Nearly ten years after the discovery of a massive fraud scheme orchestrated by Bernie Madoff – and five years after the Department of Justice created a compensation fund to deal with the aftermath – Congressman Vern Buchanan (R-FL) claims that Madoff’s victims “have not received a penny” of relief.
In response to Buchanan’s concerns, the U.S. Justice Department has agreed to examine why it has taken so long for victims of the fraud to receive any compensation. According to Buchanan, more than $4 billion sits in a fund created in 2012 to repay Madoff’s victims. The fund consists of $2.4 billion from the estate of one of his Madoff’s biggest investors, the late Jeffry Picower, and $1.7 billion from a 2014 forfeiture deal with Madoff’s bank, JPMorgan Chase & Co.
In May, Buchanan sent a letter to Attorney General Jeff Sessions (downloads as a pdf) querying why victims have not received a penny, yet the firm responsible for distributing the money has been paid $39 million. Buchanan, who represents Florida, also noted that nearly one in five of Madoff’s victims hailed from Florida, making it home to the second-largest number of victims after New York. Deputy Attorney General Rod Rosenstein subsequently committed to “figure out why it is taking so long.”
The scandal grew out of Madoff’s Wall Street firm, Bernard L. Madoff Investment Securities LLC, which he founded in 1960. For years, the firm was legitimately successful. By the 1990s, however, competitors began to wonder how Madoff was continuing to grow his business. Madoff suggested that he attracted investors by promising high returns and low fees. Eventually, it would become clear that he was operating a Ponzi scheme.
A Ponzi scheme operates like this: you put money into a pot along with everyone else’s money. The typical investor believes, of course, that a return on your investment is the result of growth. In a Ponzi scheme, what looks like a return on investment is really just other people’s money (new investors). In other words, the money isn’t growing, it’s just moving. If you and I each contribute $100 in a typical Ponzi scheme, the fraudster will point to my $100 as evidence that your $100 has “grown” to $200 – when it’s really just my money, not growth. The trick, of course, is to keep lots of parts moving to attract even more investors so that it looks like the scheme is successful. Small time cons do it with limited funds but, in the Madoff case, the scheme was thought to involve more than $50 billion (the exact numbers were never actually determined).
On December 11, 2008, Madoff was arrested for masterminding the scheme. The following year, he pleaded guilty to 11 felony counts (including securities fraud and money laundering charges) and was sentenced to a whopping 150 years in prison. A number of relatives and associates found themselves under public scrutiny: Madoff’s former secretary earned prison time while Madoff’s accountant drew home detention. Madoff’s brother, Peter, who was Chief Compliance Officer at the firm was convicted and eventually sentenced to 10 years in prison. Madoff’s sons, who were responsible for turning their dad over to the feds, met with tragedy: Mark committed suicide in 2010 and Andrew died of cancer in 2014.
The repercussions of the scheme for the public and for Wall Street were huge. The losses were said to be so great that in 2009, the Internal Revenue Service (IRS) developed a strategy for dealing with the victims of Ponzi schemes. The tax treatment, which applies to participants in “certain investment arrangements discovered to be criminally fraudulent,” was clearly triggered by concerns raised following Madoff’s arrest (Rev Proc downloads as a pdf).
Under the rules, the IRS allowed investors to use a safe harbor for claiming losses: those who did not anticipate pursuing a third-party recovery could claim a loss equal to 95% of the investment less any money received under the scheme or reimbursed as part of the fraud investigation while those investors who pursued or intended to pursue any potential third-party recovery would be allowed a loss equal to 75% of the investment less any recovery. Under the Regs, as well as Rev Proc 2009-09, income or an additional deduction could be raised in a subsequent year depending on recovery.
Notwithstanding what were considered “relaxed rules” in this case, taxpayers who are affected by Ponzi schemes – or other fraudulent schemes – may be entitled to claim a casualty/theft loss. To claim a theft loss, a taxpayer must establish that they suffered a loss from theft (typically defined as an illegal taking) and the taxpayer must be able to prove the amount of the loss. The taxpayer must also establish that no claim for reimbursement of any portion of the loss exists with respect to which there is “a reasonable prospect of recovery in the taxable year in which the taxpayer claims the loss.”
The recovery part of a loss can be tricky. With insurance, you may be able to reasonably predict whether you might eventually receive some measure of reimbursement – and in many cases, you’ll know upfront how much to expect. But with a recovery fund – like the one established for the Madoff victims – whether you’ll receive anything (and how much you might receive) is anyone’s guess: it could take years. But five years? Buchanan finds that unacceptable, saying the victims “were cheated out of their life savings and are now being denied timely compensation from a fund that was specifically created to help them.”
 

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Author

Kelly Erb is a tax attorney and tax writer.

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