Look out victims, the government wants its share now

Neil Macdonald on the second whammy facing Madoff's victims.

For the vast majority of people here, the Bernie Madoff debacle playing out in the U.S. courts has a bread-and-circus air to it — an entertaining spectacle to be watched from the stands, perhaps even with some satisfaction, given the grim, hang-the-rich mood right now

With a few exceptions, such as the beneficiaries of certain Jewish charities, Madoff's shorn marks are, or were, wealthy people. The epicenters of his thieving devastation are Palm Beach, Beverly Hills, Aspen and Manhattan.

Bernard Madoff, on his way to Manhattan federal court on March 12, 2009 where he pleaded guilty to one of the biggest Wall Street frauds in U.S. history. (Louis Lanzano/Associated Press)

Ordinary people, understandably, are much more concerned about the damage done to their life savings or the value of their homes by greedy Wall Street banks. Some would argue the banks operated in a fashion not terribly dissimilar to Madoff's Ponzi scheme, the difference being that they now are the object of taxpayer bailouts rather than prosecutions.

Still, the Madoff case contains an underreported lesson on how the U.S. legal system — and the government itself — can team up to pound on a victim. It's a lesson everyone should consider.

Taxable ghosts

Say, for example, you were one of those people who, through a friend or some family connection, managed years ago to wheedle your way past the gate and into Madoff's envied circle of select clients.

The now de-frocked financier, a former chairman of the Nasdaq stock exchange no less, generally asked for a minimum investment of $1 million.

It was a hefty entrance fee and maybe you had to mortgage something to get the cash. But then, as an investor, you began receiving those fabled (and, it turns out, impossible) Madoff returns: 10 per cent, good times or bad.

At the end of your first year, your Madoff statement said you had made $100,000. Like many of his clients, you said just let it ride and allowed the money to be reinvested.

It was all fake, of course. Completely invented. There's no evidence Madoff ever actually invested any of his clients' money.

At the time, though, it looked real enough to Madoff's investors and to the Internal Revenue Service, which compelled them to pay tax on their "returns."

Over the decades, the IRS collected untold, decidedly non-fake billions from Madoff clients. But now everybody knows these returns were phantom profits, to use the popular term.

Common sense would seem to dictate that the IRS should return the tax it extracted from you, correct? Umm, no.


As the Madoff clients are discovering, the U.S. treasury has a knack for protecting itself, especially after it's collected money.

Robert Willens, an expert who's been advising some of the people Madoff fleeced, says the IRS has gone to court to keep control of the taxes it collected from victims of past Ponzi schemes.

"The IRS argued, and the court agreed, that you cannot have a theft of something that never existed," Willens told me. "And since those phantom profits never existed, being phantom, they couldn't be the subject of a theft."

According to Willens, courts ruled that "the government did not unlawfully take those taxes and therefore there was no theft with respect to the taxes, either."

If that sounds like it was dreamed up by Franz Kafka, just wait. It gets better. Or, for Madoff's victims, much worse.

Beneficiaries of fraud

Many of Madoff's clients actually took their annual returns in cash and treated it as income. Being a Ponzi schemer, Madoff made sure to pay anyone who asked for a redemption, using money stolen from fresh investors. That's the way a Ponzi scheme works.

In fact, some of Madoff's longest-term clients received their entire original investment back that way, and then some, just as you would get your entire investment back, given enough time, from a term deposit or government bond.

Those clients paid tax on that money, too — tax they won't likely see back.

But they are now also in the crosshairs of Irving Picard, the court-appointed trustee assigned to sort out Madoff's big fraudulent mess.

The way Picard sees it, the clients who managed to get money back from Madoff were actually the beneficiaries of fraud themselves. He's made it clear he intends to launch lawsuits to "claw" some of that money back, especially from those whose "returns" eventually exceeded their original investment.

Here's how David Sheehan, a lawyer assisting Picard, explained it to a group of Madoff clients in New York: "You have to realize you got someone else's money."

Criminal forfeiture

Attorneys representing groups defrauded by Madoff have said their clients are terrified by that threat.

Some are now reportedly trying to shelter what money they have left, putting it into irrevocable trusts, houses and pension plans. Few are discussing those strategies, because that might be seen as attempting to defraud the legal system.

Imagine facing criminal charges for trying to protect what you have left, after most of your savings have been stolen.

Then, up steps Lev Dassin, the United States attorney.

In court this week, after announcing that Madoff's scheme was in fact a $65 billion fraud, not the $50 billion as originally reported, the federal prosecutor's office then declared publicly that it is seeking $170 billion — nearly three times that amount — in criminal forfeiture.

Why the huge sum? After all, Bernie Madoff has no such money left and Dassin knows it. The court trustee has reportedly identified Madoff assets at just $1 billion or so in cash and securities.

The answer is in a letter sent by Dassin to Madoff attorney Ira Sorkin. In pursuit of the $170 billion, Dassin says that the government intends to seize "all property, real or personal, which constitutes or is derived from proceeds traceable to the commission of the offences, and all property traceable to such property."

In other words, any money Bernie Madoff gave anyone, or anything bought with it, or any interest on that money, qualifies for forfeiture.

A spokeswoman for Dassin's office, insisting on speaking off the record, told me that the $170 billion basically includes everything that went into or out of Madoff's accounts over the at least 15 years that this scheme was running.

So. Is the government planning to go after his wife? His children? People who did business with him? His preferred clients? Any of his clients? After all, any money Bernie Madoff paid anyone is clearly traceable to fraud.

The spokeswoman refused to answer: "Our position is no comment. It's not a simple question. Forfeiture laws are very complicated."

But the lesson in all this isn't. Buyer beware. And beware of government, too, not just the crooks.