Here is a deceptively complex and subtle legal question involving Ponzi schemes and fraud: What are “losses” in the legal sense of the word? The question arises in the case of Bernie Madoff, whose offices cranked out account statements like they were junk mail.

As it turns out after the fact, that was all they were — merely junk mail. And that key fact is the major determinant of what the actual losses were.

By the end of his multi-decade fraudulent run, the final account statements (November 30 2008) issued to all his “clients” totalled the sum of $73.1 billion dollars. The people conned by Madoff believed they were worth a collective $65 billion dollars more than their accounts were worth.

The initial amount of cash put up: ~$20 billion dollars, beginning in the early 1960s and continuously from there forward.

The bankruptcy court in this case made the basic determination that the losses were ONLY the cash that was initially given to Madoff & Co. The extra $45-50 billion was a fictitious part of Madoff’s fraud. Therefore, it represents funds that were not actual investment losses, and are not covered by SIPIC insurance:

The key passage the bankruptcy judge issued was:

“Given that in Madoff’s fictional world no trades were actually executed, customer funds were never exposed to the uncertainties of price fluctuation, and account statements bore no relation to the United States securities market at any time. As such, the only verifiable transactions were the customers’ cash deposits into, and cash withdrawals out of, their particular accounts. Ultimately, customer requests for payments exceeded the inflow of new investments, resulting in the Ponzi scheme’s inevitable collapse.”

. . . At bottom, the BLMIS customer statements were bogus and reflected Madoff’s fantasy world of trading activity, replete with fraud and devoid of any connection to market prices, volumes, or other realities.”

Here’s the New York TImes:

“Losses should be defined as the difference between the cash paid into a Madoff account and the amount withdrawn before the fraud collapsed in mid-December 2008 . . .

The total of those account balances — the wealth investors believed they had saved — was nearly $65 billion, by far the largest financial fraud loss in history. But those statements “were bogus and reflected Madoff’s fantasy world of trading activity,” Judge Lifland wrote in his opinion. As such, they cannot reflect legitimate “securities positions” on which claims can be based, he said. As such, they cannot reflect legitimate “securities positions” on which claims can be based, he said.

Judge Lifland endorsed the approach of the Madoff trustee, Irving H. Picard. The differences between how much investors put into their accounts and the amount they took out are “the only verifiable amounts” reflected in the Madoff firm’s records, Judge Lifland said of that method.”

This approach makes sense.

Consider for a moment if some future Madoff wannabe had a Ponzi scheme even bolder, and their final statements were trillions of dollars, on returns of 100% a year — not 12%. The final amount is merely a fantasy number, how much the victim of the fraud erroneously believed they had. Their expectations of riches were the product of the scam, not based on real securities.

Any other decision leads to potential absurdities created by the reliance on entirely fabricated accounting entries. The number based on accounting fraud does not represent an actual loss — only the amount the victim was scammed into believing they actually had.

Its sad, but true . . .  The judge seems to have made the difficult — but correct — call here.


No. 08-01789 (BRL)

Madoff Judge Endorses Trustee’s Rule on Losses
NYT, March 1, 2010

Category: Legal, Mathematics, Psychology

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.

34 Responses to “What Were the Actual Losses in Madoff’s Fraud?”

  1. Here is another key paragraph:

    As Madoff admitted at his plea hearing, none of the purported purchases of securities actually occurred, and the reported gains were entirely fictitious. This has been confirmed by the Trustee’s investigation, which reveals that with the exception of isolated individual trades, there is no record of BLMIS having cleared any purchase or sale of securities in the Depository Trust & Clearing Corporation (the “DTCC”), a custodian for most stock and government debt securities issued in the United States.17 Instead, investors’ funds were principally deposited into the 703 Account, which was little more than a “slush fund.” Money was misappropriated from the 703 Account solely to enrich Madoff and his inner circle . . . At all relevant times, the fabricated amounts recorded on the monthly customer statements far exceeded the capital deposited in the 703 Account.

    -pg 12

  2. Jason G. says:

    Two questions…

    How is it that this went on for so long and the DTCC never recorded a transaction? No red flag there for anyone that can fog a mirror?

    What are the tax implications? If I was told I was making 12% on my funds, I’m sure I’d owe some taxes… do the victims get to go back and correct their returns for several years based on the fallacy?

  3. As to how it was never noticed, the bankruptcy court observed that:

    Madoff had three business units: market making (the “MM Business”), proprietary trading (the “PT Business”), and investment advisory (the “IA Business”). While these business units were financially intertwined,13 the MM and PT Businesses were largely operated separately from the IA Business.

    Specifically, the MM Business competed with other market makers, and the PT Business traded on behalf of the firm for profit. These units, albeit unprofitable, generally conducted legitimate activities; they traded with institutional counterparties, used live computer systems and trading platforms that interfaced with multiple outside feeds and data sources, and utilized a large information technology staff to support and maintain these trading platforms.

    In addition, they participated in compliance and risk monitoring programs and were held accountable by a number of entities, including the clearing houses they used, the exchanges they traded on, and the National Association of Securities Dealers and its successor, the Financial Industry Regulatory Authority.

    My guess is they are entitled to refile/amend prior tax filings to restate the phantom gains that they paid capital gains on . . .

  4. Transor Z says:

    Recognizing that the U.S. Trustee has a duty to protect creditors, this is probably best viewed as a battle between Madoff”s “investors” for fair treatment. Should a person who invested with Madoff back in the 1960s with a paper value of X have a better claim to a larger pro rata share of the bankruptcy estate than someone who invested the same amount in 2000? I think this is a fair result as among his defrauded “investors” getting a fair share of the bones.

    Also bear in mind that this isn’t about suing Madoff or his business for fraud. This is bankruptcy court. The purposes are very different. In a civil fraud claim against Madoff, there are excellent arguments to be made for applying estoppel principles to prevent him from raising such a defense (i.e., permitting him to define damages/losses by initial investment and not by his fraudulent statement valuations).

  5. wunsacon says:

    Losses? There were no losses. Just people who got out early and people who were left holding the bag.

    People are just jealous of Madoff. Let a thousand Ponzi schemes bloom…

  6. wunsacon says:

    I propose renaming “Ponzi scheme” to “Madoff scheme”, in honor of the one-upmanship.

    Don’t they rename university buildings after the most recent, big donor?

  7. bman says:

    All very interesting, one would expect dollars invested in 1960 would hopefully be adjusted for inflation, however if you were getting withdrawals, from the fund over the years it is conceivable you could be responsible for withdrawing more than the worth of the money you put in. In which case, one could be, if so inclined, morally responsible for the theft of funds from later, less fortunate clients of the same ponzi scheme. I say clients, rather than victims, because many of the clients thought they were signing up for some sort of secret cabal of market insider knowledge genius. Whether they thought it was illegal or just didn’t want to think about it, is another interesting question.

  8. [...] The Big Picture: What were the actual loses in Madoff’s fraud? [...]

  9. The judges are quite right but I would not like it creates a precedent whereby governments of sovereign sates running similar Ponzi schemes issuing debt, covered by off-balance sheet operations one day can say (to future generations):
    “The final amount of the debt is merely a fantasy number, how much was the taxpayers erroneously believed they had or to claim (for instances holding treasuries). Let’s avoid potential absurdities created by the reliance on entirely fabricated accounting entries. The number based on government’s accounting does not represent an actual debt — only the amount the taxpayers was scammed into believing they actually had buying treasuries”. That’s sovereign default at work.

  10. Mr.E. says:

    As an initial point, I believe the judge got it right – the actual immediate damages should be limited to that initially paid to Madoff. However, I suspect this will be appealed and/or additional individual suits filed claiming damages arising from lost gains as a result of Madoff’s deception. Had the investors known that Madoff’s “investments” weren’t performing a reasonable person likely would have withdrawn their funds and invested elsewhere. I haven’t a clue what might be a reasonable base investment scenario to claim as the alternative that would have been pursued, but at a minimum it probably would be interest gains from T-bills. At the extreme in might be gains (cap + dividend) that would have been realized from investment in a major stock index. I doubt we’ve heard the last word on this.

  11. jjay says:

    I’ve been hearing ads on the radio from an investment firm that promises to “match” your retirement savings you place with them at 11% a year for the next 7 years I believe. Just sayin.

  12. OT:


    • The Future of Money: It’s Flexible, Frictionless and (Almost) Free (Wired)

    from the ‘reads’-post, was a good story.

    one that delineates, well, a field that most of us are, at least, readily familiar with..
    and, with snips like: “…The banks and credit card companies have spent 50 years building a proprietary, locked-down system that handles roughly $2 trillion in credit card transactions and another $1.3 trillion in debit card transactions every year. Until recently, vendors had little choice but to participate in this system, even though — like a medieval toll road — it is long and bumpy and full of intermediaries eager to take their cut. Take the common swipe. When a retailer initiates a transaction, the store’s point-of-sale system provider — the company that leases out the industrial-gray card reader to the merchant for a monthly fee — registers the sale price and passes the information on to the store’s bank. The bank records its fee and passes on the purchase information to the credit card company. The credit card company then takes its share, authorizes all the previous fees, and sends the information to the buyer’s bank, which routes the remaining balance back to the store. All in all, it takes between 24 and 72 hours for the vendor to get any money, and along the way up to 3.5 percent of the sale has been siphoned away.

    In the earliest days of credit cards, those fees paid for an important service. Until the late 1950s, each card was usually tied to a single bank or merchant, limiting its usefulness and resulting in a walletload of unique cards. But when BankAmericard — later renamed Visa — offered to split its fees with other banks, those banks began to offer Visa cards to their customers, and merchants began accepting Visa as a way to drive sales…”

    it begins to offer insight into our, current, monetary mechanics, the effect of old ‘rules & regulations’ thereon, and the cost(s) of continuing those out-dated regulatory redoubts..

    to be sure, the V + MC Duopoly love the retarded state-of-the-art(of the State), but we might do well to wonder why we should have to ~”face the world with our head caved-in”..

    LSS: that art. may make for a good stand-alone post..

  13. KidDynamite says:

    “The number based on accounting fraud does not represent an actual loss — only the amount the victim was scammed into believing they actually had.”

    somewhere in here there is an analogy to the paper wealth many other Americans have in our stock portfolios and our homes

  14. “How is it that this went on for so long and the DTCC never recorded a transaction? No red flag there for anyone that can fog a mirror?” –Jason G., above

    nice Q:, though if we were, ever, to ‘pull back the (DTCC’s) Kimona’, ‘Investors’, of any, and all, Stripe, would go running, screaming, into that good night–with their hair afire, to light the way..

  15. “..somewhere in here there is an analogy to the paper wealth many other Americans have in our stock portfolios and our homes..”


    you better believe it~ it’s a major Reason why, if our Propensity to Hold (‘Paper’/’Electrons’/’Ethereal Derivatives’) begins to head South–in our J-I-T-rigged *World/Physical Goods Marketplace–the relative Price of Things would head North (at such speeds as to make the Spring-time migrating Flocks look like they were at a standstill..)

  16. Marcus Aurelius says:

    As the largest perpetrator of fraudulent financial and accounting crimes, our government should be disqualified from assessing damages actualized due to crimes of a similar nature (especially since they turned a blind eye to the evidence that Madoff was bilking investors). Maybe we should allow OJ Simpson to serve as a judge during murder trials.

  17. Mr.E. says:

    Running kids around this morning I caught an interesting interview on NPR’s Morning Edition with Markopolos/ Story here – link at top to listen to the interview as broadcast (some interesting comments in the broadcast interview).

    One of the likely reasons Madoff was able to carry on for so long comes out in the NPR article:
    “Madoff didn’t leave any footprints in the market because he never traded stock, Markopolos explains: “It was all made up and his story was so fanciful and far-fetched that the SEC should have seen through it immediately. And they didn’t.”

    Without the footprints of actual market activities it’s easy to see why the SEC, who focuses on markets, didn’t pick up on fraudulent client reporting. That the SEC failed to properly investigate when handed the initial evidence by Markopolos a decade ago shows, however, that someone was comatose at the wheel.

    Since this now appears to have been primarily a crime of fraudulent reporting to clients, why isn’t FINRA getting blasted?

  18. snapshot says:

    Barry – Sorry – I know I am off topic, but your interview @ EconTalk isn’t listed anywhere???
    Play time 1:13:40 podcast

  19. scharfy says:

    Legal precedent has been set on this matter by Geithner/Paulson. They deserve to get made whole by SIPIC.

    If they are not made whole by SIPIC – the entire South Florida Yacht market would tumble, to say nothing of the crater it would leave in high-end collectibles. These are technical matters and could devastate the larger economy.

  20. Darkness says:

    The SEC sitting on their hands for this long is completely believable. Once they started ignoring Madoff they were in on the conspiracy of silence and didn’t want the shit hitting the fan anymore than Madoff himself did. The longer it went on, the more freakish and scary potential revelation became.

    For decades the SEC has been run to be complicit with their buds on wall street. Toss in the occasional show-trial actions against people who are out of favor to pretend to be actually doing something. That’s why Spitzer had to go. He was breaking the pact and boy was that creating too many waves.

    As to the decision: is there an accounting of early clients who came out ahead? Given the return rate, I figure there are at least a handful.

  21. budhak0n says:

    Made WHOLE by SIPC? What nonsense.

    And how does the collapse of the F’in yacht market in south florida have anything to do with the economy?

    We’ve lost our freaking minds entirely.

    They shouldn’t get a penny back. It’s the risk you take. If they want to, they can try and feed on the early investors who got to take money out.

    Other than that. Go pound sand.

  22. budhak0n says:

    I could’ve told you in the mid 90′s that Arthur Andersen were frauds. That a large percentage of Wall Street Types were paper tigers etc etc.

    What did you pay me for the privilege? NOTHING . Want to know why? Because you want to believe in your self replicating nonsense.

    If you lost money investing with a guy who was a fraud, YOU have been scammed. Sue the freaking SIPC. I hope they don’t give you a dime, because it’s just this sense of RETURN without RISK that is the core of the ENTIRE FREAKING PROBLEM.

  23. budhak0n says:

    Want to sum up the ENTIRE problem. You maniacs think nothing costs anything.

    You want to go on living thinking that you can jump from Car lease to Car lease without ever actually paying anything.

    You don’t want to actually incur the actual phenomena that is known as “depreciation”. You think you’ve got it all figured out.

    Who me? Pay for anything. I’ll just sell somebody who can actually PAY FOR IT a loan, and then I’ll take that loan and securitize it and sell it to somebody else.

    Oh and if I lose any money in all this wonderful wheeling dealing, I’ll blame it on the GOVERNMENT.
    I’ll file a claim with the SIPC, or I’ll sue someone.

    I’m so hopping mad that I actually have to Risk capital in my business, I’m going to start entire websites to rant about it.

    I go to casinos but don’t actually think it applies to my life. LOL I don’t understand the concept at all of RISK.
    I want only Return.

    And you wonder why you have a system that by all practical analysis seems to be teetering a bit here.

    You have nobody to blame but yourselves but whenever anybody points that out just direct them to a nondescript P.O. Box or some other member of the legal community you’ve been able to bribe into actually believing the total Horse Pucky you’ve been dishing out for years.

    S.k.a.n.k.s and liars. That’s all that remains. And I am the least saintly of the bunch but it does give me some satisfaction to show you your true selves after so much time

  24. TheUnrepentantGunner says:

    Well budhakon and others, if it makes you feel better, earning 0% a year, over 20 years is pretty wretched, especially with inflation and such. While it sounds like we the taxpayers will be on the hook for 12 billion, ($38 or so for every man woman and child), that number some how feels ok to me. Nate Silver had re-introduced me to the concept of the overton window, and maybe the same thing is happening now in finance

    After the 12 figure bailouts, this number seems, well, easier to swallow I guess.

    As an aside, here is the discussion of overton windows

    I think after 2 years of ludicrous sums, something that previously would seem outrageous is now, well, whatever.

  25. Adult Franklin411 says:

    $38 or so for every man woman and child

    Is that you Grayson?

  26. formerlawyer says:

    The more difficult issue may be the legal liability of former investors who profited from Mr. Madoff’s fraud. (The Net Winners) Will they have their “interest on investment earnings” clawed back?

    In my former life, I took a number of victims through a ponzi scheme on a similar basis that this Judge did ie. that damages were measured by direct cash injections less “returns” on investment. If returns exceeded investment – no recoverable loss.

    That has now changed in my jurisdiction as a result of new case law and I am curious as to the accounting nightmare that this may occasion.

  27. Pat G. says:

    In the grand scheme of things money is irrelevant because all they have to do is print more. No, the real losses happened to entire families and possibly their future generations. You can’t measure that because it’s like a ripple in a pond that a stone has been thrown into.

  28. scharfy says:


    Sarcasm man. Of course they don’t deserve a dime.

  29. Darkness says:

    scharfy, due to the ridiculous seriousness already poisoning the well of thought, you needed one more really and truly unreal suggestion like, “and they should get free lifetime labradoodle grooming.” I thought your comment was serious too.

  30. Mannwich says:

    @scharfy: That your comment almost seemed real tells us a lot about the times. Like Darkness writes above, you almost have to be so ridiculously over the top for your sarcasm to be totally understood because of the absurd times we now live in.

  31. TripleB says:

    Wow – 65 billion is a staggering amount. Could have funded the silly high-speed rail they are considering here in Cali.

  32. [...] – Defining victim losses in Bernie Madoff’s Ponzi scheme as difference between cash paid into a Madoff account and amount withdrawn before fraud collapsed is the “difficult but correct call,” Barry Ritholtz writes. [...]

  33. GeorgeBurnsWasRight says:

    Is there some way for the victims to claim refunds for taxes they paid on the mythical income beyond the standard 3 years they have to file an amended return?