Written by Teresa Zink for HB Litigation Conferences LLC

So, what happened in the Madoff scheme?  Paccione said it is important to understand certain basic facts.   Citing the complaints filed with the SEC and the U.S. Attorney’s Office, Madoff confessed to operating a Ponzi scheme and stated that the scheme “could have been as large as $50 billion,” a number questioned by the trustee and which has been estimated to be as little as $20 billion.  Still a significant amount of money, Paccione said. 

As of late February, according to Paccione, $650 million had been recovered from banks holding BMIS (Bernard L. Madoff Investment Securities) deposits and 1,600 securities positions had been recovered from Depository Trust Company, most of which were sold by the trustee for $240 million.   There is still a lot of missing money out there, according to Paccione, “I think the expectation of recovering all that can’t be very high.”

Paccione clarified that although Madoff’s scheme has been loosely described as a hedge fund, “It wasn’t a hedge fund from what’s being reported.  It was not a pool of funds, but rather there should have been separate, segregated accounts, each in the name of a single account holder.”  This distinction will be important in determining potential recoveries from the Securities Investor Protection Corporation (SIPC), Paccione said.  “These were managed accounts with individual account holders.  It wasn’t a hedge fund.”

Paccione also noted that it is important to understand the basics of the split strike conversion strategy by which Madoff “was supposed to – but apparently didn’t – sell out-of-money calls on the index and then purchase out-of-money puts on the index.  The strategy basically is to create a boundary of profits or losses on a particular investment,” meaning that positive returns would be generated, regardless of which way the market moved.  However, Paccione noted that the trustee reported in mid-February “that there were absolutely no trades of any securities by Mr. Madoff for the past 13 years.”

He said that the questions of whether these were managed accounts, and whether Madoff  used a split strike conversion is relevant in a legal sense.  “When we talk about ‘red flags’ later on – which is going to be a buzzword in the Madoff litigation that we’re going to hear about for a long time – you need to have a basic understanding of split strike conversion.  That’s because one of the red flags that’s going to be alleged is that using that trading philosophy, someone could not have made as consistent and as large returns as Mr. Madoff did for that period of time.”

(See next post.)

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