Stakeholders in the Madoff Scandal and Their Need to Act Promptly and Proactively – Indirect Stakeholders – Installment 11

June 23, 2009Articles White Collar Defense & Compliance Blog

This is the eleventh in a series of installments on this blog that is discussing some of the issues that face the manifold stakeholders who have been materially affected by the long and worldwide Ponzi scheme scandal of Bernard L. Madoff. All potential stakeholders should consult professional advisors promptly to have their positions evaluated.

Installments 3 through 8 and Installment 10 of this series focused on the specific concerns of charities that were victims of Madoff and similar schemes. This Installment is continuing the discussion from Installment 9 on the concerns of an Indirect Individual Investor (“III”) who has been embroiled in the Madoff scandal, but not as a result of a direct investment with him.

Such IIIs may have invested with a fund, investment manager or other vehicle, such as a hedge fund that was a “feeder” for Madoff, or even a partnership of family and friends that was formed to aggregate funds sufficient to invest with him. Each of these types of entities will be defined in this series as a Direct Entity Investor (“DEI”), even though some DEIs may have invested their money with a feeder fund for Madoff that in turn invested directly or indirectly with him.

Those that are IIIs and were “fortunate” enough to have secured distributions from the DEI through indirect redemptions from Madoff in the past may believe that they were either lucky or brilliant to have withdrawn money before his arrest on December 11, 2009. However, such IIIs must be concerned about the extent to which the Madoff bankruptcy trustee or federal or state regulators may be intensifying efforts to recover money or seek criminal prosecutions from those who withdrew money from their Madoff investments. While the initial efforts by the trustee can be expected to be focused upon DEIs that received large distributions and were close to Madoff in making direct investments with him, the focus can be expected to go further down the line to IIIs as well.

The word most commonly used for such monetary recovery efforts in the Madoff morass is “clawback.” Distributions from a DEI to an III are potential targets for the bankruptcy trustee because they may be materially disproportionate to the withdrawals of the average investor (“Clawback Targets”). The word clawback actually covers a number of scenarios and theories for recovery by the bankruptcy trustee under the Federal Bankruptcy Code and various state laws that may have varying degrees of likely exposure for the III.

The basis of clawback is that all of the investors who were engaged in a single, unitary, integrated, failed Ponzi enterprise should have a relatively level playing field and that those that received disproportionate distributions should disgorge their excess receipts.

To a certain degree, the energy that will be undertaken by the bankruptcy trustee for Madoff to pursue an III will depend on (i) the absolute amount in dollars of the distribution to such III, especially in relation to the actual hard dollars invested (net of the nonexistent “returns” reported to the III by Madoff), (ii) how recently the redemption(s) took place and/or (iii) the individual factual circumstances that exist relative to the redemptions by the III. The “clawback” process may become highly complex and may be affected by state law, which may differ from state to state. Competent professional advice for IIIs is a necessity in this area.

[To be continued in Installment 12]