After Mistrial, Feds Will Retry Cay Clubs Founder In November

Authorities are hoping that Fred Davis Clark's good luck streak has finally run out.  The founder of Cay Clubs, which has been accused by civil and criminal authorities of operating a massive $300 million Ponzi scheme that duped scores of investors with promises of lucrative returns through timeshare leasing, is set to stand trial in early November after a previous federal jury deadlocked and a mistrial was declared.  This followed the May 2014 dismissal of a suit brought by the Securities and Exchange Commission after a federal judge found that the applicable statute of limitations had expired.  Federal prosecutors unveiled a 12-count superseding indictment on October 2, 2015, with the focus of the charges shifting from Clark's alleged operation of a massive Ponzi scheme to his role in allegedly orchestrating numerous sales to and from "straw buyers" designed to artificially inflate the prices of condominium units to be later sold as timeshares.  If convicted of all charges, Clark could face dozens of years in federal prison.

The Scheme

Cay Clubs operated from 2004 to 2008, marketing the offering and sale of interests in luxury resorts to be developed nationwide.  Dave Clark served as Cay Clubs' chief executive officer, while his wife Cristal Clark served as a managing member and the company's registered agent.  Through the purported purchase of dilapidated luxury resorts and the subsequent conversion into luxury resorts, Cay Clubs promised investors a steady income stream that included an upfront "leaseback" payment of 15% To 20%.  In total, the company was able to raise over $300 million from approximately 1,400 investors.

However, by 2006 the company was alleged to have lacked sufficient funds to carry through on the promises made to investors.  Instead of using funds to develop and refurbish the resorts, Cay Clubs allegedly used incoming investor funds to pay "leaseback" payments to existing investors in what authorities alleged was a classic example of a Ponzi scheme.  While the Securities and Exchange Commission initiated a civil enforcement action in January 2013 alleging that the company was nothing more than a giant Ponzi scheme, the litigation came to an abrupt end in May 2014 when a Miami federal judge agreed with the accused defendants that the Commission had waited too long to bring charges and dismissed the case on statute of limitations grounds.  

Just weeks after the dismissal of the Commission's action, authorities unveiled criminal charges against Dave and Cristal Clark and coordinated their arrest and extradition from Honduras and Panama where they had been living.  The charges stemmed from the Clarks' operation of an unrelated scheme to siphon money from their operation of a series of pawn shops throughout the Caribbean. Authorities alleged that the pair used a series of bank accounts and shell companies previously used with Cay Clubs to steal funds from the pawn shops to sustain their lavish lifestyles abroad.  Several months later, authorities filed bank fraud charges related to the Clarks' interaction with lenders as part of their operation of Cay Clubs - a strategy seemingly designed to ensure the charges would withstand any statute of limitation challenges given that bank fraud carries a 10-year statute of limitations.  

After a five-week trial earlier this summer, a federal jury deliberated for four days before acquitting Cristal Clark of all charges and deadlocking on the charges against Dave Clark.  

Superseding Indictment

In the previous indictment, prosecutors painted a wide-ranging conspiracy that was centered on the Clarks' alleged operation of a Ponzi scheme through Cay Clubs.  This conspiracy was described in that indictment as:

As the indictment later explained, the scheme involved a process in which the Clarks and other insiders would artificially inflate the prices of the timeshare units by "flipping" them in insider transactions to investors.  The original indictment focused on the misrepresentations made to those investors as well as the big-picture allegations surrounding the operation of Cay Clubs as a massive fraud..

Following the mistrial, prosecutors seem to have tweaked their strategy by honing in on the insider transactions that were used to artificially inflate the unit prices and allegedly defraud the lending institutions.  This shift in focus is evident in the superseding indictment's revised "Purpose of the Conspiracy" below:

In ensuing allegations, the indictment alleged that Clark would identify certain family members to act as "straw borrowers for loans that were used to purchase Cay Clubs units."  These straw borrowers would prepare fraudulent loan applications, which included representations about the borrower's employment and income, designed to induce lenders to approve the extension of credit.  Clark and others also allegedly prepared fraudulent HUD-1 Statements in which they certified that the borrowers had made the required down payment and cash-to-close payments when, in reality, those payments were made by a Cay Clubs entity controlled by Dave Clark.  

As a result of the fraudulent representations, the mortgage lender would subsequently issue funds that ultimately were placed into Cay Clubs accounts controlled by Clark and used to perpetuate the fraud.  While Clark would make the initial few mortgage payments on behalf of the straw borrowers, he subsequently stopped making the payments and caused the mortgages to go into foreclosure - resulting in substantial losses for the lenders.  

In addition to the seven counts focusing on the "straw borrowers," the indictment also includes four counts related to Clark's position as principal of a Caribbean pawn shop business and the alleged misappropriation of millions of dollars from that company for his own personal use.  A final count centers around allegedly false statements made by Clark to the Securities and Exchange Commission concerning his assets.  

Retrial

Dave Clark's trial is scheduled to begin on November 9th, and will likely take several weeks.  

The upcoming trial will likely feature testimony by former Cay Clubs sales executive and lawyers who have been cooperating with the government.  This includes former sales agents Ricky Lynn Stokes and Barry Graham, who each received a five-year prison sentence after entering into plea agreements with prosecutors.  Additionally, former Cay Clubs attorneys Scott Callahan and Charles Phoenix previously entered into immunity agreements in which they admitted to concealing information about Cay Clubs from lenders and agreed to provide assistance and testimony. 

While Cristal Clark was freed following her acquittal, Dave Clark has remained in jail after the court rejected an attempt by his lawyers to release him on bail pending trial.  

Previous Ponzitracker coverage of Cay Clubs is here.

A copy of the Superseding Indictment is below:

351 Second Superseding Indictment

Bank Hit With $72 Million Judgment For Role In $100 Million Ponzi Scheme

An Ohio-based bank was tagged with a $72 million judgment - ballooning to nearly $83 million with accrued interest - for its role in providing banking services to a notorious Ponzi schemer who committed suicide as authorities closed in.  Huntington Bank, a publicly-traded company with hundreds of branches concentrated on the east coast, was found liable for the return of over $72 million in fraudulent transfers it received from companies operated by Barton Watson during 2003 and 2004.  The judgment, which the bank has announced it will appeal, would represent one of the largest awards issued against a financial institution for its role in a Ponzi scheme, and would also likely represent a sizeable recovery for victims of Watson's massive Ponzi scheme.  

The Scheme

Barton Watson operated CyberNet Engineering, which touted itself as a highly-successful provider of information technology services.  CyberNet purported to achieve annual revenues ranging from $200 million to $300 million primarily through the sale of computer hardware to top-tier clients.  However, Watson and CyberNet were increasingly on the radar of authorities, and the FBI raided company headquarters in November 2004.  While no charges were initially filed, Watson committed suicide later that same month following a standoff with police in his barricaded home.  

An ensuing investigation revealed Watson's intricate use of subsidiaries and shell companies to manufacture the dizzying business growth touted to investors.  One of these companies was Cyberco Holdings, Inc. ("Cyberco"), which secured loans from lenders for the purported purchase of computer hardware.  Cyberco told its lenders that it would be purchasing this hardware from Teleservices Group, Inc. ("Teleservices"), and Teleservices received the loan proceeds after providing invoices to lenders.  However,Teleservices was another entity controlled by Watson, and neither Teleservices not Cyberco ever engaged in any legitimate hardware deals.  Instead, the loan proceeds obtained by Teleservices were simply funneled back to Watson.  

Huntington Bank

Huntington Bank provided banking services to Watson and his entities, with these services including the use of a $17 million revolving credit line that would advance new credit as payments were received on the loan.  The credit line was used frequently by Watson and his entities.  However, Huntington began raising suspicious about the relationship sometime in 2003 after it observed suspicious payments coming fromTeleservices to pay down the Cyberco line of credit, and soon thereafter asked Watson to find a new lender.  The bank initially suspected Watson of check kiting, but allowed the continued payments byTeleservices towards the revolving credit line.  In total, more than $73 million in payments were made byTeleservices towards the Cyberco line of credit.

After Teleservices filed bankruptcy following the FBI raid, the trustee subsequently filed fraudulent transfer claims against Huntington not just for the payments received by Teleservices but instead for the entire amount of funds that flowed through the account and were reloaned to Cyberco.  Following a three-week trial, the court rejected Huntington's good-faith defense, noting numerous examples of the bank turning a blind eye to obvious red flags, and concluded the bank was on the hook for the $72 million that flowed through its Cyberco account.  

Of note in the bankruptcy court's decision, which was later confirmed and accepted by the district court, was the analysis of the "good faith" defense provided to transferees of allegedly voidable transfers under certain provisions of the U.S. Bankruptcy Code.  For example, Sections 548 and 550 of the bankruptcy code provide an affirmative defense to recipients of fraudulent transfers if they demonstrate that they received the transfer in good faith and provided value.  Courts analyzing good faith have wrestled with whether to analyze a transferee's good faith in an objective or subjective standard.  However, in Judge Jeffrey Hughes' Report and Recommendation in the Teleservices litigation, he rejected the use of an objective standard and instead held that Huntington's good faith would be evaluated subjectively.  Ultimately, Judge Hughes found that Huntington could not establish good faith as to any transfers received after April 30, 2004.  In the district court's order adopting Judge Hughes' R&R, Judge Paul L. Maloney observed:

The objective standard has not been explicitly adopted by the Sixth Circuit, and the Sixth Circuit has, at least implicitly, endorsed a good faith standard that allows for subjective considerations. The Court finds Judge Hughes accurately assessed the relevant standards for determining a good faith defense. His dissection of the prevailing trend toward an objective standard of good faith reads like an academic treatise. The Trustee’s objection does not demonstrate any dispositive flaw in Judge Hughes’ reasoning. Furthermore, the phrase “good faith” is used multiple times in § 548 through § 550. In § 548© and § 550(e)(1), the phrase “good faith” is used without any additional reference to the knowledge of the transferee orobligee. In § 549© and § 550(b)(1), the phrase “good faith” is used with an additional reference to some knowledge.

Interestingly, Judge Hughes also concluded (and Judge Maloney agreed) that Huntington Bank was an immediate transferee simply upon a customer's deposit of funds into an account held at the bank, reasoning that the bank exercised sufficient control over those funds to be considered a subsequent transferee under the relevant portions of the Bankruptcy Code.  While the District Court noted disagreement among other courts, it cited Judge Hughes' painstaking analysis and ultimate rejection of those cases.  

The implications of Judge Hughes' decision are widespread.  First, it endorses the tactic taken by the trustee in seeking to recover the entirety of funds flowing through Huntington rather than simply profits enjoyed by Huntington or the amount specifically received from Teleservices.  This becomes even more striking when observing that Huntington was found liable for over $70 million despite extending "only" a $17 million credit line.  However, while banks have typically enjoyed wide latitude in disclaiming responsibility for policing their customers, Judge Hughes' decision stands for the proposition that a bank cannot willfully blind itself to an active fraud being perpetrated by a customer.  Second, the decision is likely to breathe new life (and inflate potential damages) in similar suits going forward while simultaneously giving bank counsel a new reason to fear fighting the case in court.  While Judge Hughes' decision is not binding across the country, it certainly provides a contrary perspective to the familiar defenses advanced by banks.  

Appeal

Last week, Huntington Bank appealed the judgment and requested that it not be required to post an adequate bond to stay execution of the judgment.  In defense of its request to avoid having to put up an $80 million bond, Huntington's attorneys argued that:

The bond is not warranted in any event because Huntington indisputably has the resources to pay the judgment against it should the Trustee ultimately prevail...

However, counsel for the trustee took issue with this position, responding that:

"Rather than avail itself of that option, Huntington asks this Court and Plaintiff to rely on Huntington's self-serving, unattested assurances of present and future financial stability...How reliable are Huntington's paper promises? It is difficult for anyone to know. But, there is a disinterested competitive market solution: let the sureties with their actuarial expertise in assessing collection risk make the determination. Plaintiff has carried the risk of Huntington'sfailure for years. Judgment has now been entered."

A copy of Judge Maloney's recent Order adopting Judge Hughes' R&R is below.

Order Adopting r&r - Huntington (1)

TelexFree Trustee Seeks Approval For "Unprecedented" Electronic Claims Process

"The Debtors’ operations constituted a massive Ponzi /pyramid scheme."

 - Court appointed trustee Stephen B. Darr

The court-appointed Bankruptcy trustee responsible for marshalling assets for victims of the massive alleged $3 billion TelexFree Ponzi/pyramid scheme has asked a Massachusetts bankruptcy court for permission to institute an electronic claims process to deal with the anticipated hundreds of thousands of potential claims.  Stephen B. Darr, the trustee, filed his "Motion by Chapter 11 Trustee for Entry of Order Fixing Bar Date for Filing Proofs of Claim, Approving Form and Manner of Providing Notice, Directing That Claims Be Filed Electronically, and Approving Content of Electronic Proofs of Claim" (the "Claims Motion") late yesterday evening as he seeks to begin the process of returning assets to victims of the massive alleged fraud.  The electronic nature of the claims process, while not unprecedented in Ponzi scheme cases, will undoubtedly assist in the efficient administration of the process but also raises questions as to the accessibility of such a process to many of the scheme victims who may not have access to the required hardware to submit a claim. As discussed below, the Claims Motion seeks (i) to set a Bar Date by which all claims must be submitted, (ii) approval of a Proof of Claim form, and (iii) approval of the proceduressurrounding the claims process and submission of the form.  If approved, the claims process will likely be the largest claims process ever administered in a Ponzi or pyramid scheme proceeding.  

The Scheme

As is well known by now, TelexFree raised billions of dollars from hundreds of thousands of investors through the sale of a voice over internet protocol (“VoIP”) program and a separate passive income program.  The latter was TelexFree's primary business, offering annual returns exceeding 200% through the purchase of "advertisement kits" and "VoIP programs" for various investment amounts.  Not surprisingly, these large returns attracted hundreds of thousands of investors worldwide, and participants were handsomely compensated for recruiting new investors – including as much as $100 per participant and eligibility for revenue sharing bonuses.  Ultimately, while the sale of the VoIP program brought in negligible revenue, TelexFree's obligations to its "promoters" quickly skyrocketed to over $1 billion.

In April 2014, after multiple attempts to modify the passive income program both to rectify regulatory deficiencies and to curb increasing obligations, TelexFree quietly filed for bankruptcy in a Nevada bankruptcy court with the hopes of eliminating obligations to its "promoters" and extinguish any ensuing liabilities.  This tactic failed, as enforcement actions were filed by the Securities and Exchange Commission (the "Commission") and Massachusetts regulators.  The bankruptcy proceeding was later transferred - over TelexFree's objection - to Massachusetts, where the company was headquartered and where the Commission had filed its enforcement proceeding.  The appointment of an independent trustee, Mr. Darr, shortly followed. TelexFree's founders, James Merrill and Carlos Wanzeler, were later indicted on criminal fraud charges, with Wanzeler currently a fugitive and believed to be in Brazil. 

Claims Process

Perhaps owing to the complexity of administering a claims process that could ultimately include up to 1 million claim submissions, establishment of a claims process and procedures were delayed while the trustee evaluated the most efficient way to handle such an undertaking.  Indeed, a claim bar date was initially established but later vacated at the request of Mr. Darr.  

The scale of the scheme is truly unprecedented.  According to the Claims Motion, the Trustee and his staff hvae determined that there were approximately "11,000,000 User Accounts associated with approximately 900,000 Email Addresses in the Debtors' scheme."  Because the Trustee believes that some email addresses represented multiple participants, he estimated that the number of participants "is likely in excess of 1,000,000."  To put this in perspective, if each participant submitted a hard copy of a 5-page proof of claim form, the stack alone would be nearly half a mile high, and would stretch nearly 800 miles end to end.

Based on the sheer number of participants and the Trustee's observation that each participant had previously submitted an email address, the Claims Motion seeks to institute a largely-electronic claims process utilizing participants' submitted email addresses as primary points of contact.  As the trustee's counsel submits,

The cost of attempting to manually compare amounts asserted in potentially millions of physical proofs of claim against the Debtors’ records is incalculable, particularly given the number of transactions that may be associated with any particular claim.

The claims process will be administered through an online "portal" which will be the exclusive form of submitting claims. Importantly, the motion seeks court approval to disallow any previous claims submitted by mail using the standard B10 claim form - a step which thousands of victims are believed to have taken in the aftermath of the scheme.  Thus, it is possible that those victims could be denied the ability to participate in the claims process in the event they believe their previous submission of a physical claim will be adequate to receive distributions.

The Claims Motion also requests that the Court approve a "Bar Date" that sets the last day an electronic proof of claim can be deemed timely filed.  The trustee proposes that the Bar Date be set as 4:30 P.M. Eastern Time on no earlier than the 90th day following the initial opening of the Portal hosting the electronic proof of claim.  Thus, the failure to timely submit a proof of claim by the Bar Date will preclude any victim from participating in any distributions of TelexFree assets.  

Finally, the Trustee requests approval of a modified B10 Proof of Claim form to be used in the claims process, which will require that a participant:

1. Provide his/her current contact information, including physical address, electronic mail address, and phone number;
2. Provide and/or confirm personal or business name(s), address(es), phone number(s), Email Address(es), taxpayer identification number(s), User Account name(s), password(s), and bank account information that were utilized by the Participants when establishing the User Account(s);
3. Itemize and/or confirm all payments made by a Participant to the Debtors and all payments received by a Participant from the Debtors; and
4. itemize and/or confirm all payments made by a Participant to other Participants in connection with the purchase of a membership plan, and all payments made to the Participant by other Participants in connection with the purchase of a membership plan.

Thus, in addition to submitting/confirming a loss amount, each participant will be required to attest as to (1) the payments they received after their initial investment, (2) whether they made any payments to any other participants in connection with their investment, and (3) whether they received any payments from other participants in connection with those participants' investment.  The latter two categories are aimed at those investors who may have served as "promoters" who received incentives based on their recruitment of additional victims to the scheme.  

A hearing has not yet been set on the Claims Motion.  A copy of the Claims Motion is below:

Claims Motion by jmaglich1

Claims Motion by jmaglich1

Lawyers Seek Approval To Distribute Clawback Recoveries To Ponzi Victims

Victims of one of the largest Ponzi schemes uncovered in Ohio could soon receive a partial return of their losses based on efforts by attorneys to "claw back" fictitious profits paid to some investors.  Attorneys representing victims of Glen Galemmo's $35 million Ponzi scheme are set to appear in a Cincinnati federal court next week to seek approval to distribute over $3 million recovered in "clawback" lawsuits brought on behalf of defrauded Galemmo victims.  While the federal government has collected an additional $5 million through asset forfeiture, distribution of those assets to victims may not take place until 2016 while an appeal filed by Galemmo's wife is heard.

The Scheme

Galemmo operated Queen City Investment Fund ("Queen City"), along with a dozen other investment entities. Touting himself as an experienced trader, Galemmo promised outsized returns through investments in stocks, bonds, futures, and commodities.  Investors were told Queen City had enjoyed a streak of consistently above-average returns, including a return of nearly 20% in 2008 when the S&P 500 experienced a -38.49% loss. Galemmo assured investors that Queen City was audited annually, and provided monthly statements showing steady returns.  Galemmo raised more than $100 million from individuals, trusts, and even charities.

However, Galemmo's touted trading prowess was pure fiction.  Instead, Galemmo used new investor funds to pay his promised returns - a classic hallmark of a Ponzi scheme.  Nor was the Queen Fund audited; rather, Galemmo simply listed the name of an audit firm that had not had a relationship with Galemmo or his fund since 2003.  Investors received fictitious account statements, and Galemmo paid himself tens of millions of dollars in fictitious management fees, which he used to purchase real estate, pay fictional interest and principal distributions, and even to operate other businesses such as entertainment complexes. 

The scheme collapsed in July 2013 when investors received an email from Galemmo stating that the funds were shutting down and directing all further inquiries to an IRS agent.  Victims filed a lawsuit later that month, and Galemmo was later arrested.  He agreed to plead guilty shortly thereafter, and recently received a 15-year sentence.  

The prospect of recovery for victims appeared bleak, with one source reporting that the Department of Justice estimated that victims could recoup 10% to 20% of their investment.  Authorities were able to quickly seize what remained of Galemmo's assets, which included over $500,000 in cash, various real estate including a condo in Florida and Galemmo's former office building, and over $100,000 in automobiles.

Investors Take Matters Into Their Own Hands

Last year, the Commodity Futures Trading Commission ("CFTC") filed a civil enforcement action against Galemmo and Queen City.  The CFTC did not request appointment of a receiver, perhaps because it viewed the prospect of a meaningful recovery of funds as unlikely.  

One of the largest sources of recovery for victims of Ponzi schemes typically comes from lawsuits against fellow investors who were fortunate enough to ultimately profit from their investments either through an extended investing horizon or the receipt of "commissions" or "bonuses" for recruiting other investors.  Aptly known as "clawback" suits in Ponzi jurisprudence, the suits seek recovery of fictitious profits consisting of amounts in excess of that investor's net investment in the scheme.  Because the scheme operator does not generate the promised returns from legitimate activities, these transfers are nothing more than the redistribution of new investor funds.  While extensive caselaw generally recognizes that clawback targets can keep the amount of transfers adding up to their total investment in the scheme (absent signs that the investor did not act in good faith in receiving the transfers), the law is clear that any receipt of funds over an investor's net investment can be recovered as "false profits."  

One of the "net winners," as they are known, in Galemmo's scheme was Michael Willner.  Willner was one of Galemmo's original investors, whose initial investment of several million dollars allegedly multiplied several times according to fictitious account statements provided by Galemmo.  Willner also allegedly served as a recruiter for new Galemmo investors, and the lawsuit alleged that Galemmo paid commissions to Willner for referred investors.  Willner allegedly withdrew "millions" of dollars in excess of his original investment.

Willner sent out an incriminating email to fellow investors in the days after Galemmo's announcement that the funds would be shutting down, stating: 

“To those of you that I brought into the fund you have my deepest and most sincere apologies...I am embarrassed and shamed by my actions. Like most of us I ignored the poor statements and lack of transparency in favor of the high returns. In hindsight, these warning signs should have alerted me to probe deeper and ask appropriate questions.

While Willner allegedly received "millions" in excess of his original investment, he later settled the suit for $1.4 million.  

Claims Process

Lawyers representing the victims say that a claims process will have to be administered in order to accurately distribute the funds to the over-150 investors who might be eligible to share in the recovered funds.  It is likely that each investor will receive a pro rata share of the $3.4 million, meaning that each would stand to recover approximately 10% of his/her losses based on previous government estimates of a total of nearly $35 million in losses.  

The law firm behind the lawsuit, Santen & Hughes, was the same law firm that filed the initial lawsuit accusing Galemmo of running a fraud in the wake of the scheme's collapse.  The firm has also filed other lawsuits against third parties seeking recovery for Galemmo victims, including a suit against several prominent financial institutions related to their dealings with Galemmo.  The firm was able to interview Galemmo before he reported to federal prison, and it is possible that other net winners could be pursued.  

Supreme Court Rejects Time-Based Damages For Madoff Victims

The U.S. Supreme Court refused to hear an appeal over whether victims of Bernard Madoff's historic Ponzischeme were entitled to an inflation-based upward adjustment of their losses, freeing approximately $1 billion for future distributions to victims and bringing finality to an appellate court's decision earlier this year dismissing such an adjustment.  Trustee Irving Picard indicated in a statement issued today that he intends to "immediately" move forward with making a sixth distribution to investors, who have already recovered over 50% of their net losses to the notorious conman.  Assuming Picard wins approval from the bankruptcy court for such a distribution, all investors with losses of $1.13 million or less will have recovered 100% of their losses.  Further, given that this marked the last major appeal facing the bankruptcy estate, the focus may soon turn to resolving pending litigation and winding down the estate.  

The Appeal

In the aftermath of a Ponzi scheme, a claims process is often instituted to return recovered assets to victims on a pro rata basis based on approved losses.  While a victim's claim is often decreased based on the amount of payments or distributions they received from the scheme during its existence, some of Madoff's victims took the position that they were entitled to an upward adjustment accounting for inflation during the period of their investment and/or interest to reflect the time-value of money.  As the Second Circuit characterized the victims' position, 

the claims of Madoff’s earlier investors are unfairly undervalued when compared to the claims of Madoff’s later investors.

Under the statutory framework of the Securities Investor Protection Act ("SIPA"), which governed the liquidation of Madoff's brokerage, the Second Circuit concluded that 

an inflation adjustment to net equity is not permissible under SIPA.  An inflation adjustment goes beyond the scope of SIPA’s intended protections and is inconsistent with SIPA’s statutory framework.

The Second Circuit gave weight to the absence of an inflation-based adjustment from SIPA's provisions, noting that such a provision would be "nonsensical" given SIPA's intended purpose to remedy broker-dealer insolvencies rather than the outright fraud committed by Madoff.  Rather, SIPA aims to restore investors to their position had a liquidation not occurred.

Notably, the Securities and Exchange Commission supported the victims' position - and opposed the trustee - that SIPA permitted inflation-based adjustments.  The Second Circuit concluded that this position was not entitled to any deference typically afforded to administrative interpretations, and remarked that the Commission's interpretation was "novel, inconsistent with its positions in other cases, and ultimately unpersuasive."  Indeed, the Court observed that that, while favoring an inflation-based adjustment in this case, the Commission had recently opposed such an adjustment in a "different, long-lasting Ponzi scheme."  Given that both scenarios envisioned an outcome where recovered assets would ultimately be insufficient to fully satisfy investor claims, the Second Circuit rejected any basis to further exacerbate this shortfall.

Perhaps inherent in such an outcome urged by the victims and the Commission is the result that victims that invested longer in the scheme would be entitled to a larger total claim based on the upward adjustment - an outcome which, assuming there were not enough funds to satisfy all investor claims, would result in a proportionate decrease in funds available to investors with shorter investment durations.  A policy argument opposing such a position would suggest that to do so would essentially add a degree of moral hazard in providing less of an incentive for a long-term investor to question the returns they were receiving or perform adequate due diligence.  Further, considering that Madoff's scheme lasted decades, an inflation-based adjustment of even 2%-3% annually could mean a significant increase for a long-term investor - an increase which would ultimately be borne by shorter-term investors.  

A copy of the Second Circuit's Order is below:

Madoff Opinion