in the 1930s and 1940s for failing to act against Hitler, and the moral responsibility of so many Americans for Viet Nam and now Iraq. But though the investment managers bear moral responsibility, do they also bear legal responsibility?
Until now, as said, one would have thought it very unlikely. The reason is the legal concept of duty. This is quite often kept a crabbed, narrow concept in the securities field. Supreme Court Justices, several of whom place little value on truth or honesty (e.g., Rehnquist (previously), Roberts, Alito, Scalia), keep both liability, and the associated concept of duty, narrow in the securities field lest, they say by way of excuse, a defendant be liable to many people. So here one would have thought the duty -- and therefore the liability -- of fund managers, for negligence or worse, would extend only to their funds’ investors. But when you listen to Harry Markopolos, one wonders about this limitation. Lots of the fund managers seem to have been bribed, in effect, to do no due diligence and to keep their mouths shut about deep-seated suspicions instead of blowing the whistle. The defacto bribe money seems, again defacto, to have turned them into coconspirators with BM -- or aiders and abettors of BM -- who would say nothing lest they end the incredible gravy train he was providing them. And as coconspirators, or aiders and abettors, they would be liable to everyone whom BM injured, not just to the people who invested in BM through their institutions.
That these money mangers who were in effect bribed to go along and to keep their mouths shut may be considered coconspirators and/or aiders and abettors is a possibility enhanced by another instrumental role they played. From Markopolos’ testimony, it appears that, from about 1999 or 2000 onward, Madoff needed a continuing influx of really big money to keep his scam going. He got these needed large sums from the funds and institutions, whom he defacto bribed, in order to keep his fraud going and to grow it, according to Markopolos, from between three to seven billion dollars to perhaps fifty billion dollars. Without getting the needed money from large institutions that in effect accepted bribes to look the other way, BM’s Ponzi scheme would have collapsed eight or nine years ago. In those eight or nine years, thousands of new people were sucked in, older investors increased the amount of principal they put in, and people paid large, even huge, amounts of taxes on phantom earnings. None of this would have happened had the major feeder funds and feeder banks not accepted huge defacto bribes to ignore due diligence and look the other way. The culpable funds and banks were thus coconspirators with regard to, and aiders and abettors of, the entire scheme and everyone’s losses in the last ten years or so, not just the losses of those who invested through them. For they made possible the continuation of the scheme and the last ten years’ losses.
Over the course of the next year or two, a lot more is going to be learned about the feeders and their managers. Sometimes these institutions (like European banks) or persons still have gazillions of dollars despite Madoff; they are certain to be sued by their own investors (unless they make good the investors’ losses); they might very well be sued by others; and the prospect of such suits, and of all manner of victims being the plaintiffs in those suits, are likely to increase, perhaps to increase exponentially, as more and more facts come out showing that they were in effect bribed to such an extent, and in various ways, that they became defacto coconspirators and aiders and abettors.
Let me turn now to some of the remarks made at the hearing by Congressman Ackerman. If there can be humor to be found in such a disastrous situation, Ackerman’s bitterly critical comments and the SEC’s preposterous responses provide it. They also provide a lesson in the incompetence we have had in government not just for the last nine years since the imbecile became President in 2001, but since about 1965.
Seeing that once again members of the SEC were refusing to answer legislators’ questions and statements about what had happened, Ackerman said, “We’re talking to ourselves and you’re pretending to be here.” Now that is really funny when you think about it: “you’re pretending to be here.” What a line.
Just afterwards, Ackerman said to the SEC witnesses “one guy [Markopolos] with a few friends and helpers discovered this thing nearly a decade ago, led you to this pile of dung that is Bernie Madoff, and stuck your nose in it, and you couldn’t figure it out. You couldn’t find your backside with two hands if the lights were on.”
They couldn’t find their ass with two hands if the lights were on. Now that’s funny. Markopolos put the same point a bit differently. He said that, if you put the entire SEC into Fenway Park, they wouldn’t be able to find first base. The two analogies -- finding one’s derriere and finding a base -- used to be combined in Chicago in the 1950s, where an expression was that a person couldn’t tell his ass from third base. No matter which expression is used, the description previously has fit most of the federal government most of the time since 1965 or so. A lot of us thought the SEC was competent; I personally thought hard before turning down the offer of renowned SEC Chairman Manny Cohen to work for him, in 1964 or 1965, because the SEC was regarded so highly then; but we now have learned that for several years the SEC -- like the Department of Defense, the Department of Education, the CIA, the National Security Council and other federal bodies -- hasn’t been able to tell its ass from third base.
The SEC official who took the lead in trying to make excuses while saying nothing substantive tried to ward off Ackerman by saying the SEC now has a case pending against BM. To which Ackerman replied: “You took action after the guy confessed. He turned himself in. Don’t give yourself any pat on the back for that.” The fool official responded that she cannot talk about the Madoff case itself, but only in (meaningless) generalities. To which Ackerman replied, “You know, if anybody made the case better than Mr. Markopolos -- and I don’t think anybody could -- about you people being completely inept, you have made the case better than him.” The high SEC official he was talking to resigned her position a few days later. Does anyone not think she was pushed out? -- Deservedly.