Advocating for asset forfeiture in the post-Madoff era: why the government, not a bankruptcy trustee, should be responsible for recovering and redistributing assets from feeder funds and net winners.

• Author: Martucci, Anthony

CONTENTS INTRODUCTION I. PONZI PROBLEM: COLLECTING AND DISTRIBUTING MONEY THAT DOES NOT EXIST A. How a Ponzi Scheme Works B. The Unenviable Task of Recovering Fictitious Profits 1. The Feeder Funds 2. The "Winners" of the Ponzi Scheme II. DIFFICULTIES ARISING FROM THE TRUSTEE'S RECOVERY TACTICS A. The Feeder Fund Cases B. The Net Winner Cases III. ASSET FORFEITURE: HISTORY, PURPOSE, AND OBJECTIONS TO ITS USE A. The History and Rationale of Civil Forfeiture B. How Asset Forfeiture Works C. The Current Battle Between Asset Forfeiture and Bankruptcy Proceedings IV. TAKING IT A STEP FURTHER: FORFEITURE OF FEEDER FUND AND NET WINNER PROCEEDS A. Why Asset Forfeiture Can Be Used to Recover and Redistribute Money from Feeder Funds and Net Winners B. The Innocent Owner Defense C. Asset Forfeiture: Cheaper, Faster and All-Around More Efficient CONCLUSION INTRODUCTION

On December 11, 2008, Natalie Erger and her seventy-eight year-old husband's financial lives came to a screeching halt. In a matter of seconds they had gone from comfortably retired to penniless. They still had three car payments, a mortgage, and other living expenses, but they suddenly found themselves with no money except Social Security payments and the balance in their checking account. (1) They couldn't make their mortgage payments or find someone to purchase their home, and they found it nearly impossible to work at their age. (2) Natalie and her husband were "trapped in a life style that [they] never would have chosen if [they] knew [they] didn't have the money to support it." (3) Despite their personal hardship, they worried even more about their children and grandchildren. No longer could they afford a tutor for their grandson with a learning disability or fly their eleven grandchildren out to see them for the holidays. Instead, they had become destitute, requiring assistance from their children and siblings just to survive. (4) The Ergers' story, like those of so many others, was the catastrophic result of investing their life savings in Bernie Madoff's Ponzi scheme. But the con man's fraud was not limited to novice investors such as the Ergers. He stole from longtime friends, (5) charitable organizations, (6) and even celebrities such as Steven Spielberg. (7) A few investors, so distraught after learning of the fraud, even took their own lives. (8)

These horrific tragedies led to the appointment of Irving Picard as the Securities Investor Protection Act ("SIPA") Trustee on December 15, 2008 for Bernie Madoff and Bernard L. Madoff Investment Securities ("BLMIS"). (9) As trustee, Picard's duty is to investigate the financial affairs of Madoff and BLMIS, recover and reduce to money as much property as possible, and deliver that money in a way that is most "practicable in satisfaction of customer claims." (10) This power has resulted in over 1,000 lawsuits against individuals and companies that he claims owe money to families such as the Ergers. The lawsuits require Picard to seek recovery of funds predominantly from two groups of individuals and entities who actually benefited from the fraud: "feeder funds," which were entities that helped recruit investors to join the scheme, and "net winners," investors who joined the scheme early and withdrew far more fictitious profits than they invested in principal. From the feeder funds, Picard seeks to recover fees and other forms of compensation they received, as well as punitive and compensatory damages, under theories of stolen customer property and unjust enrichment. (11) From net winners, Picard seeks to recover fictitious profits and in some cases invested principal, citing theories of fraud and willful blindness. (12) Unfortunately, many of these lawsuits are doomed to fail or to recover only a fraction of what is sought. In fact, courts have already ruled against Picard in some of them. (13) Considering these inevitable outcomes, the need for a new approach when dealing with asset distribution following discovery of a Ponzi scheme has become apparent.

This Note explores criminal and civil asset forfeiture by the United States government as a viable alternative to bankruptcy proceedings when dealing with Ponzi schemes and the fair distribution of recovered assets to victims. It focuses on current and recently settled litigation dealing with Bernie Madoff's Ponzi scheme and the liquidation of assets, but also suggests how assets should be seized and distributed as Ponzi schemes are uncovered in the future. Finding a way to collect and distribute Ponzi funds efficiently and fairly will be important for years to come as "[t]he drying up of money caused by the recent financial crisis has unearthed numerous Ponzi schemes nationwide." (14)

Part I describes how a Ponzi scheme such as Bernie Madoff's works and the types of entities from which a SIPA Trustee attempts to recover funds. Part II identifies current bankruptcy trustee tactics used to recover assets from third parties involved in Ponzi schemes. It also shows why Picard is unlikely to recover the funds he seeks from these third parties. Courts have begun to find either that he does not have the requisite standing to recover the funds he seeks or that he is severely limited in how far back in time he may reach to recoup fictitious profits from investors. This Part examines recent high-profile cases and opinions, with a focus on the now-settled lawsuit against the owners of the New York Mets.

Part III discusses asset forfeiture as an alternative to bankruptcy proceedings in light of forfeiture's history and purpose. Part III also explains how asset forfeiture is currently used in Ponzi-scheme cases to recover the assets of individuals responsible for the fraud. It explores the current criticisms of the government entering into an area that has historically been the exclusive realm of bankruptcy trustees. It also refutes those criticisms by explaining that the government has the same goals as the SIPA trustee--fair distribution of monies to victims. Finally, Part IV discusses why asset forfeiture is a more cost-effective and efficient option for recovering and distributing funds than the bankruptcy proceedings currently in place. It proposes that criminal and civil asset forfeiture is the best solution for dealing with the assets of the individual responsible for the Ponzi scheme, as well as the assets of third parties who benefitted from the fraud in some way. Asset forfeiture would allow for the quick recovery and distribution of funds to Ponzi scheme victims on a pro rata basis without thousands of costly lawsuits.

1. PONZI PROBLEM: COLLECTING AND DISTRIBUTING MONEY THAT DOES NOT EXIST

   1. How a Ponzi Scheme Works

      Bernie Madoff's scheme was simple. His company, Bernard L. Madoff Investment Securities, was registered with the SEC as a securities broker-dealer and run by its "founder, chairman, and chief executive officer, [Bernie] Madoff, with several family members and a number of additional employees." (15) To perpetuate the fraud, Madoff would keep accounts for all of his investors and show them statements containing fictitious profits made from securities trades. (16) But in reality, Madoff was not making any trades at all. (17) He simply recruited individuals to invest in his firm, and then used their money to pay other investors when "requests for distribution of 'profits' were made." (18) Eventually, the money began to dry up as people began taking much more out than was coming in via new investments. In the end, "the market that Madoff had dominated for decades finally destroyed him." (19) The burst of the housing bubble in 2008 and the resultant global financial crisis spelled the end for BLMIS. The jig, as they say, was up. (20)

   2. The Unenviable Task of Recovering Fictitious Profits

      Once a Ponzi scheme such as Madoff's is discovered, the Securities Investor Protection Corporation (SIPC) steps in under SIPA. (21) Although created by statute, the organization is not an "agency or establishment of the United States Government." (22) Rather, it is a nonprofit membership corporation, funded by its registered broker-dealer members. (23) The mission of the SIPC is to help return assets to customers of brokerage firms that close due to various financial difficulties. (24) Under SIPA, the SIPC may file for a protective decree with a U.S. district court if it determines that any member of the SIPC "has failed or is in danger of failing to meet its obligations to customers." (25) As a registered broker-dealer, BLMIS was a member of the SIPC, and after the fraud was revealed it became obvious that the company would not be able to meet its obligations to customers. Thus, the SIPC filed an application for a protective decree, which was granted by the district court. The protective order gave the court complete control over Madoff's property, and also required the appointment of a trustee for BLMIS to redistribute assets to investors. (26)

      Trustees under SIPA have the same duties as a trustee under Title 11 of the bankruptcy code, and the additional duty to "deliver securities to or on behalf of customers to the maximum extent practicable in satisfaction of customer claims." (27) With a Ponzi scheme as massive as Madoff's, these duties become much more difficult than simply liquidating company assets and distributing them according to customer claims. The trustee, Picard, along with a massive platoon of attorneys, special experts, consultants, and international counsel, is "engaged in a broad range of activities ... including evaluating claims, conducting forensic analysis of years of documents, working through complex negotiations, filing and responding to motions, assembling detailed complaints and litigating them." (28) The result of these investigations, going on since December 2008, has been over 1,000 lawsuits in which Picard seeks to recover over $100 billion. (29) The lawsuits grabbing many recent headlines involve two groups that...