The Wizard of Lies: Bernie Madoff and the Death of Trust (48 page)

Six weeks later, on Wednesday, October 14, the Madoff victims’ demands for compensation and accountability came together when lawyers for two victims held a press conference in New York to announce that they were suing the SEC, seeking compensation for the investors’ losses in the Madoff swindle. The lawsuit contended that the SEC was liable for compensating the plaintiffs because its well-documented negligence had caused their losses.

The lawsuit was a long shot. It has always been extremely difficult to win even the right to sue the U.S. government, much less to win the lawsuit itself. As in most countries steeped in English common-law traditions, citizens cannot sue the federal government over its official actions—the sovereign is immune from litigation. The logic behind “sovereign immunity” is simple: the appropriate place for citizens to challenge the actions of their elected government is at the polls, not in the courts.

There are a few exceptions to this bedrock principle. One of them is the Federal Tort Claims Act, which allows a citizen to sue if a negligent or deliberately improper action by a government employee causes damage to that individual. But that loophole does not apply to policy decisions or discretionary steps taken by federal employees carrying out their official duties.

The Madoff victims argued that they had been injured by the negligence of the SEC, not by its discretionary policy decisions. As they saw it, opening multiple investigations of Madoff may have been a policy decision protected by sovereign immunity, but bungling almost every detail of those investigations was negligence and was not protected from litigation.

The Justice Department argued for the dismissal of the case with almost poignant logic. “Plaintiffs’ losses are undeniably tragic,” it said in one legal memorandum. “And, for the purpose of this motion, the Court may assume that they were preventable—if only the SEC had shut down Madoff’s scheme; or if only it had employed better-qualified and more-experienced investigators, been more persistent in its pursuit of the facts, or devoted additional time and resources to its examinations.” Still, the department asserted, the plaintiffs nevertheless were barred from using the courts “to revisit such judgment calls by federal agencies.”

In the months to come, at least a dozen similar lawsuits would be filed, including one class-action case seeking redress for all Madoff victims. But even with the inspector general’s report mustered in support of their arguments, the plaintiffs faced a steep uphill fight. More than two years after Madoff’s arrest, they were still bogged down in the federal courts, waiting for a key ruling on whether they had the right to sue the government at all.

If this was the path toward justice, it would be a long journey to a nearly inaccessible destination.

Given the fate of private lawsuits at home and abroad, it became clear before the first anniversary of Madoff’s arrest that the most promising avenue for finding money to compensate victims was going to be through litigation by the bankruptcy trustee, Irving Picard.

The deadline for filing SIPC claims had come on July 2, 2009, and Picard’s offices in Rockefeller Center stayed open late to accommodate the mail and messenger deliveries. By the time the clock ran out, the number of claims had exceeded 15,000; the final total would be 16,518. Many of those filings were from victims who had invested through feeder funds or partnerships, people who did not meet SIPC’s definition of a customer and thus were not eligible for SIPC relief at all.

The battle over who was and was not a customer in SIPC’s eyes would likely take years to resolve. For now, the first order of business was for the courts to resolve how Picard should calculate victim losses. So, on August 28, Picard officially petitioned the federal bankruptcy court to schedule a hearing devoted exclusively to the so-called “net equity” dispute. The journey toward that hearing would entail months of briefs and reply briefs and briefs replying to the reply briefs. But at least the issue was on the calendar, and the “net winners” would have their day in court, their chance to demand their definition of justice.

Over the course of the summer and fall of 2009 the government auctioned off Madoff’s property—the beach house in Montauk sold for more than $9 million; the penthouse went for about $8 million; the Palm Beach home was still on the market for $7.25 million. The Mercedes sedans were sold, and the yachts and power boats were auctioned off. In November the U.S. Marshals held a sort of public flea market to sell a hodgepodge of personal belongings from the Madoff homes—from Bernie’s personalized New York Mets jacket to some antique duck decoys. All told, with a storehouse of items destined for future sale, the U.S. Marshals raised just under $900,000 at that auction—an impressive figure in almost any other case but a mere rounding error in the Madoff fraud.

By the fall of 2009, Picard had separately collected roughly $1.5 billion from the firm’s brokerage and bank accounts, asset sales, and a few out-of-court settlements, including a $234 million settlement with the family of the late Norman Levy. He had also pressed ahead with his $7.2 billion lawsuit against Jeffry Picower and his wife, Barbara. The Picowers insisted that they had known nothing about Madoff’s fraud, but they had recently started talking about a settlement.

However, on Sunday, October 25, Barbara Picower discovered her husband’s body drifting motionless near the bottom of the swimming pool on the grounds of their Palm Beach estate. With help from her housekeeper, she was able to get Jeffry out of the pool, but they could not revive him. He was pronounced dead at around 1:30
PM
. There were immediate rumors of suicide or foul play, but a prompt autopsy showed that Picower had suffered a massive heart attack and drowned. He was sixty-seven years old and had suffered from heart problems and Parkinson’s disease. The family’s longtime lawyer, William D. Zabel, said that the settlement talks with Picard would continue on behalf of the estate.

By late October, Picard had approved 1,561 claims and denied 1,309 on the grounds that more had been withdrawn from the holders’ Madoff accounts than had been deposited. Already SIPC was obligated to pay more in cash advances to the so-called “net losers” than the total it had paid out since its inception in 1970: $535 million. The sum of approved claims was roughly $4.4 billion, well shy of the $18 billion to $21 billion in “net loser” losses the trustee ultimately expected.

The preliminary arithmetic looked more hopeful than anyone could have imagined on the day of Madoff’s arrest. If the total claims and total assets increased at roughly the same rate in the months to come, Picard might be able to pay out as much as thirty cents on the dollar to eligible net losers—most of whom had hopelessly but firmly expected to get nothing.

But those numbers were just placeholders. No one would know what the actual equation would be until the courts decided whether Picard had been wrong to deny the claims of thousands of “net winners.”

That process would begin in earnest on Tuesday, February 2, 2010, the day for oral arguments on the dispute over Picard’s calculations of victim claims. The queue to get through security at the courthouse that day included more than three dozen lawyers. Among them was Helen Chaitman, who had been tirelessly demanding this day in court for more than a year.

The small courtroom was filled, and latecomers were detoured to an overflow room. The cheap metal coatrack near the door had long since disappeared under a mountain of down parkas and winter wool.

After a forty-five-minute delay to allow more lawyers to get through the crowded security checkpoint downstairs, Judge Burton Lifland took his seat in the plain, low-ceilinged chamber, which was graced only by a view of the New York Harbor through its deep old-fashioned windows.

Colleagues spoke of Judge Lifland as a jurist “of the old school,” and it was not hyperbole—he was born in 1929, got his law degree in 1954, and had been on the bankruptcy court bench since 1980. Even at age eighty, he was a diligent judge, studying all thirty-three legal briefs submitted in this case and twenty-two letters from individual investors. A small bespectacled man with an easy smile, he rarely raised his voice, much less lost his temper.

At the judge’s nod, David Sheehan, who was presenting Picard’s case, carried a three-inch stack of notes and references to the boxy lectern between the two counsel tables.

Sheehan was blunt and direct, as usual. Most of his opponents had argued that Madoff’s Ponzi scheme was different from other Ponzi schemes simply because it was a SIPC case. “They are wrong,” he said. They were ignoring the fact that the cherished final account statements were simply the artifacts of a fraud. “No one in their right mind would say you have to use the last statement,” he said in a flash of passion.

Sheehan was quickly drowned out by jeering laughter from the courtroom. He fell silent for a moment, flushed with embarrassment or perhaps anger. Then he continued softly. “It’s really sad that some of my colleagues have led people down this path.”

Judge Lifland looked startled at the outburst; it was not the sort of thing that typically happened in bankruptcy court. He nodded to Sheehan to continue.

A few moments later, when Sheehan referred to some detail in the convoluted
New Times
case, the basis for so many conflicting claims about the adjudication of Ponzi scheme losses, there was another outburst of scornful laughter.

This time, Lifland did not let it pass. The crowd was “not here as a cheering section,” he said sternly. “Let’s have some decorum in the court.” As he spoke, there were red faces among the opposing counsel. It did not help their case if their clients’ boorish behavior insulted the judge, even-tempered as he was.

Sheehan’s opponents included the lawyers for baseball’s Wilpon family and for the millionaire Carl Shapiro in Palm Beach. However, they focused on their most sympathetic clients, those middle-class victims who had been living off the proceeds from their Madoff accounts, arguing that Picard’s stand on net equity was denying those clients the SIPC cash advance of up to $500,000 that many of them needed desperately to meet their daily expenses.

Helen Chaitman told the judge that her clients included both net winners and net losers, “but every single one of these people believes that SIPC guarantees to them $500,000.” Calmly intense, she moved eloquently through her argument—that it would cost SIPC’s Wall Street members just $700 million more than was already in its reserve fund to pay all the direct investors $500,000 apiece, regardless of their net equity status. “To SIPC’s members, $700 million is not a lot of money,” she said, but for some of her clients the SIPC payment “is the difference between living with bleeding ulcers or living without them.”

To Sheehan, Chaitman’s proposal was unjust; it would mean that many people who had already recovered all of their initial investment would now get more—up to $500,000 more. Meanwhile, those victims who had not recovered any of their initial investment might never do so. “At the end of the day, they still wouldn’t be as well off as those who got all their money out,” he said.

After nearly a year of opposition, six months of court filings, and four hours of argument, there was not a lot left to say. Judge Lifland thanked the lawyers on both sides but reminded them, “No matter how I come down and rule, it is going to be unpalatable…to one party or another.”

Precisely one month later, on March 2, Judge Lifland affirmed Picard’s “cash in, cash out” definition of net equity in the Madoff Ponzi scheme. In a carefully drafted opinion, the judge recognized that there was some fuzziness in the law, but he concluded that “a thorough and comprehensive analysis of the plain meaning and legislative history of the statute, controlling…precedent, and considerations of equity and practicality” all supported the trustee’s approach.

Judge Lifland’s reasoning closely tracked Sheehan’s arguments: after the initial cash investment, all the securities supposedly purchased for customers were actually paid for with fictional profits, so they were not legitimate “securities positions” as defined in SIPC statute. “Given that in Madoff’s fictional world no trades were actually executed,” he noted, “customer funds were never exposed to the uncertainties of price fluctuation, and account statements bore no relation to the United States securities market at any time.”

Consequently, “the only verifiable transactions” were the deposits and withdrawals of cash, not the balances shown on the final account statements, which were “entirely fictitious, do not reflect actual securities positions that could be liquidated, and therefore cannot be relied upon to determine net equity.”

He concluded, “It would be simply absurd to credit the fraud and legitimize the phantom world created by Madoff.”

The judge and the lawyers on all sides agreed to seek a fast-track review by the Second Circuit Court of Appeals, the next stop in the net winners’ long, unsatisfying search for justice.