When the world learned on Dec. 11, 2008 that Bernie Madoff had masterminded the biggest Ponzi scheme in history, the news had ripple effects far beyond the offices of his New York-based brokerage firm. The scheme’s collapse also forced “feeder funds,” investment funds that acted as conduits to Mr. Madoff’s firm, into liquidation, causing billions of dollars in losses.
Now, the Virgin Islands-based liquidators of two families of VI-registered feeder funds, the Kingate and Fairfield funds, are working to maximise the amount of money returned to the defrauded investors.
That task has prompted an extensive legal battle, attempts to “claw back” funds from feeder fund investors, and settlement talks with Irving Picard, the United States trustee liquidating Bernard L. Madoff Investment Securities, the brokerage firm.
VI firms’ role
The legal fight involving the Fairfield liquidators’ right to make claw-backs from investors who withdrew before the scheme’s discovery is ongoing, said Ken Krys, whose firm KRyS Global is liquidating the Fairfield funds.
“There is no easy way to do this,” said Mr. Krys, whose firm maintains a VI office. “The unfortunate part of this one, a Ponzi scheme like this, is if we did nothing. We’ve talked to our liquidation committee and asked what if we didn’t go after these assets? [Without the claw-back claims], there is such a small pool of assets here that people would be paid 0.001 cents on the dollar.”
Investors in the Fairfield funds, who lost somewhere in the range of $6-7 billion, invested indirectly with Mr. Madoff through the funds for confidentiality, tax considerations or other reasons, he said.
Because Ponzi schemes work by using new investors’ money to pay seemingly lucrative returns to existing investors, nearly all of the funds that flowed through the feeder funds were part of the fraud, Mr. Krys said. That includes funds from investors who successfully withdrew their initial investment and closed their account.
“It’s not only just the winners, because that would say, ‘Well, you only put your winnings back in.’ But it’s actually saying your entire redemption that was paid out was somebody else’s funds,” he said. “You just stole somebody else’s funds, and therefore there’s never going to be enough funds for everybody and so we’re going to collect all of it: not only your winning but also everything you had paid back so that everybody shares the pain.”
‘Net winners’
That approach prompted objections from some of the “net winners,” especially large institutional investors, and a lawsuit against the Fairfield liquidators. Lawyers from the VI offices of four law firms representing the net winners successfully argued before the Commercial Court and later the Eastern Caribbean Supreme Court of Appeal that the claw-backs shouldn’t be allowed.
The London-based Privy Council, the VI’s highest court, has agreed to hear the case next year, Mr. Krys said.
Even if the Privy Council sides with the liquidators and allows the claw-backs, getting those legal judgments enforced will present other problems, Mr. Krys said.
“Those parties that I’m pursuing are in foreign jurisdictions. Some of those parties don’t exist anymore,” he said. “They’ve gone into liquidation themselves. Some of those parties may have left. Some of those parties will not have those assets anymore.”
Kingate funds
Watching the claw-back case closely from the VI office of Zolfo Cooper is Stuart Mackellar, the office’s managing director. The firm is liquidating four relatively small funds in the Kingate family, he said. Because the feeder funds acted as a conduit, deposits and withdrawals from investors flowed through the funds frequently.
“There was money going out and money coming in every month,” he said. “What brought the crash of the funds was that Bernie was found out and money stopped coming out of BLMIS. And that’s what gives these guys the problem, because somebody says, ‘In 35 days I want to have $100,000 back, please.’”
Depending on the precedent set by the pending legal case, the Kingate funds may issue their own claw-back claims, Mr. Mackellar said. But currently, the funds’ biggest chance to reclaim investors’ monies lies in a settlement with Mr. Picard, the Madoff brokerage trustee, who has previously paid other claimants 42.8 cents for every dollar lost, Mr. Mackellar said.
“We have a significant claim against the Madoff estate. We want to receive our dividend from BLMIS,” he said.
But in order to have the validity of their claim recognised by Mr. Picard, the liquidators have to first pay back roughly $800 million disbursed to the feeder funds’ investors, Mr. Mackellar said.
“The trustee has said to us, like he has said to everybody else, ‘I’m not paying you until you pay me for the withdrawals that the funds have made,’” Mr. Mackeller said.
There aren’t nearly enough assets on hand to make that payment, he said, but he added that a third-party funder has been identified and settlement talks are ongoing with Mr. Picard.
Recovery
Messrs. Krys and Mackellar both said they don’t expect that feeder fund investors will ever recover all of their losses, as is typical in fraud cases.
But Mr. Mackellar is hopeful that the amount will be more than what some fraud victims currently expect.
There is a market through which Madoff victims can sell their legal rights to their share of assets recovered by Mr. Picard. Several hedge funds have been optimistically buying those rights, Mr. Mackellar said, despite the fact that Mr. Picard is currently paying only 42.8 cents for every dollar of losses.
“I’m getting the impression from the trading that’s going on that these guys expect the trustee to pay 75 cents on the dollar,” Mr. Mackellar said.