A New York appeals court ruled Tuesday that some investors in Bernie Madoff's Ponzi scheme are not entitled to any of the unlawful profits being recovered to compensate other victims.

A three-judge panel of the 2nd U.S. Circuit Court of Appeals agreed with the man tasked with recovering as many funds as possible to pay back Madoff's real victims, that people who withdrew more than their initial investment in Madoff's funds before it collapsed shouldn't be entitled to any more compensation.

Madoff is currently serving 150 years in prison for masterminding one of the largest frauds in American history. For more than two decades, he duped investors with fictitious account statements showing thousands of clients had investments worth $65 billion U.S. But investigators said he never traded securities, and instead used money from new investors to pay returns to existing clients.

Bernard L Madoff walks along a street in New York months before his fraud conviction in 2008. (Don Emmert/AFP/Getty Images)

Bankruptcy trustee Irving Picard is trying to collect as much of the money as possible to pay back the victims as much as possible. His position has always been that those he calls "net winners" — those who got their initial investment back by withdrawing funds before the funds collapsed, but did not get any of the subsequent fake profits — should get no more.

Helen Davis Chaitman, who argued the case for investors, said the ruling "will destroy investor confidence in the capital markets" because investors will no longer trust that they will recover their money if they are cheated by dishonest brokers.

"The message to every American who invests in the stock market is clear: invest at your own risk" because insurance cannot be relied upon, she said in a statement.

Amanda Remus, a spokeswoman for trustee Irving Picard, called the ruling "an important step forward for customers with allowed claims."

"We have maintained all along that our definition of net equity — which is supported by longstanding precedents in bankruptcy and securities laws — is the fairest approach to the determination of claims, and we hope that the court's decision can be the final word on the issue," Remus said in a statement.

The ruling Tuesday vindicates that view and limits the number of people who will have claims on whatever funds he recovers.

As of last month, Picard had recovered something in the neighbourhood of $11 billion. But there are dozens of outstanding lawsuits against individuals and corporations, trying to recover more.

With files from The Associated Press