More Fallout From the Madoff Disaster

One of the problems with the litigious nature of the Bernie Madoff Ponzi scheme issue revolves around how the losses incurred in the fraud are calculated. The current court-appointed trustee assigned to this case is calculating a loss as the total amount of money a individual put in to the scheme, minus the total amount of money they withdrew. Pretty straight-forward, right? That formula will return to the investor the exact amount of real money that they lost in the scheme. But some of the fraud victims have a problem with that formula.

These litigants want the account balance shown on their last statement from Madoff to be considered the amount of money they lost, despite the fact that those numbers were completly fabricated by Madoff and have no base in reality.

A few months ago – back in June – the litigants filed their complaint in a New York City federal bankruptcy court in an effort to force the trustee to use their stated account balance in their claims eligibility calculation.

In this situation, and in other similar investor fraud incidents, a litigant is considered eligible if they are determined to have suffered a loss under the fraud. If that is the case, then the Securities Investor Protection Corporation steps in and provides them up to $500,000 in coverage, including $100,000 in cash.

Any losses over $500,000 are compensated for by splitting up the fraud perpetrator’s assets seized by the court-appointed trustee (which is, in and of itself, a very complicated issue, particularly in the Madoff case). Because some of the victims withdrew money out of their investment accounts with Madoff that in total exceeded the amount of money they put in, they wouldn’t be considered eligible under how the trustee is currently determining eligibility. But by altering how a loss is determined, more victims would be eligible for coverage by the SIPC.

Obviously in that scenario, the SIPC would be compelled to doll out more money. The SIPC is not a government agency; it uses money it collects from it members – broker dealers – to pay out in the event of fraud. If, however, the SIPC is not able to cover the fraud payouts, they could use taxpayer money to make up for the loss.

If the changes proposed above are enacted, the required payouts could total Billions of dollars, a sum total that would certainly empty the SIPC coffers (the SIPC currently has less than $2 Billion in assets) and the federal government would certainly have to step in to cover the gap.

Therein lies the controversy; it would be a difficult task for someone to justify dramatically altering the current practices of the SIPC in order to cover.

I’ll certainly be tuning in to see how this turns out; but I don’t expect a resolution to come any time soon, especially because this particular complaint is wrapped up in a series of other complaints that have been levied as part of the litigation process.

Readers: how do you feel about this scenario? Certainly arguments can be made on either side of the issue, but I personally wouldn’t support changing the current practices of the SIPC.

-Michael