Transcript Document

Strategies to Minimize Damages
From Madoff & Other Recent
Investment Scandals
G. Robert Marcus
Erin T. Welsh
Gary N. Marks
Morris S. Bauer
The material provided herein is for informational purposes
only and is not intended as legal advice or counsel.
Charles A. Bruder
Melinda Fellner Bramwit
John J. Eagan
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Strategies to Deal with Madoff Losses
That Are Not Available or
Not Cost Effective
• Joining a class action
• Suing related Madoff parties individually
– Trustee and big money will be chasing these people
– Any action will be stayed by the U.S. attorney or the
Bankruptcy Court
• Suing the IRA or 401(k) administrators
• Suing the SEC or the U.S. Government
• Any action designed to change the IRS position that
a theft loss deduction is unavailable to a retirement
account
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The Securities Investor
Protection Corporation and
Recovery of Customer Claims
Erin T. Welsh
Overview of the Securities Investor
Protection Corporation (“SIPC”)
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What is SIPC?
SIPC’s Role
SIPC’s Current Resources for Claims
Types of Losses Covered
Investment Products/Losses Not Covered
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The Liquidation Proceeding
• Customer Protection Proceeding
– Bernard L. Madoff Investment Securities, LLC (“BLMIS”)
– Placed in liquidation proceeding December 15, 2008
– Irving H. Picard appointed as Trustee
• Trustee May Transfer Customer Accounts or
Forward Securities and Cash to Customers
– BLMIS accounts could not be transferred to another brokerage firm
• Customer Claims
– 8,000 claim forms sent to BLMIS investors
– SIPC Trustee must determine whether claims are (1) “ascertainable”
from the failed brokerage firm’s records or (2) established to the
satisfaction of the SIPC Trustee
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SIPC Claims
• Who Should File a SIPC Claim?
– Who is a “Customer”?
• Multiple accounts
• Feeder funds and other indirect investors
• What is the Amount of Each Customer Claim?
– Difference between total amount put into account and total
amount taken out of account
• What Documents Should be Filed With the
Claim?
• When Should a Claim Be Filed?
– July 2, 2009 deadline
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Satisfying Customer Claims
• Customer Name Securities
• Advancements from SIPC Fund
– $500,000 limit per customer, including
$100,000 for cash claims
• Ratable Share of Customer Property
• General Estate
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Clawbacks
• Trustee will seek to recover false profits from
some customers
• Factors Considered:
– Size of investment and amount of fictitious profits at issue
– Time period over which money was invested
– Investor’s relationship with Madoff or other insiders
– Review of account statements
– Account activity and any other factors deemed
appropriate by Trustee
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Clawback
Gary N. Marks
Morris S. Bauer
How We Got Here
• SEC files for preliminary and injunctive relief versus
Madoff and Madoff Securities on 12/11/08 – Southern
District of N.Y.
• SIPC petitions Southern District to protect Madoff
Securities customers under Securities Investors
Protection Act (“SIPA”) on 12/15/08
• Federal District Court appoints Irving Picard as SIPA
trustee and transfers liquidation proceedings to
Bankruptcy Court
• Judge Burton R. Lifland presiding in Bankruptcy
Court.
– Judge Lifland has previously addressed many issues that
will likely arise in the Madoff case in another Ponzi case,
Manhattan Investment Fund
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Power and Authority for Trustee’s
Clawback Powers
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SIPA liquidations typically mirror liquidations under Chapter 7 of the Bankruptcy
Code
SIPA expressly vests power in the Trustee to recover fraudulent transfers and
preference payments
11 USC § 547
– Permits the Trustee to recover preference payments made to creditors
within 90 days of the petition
11 USC § 548
– Bankruptcy Codes fraudulent transfer law
– 2 year reach back period
11 USC § 544
– Permits trustee to use applicable non-bankruptcy law to recover fraudulent
transfers
– Trustee may utilize provisions of New York Debtor and Creditor Law § 273276
• New York’s fraudulent transfer law
• 6 year reach back period
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• Compare: NJ and Fla 4 year reach backs
Constructive Fraudulent Transfer
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A constructive fraudulent transfer is a transfer made for less than
reasonably equivalent value or fair consideration by an entity that is
insolvent or under capitalized
Investors are considered to have given reasonably equivalent value for
their redemptions to the extent of their original investment
Example: Actual dollars in $100,000; redemptions within 6 years
$100,000; real dollars and in equal dollars taken out; therefore, no
fraudulent transfer since the redemptions were for reasonably
equivalent value
Example: Same as above, except $200,000 redeemed within 6 years;
reasonably equivalent value only to the extent of the original $100,000
invested; no reasonably equivalent value given for the excess;
therefore $100,000 is recoverable as a fraudulent conveyance
Distinction between withdrawals of principal versus withdrawals of
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interest?
Actual Fraudulent Transfer
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An actual fraudulent transfer is a transfer made with actual intent to
“hinder, delay or defraud creditors”
One view (the Bayou case)
– All transactions by Madoff are presumed to be with the intent to hinder,
delay or defraud creditors
– Even if investors are not guilty of any wrongdoing
– No distinction between principal and interest
•
Alternative view:
– Recovery as an actual fraudulent transfer requires fraudulent intent on the
part of the redeeming investor
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Example: Innocent investor; $100,000 invested; redemptions within 6
years are $200,000, half principal, half interest
– Under Bayou – Presumed to be an actual fraud even if investor has done
no wrong; all $200,000 recoverable as fraudulent transfer
– Alternative – Since no fraudulent intent on investor’s part there is no actual
fraud; only $100,000 recoverable by Trustee
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Good Faith Defense
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Shields transfers made for “reasonably equivalent value” or “fair
consideration”
– Applies to redemptions of principal
– Fictitious profits of phantom income usually not subject to the defense
– To assert defense investor must establish:
• No “actual notice” of the fraudulent scheme
• No “inquiry notice”
– Objective test
– Should reasonably prudent investor have been “on alert” and
required to learn more
– Investor who is on inquiry notice, makes diligent investigation and
finds nothing can still avail himself of defense
– In Madoff case, since SEC and sophisticated financial institutions
could detect no fraud, a good faith defense by an individual
investor could prevail
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Subsequent Transferee
Liability
• Example: Investor in a feeder fund requests a
redemption; feeder fund in turn redeems from
Madoff and pays investor,
– Principals of actual and constructive fraudulent
transfer still apply, but
– Those cases will be muddied with proof problems
– Unclear whether Picard will attempt to extend his
clawback power this far
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The Clawback Pursuit
• When?
– 2 year statute of limitations from Commencement
Date (December 15, 2008) to file clawback
lawsuits
• Who?
– Unknown – Trustee states recipients of phantom
income will be pursued. However, until the
process is started, the Trustee still has the
discretion to seek recovery from anyone who
received payments.
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The Clawback Pursuit (cont’d)
• How?
– Demand letters
– Test case
– Settlement guidelines
• Trustee may file motion with the court under
seal seeking approval of settlement parameters
– Filing of complaints
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Settlement Strategies
• Negotiating settlements
– Representation by counsel
– Disclosure of personal financial condition,
i.e. evidence of wherewithal or limitations on
ability to repay the clawback claim
– Waiver of proof of claim
– Sympathy factor
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Investment Losses and Tax-Deferred
Accounts
Charles A. Bruder
Tax-Deferred Investment
Accounts – Issues Summary
1. Individual Retirement Accounts
– No theft loss income tax deduction
• Roth IRA exception
– SIPC Claim
2. Defined Contribution Plan Accounts
– No theft loss income tax deduction
• After-tax contributions exception
– SIPC Claim
• Single claim or multiple claims?
– Potential Fiduciary Liability
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Tax-Deferred Investment
Accounts – Issues Summary
3. Defined Benefit Plans
– No theft loss income tax deduction
– SIPC claim
– Pension Benefit Guaranty Corporation (“PBGC”)
– Potential fiduciary liability
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Plan IRA/Participants Owners
• Theft loss income tax deductions are not
available for pre-tax funds
– No basis in these amounts for income tax
purposes
– IRS: Plan participants/IRA owners receive the “tax
benefit” of avoiding taxation on the income that
would have been generated by these accounts
• Question: Did you ever pay income taxes on
any portion of your retirement plan/IRA?
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IRA Owners
Possible Theft Loss Tax Deduction
• Potential sources\ of theft loss income tax
deduction
– Roth IRAs
• IRA which has been “converted” by the owner through
the payment of income taxes on some portion (or all) of
the account balance
• As the owner has an income tax basis in the Roth IRA, a
theft loss income tax deduction may be supportable
• Limited to the amount of the income tax basis
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IRA Owners
Other Sources of Potential Recovery
• Third Party Liability
– Asset custodian – FISERV
– Investment Advisors/Managers
– Investment Sales Representatives
– Other professional advisors
• SIPC Claim
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Special Considerations – Defined
Contribution Retirement Plans
• SIPC Claim – Unresolved Issues
• Possible theft loss tax deduction
• Defined contribution plans which permit after-tax
contributions
• Must have been permitted under the terms of the plan
• After-tax plan contributions = income tax basis
• Theft loss income tax deduction will be limited to the income
tax basis
• After-tax contributions are not permissible for defined
benefit (i.e., pension) plans
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Special Considerations – Defined
Benefit Plans
• No theft loss income tax deduction
– All pension funds are pre-tax employer
contributions
• SIPC Claim – filed on behalf of the defined
benefit plan as a single account
– No individual SIPC claims
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Special Considerations – Defined
Benefit Plans
• Pension Benefit Guaranty Corporation (“PBGC”)
– Inability to pay accrued plan benefits when due is a
“Reportable Event”
– Must file a PBGC Form 10 within 30 days of “knowing or
having reason to know” that a Reportable Event has
occurred
– Failure to timely file may result in a loss of PBGC recovery
– Maximum annual benefits – subject to adjustment
• 2009 - $54,000
• 2008 - $51,750
– Potential subrogation claims for plan fiduciary/participants
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Special Considerations –
Retirement Plans
• Plan Sponsors/Fiduciaries
• Potential Areas of Liability
• Breach of fiduciary duty
• Failure to exercise due diligence in investment decisions
• Failure to diversify investment funds
• Self-Directed Plans: Failure to adequately inform participants of
investment risks
• Informed communication with plan participants is critical
• Review fiduciary bond provisions for potential
claim/exposure
• Potential claims against third parties (i.e., asset custodians,
investment managers, plan administrators, etc.)
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Tax Impact
John J. Eagan
Melinda Fellner Bramwit
Income for 2008 Tax Year
• February 5, 2009 Announcement by
Irving Picard
• Recommended Action For All Affected
Taxpayers
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Current Positions on Refund ClaimsIRS Revenue Procedure 2009-20 IRS
Revenue Ruling 2009-9
• Optional Safe Harbor Method
• Illustration
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Optional Safe Harbor Method:
Hypothetical Basis Calculation and
Theft Loss Calculation
Bernard L Madoff Investment Securities LLC
November 30, 2008 Account Balance (includes all
previously taxed income)
Less 2008 earnings (no 1099)
Theft Loss Tax Basis
Subtractions
5% of 11/30/08 balance if no third party claims
(25% if third party claims)
Reimbursement Claim-SIPC
Theft Loss Deduction
$
$
$
2,500,000
( 200,000)
2,300,000
$
( 115,000)
$
$
( 500,000)
1,685,000
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Current Positions on Refund ClaimsIRS Revenue Procedure 2009-20 IRS
Revenue Ruling 2009-9
• Optional Alternate Method
• Illustration
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Optional Alternate Method: Hypothetical
Basis Calculation and Theft Loss
Calculation
Bernard L Madoff Investment Securities LLC
November 30, 2008 Account Balance
Less 2008 earnings (no 1099)
Initial Theft Loss Tax Basis
Subtractions
Reimbursement Claim-SIPC
Additional Subtractions
2005 earnings (eliminated by amended return)
2006 earnings (eliminated by amended return)
2007 earnings (eliminated by amended return
Theft Loss Deduction
$
$
$
2,500,000
( 200,000)
2,300,000
$
( 500,000)
$
$
$
$
( 200,000)
( 200,000)
( 200,000)
1,200,000
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State Law Views
• New Jersey
• New York
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Net Operating Losses, Alternative
Minimum Tax and Other Notable Issues
• Mechanics of the NOL rules- potential 5
year carryback
• AMT issues
• Reportable Transactions
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Recommended Action Plan
• 2005-2007 - safe harbor without
amended returns versus alternate
method with amended returns and state
effects
• 2008 theft loss - alternative if you are in
a refund position for taxes unrelated to
Madoff
• Claim optional NOL carryback for 200338
2007
Questions and
Answers
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