Investing With Bernie Madoff: How It Happened


Global Research, January 23, 2009



What Happened, And What Might Be Done.

I turn now from preliminary comments to specific courses of action. As you will see, each course of action being generally discussed in the media today will be insufficient, will be too little, too late, especially because the law is not designed to handle a disaster of this magnitude.

There is, first, the Security Investors Protection Act, commonly referred to as SIPC (pronounced Sipic). Under this Act investors can receive up to $500,000. But, if they have taken money out of Madoff, this might be subtracted from the amount they receive -- it is not yet completely clear how SIPC intends to handle this question, although one major straw in the wind could be that the head of SIPC told Congress that SIPC would reasonably quickly pay people who could show they never took money out of Madoff. However, SIPC will not cover persons who invested through a fund, rather than directly with Madoff. (One person has filed a petition requesting that this limitation be dropped.) SIPC covers only a portion of people’s losses, even small people. And if SIPC subtracts from the $500,000 the amounts that a person has taken out of Madoff, it is likely that those who are most desperate will get nothing: those who were living off what they thought were their earnings from Madoff -- e.g., older people -- have been taking money out every year, and likely would get no money from SIPC.

Then there is the possibility of recovery from the Trustee in Bankruptcy, who has taken over Madoff’s business and estate, is seeking hidden monies, and will divide proceeds among the investors. A problem here is that it is widely thought that the Trustee is not going to uncover much money, at least not in comparison to the amounts investors are owed. So investors will get little back from the Trustee.

Another problem here is the so-called clawback problem. The media, and lawyers whom it quotes for reflexive positions representing the conventional wisdom, say that people who took money out of Madoff during the last six years will have to give back that money -- this is the so-called clawback. This is terrifying to people, and, rightly so. Having been wiped out, or having suffered a huge loss that leaves one with only a small percentage of what one had, people now face the prospect of being obligated to give back six years of withdrawals -- often withdrawals they needed to live, as with older people, or for perfectly reasonable purposes like buying a house. However, what is given much less media play is that, as I read the leading case in the field, clawbacks, in part at least, will not apply to people who had no inkling that anything was wrong -- as true of so many of Madoff’s victims. It applies only to people who took out money after learning of facts that reasonably should have put them on notice that something was wrong (and it would apply, I assume, though I haven’t read anything explicit on this, only to money they took out after being put on such notice). And finally, clawbacks will not apply, I believe, to the extent that money innocently taken out, with no knowledge of possible illegality, did not exceed the principal put in.

It is, of course, in a way quite perverse to claw back money form people who took out their money after they learned that something could conceivably be wrong. For taking out their money then, as I think one pension plan actually did if I remember correctly, is exactly what one would expect and hope they would do. What else should they have done -- left their money in if they believed it was being stolen? Of course, it is possible that they should have gone to the SEC but didn’t, and there are theories under which this could also make them liable to others, but leaving their money in to be stolen by Madoff hardly seems what a capitalist system expects from people.

Whether the Trustee in Bankruptcy is going to insist on clawbacks, at least from those who were not completely innocent of knowledge that something unlawful was happening, is unknown. But people remain terrified of the possibility, and as the media has said, many who innocently took out monies are considering not making claims either to SIPC or the Trustee lest their withdrawals come to these parties’ attention when otherwise they might not due to the abominable condition of Madoff’s records. Victims of Madoff are understandably terrified of being denuded of their few remaining assets, if any.

Then there are tax refunds. Persons who took supposed earnings (shown by their monthly statements) out of Madoff -- to live, for example, or to buy a house -- paid income taxes on that money at the rates applied to ordinary income -- roughly a bit more than one-third the supposed earnings. They can get refunds of their last three years of taxes (2005, 2006 and 2007), and of estimated taxes already paid on the supposed Madoff earnings in 2008. But this will amount to only a fraction of the total income taxes many of them paid on supposed Madoff income (called phantom income) over the years -- over 20 or 30 years of investing with Madoff.

You know, if these people had been committing tax fraud on the government for the 20 or 25 years, so that the government never got the tax it was entitled to, the government could go back and collect the taxes -- with interest -- for the full period of 20 or 25 years. But when the government, for 20 or 25 years, got taxes it was not entitled to because the tax was paid on phantom income, and when the horrible dereliction of a government agency is heavily responsible for the people thinking they had real income and paying taxes on it to the government, the people get refunds for only three years. The government can get all 20 or 25 years, the people can get only three years. This does not seem fair, and still less so in the context of governmental dereliction. If you ask me, there should be a special law allowing Madoff victims who paid taxes on phantom income to the government -- taxes which would not have been paid but for governmental dereliction -- to recover all the taxes they paid on phantom income. This would go some way towards easing the financial problem -- the problem of how to live -- of many Madoff victims, especially those who have been economically devastated. Refunds of income tax will not, however help all investors. In particular, charities and pension plans that were crippled or wiped out are nonprofit, tax-free organizations. So they never paid income tax, and will get no refunds of tax. Neither will people whose IRA monies were in Madoff, because they too paid no taxes on supposed earnings from Madoff.

There is also another tax consequence besides refunds for people who paid income tax on phantom income. There is a theft deduction for the amount lost by fraud. The deduction can be taken against income in 2008, when the theft was discovered, can be used against (can be “carried backâ€