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Entries in Madoff (33)

Sunday
Nov112012

Former Madoff Controller Pleads Guilty To Fraud Charges

The first non-Madoff employed at Bernard Madoff's brokerage firm pled guilty to aiding and abetting Madoff's $65 billion Ponzi scheme for more than two decades.  Irwin lipkin, the former controller of Bernard L. Madoff Investment Services ("BLMIS") and the third employee after Madoff and his wife, entered a guilty plea to several fraud charges including conspiracy to commit securities fraud, to falsify records, and to make false filings with the SEC.  Pursuant to his plea agreement with authorities, Lipkin, 74, faces up to ten years in federal prison.

Lipkin was hired in 1964 as the first non-Madoff at BLMIS, and participated in maintaining the firm's financials in his job as Controller, as well as assisting Madoff in performing internal audits of the securities positions held by BLMIS.  Along with several other Madoff employees, Lipkin maintained the BLMIS General Ledger and Stock Record.  Beginning in the 1970's, Lipkin falsified entries in the General Ledger designed to manipulate the purported profits and losses realized by BLMIS, and were done at Madoff's behest.  Additionally, in connection with audits by the Internal Revenue Service ("IRS"), Lipkin and others backdated the General Ledger and other supporting documents to appear consistent with representations made to the IRS.  After his retirement, Lipkin also instructed other Madoff employees how to continue his duties to perpetuate the fraud.  

According to authorities, Lipkin also arranged for his wife to receive a regular paycheck from BLMIS despite the fact that she did not work at BLMIS or provide any services on its behalf.  Even though Lipkin retired in 1998, he continued to receive a salary and benefits until the scheme was uncovered in December 2008.  

As part of his restitution agreement, Lipkin has agreed to forfeit $170 billion, which includes all real and personal property owned.  He is scheduled to be sentenced on March 13, 2013.  

A copy of the criminal charging document against Lipkin is here.

Thursday
Nov242011

Congress: SIPC Needs to Decide Whether it Will Provide Coverage to Victims of Stanford Ponzi Scheme

Nearly six months after the Securities and Exchange Commission ("SEC") issued a formal request to the Securities Investor Protection Corporation ("SIPC") for coverage of losses suffered by victims of R. Allen Stanford's $7 billion Ponzi scheme, investors are still waiting to hear whether SIPC will heed the SEC's request and begin proceedings to return some or all of investor losses.  The SEC made findings in a report released in mid-June that Stanford's broker-dealer, Stanford Group Company ("SGC"), had failed to meet its obligations to customers, and as a result of its membership in SIPC, was the proper subject of a customer protection liquidation and thus entitled to compensation from SIPC.  Should SIPC fail to take appropriate action, warned the SEC in a thinly-veiled directive, the SEC Division of Enforcement was prepared to institute legal action against SIPC to compel such a proceeding.  With no decision yet issued, pressure has continued to mount on SIPC from several fronts, and a recent letter from Congress has demanded a "satisfactory update" or decision on the matter by December 15.

The Securities Investor Protection Act of 1970 ("SIPA") mandated the creation of SIPC, which it saw as a way to allay investor fears and save the securities market in a time of crisis.  While the creature of congressional legislation, SIPC is unique in that it is funded through membership fees paid by member institutions, which by statute are all persons registered as broker-dealers under Section 15(b) of the Securities Exchange Act of 1934.  From 1996 until 2009, these member assessments were pegged at $150 per institution - regardless of the size of the firm's securities business.  Thus, financial titans such as Goldman Sachs or JP Morgan paid $150 to sustain a fund used in the event of financial collapse.  However, after the recent financial crisis, SIPC bylaws were adjusted as of April 1, 2009 to peg member assessments as the greater of $150 or ¼ of 1% of net operating revenues from the securities business.  The $150 minimum requirement was later eliminated upon the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act in July 2010.  Firms such as Goldman and JPM, whose securities businesses generate tens of billions of dollars in annual revenues, now face SIPC membership fees in excess of tens of millions of dollars.

When a member broker-dealer fails, SIPC acts to organize the distribution of customer cash and securities to investors.  To the extent that customer cash or securities are unavailable, a SIPA liquidation would provide insurance coverage of up to $500,000 of the customer's brokerage balance, including up to $250,000 in cash. Should a customer's investment exceed the compensation afforded by SIPC, a SIPA trustee would then be tasked with recovering further assets to satisfy the difference.

SIPC coverage is not all-encompassing, however, and generally does not apply to investments such as commodity of futures contracts, investment contracts, and oil/gas/mineral leases unless those investments are registered with the SEC.  Most types of securities, such as stocks, bonds, certificates of deposit, and notes are generally covered by SIPC.  According to its website, 

no fewer than 99 percent of persons who are eligible have been made whole in the failed brokerage firm cases that it has handled to date.

Since its inception in 1970, SIPC has advanced $1.6 billion as part of wider efforts to enable the recovery of $109.3 billion in assets for nearly 750,000 investors.  

SIPC has played an instrumental role in the ongoing liquidation of Bernard Madoff's failed brokerage firm.  Of the $7.3 billion of claims allowed by trustee Irving Picard, SIPC has provided nearly $800 million in advances to customers of Madoff's fraud.  In Picard's motion for approval of a first interim distribution to investors, he revealed that SIPC advances alone fully satisfied the claims of 868 Madoff victims.  

Stanford's scheme advised clients from 113 countries to purchase more than $7 billion in certificates of deposit ("CDs") from the Stanford International Bank in Antigua.  The SEC instituted civil proceedings in February 2009, and a receiver, Ralph Janvey, was appointed to marshal assets for victims.  A criminal indictment soon followed in June 2009.  Soon after his appointment, Janvey inquired as to whether Stanford's victims qualified for SIPC coverage.  Responding to Janvey's letter in August 2009 (the "August 2009 Letter"), Stephen Harbeck, the President of SIPC, gave several reasons for the decision that "there is no basis for SIPC to initiate a proceeding under SIPA," which included:

  • The SEC had not formally notified SIPC of the need to act;
  • The CDs were issued by Stanford International Bank Ltd. ("SIBL"), which is not a SIPC member;
  • SGC did not issue purchase confirmations for the CDs, nor were the CDs held at SGC's clearing firms;
  • Investors received custody of their CDs after purchase; and
  • Antiguan liquidators believed that substantive consolidation was not warranted.

Additionally, even had Stanford implied that SIPC would protect the underlying value of the CDs, Mr. Harbeck stated that this had no impact on his analysis.  

Following the August 2009 Letter, a consortium of nearly fifty members of the U.S. Senate and House of Representatives sent a letter to then-SEC Chairwoman Mary Shapiro, requesting that the SEC take immediate action to order a liquidation proceeding of SGC and examine the possibility of extending SIPC coverage to Stanford victims.  Over the next two years, ten more letters (available here) followed from various members of Congress urging the SEC to expedite its review of the applicability of SIPC coverage.  At one point, United State Senator David Vitters (R., La.) threatened to block two nominees to the SEC until the agency released its decision.  (The SEC released its decision the next day).  

On June 15, the SEC issued its decision, finding that SGC had failed to meet its obligations to customers, and "that the statutory requirements for instituting a SIPA liquidation are met here." The main point of dispute centered on the interplay between SGC - a SIPC member - and Stanford International Bank - a non-SIPC member.  In the Stanford scheme, investors with accounts at SGC purchased SIBL CDs by depositing funds with SIBL.  SIPC had taken the position that coverage was not appropriate because investors purchased the CDs from SIBL, not SGC.  However, the SEC's analysis focused more on the substance of the transactions, rather than the form, in finding that disregarding the separate corporate form of the Stanford entities was appropriate.  Thus, by purchasing CDs from SIBL, customers were effectively depositing money with SGC.  The SEC also likened any result to the contrary as consistent with the goals of the fraudster, saying

Based on the totality of the facts and circumstances, the Commission has concluded that investors with brokerage accounts at SGC who purchased SIBL: CDs through SGC should be deemed to have deposited cash with SGC for purposes of SIPA coverage.  Doing otherwise on the facts of this case would elevate form over substance by honoring a corporate structure designed by Stanford in order to perpetrate an egregious fraud.

SIPC pledged to review the SEC's findings "as quickly as possible" and declared that it would provide a decision by September 15.  However, after September 15 came and went, SIPC Chairman Orlan Johnson issued a statement on September 16 stating that SIPC was "continuing its careful review" of the Stanford case and did not have a decision to announce.  

In response to SIPC's continuing silence, a group of Congressional members sent a letter on November 22, stating that "after more than 22 weeks, the Stanford victims and the American people want and deserve answers." In offering their assistance, the Representatives also noted that the lack of a final decision or satisfactory update on SIPC's progress by December 15th - six months after the SEC decision and three months after the SIPC board meeting - would result in the recommendation to the House Financial Services Committee for the intitiation of a formal inquiry into SIPC's handling of the matter.  SIPC has not issued a response to the letter.

The court-appointed receiver for the Stanford entities, Janvey, has been criticized for the failure to recover more assets for victims.  Indeed, a June filing by a group of Stanford investors accused Janvey's legal team and associated experts of collecting nearly all of the $120 million recovered to date in fees.  A federal judge later expressed his concerns that Janvey's search for additional resources was duplicative of ongoing efforts by the Department of Justice, and asked when a claims process might be instituted for victims.  Janvey recently filed papers seeking approval for a proposed claims process, although he declined to speculate as to the amount that investors could expect in an initial distribution. 

A decision by SIPC to provide coverage to Stanford victims, as urged by the SEC, would be a welcomed move. At present, the victims stand to receive pennies on the dollar for funds lost to Stanford's scheme.  However, a look at the effect of SIPC intervention in the Madoff proceeding shows that over 1/3 of the approximately 2,425 allowed claims were fully satisfied as a result of SIPC advances.  While such a system differs slightly from typical Ponzi proceedings where all victims are promised a pro rata share in any recovered proceeds, a SIPC-involved proceeding would aim to compensate each investor equally - at least up to the first $500,000 of losses.

A copy of the August 14, 2009 letter from SIPC to Janvey is here.

A copy of the SEC decision directing SIPC coverage is here.

A copy of the Congressional letters sent to the SEC in support of the decision on SIPC coverage is here.

A copy of the November 22, 2011 letter from Congress is here.

Tuesday
Nov012011

Judge Dismisses $20 Billion in Madoff Claims Against JP Morgan and UBS

In a severe blow to the quest to recover funds for the benefit of victims of Bernard Madoff's $50 billion Ponzi scheme, a New York federal judge threw out $20 billion of common law claims that the court-appointed trustee had asserted against banking giants JP Morgan Chase & Co. ("JP Morgan") and UBS AG ("UBS").  In granting the motions to dismiss previously filed by JP Morgan and UBS, United States District Judge Colleen McMahon ruled that court-appointed trustee Irving Picard lacked standing to assert common-law claims, including allegations of aiding and abetting fraud and breach of fiduciary duty, on behalf of victims of Madoff's fraud.  

To put the magnitude of the dismissal in context, the $20 billion in dismissed claims, combined with the $9 billion dismissal of claims by Judge Rakoff against HSBC in late-July, is over three times the amount of funds recovered thus far by Picard and his legal team and nearly double the amount of principal estimated lost by Madoff victims. Picard estimated that he has recovered approximately $8.6 billion to date out of approximately $17 billion in valid customer claims.

In the decision, Judge McMahon echoed Judge Rakoff's reasoning in his dismissal of common-law claims against HSBC that Picard lacked the standing, and was thus legally prevented from bringing claims, to sue on behalf of former customers of Madoff's brokerage firm Bernard L. Madoff Investment Services ("BLMIS").  Thus, Picard can only assert claims in his capacity as trustee of the bankruptcy estate of BLMIS.  Rationalizing her decision, Judge McMahon stated that:

giving the Trustee the power to pursue claims on behalf of creditors would usurp the creditors' right to determine whether and in what forum to vindicate their legal injuries.

In an interesting analogy, Judge McMahon drew parallels between Picard's attempt to sue Madoff for damages on behalf of his victims to the situation of a parking garage owner attempting to assert claims on behalf of a car that suffered damage while in traffic and before it entered the garage.  Like Picard, she stated, the garage would have no legal standing to pursue recovery for the injury sustained before the car entered the garage.  

Picard will most likely appeal Judge McMahon's decision to the Second Circuit Court of Appeals simply due to the amount potentially at stake.  He has already declared his intention to seek review of Judge Rakoff's July decision dismissing similar claims against HSBC.  

Assuming that Picard does not succeed with his planned appeal, the dismissal of common-law claims leaves the only remaining avenue of recovery against JP Morgan and UBS in federal bankruptcy claims, of which $425 million is sought from JP Morgan and $1 billion from UBS.  Because the remaining claims solely concern issues of bankruptcy law, they will be transferred back to federal bankruptcy court before United States Bankruptcy Judge Burton R. Lifland.   

Sunday
Oct162011

Judge: Cayman Islands Lawsuit Against Madoff Trustee is Void

A Bankruptcy Court Judge issued a strongly-worded order holding that a lawsuit recently filed in the Cayman Islands against the Madoff trustee was void and could not proceed any further.  Irving Picard, the court-appointed trustee for Bernard L. Madoff Investment Securities ("BLMIS"), sued Maxam Absolute Return Fund, Ltd ("Maxam"), seeking the return of nearly $100 million in fraudulent transfers made in the six years preceding the bankruptcy filing of BLMIS.  After answering that complaint, Maxam then filed an action in the Cayman Islands (the "Cayman Action") seeking a declaration that Maxam was not liable for the transfers.  According to Judge Lifland, that action is forbidden by the Bankruptcy Code and other federal laws, and constitutes a "clear attack on this Court’s exclusive jurisdiction and a blatant attempt to hijack the key issues to another court for determination."

While such an action would normally be allowed, the act of filing for bankruptcy triggered provisions in the Bankruptcy Code that forbid actions by third parties to recover or obtain assets in the bankruptcy estate. Specifically, section 362 of the Bankruptcy Code contains what is known as an "automatic stay" provision that forbids:

the commencement or continuation . . . of a judicial, administrative, or other action or proceeding against the debtor,” or “any act to obtain possession of . . . or to exercise control over property of the estate.

Additionally, BLMIS's membership in the Securities Investor Protection Corporation ("SIPC") resulted in the bankruptcy being subject to the provision of the Securities Investor Protection Act, which contains similar prohibitions.  In the Cayman Action, Maxam sought 

a declaration that Maxam Limited is not liable to the Trustee for either the $25 million Maxam Limited received from Maxam Fund within the period of 90 days prior to the Filing Date or any amounts in excess of the $25 million that Maxam Limited received from Maxam Fund within the period of two years prior to December 11, 2008.

However, according to Judge Lifland, the Bankruptcy Code and SIPA prevent such an action from continuing. Noting that Picard would be forced to essentially relitigate the merits of the clawback lawsuit, Judge Lifland opined that unneeded time, expenses and resources would be expended.  Additionally, the suit interferes with the Bankruptcy Court's exclusive jurisdiction over the property of Madoff's brokerage firm.  Finally, Judge Lifland also noted that the suit violated the Barton Doctrine, which is a judge-created rule that before a court-appointed receiver or trustee can be sued, the petitioning party must first seek leave of the court.  

Under Section 105 of the Bankruptcy Code, a Bankruptcy Court is granted equitable powers to “issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of [the Code].” Noting the ramifications should each foreign individual or entity sued by Picard be permitted to seek relief in their own country, Judge Lifland utilized these powers by issuing an injunction preventing Maxam from continuing the Cayman Action.   

A copy of the Order is here.

Friday
Oct142011

New York 'Mini-Madoff' Receives Twenty-Five Year Prison Sentence

A New York man whose $400 million Ponzi scheme earned him the nickname of Long Island's Mini-Madoff was sentenced to twenty-five years in federal prison on Friday.  United States District Judge Denis Hurley handed down the sentence to Nicholas J. Cosmo, 40, along with an order to pay $179 million in restitution to more than 4,000 investors defrauded by the scheme.  Originally indicted on thirty-two counts of wire fraud and mail fraud, Cosmo pled guilty on October 29, 2010 to one count each of wire fraud and mail fraud.  He had faced a maximum sentence of forty years in prison at his sentencing.  

From October 2003 to January 2009, Cosmo owned and operated Agape World, Inc ("Agape") and Agape Merchant Advance ("Agape Merchant").  Potential investors were told that their money would be used to fund short-term bridge loans to commercial borrowers and loans to other businesses that accepted credit cards.  Investors were promised annual returns as high as eighty percent.  In total, Cosmo convinced thousands of investors to entrust approximately $413 million with Agape and Agape Merchant.  However, Cosmo used only $30 million of investor funds to make short-term bridge loans, and made roughly $80 million of unauthorized trades in commodities and futures positions.  The remainder was used to perpetuate a massive Ponzi scheme, using funds from new investors to pay returns to existing investors and create the appearance of a highly successful operation. Cosmo also used investor funds to support a lavish lifestyle and to pay over $60 million in commissions to Agape brokers for continuing to bring in new investors.

The scope of the operations were so large that Bank of America at one point established an unofficial branch within Agape headquarters in Hauppauge, New York, to provide on-site banking services.  The branch, staffed by one Bank of America employee, was dedicated solely to Agape's banking needs, and had access to Agape's business records.  After the fraud was exposed, Bank of America was named, along with several other defendants, in several lawsuits alleging claims of negligence, aiding and abetting fraud, and aiding and abetting breach of fiduciary duty.  The suits alleged that Bank of America ignored many "red flags" that should have alerted them to Agape's fraud.  However, the standard in assessing liability against banking institutions such as Bank of America is a high one; actual, rather than constructive, knowledge is required.  The Eastern District of New York granted Bank of America's motion to dismiss based on this heightened standard, concluding that:

The Plaintiffs have failed to adequately allege that BOA had actual knowledge of Cosmo's scheme. Nor have they adequately alleged that BOA provided substantial assistance to that scheme. 

Additionally, this is not Cosmo's first fraud conviction.  In 1999, he was sentenced to a 21-month prison sentence after pleading guilty to a fraudulent scheme while employed as a stockbroker at Continental Broker Dealers.  Following that conviction, Cosmo was forbidden from associating with any other broker-dealers and was forced to surrender his broker's license.  The U.S. Commodity Futures Trading Commission has also instituted proceedings against Cosmo.

A copy of the complaint filed by the U.S. Commodity Futures Trading Commission is here.

A copy of the order granting Bank of America's motion to dismiss the civil lawsuit is here.

A copy of the 1997 criminal complaint against Cosmo is here.