Madoff Victims May Have to Return 6 Years of Profits, Principal

By Carlyn Kolker, Tiffany Kary and Saijel Kishan

Dec. 23 (Bloomberg) -- Like some of Bernard Madoff’s clients, a Florida restaurant owner was lucky enough to withdraw part of his investment before the money manager allegedly confessed to a $50 billion Ponzi scheme. Now he’s worried he might be asked to give it back.

The 53-year-old investor, who asked not to be identified to protect his stake, took out about $600,000 this year from his $1.5 million account, using some of it to pay down a mortgage. He and other Madoff clients who withdrew funds as long as six years ago may be sued on behalf of other victims to return profits and even principal, securities and bankruptcy lawyers say.

“Right now there are Madoff winners and Madoff losers,” said Lynn LoPucki, who teaches bankruptcy law at Harvard University. “Before this is over there will be nothing but Madoff losers.”

Clients of Madoff had about $36 billion with his firm, according to a Bloomberg tally that may include some double counting. Before his arrest on Dec. 11, Madoff, 70, confessed to employees that his “giant Ponzi scheme” may have cost as much as $50 billion, according to an FBI complaint. His misconduct may have stretched back to at least the 1970s, two people familiar with the government’s inquiry of Madoff said last week.

The Florida investor, who first gave his money to Madoff five years ago, said he had no hint of fraud and would go to jail rather than give up the amount he took out.

Irving Picard, the trustee appointed to liquidate Madoff’s brokerage, Bernard L. Madoff Investment Securities LLC, holds the fate of the restaurant owner and other investors in his hands.

Enough Funds Left?

Picard, who didn’t return a call seeking comment on plans to sue victims to recover funds, said in a court filing yesterday that “there has not been any showing or determination that there are sufficient funds” to satisfy victim claims.

A so-called clawback of paid-out funds in the Madoff liquidation could result in lawsuits against investors such as charities, hedge funds and individuals who redeemed profits and took out principal. Nonprofit institutions such as the Carl and Ruth Shapiro Family Foundation, a foundation controlled by Democratic U.S. Senator Frank Lautenberg of New Jersey, and Yeshiva University relied on funding from Madoff investments.

Lawyers and representatives of the Shapiro and Lautenberg foundations didn’t return calls seeking comment. In a statement, Rick Matthews, a Yeshiva university spokesman, said, “Our lawyers and accountants are in the process of an investigation.”

‘Further Risk’

“Charities are looking at their legal options as regarding their right to recoup money,” said Mark Charendoff, president of the New York-based Jewish Funders Network, whose 1,000 members fund Jewish causes and are assessing losses from Madoff investments. “I don’t know that they’ve been focused on or are aware that they may in fact be at further risk of loss.”

Bankruptcy laws authorize a trustee like Picard to recover money that was distributed as part of a fraud and share it among the victims, LoPucki said.

“The purpose of these laws is to balance the losses among the various investors, but how that balance is supposed to be struck is not clear,” LoPucki said.

Under New York state law, which can be invoked for Madoff recoveries, a trustee can seek redemptions going back six years, said Tracy Klestadt, a New York bankruptcy lawyer.

In a similar case, U.S. Bankruptcy Judge Adlai Hardin in White Plains, New York, ordered investors of defunct hedge-fund manager Bayou Group LLC in October to disgorge profits they’d taken out. Investors were required to pay back any gains they’d redeemed involving “fictitious profits.” Before the fraud was discovered, Bayou paid out more than $135 million, according to court papers.

‘Good Faith’ Rule

Hardin also ruled some investors would have to hand back their principal. Only investors who acted in “good faith” -- a legal standard that makes investors prove they didn’t have knowledge or suspicion of fraud -- could protect their initial stake, Hardin ruled. He said investors could show they had good faith if they didn’t see any “red flags” when they withdrew the funds.

That decision could be a guide for Picard, Klestadt said.

The Bayou decision set a high bar for investors who hope to protect their principal, said Carole Neville, a lawyer representing Bayou investors.

“What the Bayou case holds at the moment, is, if you had any reason to feel uncomfortable about your investment and took your money out, you don’t have good faith,” Neville said.

“On the surface it seems a standard that’s almost impossible for people to meet,” said Robert Crane, president of New York’s JEHT Foundation, a group dedicated to criminal justice matters that relied on donors who invested with Madoff and said it’s closing in January.

Seeking money from investors who say they were defrauded can result in protracted litigation. In the Bayou case, which is being appealed, $20 million of the $33 million recovered from redeeming investors went to pay legal fees, Neville said.

To contact the reporters on this story: Carlyn Kolker in New York at ckolker@bloomberg.net; Tiffany Kary in New York at tkary@bloomberg.net; Saijel Kishan in New York at skishan@bloomberg.net.