New York economist Irwin Kellner says Bernard Madoff defrauded him of at least $2.3 million in what may be history's largest Ponzi scheme. He's sued the disgraced financier — but left room to add up to 100 yet-to-be-named co-defendants.
Illinois investor Pasha Anwar says he, too, was a victim. He's suing Fairfield Greenwich Group, one of several feeder funds that channeled clients' investments to Madoff.
New York retiree Phyllis Molchatsky says she lost her $1.7 million life savings to the alleged scam. She's suing the Securities and Exchange Commission, the agency that regulated Madoff's business.
Chilean firm Inversiones Mar Octava Limitada says it was defrauded of $300,000. The company is suing Banco Santander, the Spanish bank that invested billions of dollars in clients' funds with Madoff. Other defendants include divisions of HSBC and accounting firm PricewaterhouseCoopers.
And a Philadelphia-area pension fund for hospital and health care workers says it lost about $700,000 in the alleged fraud. It's suing the fund adviser that placed the investment with Madoff.
As the alleged losses in the scandal mount, rising toward the $50 billion estimate Madoff gave the FBI, victims are focusing their recovery efforts less on the accused fraud architect than on the institutions, individuals and others that had dealings with him. The legal strategy reflects the reality that Madoff's assets almost certainly won't cover the losses, and it signals a search for related deep pockets that might.
"Victims are scrambling as they try to figure out whom they can sue," says Michael St. Patrick Baxter, a Covington & Burling law firm partner in Washington, D.C., and chairman of the American Bar Association's business bankruptcy committee.
"Their exit strategy is basically to sue somebody who has the wherewithal to make them whole," Baxter says. "And that might be the fund that got them involved, or it might be the financial adviser who looked at the investment and recommended it."
With billions of dollars riding on the outcome, plaintiff lawyers predict the growing array of lawsuits and alternative targets will ultimately reimburse victims for at least some of the expected repayment shortfall. Federal prosecutors, meanwhile, are separately pressing a criminal prosecution of the disgraced financier.
Madoff earlier this week agreed to voluntarily transfer his businesses, related Manhattan real estate, personal property in the offices and corporate entertainment tickets to Irving Picard, the court trustee appointed to seek assets for distribution to victims of the alleged fraud.
But a Monday court filing shows his attorneys contend that the $7 million apartment where he's under house arrest, $45 million in municipal bonds and $17 million in a Wachovia bank account all belong to his wife, Ruth, "are unrelated to the alleged Madoff fraud" and should not be seized.
During an initial Feb. 20 meeting with Madoff investment clients, Picard said he'd received approximately 2,350 customer claims, totaling roughly $1 billion. The number of claims is expected to at least double by a July 2 filing deadline, said David Sheehan, a lawyer assisting Picard.
No trade history for 13 years
Picard, who said there's no evidence Madoff bought any securities for his investors for at least 13 years, has so far managed to recover less than $1 billion in assets. While the pot will grow with the planned sale of a Madoff business that matched stock market buyers and sellers — as well as efforts to claim funds from any confederates with complicity in the alleged fraud — the recovery effort is likely to come up short.
Even the prospect of as much as $500,000 in repayment for each customer account from the Securities Investor Protection Corp., a federally established, insurance-like program, won't be enough to fully repay Madoff investors.
"There will be a shortfall somewhere along the line," Sheehan told creditors during the meeting.
Moreover, some of those who now count themselves as Madoff victims could find themselves being pursued by the trustee, because they withdrew phantom "profits" that exceeded their investments.
In a legal procedure known as a claw-back, Picard can attempt to force some of those investors to return the money. Federal or state laws authorize him to target any "preference" repayments made within 90 days of the December collapse of the alleged fraud, plus so-called fraudulent transfers stretching back as long as six years.
"You have to realize you got somebody else's money," said Sheehan, describing what he called the "sharing the pain" procedure to Madoff clients.
But even dozens of successful claw-backs — such as those that raised millions for repayments in the 2005 Bayou Management case, a hedge fund that collapsed from a multiyear fraud — would represent little more than a financial Band-Aid for victims in a case as massive as the alleged Madoff scam.
"The unfortunate reality is that in most of these massive frauds, the recovery for investors is very small. It's often less than 10 cents on the dollar," says Keith Dutill, a partner at Stradley Ronon Stevens & Young in Philadelphia who helped a court receiver recover $75 million for investors defrauded by the collapse of a Cayman Islands hedge fund.
Madoff 'could be left penniless'
Consider developments in the proposed class-action lawsuit that Uniondale, N.Y., attorney Mark Mulholland's law firm filed against Madoff on behalf of Kellner, the chief economist for MarketWatch and proposed lead plaintiff. Docketed one day after Madoff's Dec. 11 arrest, the case grabbed instant headlines.
But Picard's appointment legally blocked individual claims against Madoff, as well as any other potential recovery targets the trustee might pursue, Mulholland says. How much might a class-action case eventually recover?
"That certainly is an open question. Once Mr. Madoff resolves his problems with the U.S. Attorney's office and any other governmental entity that has jurisdiction, he could be left penniless," says Mulholland.
That's one reason he left room for 100 "John Does" as potential co-defendants in the case. "It quite well could be that one of them would become most interesting from a financial recovery perspective," says Mulholland.
Victor Stewart, a lawyer representing Anwar, an international finance executive who lives near Chicago, says he recognized that the chance of a significant recovery from Madoff was low.
Hoping to restore the broken nest egg Anwar and his wife had built to send their two children to college, Stewart sued the Fairfield Greenwich Group and its principals for alleged negligence, failure to perform fiduciary duty and unjust enrichment.
"If they had been doing even a modicum of what they were supposed to be doing, they would have vetted Bernie Madoff to begin with. And they would have checked on him as time went on," says Stewart, a partner at Lovell Stewart Halebian in New York. "They weren't doing any due diligence of any kind."
Although Fairfield Greenwich says the investment company and its executives were fooled by Madoff, too, Stewart calls that claim "the height of arrogance."
Molchatsky, a 61-year-old New York resident forced into retirement by Parkinson's disease, is taking a legal gamble to recover her life savings by suing the SEC.
In most cases, federal agencies are immune to negligence lawsuits such as the one filed on Molchatsky's behalf by Howard Elisofon, a Herrick Feinstein law partner in Manhattan. But the Madoff scandal includes reports that the SEC was repeatedly warned about the financier by Massachusetts fraud investigator Harry Markopolos and others.
Elisofon argues that instead of mounting a full investigation in response to the warnings, the SEC violated its own procedures by essentially kicking the tires in reviews that found no major wrongdoing with the money manager's operation.
"If they had exercised even a modicum of care, they would have found a fraud," says Elisofon.
The SEC has declined to comment on its Madoff oversight because the issue is the subject of an internal investigation by agency Inspector General David Kotz.
Several attorneys not involved in the case say the legal strategy represents a long-odds effort at best. But Molchatsky, who says the fraud may force her to sell her suburban New York City home, remains hopeful.
"If the government knew you were being stalked and it didn't stop the stalker, then you should be able to sue the government," she says.
Like Anwar, Inversiones Mar Octava Limitada, the investment firm based in Talcahuano, Chile, raises the legal claim about a fiduciary's duty to investors — but aims it at one of the world's most prominent banks.
"They had invested through Banco Santander, and they ended up with Mr. Madoff without realizing it," says Michael Hanzman, the Florida attorney representing the company.
The federal complaint in the proposed class-action lawsuit charges that the website of Optimal Investment Services, a fund controlled by Banco Santander, stated that it subjected proposed investments to "detailed scrutiny," and based decisions "on a careful analysis of many investment managers."
But the lawsuit charges that carelessness and a "lack of scrutiny" of Madoff "falls far short of the legal duties owed" to the Chilean company and similar investors.
"Indeed, there was a plethora of red flags that would have alerted any reasonable investor that Madoff was running a Ponzi scheme," the lawsuit charges.
Banco Santander and co-defendants in the case say they were fooled by Madoff. The Spanish bank has offered its private banking clients $1.8 billion in shares for losses tied to the alleged Madoff fraud. The bank said last month that 70% of its customers had agreed to accept the compensation offer.
'Any number of red flags'
Fiduciary duty also plays a central role in the proposed class-action lawsuit filed last month by a pension fund that represents more than 10,000 Philadelphia-area hospital and health care workers. The lawsuit targets Austin Capital Management, an investment firm that placed part of the fund's investments with Madoff.
But in a legal twist, the fund charges that Austin Capital violated the Employment Retirement Income Security Act, the federal law that sets minimum standards for retirement and health benefit plans. KeyCorp key, parent company of Austin Capital, says it does not comment on pending litigation.
Theodore Lieverman, a Spector Roseman Kodroff & Willis law partner representing the pension fund, says ERISA regulations designate investment managers as fiduciaries and require them to act "prudently" when they make decisions for retirement and benefit funds. As a result, he says, the pension fund merely needs to prove "that Madoff was not a prudent investment."
"We're arguing that there were any number of red flags out there that Austin Capital Management or anyone else investing should have seen," says Lieverman. "It's hard to argue it was a prudent investment."