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.
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: