Photo provided by Holland & Knight

Photo provided by Holland & Knight

Bernard Madoff made off with his investors' money through an intricate Ponzi scheme that lasted for decades. The complexity of the matter raises issues across the board covering fraud, losses to the tune of $50 billion, bankruptcy, corporate law, due diligence failings, tax implications and the list goes on. Holland & Knight has formed a Madoff advisory group to guide its clients affected by the Madoff madness.

Sean Sheely, a partner in the litigation practice group of the firm's New York office, is one of the group's members. He is a commercial litigator who represents clients in government and regulatory investigations and has experience litigating claims involving fraud and breaches of fiduciary duty. While he declined to discuss any specific client matters, Sheely talked with Lawdragon about the complex issues raised by the Madoff scandal, including potential claimants and defendants, sources for recovery and what we can expect in terms of future regulation and legislation to protect investors.

Lawdragon: Why has the firm formed a special practice group to address the Madoff matter?

Sean Sheely: I think the size and the scope of the Madoff matter is really, to some extent, unprecedented and Holland & Knight has formed this Madoff Advisory Group to try to assist clients with the complex issues that we anticipate are going to be raised in the matter. For example, we have a team of lawyers throughout the country to address finance issues, government issues, securities issues, white collar issues and tax issues that will all come to bear I think on this. This is really a unique circumstance.

LD: Do you see this as going on for years with lots of cases?

SS:: No doubt the issues in the Madoff matter are going to take time to sort out and I anticipate that the resulting lawsuits are certainly going to continue for some period of time.

LD: How about potential claimants aside from the investors? Do you see other types of claimants coming forward?

SS:: Yes. I think there is a broad range of institutional clients and individuals that are impacted by the Madoff matter. There are financial institutions, hedge funds, charitable foundations and that list includes international organizations as well as domestic entities. These are all intermediaries in this chain. Whenever you have a fraud involving economic loss you are going to have economic loss and a chain that connects those entities to the loss. So far, anyway, the organizations that have been identified or that have been impacted have been somewhere within that chain. But the full impact of this is still being sorted out.

LD: Will the civil claimants have to hold off until the criminal matters are resolved? Will your clients essentially all be kept waiting to proceed?

SS:: Ordinarily, criminal matters get resolved earlier than civil matters and so there is some precedence for having the criminal matters go first. In some cases, a pending criminal action will result in a stay of discovery in a parallel civil proceeding. It's probably too early to tell if that is going to happen here. Parties are going to have to seek a stay in court.

LD: What is the current status of the Madoff mess?

SS:: The advisory group has been monitoring it. Obviously we've seen criminal charges filed against Madoff. The SEC has appointed a receiver. SIPC [referring to the Securities Investor Protection Company, explained below] liquidation proceedings have been initiated. So it is all happening very quickly but I think there'll be more to come in the weeks and months ahead. There's not a defined order. Parties are going to make their claims and protect their interests as they see necessary.

LD: Tell me about the SEC charges against Madoff and how they will support individual investor claims?

SS:: The SEC is seeking emergency relief for investors including an asset freeze of the Madoff funds and the appointment of a receiver of the Madoff investment firm so to some extent they will overlap and should provide some support for the investor claims.

LD: How about other potential defendants like hedge fund and other investment managers for failing to conduct proper due diligence?

SS:: Our advisory group has already seen suits filed against money managers, accounting firms, investment firms that placed investor funds with Madoff and it's a pretty large group of potentially impacted organizations. So I think we have just seen the beginning of those lawsuits.

LD: What grounds can be asserted against these managers? Obviously failure to exercise proper due diligence, but then again the SEC itself failed to uncover the problems despite warnings.

SS:: I think these issues are really complex and in part because of the unprecedented size and scope of the Madoff matter. There are very fact-specific inquiries made in framing what causes of action you have or what duties are owed to you and then what breach there might have been of those duties. You identified one, due diligence, but there may be others as well. That's why Holland & Knight set up this group to try to address the very complex issues that are here on liabilities and on the damages. It's hard to comment in the abstract about what causes of action there might be without having the underlying actual basis.

LD: How about actions against the SEC and its liability to investors? Will those all be precluded because of government immunity?

SS:: As a general matter, the federal government has sovereign immunity and may not be sued unless it has waived its immunity or consented to suit. Sovereign immunity is a complex legal issue that requires a case-by-case analysis. For example, the Federal Tort Claims Act provides a limited waiver of sovereign immunity when a government employee acts negligently within the scope of his or her employment. Whether any conduct by the SEC in the Madoff matter is outside the scope of sovereign immunity are issues that investors and lawyers may look to test.

LD: What about the sources from which recovery can be drawn? What is the extent of coverage from Securities Investor Protection Company (SIPC) and is there other insurance that may cover the losses?

SS:: SIPC is intended to provide protection to investors when a brokerage firm fails. In general, SIPC provides coverage for losses up to $500,000 per account. However, given the scope and magnitude of the alleged losses in the Madoff matter, it is uncertain what level of protection SIPC will be able to provide to investors without additional resources. Whether or not there are other lines of insurance coverage for any of the investor losses here is really going to depend on the facts that are developed in discovery or in the ongoing investigations.

LD: How about the possibility of claiming a theft loss on tax returns - is that a viable claim?

SS:: That really is a good question. I know that when you have anything that's the size and scope of the Madoff matter, people are going to be asking questions and asking them in a way they may not have asked them before, looking at them in a new way. The tax issues are going to be among those issues that are going to be challenging and complex.

LD: I think this is really going to be about creative strategy.

SS:: I think that's right and that's part of the reason why Holland & Knight formed the advisory group -to try to position ourselves to assist clients with the complex issues that are going to come out of this $50 billion fraud.

LD: How about the potential liability of those investors who made money and pulled out before the scheme caved in - the "clawback" of their profits? How far back can the bankruptcy receiver look back when seeking a clawback?

SS:: Holland & Knight lawyers have experience with clawback claims in other contexts and we expect that we will be advising clients in the Madoff matter about the potential risks and benefits of clawback recoveries. In terms of the timeframe governing clawback claims, that is an issue that depends on what law applies. Individual state rules may come in that are going to have different time periods. There's not one answer to that question.

LD: Also how about preferences in bankruptcy - I believe money paid out within 90 days can be brought back?

SS:: Under the bankruptcy rules there are preference rules that talk about claims that are paid out within those 90 days as having preference attached to them.

LD: How about the criminal and civil liability of the key management leaders? Managers can't be willfully ignorant.

SS:: Correct. I think that it will depend on who knew what and when they knew it. Those are going to be questions that investors and regulators are going to be asking over the coming months.

LD: How will the bankruptcy proceedings impact the investor claims?

SS:: There is an automatic stay in bankruptcy that protects the debtor. But it is probably premature to assess the impact the automatic stay may have on any of the litigation that relates to these other entities and parties that were involved or caught up in this. The concept is that the bankruptcy court wants to protect the debtor from lawsuits during the period of the bankruptcy. There are a lot of ways the bankruptcy court can deal with that, but the claims are not precluded. It's just slowing things down so that the debtor's estate can be administered in an orderly fashion.

LD: What will be the greatest challenge facing investors in terms of obtaining recoveries? Uncovering assets? Determining the losses?

SS:: I think with any type of fraud or Ponzi scheme a significant challenge is uncovering the assets. But the size and the scope of the Madoff matter is so complex. That's part of the reason Holland & Knight set up this team - to try to position our clients to reduce the likelihood of claims against them and to provide them with avenues for relief to recover on their losses.

LD: How will the losses be determined? Will they be based on the original investment since profits aren't really made until the money is pulled out?

SS:: That is going to get very complicated, too - how you allocate or how you try to define what your damages are. There are also the taxes paid on gains. So there really can be a lot of consequential damages involved here and figuring out what number applies is going to be heavily litigated.

LD: What the heck is easy in the case?

SS:: That remains to be seen!

LD: What are the next steps for those impacted by the Madoff events?

SS:: The advisory group is helping clients stay abreast of developments, including civil and criminal litigation, and any legislative and regulatory actions that are on the forefront here that may impact their potential claims or tax situation. But I think that for the next month or so we're just going to have to keep watch on what's going on out there.

LD: Any clues about regulation and legislation - what will likely come down the road? Congress has so many other problems to address in this down economy already?

SS:: At a minimum, investors can expect Congress to consider tougher financial regulations intended to prevent a crisis like this from happening again. Indeed, President-elect Obama has vowed to overhaul the regulatory systems and oversight of such investments.

LD: What about lessons and advice for clients?

SS:: I think most of the advice to investors is on a practical, common sense level. From a legal perspective, I don't know that anything can be done to eliminate fraud. People who commit fraud are always coming up with ways around whatever regulations and practices are put in place so it is really difficult to come up with some sort of prophylactic advice. I think that financial investors and advisors have recommended diversification for a long time and for a lot of good reasons and this may be added to that list of good reasons.