Waiting For The Other Shoe To Drop


by Seth Lipner
Special To The Jewish Week

The initial news reports were staggering. Hadassah, and many other Jewish charities, had invested with the arch-thief Bernard Madoff. Whatever they put in, whatever they thought they had, it was all gone in the biggest fraud in history.

In a December 2008 letter to contributors, first reported in these pages, Hadassah disclosed that it had invested $7 million with Madoff in 1988, and added another $33 million over the next decade. When Madoff was revealed to be a latter-day Charles Ponzi, the Hadassah account had, according to reports, grown to a fictitious $90 million. Whether one measures the loss at $40 million or $90 million, it is staggering, even for a well-funded charity. Hadassah has tried to put on a good face by

pointing out that its endowment is still $412 million.

But the losses may turn out to be just a part of this ugly story, not just for Hadassah, but for many others who invested with Bernard Madoff. That’s because Madoff-investors who withdrew money over the years may be subject to claims by SIPC Trustee Irving Picard to recover those withdrawals.

The legal basis on which Picard will proceed is that those who withdrew money received benefits in comparison to those who invested with Madoff but withdrew nothing. Bankruptcy law tries to put all creditors — here victims of Madoff’s fraud — on an equal footing. As Picard explained in a May conference call, “I have a statutory duty to treat fairly all customers, and part of that duty requires pulling together the largest possible fund of customer property from which to make payments.” Withdrawals that are recovered by Picard will go into the “pot” from which all the victims will share pro-rata. While no one will be made anywhere near whole, the more recovered by Picard, the more each victim will get when the “bankrupt estate” is distributed.

Bankruptcy lawyers call these “clawback suits,” but the ugly name is not deserved. Since the essence of a Ponzi scheme is that some investors are paid out of the contributions of others, the idea behind these suits makes sense.

The right of a bankruptcy trustee to seek return of withdrawals comes from the Uniform Fraudulent Conveyance Act. Under that statute, if an insolvent entity made a transfer that diminished its assets, the recipient of those transfers must return the amounts received in the transfer. It does not matter that the recipient did not know about the fraud — it is the fraudulent intent of the transferor that gives rise to the liability. The law’s purpose is not to “punish” the transferee, but rather to put transferees who benefited disproportionately from withdrawals on an equal footing with creditors who did not benefit.

Faced with the daunting task of unwinding the Madoff fraud, Picard is proceeding slowly. So far, he has only gone after people and entities that he asserts were knowing participants in the fraud, like Jeffrey Picower. Picard’s suit against Picower alleges that Picower knew or should have known that Madoff was a fraud. Picower has denied the charges.

Hadassah and most other Jewish charities probably don’t face accusations of knowing participation, but they are still worried, and with good cause. When Picard comes knocking, they will find they have little in the way of legal defenses. But despite Picard’s public statement that he has a legal duty to recover withdrawals, he is empowered to exercise some discretion, and to consider the hardship that might be caused. Individuals and charities that acted in good faith — for example by withdrawing moneys to pay living expenses or operating costs — innocently relied on what they believed they had in their Madoff accounts.

Picard has stated that he is not unsympathetic to these Madoff investors, but he has been silent as to what criteria he will employ when deciding what to do with charities like Hadassah, whose long-term financial planning has been upended, and of the potential for these suits, whose planning is still up in the air. One can only hope that Picard will consider the level of damage already done to such investors when he decides whom to go after, and for how much.

The amount Picard can pursue depends on the circumstances. First, the statute of limitations only permits a trustee to go back six years. Second, the law seems only to allow the trustee to seek withdrawals in excess of contributions. That means that if Hadassah took out only $40 million — the amount of its contribution – then it has no liability. But any withdrawals in excess of the $40 million are subject to a claim by the trustee.

The repayment of these excess withdrawals will no doubt be onerous, but in the end, Hadassah will get to keep the first $40 million withdrawn. In other words, when all the dust settles, Hadassah will have no “out-of-pocket loss.” Those who withdrew nothing, by contrast, get only a pro-rata share of the money Picard recovers — far less than the amount they put in.

That comparison won’t make Hadassah feel any better. No matter which category one is in, the situation is horrible.

Seth Lipner is a professor at the Zicklin School of Business, Baruch College, CUNY.