Ponzi Scheme Madoff Recovery Maze

The lower interest rate environment is revealing a soft underbelly of Investment Scams and Ponzi Schemes. What many of these schemes have in common is the breach of trust, and victims “holding the bag”. In some cases, a partial recovery of the investment may be possible against a licensed investment professional. In others, a small benefit may be obtained by obtaining a “theft loss” available through Section 165 (c) (2) of the Internal Revenue Code.

FINRA Arbitration recoveries against brokerage firms may be possible if arbitration panels believe that a continuing fraud occurred to allow some older claims to proceed to hearing. The nature of many Ponzi Schemes is such that are not detectable by the victims or regulators until many years after they begin. Another curve in the Maze is that the “theft loss” provision has many technical requirements which may limit the recovery available by the “theft loss” provision.

The best course of action may be for the tax preparer to take this information to a tax attorney. An experienced attorney can help determine if the legal requirement of a “theft” has occurred. Whether a loss constitutes a “theft loss” is often determined by examining the law of the state where the alleged theft occurred.

Further, the attorney can help determine whether there was actual fraud with the necessary element of “scienter” which is “intent”. Thus, to claim a theft loss, the taxpayer must prove that the loss resulted from a taking of property that is illegal under the law of the state where it occurred and that the taking was done with intent.

The investor must have bought the investment directly from a seller that committed fraud under local law. This leads to a requirement of “reliance” that the investor relied on the fraudulent information when parting with their property. The Courts have consistently disallowed theft loss deductions relating to a decline in the value of the stock that was attributable to corporate officers misrepresenting the financial condition of the corporation, even when the officers were indicted for securities fraud or other criminal violations.

Some claim that the Securities Investor Protection Corporation (SIPC) provides investors who have been defrauded with some protection. However, others believe SIPC should be called the “Securities Investor Persecution Corp.” and that the government corporation operates “like a big insurance company, wanting to pay out as few as claims as possible.”

These advocates point to its payments of only about $400,000 to only nine investors out of more than 3,000 who applied for reimbursement when boiler room brokerage firm Stratton Oakmont, made famous by ‘The Wolf of Wall Street’, was shut down by regulators.

SIPC which controls assets totaling more than $1.2 billion interprets the law far too narrowly with the goal of not paying claims. They’ve created internal rules that may never have been intended by Congress, rules which make it too difficult for most investors to be able to obtain restitution of their funds.

But, with so many fat-cats being victims of the Madoff and other scams, there may actually be hope for some recovery to those victims who make it through the Maze.