 The Wild Wild World of Wealth |  |
Judge Denny Chin sentenced Bernie Madoff to 150 years today. But the BM story is far from over. The next chapter will examine the Securities Investor Protection Corporation (SIPC). And there’s one question for every American?
The problem is the “success fee.” Irving Picard is the trustee in the Madoff case. According to Time, he receives compensation tied to the assets he collects. There is debate whether the fee is formulaic, but trustees in similar cases have received 3 percent for their efforts. Picard could receive $60 million, for example, if he recovers $2 billion in assets.
Hey, $60 million sounds like the kind of pay package that gets bank CEOs in trouble.
Acrimoney endorses success fees. People work late when there are incentives. And the Madoff collection efforts—international in scope—are complex. They require long hours.
No one works for free. But this trustee sounds like the A-Rod of bankruptcies.
Picard’s potential compensation is a red flag. When brokerage commissions total 3 percent, Acrimoney questions whether the underlying assets are toxic. We don’t know if Picard will receive 3 percent, but the possibility made us probe further.
Things gets worse.
SIPC pays the trustee from their reserves of about $1.6 billion. The trustee’s compensation, therefore, does not reduce the amount paid to Madoff victims.
This structure almost sounds generous—at first.
The problem is the conflict. The trustee can make decisions, subject to court approval, that benefit SIPC to the detriment of some Madoff victims. Picard introduced a concept, for example, which he calls “net equity.” If Madoff victims pulled out more than their initial investment, they have no “net equity.” They are not entitled to SIPC’s maximum payments of $500,000. Let’s review two cases:
Case one: An investor deposits $1 million with Madoff. The account grows to $1.5 million over five years, and the investor takes zero in distributions. He or she is entitled to $500,000 from SIPC. It’s thirty-three cents on the dollar. But it’s better than nothing.
Case two: A different investor deposits $1 million with Madoff, which also grows to $1.5 million. At the last minute, he or she withdraws $1 million leaving an account balance of $500,000. The investor is entitled to $0 from SIPC under Picard’s definition of “net equity.”
So the trustee is both A-Rod and umpire?
Here’s the conflict: SIPC rewards the trustee, who makes decisions that can reduce SIPC’s outflows. And presumably, payment reductions help SIPC.
Everybody wants to pay less, right?
The reduction more than helps SIPC. By limiting SIPC’s payments through the concept of “net equity,” the trustee is solving a problem. With $1.6 billion in reserves, SIPC can pay 3,200 claims of $500,000 each before it runs out of money.
There are 8,800 claims, and counting, in the Madoff liquidation. If SIPC paid $500,000 for every claim, they would be forced to seek a bailout from the US Treasury. If you’re SIPC, it helps to have the trustee on your side.
The trustee’s 3 percent success fee sounds cheap relative to $1.6 billion.
The Madoff case is big and complicated. There are many differences of opinion. Even Madoff victims differ over the concept of “net equity.” But Acrimoney believes the system is broken, rife with conflict. It’s immaterial—from an ethical perspective—whether “net equity” is just. But it’s not right that a trustee can favor the institution that pays him.
If the system is broken, can Madoff victims expect just solutions? And since when do umpires share in the spoils of victory?
JeffM says:Sorry
This sentence, “Or did I miss your point when you compared the 33 cents on the dollar received by Party A from the SIPC to the nothing received from SIPC by Party B as though implying that the net result is that Party A suffers more than Party B”, should read, “Or did I miss your point when you compared the 33 cents on the dollar received by Party B from the SIPC to the nothing received from SIPC by Party A as though implying that the net result is that Party A suffers more than Party B.”
JM,
Sorry for the confusion. The two cases are a simple illustration. They show the trustee can minimize payments through the concept of “net equity.” The illustration is nothing more. It is not a statement about who fared better—A or B.
Here’s one example where the issue of “net equity” is extremely complicated to my mind. Some of the older investors were pulling out their “earnings” every year for a good long while. At a rate of 12% per year, they hit 96% of their hard dollars invested after 8 years. By year 9, they no longer had any “net equity.” No SIPC money.
Here’s the problem. According to NY clawback laws, the trustee can only chase withdrawals six years back. At 12%, therefore, the investors would only have 72% of their hard dollars in assuming the investors limited withdrawals to the admittedly fake earnings. There is still some net equity, 28%.
It seems to me this is a double standard. The trustee can reach back forever to protect SIPC. He can only reach back 6 years to overturn preferential transfers. Why? The double standard is unfair.
One other thing. I am not a Madoff investor. I have met a few, however, and think it is unfair to generalize across the board about greed. Madoff was able to full so many people, even the SEC which had the benefit of Harry Markopolis gift-wrapping the Ponzi case against him.
The process for resolution is less than perfect, and I don’t blame investors for their anger.
Norb
JeffM says:Norb
No need to apologize for any confusion. There was really no confusion on my part, except rhetorically. I understand your point that the position Picard is taking benefits the SIPC. To the extent that the SIPC employs Picard, that raises obvious doubts about whether his position is based on the best reading of law and equity or a plausible reading that benefits his employer. I get that point as well. Legal ethics are a lot like military intelligence.
My point is whether Picard’s position is the ethically correct one. Just because he has a bias does not mean that his argument is ethically wrong. In every dispute, each disputant has a bias, but one must be more right than the other despite any bias.
A big part of the problem is that disputes about which innocent party must bear a loss are intrinsically hard. Our sense of fairness says that the guilty must pay all the innocent, but that emotional reaction is worthless when the guilty cannot pay. As I understand the situation, the bulk of the losers are not involved in this SIPC dispute directly because they invested through feeder funds. This is a question the answer to which I do not know: do the payouts by the SIPC become priority claims against the receviership? If the answer to that is “yes,” analysis in terms of disputes about who gets paid how much by the SIPC ignores the interests of the majority who invested through the feeder funds. I am sure the lawyers who are getting paid by the SIPC-covered plaintiffs are not protecting the interests of those lacking coverage at all. (The argument contra hominem cuts both ways.)
I must beg to differ with you about the greed of most of the Madoff investors. I am sure some were incredibly naive: “Oh, that lovely Mr. Madoff will pay 12% risk free, but my crooked bank and the crooked US Treasurty only pay 3%. It must be EVERYONE but Bernie is a crook, skimming off 9% of the risk-free 12% they are making.” Do I deny some investors were that incredibly stupid? No. Do I think people who have not a clue about risk-reward trade-offs or diversification of risk deserve a great deal of sympathy when they invest everything in something they know full well they do not understand? No. Moreover, most of the victims are not stupid. Frank Lautenberg is not stupid. And on and on and on. And many of these very sophisticated victims must have suspected that Madoff was a thief, they just suspected he was stealing from others through front-running rather than stealing from them. Do I think those people deserve any sympathy at all? No.
Now getting back to the ETHICAL merits of the “net equity” dispute. I like your point that the absolutist position of Picard ignores the time value of money. That is an insight that is original with you as far as I know. I also like your point that the clawback provisions under state law have a time limit (although I suspect that state law is legally irrelevant in what is a federal case). These victims are not criminals, and even criminals are mostly protected by a statute of limitations. Addressing these points may lead to a more equitable result than Picard’s time-insensitive argument. My main point here is that no one seems to be asking what is the ethical and equitable result. Everyone is just saying “Gimme.” It is not an edifying sight.
JeffM
Ellen R says:I am a retiree with no personal involvement with Madoff. I have mixed feelings about the characterization of Madoff victims as “greedy”. I have a retirement account at Merrill Lynch and have been victimized by a greedy broker who put his commissions ahead of my interests. I have no recourse for following his bad advice. I had to suck it up and move on. On the other hand, I think that an astute investing professional at a hedge fund can fairly easily give his clients a 10-12% return on their money through capital gains and dividends. I always assumed that hedge funds existed to give wealthy people better returns than us “little” people. My thought about Madoff’s clients were that they believed they were not in the “little” people category where 3-5% returns were more the norm. Are all people who invest in hedge funds fools? Did anybody ever report Madoff (or a hedge fund) for having unreasonably high returns on investments? I certainly feel that a measure of blame belongs with the victims, although I think they were also screwed by the lack of government oversight. Nobody is coming to my aid because I trusted the wrong broker at Merrill Lynch. I certainly don’t want my tax money used to make the Madoff victims whole, unless the government decides to reimburse all of us who were taken advantage of by sleazy brokers and investment scam artists.
Ellen,
Here are some thoughts as you have a few different threads running through your comment. You can always complain to a broker’s boss. As an ex-broker myself, I assure you that complaints set off alarm bells whether at Merrill or now Bank of America. Have you gone this route?
Here’s a web link whether you can check whether others have complained about the individual with whom you worked: http://www.finra.org/Investors/ToolsCalculators/BrokerCheck/index.htm.
A 10 to 12% is no easy feat, particularly if it’s consistent. Madoff reported 12 percent returns to his investors every year. They were a sham. Consistent double digit returns should generate questions among investors.
Nobody is coming to the aid of Madoff victims. They’re fighting for reimbursement (up to $500,000) from SIPC and their pro-rata share of recovered assets. The fight at SIPC is not about some kind of bailout. It’s more over the meaning of what SIPC covers. And personally, I think the language is incomprehensible.
All that said, Ellen, I’m sorry you got burned. It’s really important for everybody to keep an eye on their finances because…nobody cares about your money more than you. Thanks for visiting Acrimoney.
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I am not a lawyer, and what is the LEGAL definition of “net equity” will be thrashed out in the courts.
I am sympathetic to your view that a trustee in bankruptcy should be hired by and answerable to the court, not to any party with skin in the game. I am also sympathetic with your view that incentive compensation based on what is recovered for the benefit of those facing loss (and how quickly) is not a bad idea.
I found, however, your example dealing with the ETHICS of the “net equity” dispute odd to say the least. In your example, parties A and B both invest a $1.0 million and both are given statements that show they have earned $0.5 million in spurious profits and so have a balance due them of $1.5 million. Party A withdraws $1.0 million before the collapse and so regains all principal but loses all the earnings under the trustee’s approach (if I understand it correctly). Party B fails to withdraw anything and, again as I understand the trustee’s approach, gets $0.5 million from SIPC, representing half of the principal and none of the earnings. You seem to be arguing that the one who got the short end of that stick is Party A because Party A received nothing from the SIPC. Or did I miss your point when you compared the 33 cents on the dollar received by Party A from the SIPC to the nothing received from SIPC by Party B as though implying that the net result is that Party A suffers more than Party B. If we take the approach that you seem to be advocating, Party A gets 100 cents on the dollar and party B gets 33 cents whereas under Picard’s approach, Party A gets 67 cents and Party B gets 33 cents. In neither case, is Party A the one with the short end of the stick.
Look, I understand that the SIPC saves $0.5 million under the trustee’s approach and that makes the trustee’s good faith suspect, but ethically his position seems much stronger than that of the people who want their principal plus their fictitious gains while others get only a fraction of their principal. People who invested with Madoff were, mostly, greedy, and these class action suits prove some still remain ddisgustingly greedy. Of course to the extent they are going after SIPC, they are going after an entity that perhaps deserves little sympathy.
As I said, I have no clue what the law is; if it contravenes the ethics of the situation, it will not surprise me in the least.
JeffM