Today’s NYT (and Monday’s WSJ) each have articles which compare Madoff investors with those of recent $400 million dollar hedge fund fraud Bayou Group.

I believe this misunderstands the applicable law of partnership, fraud, and investing.

Hedge fund investors are limited partners, and as such, they have a fiduciary duty to their other partners. Regardless of the additional due dilly, the gut instinct, or any other basis one investor had when they pulled their capital, the Bayou case grants the other LPs the opportunity to clawback that money.

That was the Bayou decision — one I disagree with, but its the law (for now).

Managed account investors have no such legal obligation. Indeed, some people have argued that the doctrine of fraudulent conveyance might apply. But that requires that the investor who pulled money out of Madoff knew it was an illegal Ponzi scheme, and that their transfer of property was illegal and done with the intent to commit fraud.

Merely pulling money out of what you legitimately believe is your own brokerage account hardly qualifies as the appropriate mental state for fraud . . .



UPDATE: December 20, 2008 6:32am

Let me clarify one thing — I assumed that some of the investors were actually investors, and that the Ponzi scheme didn’t start until much more recently (5-10 years).

If its the case that the entire operation has been a scam from day one, well then, all bets are off. That is a different story. Whatever proceeds and withdrawals there were may simply be the proceeds of illegal activity.  Then you may not get to keep anything, and there is a pro-rata redistribution of all assets.

But I strongly suspect that much of the early years were legitimate investing. My best guess is he went Ponzi to hide a bad quarter, and it snowballed from there.


Even Winners May Lose Out With Madoff
Investors May Have to Surrender Gains
WSJ, DECEMBER 15, 2008

Even Winners May Lose With Madoff
NYT, December 18, 2008

Category: Hedge Funds, Legal, Regulation

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

23 Responses to “Hedge Fund Partners vs Managed Account Investors”

  1. dead hobo says:

    Per common law
    Merely pulling money out of what you legitimately believe is your own brokerage account hardly qualifies as the appropriate mental state for fraud . . .

    Per statutory law
    “___________________________” (To be filled in by appropriate state law relating to such matters.)

  2. jason says:

    I just pulled out my rally monkey! SP 1500 baby!

    Just over the wires the recession was a vast conspiracy led by a group of rogue shorts and few pranksters.

    GM & Chrysler are increasing production. Dealers nationwide are reporting a shortage of sales people and are hiring anyone with a pulse.

    Several leading banks are blaming the CDS problem on a previously undetected Y2K bug. Record losses were erroneously reported and are being restated as profits. The same Y2K bug lead to bogus UE claim numbers. Actual numbers suggest that only six American are without work, 2 are panhandling in San Francisco, the other four are in LA. Foreclosures are a myth.

    A underground group known as the JAPs (Jew American Pranksters) is claiming responsibility for the Madoff Fraud, which was an elaborate prank launched just for sh$t and giggles. President Bush, always a fan of a good prank and not wanting to be out done announced that he is bailing out GM and Chrysler.

    I will repeat the economy is not in the sh#tter. Think of this message as a Holiday Gift. It was all a gag. Your 401k just doubled.

  3. broker12 says:

    “New York State law may allow the receiver or bankruptcy trustee to demand that Mr. Madoff’s investors return money they received from the scheme any time in the last six years.

    Such so-called clawbacks may occur even if the client had no idea that the gains were fraudulent.”

    Jay B. Gould, a former lawyer at the Securities and Exchange Commission

    Issue is not as clearly resolved as you state Barry. The courts will determine the outcome in this situation. The lawyers should make out pretty well.

  4. karen says:

    good news!

    (AP:NEW YORK) A federal judge has extended an order that freezes the assets of money manager Bernard Madoff in his massive fraud case.

    Judge Louis Stanton signed an order late Thursday approving agreements by the 70-year-old Madoff to surrender control of his assets. As a result, a hearing scheduled for Friday was canceled.

    The order also puts control of all of his artwork, property, cars, jewelry and other items in the hands of a court-appointed receiver.

  5. Brian Shriver says:

    I think the argument for fraudulent conveyance would be based on Madoff’s actions – he was fraudulently using new investor money to pay off old investors. It wouldn’t matter that the investors were unaware of the fraud.


  6. Stuart says:

    I have zero faith in the system and seeing Madoff only placed under house arrest for only ripping off $50 billion is outrageous and corrosive to the credibility of the system keepers. We have all witnessed so many examples of white collar crime where if a fraction of the money looted was done through traditional, break and enter theft, the culprits would’ve been locked up within seconds. Until these crimes are taken more seriously, faith will not be restored by investors. It’s really that straight forward. Until then, perception will remain that the extent and depth of corruption is too pervasive to prosecute, too big to jail, and too incestuous to take corrective measures seriously.

  7. Mannwich says:

    Another day, another bailout. Yawn. Next.

  8. Stuart says:

    Seeing Madoff only placed under house arrest for only defrauding investors of $50 billion is outrageous and corrosive to the confidence in, and credibility of financial regulators. We have all witnessed so many examples of white collar crime where if a fraction of the money looted was done through traditional, break and enter theft, the culprits would’ve been locked up within seconds. Until these crimes are taken more seriously, faith will not be restored by investors. It’s really that straight forward. Until then, perception will remain that the extent and depth of corruption is too pervasive to prosecute, too big to jail, and too incestuous to take corrective measures seriously.

  9. karen says:

    excellent, straight forward interview with stephen roach at bloomberg

  10. dead hobo says:

    Mannwich said:
    December 19th, 2008 at 11:12 am

    Another day, another bailout. Yawn. Next.

    You cynical bastard. There will not be a bailout here. There might be restitution due to incompetent Federal oversight, but that’s not a bailout. It’s justice rightly due to people who are not at fault for trusting the most grandfatherly person ever put in a photograph. He’s the nicest person you would ever want to meet, as well, according to CNBC. Uncle Stupid owes these people. It’s not their fault for giving him truckloads of money because he promised to do good with it. Discussing where to go for lunch is far more important than a little detective work, as some of our banker friends across the Pond well know. (Good thing it was OPM as far as the Eurobankers were concerned).

  11. par1 says:

    While it’s a state law issue, I think in general you’re wrong on both counts. First, LPs have no fiduciary duties to other LPs, only the GP does; LP rights and obligations are contractual, as defined in the LP Agreement (suppose in a situation that’s free of fraud, one LP knows that pulling his money out of a fund will severely impact other investors – does he have a fiduciary duty to leave the money in?). I don’t understand the Bayou ruling or necessarily agree with the results, but I believe it was based on fraudulent conveyance law, not fiduciary duties. [BR: I don’t agree witht the Bayou ruling — but that’s what it was]

    Second, even a good faith belief that money in my account represents bona fide profits doesn’t make it so if in fact the profits are phony and the money belongs to someone else – I don’t think mental state comes into it, it’s just a matter of legal ownership. Imagine a bank puts a dollar a day in your account from someone else’s – they don’t notice and you think the bank is rewarding you for being a good customer: do you get to keep that money?

    But hey, I’m just an ex-lawyer.

    [BR: We are in agreement about the profits — but not the original “investment” ]

  12. leftback says:

    I just heard about a personal acquaintance who was a Madoff victim and I am quietly rather shocked.

    Why is anyone watching Jan crude? – the out months are the only thing that matters.

    @ jason, put your rally monkey away, we don’t want to frighten the horses.

  13. karen says:

    lb, that’s something! young, old, male, female… could we have a tiny bit more info?

  14. Mannwich says:

    A rather underwhelming response by the market to the latest bailout news. Santa is losing his confidence.

  15. batmando says:

    vis-a-vis dead obo’s

    Per statutory law
    “___________________________” (To be filled in by appropriate state law relating to such matters.)

    as in ““yashudanodebeddah”

  16. g8tor says:

    If prior Ponzi schemes are any guide, a lot of people who received false profits are going to have to pay those back, regardless of the fact they were unaware of the fraud.
    In approx. 2001, a big Ponzi scheme (or seemed so at the time) was perpetrated by one of the founders of Earthlink, Reed Slatkin, who stole somewhere between $200 and $600 million from investors in a pretty similar scheme. He rolled $75,000 in seed money in Earthlink into $100 million and cemented his reputation as a genius stock picker. Unfortunately it came out much later that he was just a fraud who got very lucky. He used his prior success to dupe a lot of otherwise successful business people, along with a big group of celebrities/scientologists. Slatkin was at the time an OT VIII in Scientology (pretty much as high as you can go in that group) and used that position to prey on fellow believers, which frequently occurs in this type of investor driven financial fraud.

    Here is what the LA Times said about the bankruptcy trustees’ plans at the time to recover those supposed “profits” paid to investors.

    ‘Investors who profited from Reed Slatkin’s alleged Ponzi scheme will be asked–and if necessary sued–to pay back millions of dollars they received in bogus gains, a U.S. Bankruptcy Court trustee said Thursday.

    Trustee R. Todd Neilson said he is reviewing a list of 75 people who allegedly reaped $151 million in profits from their investment with Slatkin to determine who will receive a letter demanding they return the money. Those who do not comply could face lawsuits, Neilson said.

    The list of investors includes CNN legal commentator Greta Van Susteren, actor Peter Coyote, Hollywood producer Armyan Bernstein and HGTV host Susie Coelho–all of whom said they were unaware they were benefiting from a Ponzi scheme.

    The investors were among the 800 people who gave Slatkin $593 million to invest during the last 15 years, according to a report Neilson filed Dec. 14 in Bankruptcy Court in Santa Barbara. Slatkin told investors he was buying stocks, but instead used money from new investors to pay bogus returns to prior investors in what’s known as a Ponzi scheme, the report alleges.

    About half of Slatkin’s investors ultimately lost money and about half got back more than they invested, Neilson said. The 75 investors on his list got back much more than they put in, he said.

    Neilson said he would decide “in the near future” which investors would be asked to return money under laws that prohibit “fraudulent conveyance,” or the transfer of money or property to one party when it rightly belongs to another. Neilson said he can legally recapture phony profits that were paid out in the last seven years, when the bulk of the $151 million was distributed.

    Even innocent parties usually are required to return money that was fraudulently transferred, Neilson said. A request for repayment doesn’t necessarily mean the investors are suspected of fraud or that they knew Slatkin was operating a Ponzi scheme, he said.’

    As predicted in the quoted LA Times Article, Neilson filed fraudulent conveyance actions under bankruptcy law and borrowing California state law, and was very successful in forcing winners to at least return their gains to the bankruptcy estate. I don’t recall if they also had to pay back principal that had been returned to them. Susteren and her husband began the case saying they would never pay the money back, but they did. Same with Peter Coyote, even though he claimed it was money he needed to live on in retirement. The end result was most victims received approx. 80% of their losses back, after law firms, financial institutions and other parties also settled claims alleging they allowed the fraud to fester or helped make it possible.

    It is much too early to think that Madoff’s victims will enjoy anywhere close to that recovery, because no one seems to know where the money went. After a lengthy forensic accounting, it was clear Slatkin used the bulk of the missing money to pay earlier investors. If Madoff did the same and there is a similarly aggressive bankruptcy trustee, and those who received profits are still in a position to return them, it is possible the victims will see some of their losses returned. But it will likely take several years at least. And for each of those victims there may be a sad story of a retiree who was living off the payouts from Madoff and now will be asked to return money they can ill afford to part with.

  17. wingnut says:

    They will look to Madoff’s state of mind, not the investors’.

    “Even good faith purchasers of property who are the recipients of fraudulent transfers are only partially protected by the law in the U.S. Under the Bankruptcy Code, they get to keep the transfer to the extent of the value they gave for it, which means that they may lose much of the benefit of their bargain even though they have no knowledge that the transfer to them is fraudulent.”

  18. ottnott says:

    Barry wrote:
    “Merely pulling money out of what you legitimately believe is your own brokerage account hardly qualifies as the appropriate mental state for fraud . . .”

    It is true that it isn’t fraud to do so, but legitimate belief that it is your money does not mean that it really is your money to pull out.

    Remember, Madoff was sending phony statements to his investors. Their legitimate beliefs were misinformed by the fraudulent statements.

    With the large number of years and large number of dollars involved in the Madoff case, it will be an unholy mess to unscramble.

    Forensic accounting might offer the best job security over the next decade.

  19. leftback says:

    Madoff apparently was consistent on the course as well as in the markets. I wonder if he actually played at all?

    It’s funny he reported a handicap of 9.8, my experience is that real golfers don’t use decimal places. In addition, I play off a 15 handicap and I can’t tell you how many times I shot 90 and beat guys by several strokes in head-to-head competition, even though they had claimed a single digit handicap. Usually it was because they “had a bad day”, “didn’t like the course” or “have to get used to a new driver”. Might also be because I don’t let them cheat….

  20. robert d says:

    I wrote a long response to this morning’s NY Times article written by 6 or 7 reporters and surmised the same conclusion. But the Times did not print my comment because, I guess, it did not respond to the direction of their article.
    No one begins a scheme like this out of thin air. They get in trouble first and then try to figure out a way to recover. Recover he did, but his clients never did and never will.
    I believe the disaster began in the second half of 1983 when a not-so-mini technology IPO boom occured. Beginning in June or July the Nazz techs crashed. Madoff must have been down very large percentages and from then on had to bring in new money at astounding rates to keep up the ruse of steady returns.
    I was a broker at the time and remember it well.

  21. mknowles says:

    Evidence that Madoff started the fraud 1970′s and over 4,000 customers:

    Dec. 19 (Bloomberg) — U.S. regulators, trying to unravel the breadth of Bernard Madoff’s alleged $50 billion fraud, have found evidence of misconduct stretching back to at least the 1970s, two people familiar with the inquiry said.

    Madoff’s investment advisory business, where he allegedly operated the biggest Ponzi scheme in history, is now estimated to have had more than 4,000 customers, the people said, declining to be identified because the inquiry isn’t public. An advisory unit Madoff registered with the Securities and Exchange Commission claimed in a January filing to have no more than 25 clients. People familiar with the investigation said Dec. 14 he also ran a secret unregistered business.

  22. TheReformedBroker says:

    no shot in hell they’re getting money from people who pulled out…

    these were accounts at a broker/dealer, just because they had the same “investment manager” doesn’t change the fact that we titled in each individual’s name. some were IRA’s some corporate accounts, some UGMA’s, some joint with tenants in common or with rights of survivorship…

    nobody’s unwinding that on former clients who are (fortunately) long gone…give me a break


  23. TheReformedBroker says:

    “we titled” should read “were titled”