Some Protection for Madoff Victims

When Bernard Madoff plead guilty to eleven criminal counts in federal court on Thursday, many of the victims of his Ponzi scheme were present in the courtroom. And although there was applause and satisfaction from the investors present, it does not necessarily improve there future prospects. While estimates of the exact amount of total losses vary from a few billion to $65 billion, depending on how one accounts for the fraud, there is no doubt that many individuals have been emotionally scarred and left in a precarious financial situation.

With so many government dollars invested in bailing out the financial and automotive sectors, and additional federal assistance approved for the unemployed, is there any recourse for not only the Madoff victims but also other sophisticated or high net worth individuals? Federal securities laws, namely the Securities Act of 1933, Securities Exchange Act of 1934 and Investment Advisers Act of 1940, were passed with the goal of protecting investors from fraud. But there are also exceptions to these laws, designed to allow certain individuals to make investments without having to register their securities and fully disclose the nature of their operations in order to hopefully achieve a greater return on a particular investment. The investors in the Bernard L. Maddof Investment Securities LLC would have (or should have) fallen into this category, so what federal protection is available for these individuals?

Enter the Securities Investor Protection Corporation (SIPC, http://www.sipc.org). Created in 1970 under the Securities Investor Protection Act, this is actually a non-profit corporation, somewhat akin to the FDIC, who charges member investment firms a certain fee to maintain a small security blanket for investors. Unlike the FDIC, which guarantees deposits up to a certain amount regardless of how a bank loses the money, the SIPC does NOT grant relief for normal investment losses. But the SIPC does provide relief in the event that a brokerage firm fails and the cash/shares are missing from an investor’s account, which is what happened for the Madoff victims whose investments were not used to purchase stocks or other legitimate investment instruments but went instead to pay other investors.

For the Madoff victims, the SIPC has granted a waiver to allow for the maximum $500,000 claim. In combination with the fraudulent transfer laws incorporated into bankruptcy law, it might be possible for the victims to receive a more equitable portion of their original investment, but undoubtedly the measures will not provide full compensation. Investors looking into any brokerage or investment firm would be well advised to ensure that the firm is in fact a member of the SIPC, and to consider the maximum amount of coverage available when deciding how much to invest in any one financial institution.

Concerning the SEC, was it negligent of not pursuing the matter further, considering the reports of tips of possible fraud it had received about Mr. Madoff’s operations? While it is true that securities laws in general allow for sophisticated or high net worth individuals to invest in firms which do not have to fully comply with all aspects of securities laws, the intent being to allow for such individuals to invest without having to deal with the costs of reporting and to prevent others from duplicating their methods of attaining high returns, it is also true that the securities laws contain anti-fraud provisions which can never be waived. In fact, on the same day federal agents arrested Mr. Madoff, the SEC filed a civil suit against him accusing him of violating the anti-fraud provisions of the securities acts and seeking an injunction to cease Mr. Madoff’s operations (http://www.sec.gov/litigation/litreleases/2008/lr20834.htm). So there were in fact provisions in the regulatory framework which the SEC could have invoked to initiate an investigation against Bernard Madoff years ago, meaning that there does not necessarily have to be any change in the regulations, but there does have to be enforcement of the existing laws to ensure protection for all classes of investors.