The Wizard of Lies: Bernie Madoff and the Death of Trust (42 page)

From her résumé, Helen Chaitman seemed an unlikely candidate for the role of Joan of Arc in this war over how to calculate net equity. She was a Bryn Mawr graduate who decided to go to law school in the mid-1970s. She was in private practice with the firm of Phillips Nizer, and she divided her time between its Manhattan offices and a small outpost in suburban New Jersey. Her specialty was lender liability, a substratum of bankruptcy law as arcane as SIPC liquidations; she had even written a respected textbook on the topic.

Tall, thin, and pale, with a short bob of strawberry blond hair, Chaitman looked much younger than her years and spoke in a soft, calming voice. But she was a tireless and fiercely tenacious advocate for her clients. In her pro bono work, she stood firmly with the underdog, and in all her legal battles she had a talent for powerful, persuasive language—inside the courtroom and out.

And, in this battle, she had skin in the game. On the recommendation of a friend, she had invested all her savings in 2004 with Madoff. The strategy looked “safe and conservative,” she later wrote. “I told my friend the only risk was that Madoff was a fraud,” she continued. “My friend laughed and said that Madoff had an impeccable reputation in the industry, had been chairman of the Nasdaq.”

From the day of Madoff’s arrest, Chaitman was determined to salvage whatever she could from the rubble and to hold somebody accountable. She focused her arguments on a knotty appellate case called
In re New Times Security Services
, which dealt with a much smaller Ponzi scheme liquidated by SIPC years earlier. It was a complex, muddled case that featured three sets of victims, each with distinctive circumstances; an internecine dispute between SIPC and its own trustee; and two separate visits to the appellate court.

For one set of
New Times
victims, those who thought their stolen money had been used to buy brand-name mutual funds, SIPC honored the final account statements—whose balances, unlike those in the Madoff accounts, accurately tracked the real-world fluctuations in the prices of the listed mutual fund shares, going up and down with the market tide. That decision was never challenged on appeal.

But the court upheld SIPC’s refusal to honor the final account statements of another set of
New Times
victims who had purchased high-yielding securities that were actually invented out of whole cloth by the Ponzi schemer. “Treating…fictitious paper profits as within the ambit of the customers’ ‘legitimate expectations’ would lead to the absurdity of ‘duped’ investors reaping windfalls as a result of fraudulent promises made on fake securities,” the court decided.

So which aspect of the
New Times
rulings applied? The blue-chip stocks the Madoff customers thought they owned were obviously more akin to the real mutual funds than to the make-believe securities in the
New Times
case. But the values Madoff attributed to those stocks more resembled the unattainable fantasy values of the fictional
New Times
securities than the accurate up-and-down prices of the mutual funds. So it was a stretch to say that the rulings in
New Times
were crystal clear in favor of Chaitman’s position—or, indeed, crystal clear about anything.

There were other court decisions that flatly contradicted her—
In re Old Naples Securities
, for example. In that case, decided in Florida in 2002, the court had acknowledged that “there is very little case law on point for determining what constitutes a customer’s net equity in a situation such as this,” another small Ponzi scheme being liquidated by SIPC. But the court nevertheless decided that letting the victims “recover not only their initial capital investment but also the phony ‘interest’ they received…is illogical.”

So Chaitman also grounded her arguments against Picard on her reading of the 1970 law that created SIPC and the comments that lawmakers had made about their intentions. As she saw it, SIPC was an insurance program, created to restore investor confidence after the collapse of the wild go-go markets of the 1960s. Investor confidence could be maintained only if SIPC honored customers’ “legitimate expectations.” In this case, she argued, those legitimate expectations were based on the final statements they received just before Madoff’s magic kingdom went up in smoke.

Again, this was not an undisputed thesis. The SIPC statute itself did not clearly address how a trustee should calculate net equity in a Ponzi scheme; nor did it flatly require the trustee to honor customers’ final account statements, regardless of the circumstances. It did, however, define “net equity” in a convoluted way that might support Chaitman’s position. It said the term meant “the sum which would have been owed by the [brokerage firm] if the [firm] had liquidated…all securities positions” of the customer, after subtracting any money the customer still owed the firm for those securities.

Irving Picard’s response was that, for years, Madoff’s victims had been paying for the “securities positions” shown on their account statements with play money—with the phony profits credited to them by Madoff. They had not actually given Madoff any real money with which to pay for the securities shown on their statements—except for the various cash payments they made, for which Picard was giving them credit.

Some previous legal rulings challenged Picard’s reading of that portion of the statute, and it was certainly an issue that needed clarification from the courts or from Congress. However, it was not true to say that his definition of net equity was “invented,” or that his position was indefensible or in clear contradiction of the law and prior court rulings.

But this is what Helen Chaitman did say—repeatedly, eloquently, widely, in any forum available to her. For her, this was not a topic about which reasonable people could disagree; this was not even a topic desperately in need of judicial clarification. She argued that she was correctly defining net equity and that Picard was deliberately ignoring the law to shortchange victims and protect SIPC and its Wall Street masters.

Her clients and admirers did not doubt her for a moment. For the tragically mischaracterized “net winners,” who were denied any SIPC payment under Picard’s analysis, she was a beacon of hope for a better outcome. They trusted her completely.

Chaitman’s unequivocal opinions were amplified in the echo chamber of the Internet by an increasingly visible blog created and nurtured by another outspoken Madoff victim and Picard critic, a law school dean named Lawrence R. Velvel.

Like Chaitman, Velvel had been steered to Madoff by a trusted friend and had seen his nest egg crushed in the Ponzi scheme’s collapse. But his résumé clearly suggested he would be an implacable foe of SIPC from day one—he was a self-defined radical, and had been since the antiwar movement of the 1960s. He also was a cofounder in 1988 of the Massachusetts School of Law in Andover, a small low-cost law school whose mission was to serve working-class students.

Velvel looked like a genial gnome, short and stocky with a chin-circling white beard and owlish spectacles. When aroused, however, he could employ his words like a blowtorch.

In his view, justice had to incorporate “the simple dictates of humanity,” or it was not justice. This meant that the only just definition of net equity was one that provided SIPC money to Madoff victims who otherwise “will have to continue living on welfare or dumpster diving.” If destitution was the result of Picard’s net equity formula—as it would be for some as-yet-unknown number of victims—then Picard’s formula could not possibly be just.

Chaitman and Velvel became two of the most visible champions of the unlucky “net winners.” Their analysis of the
New Times
case was passed back and forth by e-mails and supplied to reporters as infallible doctrine. A few of their angriest supporters berated anyone—in the media or on victim chat sites—who did not agree with them.

It seemed impossible for them to shake free of the Wall Street vocabulary that Madoff had used to disguise his crime. His victims were “clients” who had been making “investments.” He had been generating “profits,” and they had been withdrawing them as “investment income”—even paying taxes on it, for heaven’s sake. Thanks to those “profits,” they still had money in their accounts when Madoff confessed. And that final account balance was the measure of what they had lost in Madoff’s fraud, plain and simple.

But Irving Picard and David Sheehan did not see “investments” and “profits” and “account balances.” Instead, they saw crimes and lies and stolen loot. In their view, Madoff was simply a thief. He had ridden into town and swindled everybody. Some people had been lucky enough to ask for their money back before he rode off into the sunset. He had given it back to them purely to forestall the cries of “Stop! Thief!” that would have broken out if he had refused. At the end of the day, those victims had dodged the bullet—they had narrowly avoided being robbed.

Other victims, the unlucky ones, had not retrieved a penny before Madoff galloped away. In their case, the bullet had hit home, the robbery had been consummated. As Picard and his posse saw it, any loot left in the crook’s saddlebags when he was finally captured clearly belonged to those unlucky victims, to the thousands of “net losers,” and to no one else.

But the net winners did not feel lucky. They felt as if they had been robbed, too—robbed of the wealth they thought they had. They felt betrayed by Madoff and by the SEC—and they were right; they had been tragically betrayed. But so had the “net losers,” and at much greater cost, at least in terms of out-of-pocket cash. So the “lucky net winners” were not lucky and they were not winners. They simply were not eligible for immediate relief, under Picard’s calculations, no matter how genuinely needy some of them might have been.

Picard’s job, as the courts had long interpreted it, was to try to get all the innocent Madoff victims into the same boat, a boat whose occupants had sacrificed all their fictional profits but recovered all of the cash they originally invested. On the day Madoff was arrested, the net winners had already gotten all their cash back and the net losers had not. The net losers had never received any fictional profits, and the net winners had.

Madoff had robbed Peter to pay Paul; the only way to fix that was to take money back from Paul to repay Peter. Even if the trustee could find a way to repay Peter from some other source of money, Paul would still be better off than Peter because he had his fictional profits and Peter didn’t. Unless everyone, somehow, could recover the full amount shown on their final account statements, the net losers would inevitably be treated worse than the net winners, which could not possibly be fair.

Was there a moment immediately after Madoff’s arrest when a different approach could have been applied to helping the neediest casualties of his crime?

The justice available through the bankruptcy court was blind. It would treat wealthy “net winners” such as the New York Mets’ owners the same as nearly impoverished “net winners” such as retired school-teachers or a struggling freelance writer. It would treat all “net losers” the same, whether they were rich hedge funds in the Caribbean or a retired small-town mayor in New Jersey. And this brand of justice was not only blind but slow, far too slow to deliver emergency relief.

There was a template for a different approach. After the 9/11 terrorist attacks, Congress recognized that the court system—the forum that would have to deal with lawsuits by victims’ families against the airlines, the airports, and the Port Authority of New York and New Jersey—was a ruinous option. Thousands of breadwinners had been killed, and their families needed immediate relief, fairly distributed. So Congress created a victim compensation fund, whose special master was empowered to tailor compensation awards to reflect both justice and mercy, with financing from Congress—in exchange for an agreement not to sue the airlines or any other entity that could have been held negligent. The final distributions were made within two years and were generally considered fair.

More recently, when a massive oil spill inflicted enormous damage on the communities and businesses on the Gulf Coast of the United States in the spring and summer of 2010, a similar approach was taken, with the same special master appointed to make fast-track decisions to distribute funds set aside by British Petroleum for damage claims. The effort got off to a rocky start after the special master promised quicker decisions than he could produce. But while going to court remained an option for those dissatisfied by his rulings, the concept was still generally viewed as a faster route to recovery than a long trip through the judicial system.

Of course, a special master for some sort of “Madoff Victim Restitution Fund” would have faced all the same problems that the SIPC trustee confronted: the criminal investigation, the possibility that some Madoff victims were actually accomplices, the unreliable or nonexistent records. Taxpayers willing to finance compensation to 9/11 widows and orphans would no doubt have balked at reimbursing wealthy offshore hedge funds, and the only deep pocket that could have played the role of British Petroleum in paying claims was SIPC itself, which was institutionally committed to the bankruptcy process.