Once Again, Seeing the Shadow of Madoff
Peter J. Henning, a professor at Wayne State Law School, specializes in issues related to white-collar crime and follows them for DealBook’s White Collar Watch.
Like the brief appearance of Punxsutawney Phil on Groundhog Day, the fallout from the enormous Ponzi scheme perpetrated by Bernard L. Madoff occasionally pops to the surface, only to recede again into the shadows, perhaps until spring arrives.
Last week, legal action in different courtrooms highlighted how slowly the government’s investigation of wrongdoing by others who operated near Mr. Madoff is progressing and indicated that there may not be much more to come in the way of enforcement actions.
Mr. Madoff’s sons mark and Andrew, his brother Peter and his niece Shana, all of whom worked at Bernard L. Madoff Investment Securities, agreed to a $200 million asset freeze in a case filed by Irving H. Picard, the trustee liquidating Mr. Madoff’s assets to pay off his victims. Mr. Picard contends that the family members received $141 million in the six months before the revelation of the Ponzi scheme, and that these and other payments constitute ill-gotten gains that belong to investors who lost money.
Mr. Picard and his lawyers faced a group of investors in Mr. Madoff’s firm in Federal Bankruptcy Court earlier in the week in a highly contentious hearing over how to calculate the amount of their losses. The fight is over whether the final — and completely fictitious — account statements sent out to investors should be the basis for their claims, or whether any amounts they received during the Ponzi scheme should be deducted from the amount each invested, not including any illusory gains, to determine actual loss.
Whatever the bankruptcy court decides to resolve this core issue is sure to be appealed, thus further delaying settlement of the investor claims. and any money the Madoff family members may be required to contribute to Mr. Picard’s recovery effort is certain to be just a drop in the bucket compared with the billions of dollars lost, however you care to determine that amount.
While the investor side of the case plods along, the enforcement side took a hit in Federal District Court early in the week when Judge Louis L. Stanton dismissed a lawsuit filed by the Securities and Exchange Commission that alleged fraud by one of the “feeder” firms that directed assets to Mr. Madoff’s firm in exchange for lucrative commissions. In June 2009, the S.E.C. filed suit contending that Cohmad Securities and its principals — Maurice J. Cohn, Marcia B. Cohn and Robert M. Jaffe — aided the Madoff Ponzi scheme by not taking steps to learn the true nature of Mr. Madoff’s investment program, which would have been revealed as a complete fiction.
The S.E.C. never accused the defendants, whose firm was partly owned by Mr. Madoff himself, of actually knowing what he was doing, but instead argued that there were red flags that should have tipped them off to delve deeper into his investment program. The complaint stated that “the Cohns were aware of highly suspicious facts and took affirmative steps indicating that they knew or recklessly disregarded that Madoff was engaged in a fraud.”
Unfortunately, after reading the scathing review of the S.E.C.’s investigations of Mr. Madoff over the years by the agency’s own inspector general, H. David Kotz, the same could well be said of the S.E.C.
Judge Stanton found no basis to plausibly infer any fraudulent intent by the defendants, which is required for the case to move forward. He also rejected the S.E.C.’s contention that Mr. Jaffe’s assertion of the fifth Amendment could support a finding that he had the requisite intent, noting that it was a “justifiable concern for anyone who did business” with Mr. Madoff’s firm to refuse to answer questions about his or her conduct in relation to his Ponzi scheme.
Judge Stanton dismissed the case pursuant to Federal Rule of Civil Procedure 12(b)(6) before it even got into discovery, which means the complaint was particularly deficient because any benefit of the doubt goes to the party opposing the motion. While the judge gave the S.E.C. the right to refile its fraud case within 30 days, it is hard to see how it can frame a complaint that will show the defendants were anything more than dupes in Mr. Madoff’s scheme.
The dismissal of the S.E.C.’s case highlights a greater problem the government faces in pursuing those who operated in the vicinity of Mr. Madoff’s scheme. Proving that any of them were actual participants in the fraud will be difficult because the entire premise of the scheme was to keep as much of it as possible hidden away from regulators and investors. The feeders who directed their clients’ investments to Mr. Madoff were handsomely rewarded, as Cohmad was, but being greedy is not enough on its own to show that one participated in a fraud.
If the S.E.C. cannot get past a motion to dismiss against a feeder, then the likelihood of any criminal charges for participating in Mr. Madoff’s fraud against those who funneled money to Mr. Madoff is nonexistent. It may be possible to file tax or record-keeping charges against them, depending on whether they were registered with the S.E.C. and correctly reported their purported gains, but those would not go to the core of the scam.
There have been only a handful of criminal cases arising out of the Ponzi scheme, none of which involve charges that the defendants knew what Mr. Madoff was doing. his chief assistant, Frank DiPascali Jr., and the firm’s former accountant, David G. Friehling, pleaded guilty to charges involving falsified records, but both acted more as enablers who greased the wheels for the fraud, never being let in on its inner workings. their cooperation could be useful against the feeders, but more along the lines of falsified records or tax evasion than anything else.
Two computer programmers who helped produce the reams of account statements used to assure investors were also charged with creating false books and records, but again they were simply cogs in a much larger machine.
Peter Madoff’s lawyers, in a recent filing in a civil case filed in New Jersey, disclosed that their client was a “subject” of the criminal investigation being conducted by the United States attorney’s office for the Southern District of New York, which was the reason why he asserted his fifth Amendment privilege in that lawsuit. This is hardly news because Peter Madoff was the chief compliance officer for Bernard Madoff’s investment advisory business and so was ostensibly responsible for overseeing its compliance with the securities laws — a job he clearly was not performing.
Other family members, such as Mr. Madoff’s wife and sons, do not appear to be targets of the criminal investigation any longer, so the potential pool of criminal defendants is fairly small.
Peter Madoff may be the last person who can plausibly be charged with actually participating in his brother’s Ponzi scheme, but even that appears to be a stretch at this point. The government has been investigating this case for over a year, and Mr. DiPascali has been cooperating for six months, but still no word on a criminal prosecution. While it would seem to be fairly easy to charge Peter Madoff with the same false-reporting crimes as others who worked at the firm, it is an open question whether a stronger case can be put together against him showing that he directly helped his brother defraud investors.
In looking at where the various cases are at this point, I am left with the distinct impression that Bernard Madoff will be the only one charged with perpetrating a Ponzi scheme of almost unimaginable proportions. To defraud that many investors, a number of whom were reputed to be quite sophisticated, of that much money for as long as it did should not have been possible by the work of one man operating with a few aides who were willing to turn a blind eye to what might be happening. but, perhaps it was.
The lesson that can be drawn from this, absent the revelation of greater involvement by others, is that a multibillion-dollar Ponzi scheme can be largely the product of one man able to win the trust of others and then prey on them. If Bernie Madoff could pull it off more or less on his own, then it may be that this was not an aberration — and that other huge Ponzi schemes are out there waiting to happen.
– Peter J. Henning
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Once Again, Seeing the Shadow of Madoff