Madoff-Ponzi-Scheme-article-photo-250xOn August 16, 2011, “net winners” in the massive Madoff Ponzi scheme were delivered a blow by the Second Circuit U.S. Court of Appeals. The Madoff “net winners” argued for a method whereby gains or losses in the Ponzi scheme would be determined by the market values as shown on their last statement. The “net winners” based their argument on the theory that pursuant to securities regulations they had a right to rely on the statements issued by Madoff to determine the value of the securities they purchased from Madoff, a licenced broker. The Court held, however, that Madoff never actually purchased the securities. Therefore, such a result would have the absurd effect of treating fictitious and arbitrary paper profits as real and would give legal effect to Madoff’s machinations.

The Court adopted the method proposed by the Trustee whereby the amount of an investor’s loss or gain was determined solely by the amount actually invested, minus any withdrawals. Simply put, if a Madoff investor took out more than they put in they are a “net winner” and will be foreclosed from receiving any restitution as a victim. Conversely, if the investor put in more than they took out the investor is a “net loser” and will be able to receive a distribution as a victim of the Madoff scheme.

The “net winners,” many of whom are defendants in claw-back lawsuits by the Madoff Trustee, now must face the reality that they will be precluded from receiving any distribution as victims of the Madoff scheme. The “net winners” will be subject to a judgment for the amount of the false profits, plus prejudgment interest. The prejudgment interest will be calculated based upon the amount of the false profits from either the date of the Trustee’s demand for repayment or the date the claw-back suit was filed. This reality, however, must be tempered by the fact that the Madoff “net winners” will retain the full amount of their actual investment, whereas “net losers” will never be made whole.

Although the Madoff “net winners” are crying foul, the Second Circuit’s decision regarding the method for determining “net winners” and “net losers” is not groundbreaking. In fact, the Second Circuit’s decision is in line with the treatment of “net winners” and “net losers” in other Ponzi scheme cases being prosecuted throughout the United States. In the Petters claw-back cases in Minnesota, which arise from the Petters Ponzi scheme, the Trustee has, for the most part, limited claw-back lawsuits to “net winners” who received more than the principal amount of their notes from one of the Petters entities. Although not surprising, the Second Circuit’s decision in Madoff is a win for “net losers” and a loss for “net winners.”