The Madoff Litigation

John Quinn is joined by Robert Loigman, partner in Quinn Emanuel’s New York office, and Eric Winston, partner in Quinn Emanuel’s Los Angeles office.  They discuss the extensive litigation that has followed the 2008 collapse of Bernie Madoff’s Ponzi scheme.  The litigation stems from a liquidation by a court-appointed trustee under the Securities Investor Protection Act (SIPA).  The primary goal of the liquidation was to recover assets for Madoff’s victims.  The litigation has continued for 17 years, so far, because of the number of parties involved and the multitude of proceedings and appeals in both the U.S. and foreign courts.

The trustee has pursued clawback claims against “feeder funds” under fraudulent transfer theories, targeting both “net winners” who withdrew more than they invested and “net losers” who withdrew less than they invested.  After the estate recovered $7 billion recovery from one feeder fund, investors began to anticipate higher recoveries than normally occur in SIPA proceedings.  Over time, a secondary market in Madoff claims developed, with distressed asset investors buying claims at steep discounts and profiting when recoveries exceeded expectations.  

The Madoff litigation has led to several significant legal developments.  One key issue involved included the safe harbor under the Bankruptcy Code for good faith conduct.  Initially, a judge in the SDNY ruled that to show a lack of good faith, a trustee must show that an investor was willfully blind to the fraud at issue.  In 2021, the Second Circuit ruled that simple inquiry notice is enough, placing a greater burden on investors to investigate irregularities.

Another significant legal development was the Second Circuit’s ruling that U.S. bankruptcy law could reach transfers between foreign debtors and foreign transferees, expanding the potential reach of clawback efforts.  

Finally, the Second Circuit ruled that in a Chapter 15 bankruptcy case, certain U.S. standards would apply to transactions between foreign entities even though the foreign courts with jurisdiction over the entities would apply different standards.

The uniquely large and visible fraud in the Madoff litigation case may have led courts to expand legal doctrines in ways that affect bankruptcy and investor litigation more generally.

Podcast Link: Law-disrupted.fm
Host: John B. Quinn
Producer: Alexis Hyde
Music and Editing by: Alexander Rossi

Transcript

Note: This transcript is generated from a recorded conversation and may contain errors or omissions. It has been edited for clarity but may not fully capture the original intent or context. For accurate interpretation, please refer to the original audio.

JOHN QUINN: This is John Quinn, and today we're speaking with two of my partners, Robert Loigman, who's a partner in our New York office and Eric Winston, who's a partner in our Los Angeles office. We're gonna be talking about the Bernie Madoff scandal and the follow-on litigation which has been going on now, I think for something like 17 years.

Is that right, gentlemen? 17 years ago, Bernard Madoff was arrested for a historic fraud scheme. How is it possible that this litigation or these litigations could go on for 17 years? What's been going on, Bob? 

ROBERT LOIGMAN: So, one might scratch their head and say, what about statutes of limitations? What's going on here? And, the reality is, almost all the cases I think that exist today were filed years and years and years ago and sort of the immediate aftermath of the arrest and the few years that followed that.

And then they have taken so long to litigate because they have gone from bankruptcy court up the Second Circuit back around in circles. And on top of that, a lot of these cases have involved foreign entities. So they've gone through foreign liquidation proceedings, foreign courts, all the way up to foreign Supreme Courts.

This has just been a very, very long and drawn-out litigation. But it has decreased pretty substantially over the years. I mean, I think if you go back to, you know, when, now they're down to maybe about a hundred as it starts to dwindle down. 

JOHN QUINN: And generally, what is the structure? I know that there's a trustee in place. Eric, maybe you can tell us there's a trustee in place and is the litigation mostly the trustee trying to claw back funds or are there, you know, ancillary proceedings relating to those types of claims?

ERIC WINSTON: So lets first answer your question about what this is. Even though this is in bankruptcy court, this was a form of liquidation called SIPA liquidation, which is a Securities Investor Protection Act liquidation. It just happens to be in bankruptcy court 'cause it can and very much mimics a bankruptcy.

But the SEC appoints a liquidator or trustee, which they did. And then that trustee's job is to marshal assets of the securities firm, which in this case was the Bernie Madoff fund and gives priority to what are called customers first and then general insecure creditors. And then if there's anything left after that.

And the issue about Madoff was at the time of the appointment of the trustee, it was very unclear whether there would be much of a recovery at all. But it turns out that there was, you know, quite a bit of assets available. But more importantly, a lot of the transfers that had been done out of Madoff went into other entities.

Bob referenced foreign entities. A lot of them were called feeder funds and they had assets and so very quickly the trustee started suing lots of different people associated with the collapse of Madoff. And perhaps coincidentally, you know, by luck early on in the case they got $7 billion from a single feeder fund called the Picower Fund, after the guy that ran that fund was found floating dead in his pool and his wife agreed to a settlement of returning $7 billion. That really sort of made the Madoff liquidation far more successful than I think a lot of people thought at the time.

JOHN QUINN: I mean, what were the theories that the trustee used to pursue these funds? To pursue these claims against feeder funds and others? 

ROBERT LOIGMAN: Yeah, so I’ll tackle that one first. John, there were, I think, a number of different theories that the trustee went under. I mean, basically they all fall under the sort of fraudulent transfer, fraudulent conveyance type of law.

And the first sort of easiest targets were the so-called net winners. And the net-winners were the ones who withdrew more money than they had invested into Madoff. And so if you invested $1 billion and over the course of several years, you withdrew one and a half million dollars, it was easy to see how you benefited from the fraud, and the trustee could easily go after that 0.5 half billion.

And in funds or institutions that still had that money, and, Picower is a great example of somebody who had a lot of money and who had, you know, a motivated person, his wife to settle. But the trustee sort of expanded beyond that in a way that a lot of people viewed as aggressive, which was going after net losers.

And our former client that Kingsgate funds are a good example of a net loser. They invested about $1.7 billion over years in Madoff and withdrew maybe $900 million over that same time. So on the day that Madoff was arrested, and this whole SIPA proceeding began, they were net losers to the tune of $800 million.

You would think they'd be a pretty tough defendant to go after since they lost so much money, hard to say if they knew about the fraud or they were in on it. All sorts of intent issues because they lost so much money. But nonetheless, the trustee went after a lot of feeder funds that were net losers and ultimately got settlements from a lot of them where they agreed to pay back the money that they had withdrawn from Madoff, sometimes within the last two years before the bankruptcy, sometimes within the last six years.

So that was aggressive of the fraudulent transfer laws and the trustee had a lot of success with that. 

JOHN QUINN: I mean, Eric, I assume in these cases it would be a defense to say you know, good faith. I had no idea. I had no reason to know this fraud was going on. And if you could establish that the trustee wouldn't have a claim, is that fair to say?

ERIC WINSTON: It depends, there are certain kinds of fraudulent transfers where good faith isn't a defense. If those are constructive fraud transfers, you gave reasonably equivalent value or you didn't in exchange for the transfers, it doesn't really matter whether you had a good or bad intent.

But what was more interesting was, in order to go after older transfers and to get around some safe harbors that the bankruptcy code imposes that are applicable in proceedings intent, did start to matter. And there was a lot of litigation over what needed to be pleaded by the trustee to overcome the assertion of good faith  by the recipient, by the feeder funds or their subsequent transfers, people that took money out of the feeder funds.

And there used to be a big fight in bankruptcy cases and the Madoff case really brought it to a head of what meant lack of good faith. Was it you were part of the fraud or was it you've got enough red flags and you should have known that there was something problematic going on? And in fact, where you see cases of people pulling money out because they suspect fraud, in one sense, they get penalized for that because they didn't act in good faith.

In a sense they knew something was problematic. On the other hand, it's also kind of nutty to think about if someone suspects there's mal intent, and once they get out of it, they get penalized for that. 

JOHN QUINN: Yeah. That's kind of crazy in a way. I mean, if you start to think something's wrong, something's fishy, you wanna take your money out, that would be a good faith response.

I mean, what does the trustee expect? That you're just gonna leave your money in and suffer the consequences? 

ROBERT LOIGMAN:I think it's fair to say under the circumstances, John, if you suspect that there's something wrong, you're always better off pulling your money out. Because, even if ultimately the trustee is able to claw back because it was a fraud, at least you had that money for a while and at least there was a chance he wouldn't be able to claw back.

Whereas if you leave it there and let it go down with the ship, you're certain to lose it. But you know, and Eric pointed it out, it's not been clear cut what the standard is. In fact, what happened in the Madoff case is pretty interesting because Judge Roff in the Southern District issued a ruling that said, in order to show a lack of good faith, the trustee had to show that an investor was willfully blind to the fraud.

Meaning that basically someone put it right in front of him and he just ignored it because, for example, some feeder fund managers wanted to make a lot of money, people investing in their feeder funds and so they ignored the fact that the fraud was there right in front of their eyes, and Judge Rakoff said, it is the burden on the trustee to allege enough facts showing this willful blindness.

That rule was in place for years and ruled the Madoff proceedings for years, and a lot of the settlements that were completed were done under that rubric when that was the law. And then more recently, and it's funny because recent in this case isn't necessarily what we would normally think of as recent, but back in 2021, the second circuit ultimately overruled Judge Rakoff and said, no, you don't have to show willful blindness.

But simply inquiry notice is enough. Like, you know, as you said, you have an inkling of something's wrong, something doesn't seem right, you should look into it. The Second Circuit said that's enough to show a lack of good faith and the Second Circuit also said, it's not even the burden of the trustee to allege facts showing the burdens on the investors.

So in recent years, it's become even easier in some respects for the trustee to claw back money from investors to the extent there is any left there to claw back money.

JOHN QUINN: Now, how much money in total has the trustee been able to collect in these proceedings? 

ROBERT LOIGMAN: So, the trustee, if you look at his website,says, I think that he has collected about 17 billion.

Actually, no, I think the number is $14.9 billion, something like that. It's right at his website, Madofftrustee.com. And it's pretty interesting because the way that he calculates that 14 points, I think 14.7, 14.8 actually billion dollars that he got back is by saying, you know, this is all what he's collected from feeder funds and other investors and banks.

But some of that is not exactly money coming back. So take for example, again, they were our clients, they were net losers by about $800 million. Ultimately, they agreed to pay $860 million back to the trustee. That $860 million is included in that $14.7 billion recovery. But at the time they agreed to do that.

That 860 million added to what their net losses of $800 million were. So they now had a $1.6 billion claim against SD. And so when they agreed to pay it back and when the settlement was consummated, they didn't pay any money to the trustee. The trustee actually paid money to them because they had such a large claim.

50, 60, 70, whatever the percentage was of recovery at that time was more than the hundred 60 million they would pay to the trustee. And they are far away, not the only fund that's in that set of circumstances. So there are several funds out there, including one within the last one or two months that settled the Luxembourg Fund where they agreed to pay money to the trustee.

But the real result was money going back out the door, feed that had lost so much money. 

JOHN QUINN: So if we do the net analysis about whether the trustee has recovered the claims made by parties who lost money, do we have a sense what the net recovery is that the trustee generated? 

ROBERT LOIGMAN: I don't know if that number exists and I think what the trustee would say is that he really did collect that amount.

It's just that he ultimately paid it out to somebody who lost money. Yeah. So, you know, at this point he has collected, you know, this 14.7, 14.8 billion. He has paid out customer claims of almost $14 billion. And so, the rest is being held in reserve maybe for other potential claimants, things like that. 

JOHN QUINN: I think of that 14.9 billion, some 7 billion is that early settlement with Jeffrey Picower.

ERIC WINSTON: That's right, and one good way to think about how the recoveries go in these cases is claims trading. There's been a very robust market, a lot of litigation associated with trading of claims against the Madoff estate and early on in these cases, these claims would trade less than 30 cents on the dollar.

After the Picower settlement came out, trading went above 60 cents, 70 cents on the dollar. And now I think if you were to include distributions that have actually come in, probably they're north of 80 cents on the dollar, which, you know, in fairness is a great outcome in a case like this, even though it's been extremely expensive, taken a long time.

There was a lot of money that was recovered for victims of Madoff. But as Bob said it's interesting how they presented on the website versus how people probably would treat it commercially and legally. 

JOHN QUINN: Yeah. So, Eric, who are these investors who trade in Madoff claims? Are they the usual kinds of opportunistic distressed investors who we all know and many of whom we represent, who are these parties?

ERIC WINSTON: Yeah. Not only do we know them we've actually represented some of them in the Madoff case, so yes, definitely it's folks that saw opportunities early on that if the trustee were successful, this could be a very big outcome for them, particularly for people that had been original investors in Madoff or the feeder funds that had invested in Madoff that were liquidating and just wanted to sell out and get cash out as fast as possible.

Lots of litigation over claims trading, particularly when claims were traded. And then news would come out, like the pick hour settlement or otherwise, and then people would start reneging on deals. Our firm was involved in that with respect to something called Fairfield Century. I think others within our firm may have been involved in other claims trading.

It's a very interesting sort of ancillary aspect of this, sort of the cognitive industry of claims trading and the litigation that broke out over it, and just to be kind, you know, add icing to the cake, in addition to recoveries from the Madoff state itself, there were other sources of recovery for victims including a U.S. DOJ program that was trying to recover money. And there were fights about who owned, you know, slices of that share if the claims were being traded. 

JOHN QUINN: Right. I know we also represented a well-known, large bank in the Middle East, with respect to you know, defending Madoff claims made against that bank. So I'm not sure I know all the Madoff claims that our firm handled.

What was the Madoff fraud?  Bob, what exactly did he do? How did he get away with it? 

ROBERT LOIGMAN: It's a good question. Obviously it underlies all of this, John. So, Madoff had a very large business called, Bernie L Madoff Investment Securities, or B-L-M-I-S, and there was a very, I think, legitimate side to B-L-M-I-S that did market making and trading in Nasdaq. And then, Peter Madoff, his brother, I think, had a very prominent position within Nasdaq. So it was a big company that had real involvement and real effect on the U.S. markets. On the other side, Bernie Madoff was running this essentially private hedge fund. The idea that people could invest with him, he would invest their money and he would give them a return.

Remarkably, he was able to do it.  People would invest with him and year after year after year, he could produce a steady sort of, you know, very one to 2% per month increase so that people were getting very steady, very good returns, nothing crazy, not, you know, making 50% right away, but very steady, even in down markets.

And the way he did this, he explained to investors, was using something called the split strike conversion strategy. I cannot explain precisely how the split strike conversion strategy worked. I don't think anybody could, because it didn't actually work. Because the idea behind it was you'd buy a put, you'd buy a call, you'd do that in a range around the selling price of stocks that were in the S&P 100.

He would buy buckets of each of these and he would be protected from going, you know, from losing too much or from making too much, and that by doing this, he could guarantee essentially a return each month. It doesn't actually work mathematically, but it sounded really, really complicated and lots of investors, including a lot of sophisticated investors, bought into it a sort of hook, line and sinker.

JOHN QUINN: And how was it ultimately discovered? 

ROBERT LOIGMAN: So I think the way it was all, it's interesting it, first of all, it was discovered, if you wanna say that, even earlier than his arrest in 2008, because there was a guy out there who was a quant, a guy named that, I'm gonna pronounce his last name incorrectly, so I apologize - Harry Markopolos, he saw these returns that Madoff was getting and tried to replicate them at the company that he was working at and realized that you could not mathematically replicate the returns that Madoff was achieving and that in order, for example, have enough puts and calls in order to support Madoff's very, very large investment amounts, you would actually have to buy more puts and calls than were issued, even if you could use the tragedy. 

And so early on, I think in the 2001, 2005 range or so, this guy, Harry Markopolos went to the SEC and said, Madoff is a fraud. It's a giant Ponzi scheme. And he did it once, twice, three times I think. And they did sort of, you know, sort investigations. The Boston office said, this looks really interesting, it's not within our jurisdiction, this has to be the New York office, and ultimately led nowhere, which led to a lot of, as you might imagine, second guessing and investigations after this all came to light, but it really all came to light in 2008 when, you know, the markets turned down, people didn't have as much to invest.

And that's the way all Ponzi schemes ultimately come to light, right. When there's not enough money to go in, you can't fund the money going out and they just all fall apart pretty quickly at that point. 

JOHN QUINN: Well, there have been hundreds and hundreds of decisions in this case and some of them, I'm sure, are pretty significant decisions.

You referenced some of the decisions, inquiry notice. Are there any other decisions, Eric, that stand out, changes in the law that have emerged in the Madoff litigation? 

ERIC WINSTON: So, I would think there are two that are worth noting 'cause they really go beyond just the Madoff case. The first goes to the extraterritorial impact of fraud.

There's been a long debate in the law of whether a transfer from a foreign debtor to a foreign transferee is recoverable under U.S. fraudulent transfer laws, bankruptcy code or otherwise, and much of what occurred in Madoff came out of New York where Bernie Madoff Securities was located, went to foreign feeder funds, and then from there, went on to foreign subsequent transfers, that's where the money ultimately went. 

And the second circuit in 2019, which again in this case is a recent one, but in our world would be, you know, pretty, ancient at this stage, held that under the bankruptcy code. It would apply to that transfer from a foreign feeder fund to the foreign subject transferee. That was, I think, a bit surprising that they took the bankruptcy codes language and interpreted in a way that it would apply extra-territorially. So that actually makes it a much greater risk for people that probably have no idea that there is a risk, that they may be subject to litigation in the United States because of a bankruptcy filing and that rule applies not just in Madoff or SIPA cases. 

That rule would apply in virtually any bankruptcy case. And then the other interesting one, this goes to not fraudulent transfers, but goes to chapter 15 law, which is a U.S. ancillary bankruptcy case in aid of a foreign bankruptcy, the Second Circuit, again, in the Fairfield century, chapter 15 case, which was a feeder fund and relating to a sale of the Madoff claim that Fairfield Century had, held that once a chapter 15 has started certain U.S. standards apply to transactions even though the foreign court, which is overseeing the foreign entity, you know, I would've taken a different position.

And most people beforehand would've thought, no, the purpose of a U.S. court in that circumstance is to give comity, to defer, to be assisting, and the Second Circuit slammed that down. And there was a lot of briefing by Amicus, you know, by Amicus folks saying that's not really the intent of chapter 15.

It's been criticized, you know, in other jurisdictions. But that is the rule in New York that once a chapter 15 starts, you may be very much subject to standards that people just don't ever expect. 

JOHN QUINN: So, any other final thoughts, Bob? Lessons learned or significance of the Madoff investigation? 

ROBERT LOIGMAN: I think one of the lessons learned from this is, you know, how broadly the U.S. bankruptcy law can reach and to go to that decision that Eric just talked about, the extraterritorial application.

I mean, just imagine you're an investor living in Spain and you invest in some fund out of Portugal. And, one day you get hit with an action in the United States bankruptcy court, that would be pretty shocking. And to think that the Second Circuit has now said, well, that's okay, as long as that fund in Portugal was investing in a U.S. entity, it's a pretty remarkable outcome. And it's a pretty, I think, broad extension of U.S. law. And there’s a real takeaway from this. And by the way, Ponzi schemes are much more common than one might imagine. Obviously, ones of this size is pretty rare, but you know, there's this guy Tom Petters, who ran an enormous Ponzi scheme out of Minneapolis. And in 2008 when he was arrested, it was the largest Ponzi scheme in history. And he had that wonderful title for all of one month until Bernie Madoff.

One thing that you know comes out is, they are much more common than you would think. And in the past, I think people had a tendency to think that the recoveries in these Ponzi scheme cases would always be very low. You know, they'd be cents on the dollar sometimes, and that will still be the case.

Sometimes it's very hard to recover. But this case is one example and I think there will be others where it really can be very high. And what that means is there will be a lot of activity in the secondary trading market. 

JOHN QUINN: I mean, there's a saying that hard cases make bad law, I think is the expression, is this an instance where easy cases make problematic law? I mean, when you look at the whole Madoff situation and the huge, enormous bankruptcy court where you think, well, maybe there'll be a thumb on the scales in the favor of the bankruptcy estate trying to, you know, aggregate, collect all the assets.

Do you think that's had an effect, that the law's been pushed forward in a way that really favors the estate? You know, new ways of looking at things that we're now going to have lived with in context? Do you see it entirely differently? If my question makes sense? 

ERIC WINSTON: Look, that's a very interesting question.

Thinking about the Second Circuit, which is where this was, in some ways I would say schizophrenic because some of these decisions are surprising or remarkable and no doubt favor the bankruptcy estate or the extension of the bankruptcy code. And yet the Second Circuit, in other circumstances that could have come up through Madoff, have taken very harsh outcomes towards bankruptcy estates like the application of the safe harbors, which was an issue in Madoff and so I'm not sure I could say for sure.

It puts the thumb on the scale. It could be that Madoff was such a, you know, black swan event. In the world of public he was, and yet everyone missed this for a decade, that maybe the answer was, we've gotta send a signal, this can never happen again. But that's, you know, me just being a conspiracy theorist perhaps.

JOHN QUINN: Alright, we've been talking about the Bernie Madoff scandal, litigation going on now for 17 years and running. It is dwindling down now, hopefully to a conclusion for everyone in the near future. We've been talking with Bob Loigman and Eric Winston, two of my partners who have been involved in this in the Madoff Litigation. This is John Quinn. This has been Law, disrupted.

Thank you for listening to Law, disrupted with me, John Quinn. If you enjoyed the show, please subscribe and leave a rating and review on your chosen podcast app. To stay up to date with the latest episodes, you can sign up for email alerts at our website, Law-disrupted fm, or follow me on X at JB Q Law or at Quinn Emanuel.

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