The hunt for Madoff's money

Getting the fraudster jailed for life was just the start of a long battle for justice for Bernard Madoff's victims. Stephen Foley reports on the investigation into the missing millions

Step by tiny step, the giant totaliser is being filled in. As if in a charity telethon, the trustees of Bernard Madoff's fraudulent investment empire are seeking money from every source they can, in the hope of compensating thousands of the swindler's victims around the world. Last Friday, a couple of fur coats worth $48,500 and $21m of jewellery were among the items "donated" to the cause – items seized from Madoff's wife, Ruth, in the couple's financial settlement with prosecutors. Yesterday, it seemed as if we might add in $120m from an art sale by Ezra Merkin, the philanthropist who owns the largest private collection of works by Mark Rothko, after Mr Merkin buckled under legal pressure from the New York attorney-general for his role in channelling money to Madoff.

The perpetrator of history's largest fraud may have been put behind bars for a term of 150 years this week, but that assuages only one of the concerns of the Madoff investors who trusted him, in many cases, with their entire savings. Of more practical importance to them: will they get their money back?

The answer is some of it, but certainly not every penny they thought was in their account on 10 December last year, the day before Madoff sensationally revealed that his investment business had been a pyramid scheme. If you add up all the fictional account statements that Madoff sent to his victims, they total $65bn. But none of the investment returns that those statements showed, sometimes over more than two decades, was real. Money coming in to the fund had been paid to clients cashing out. The pot was close to empty.

Even today, as the trustee, Irving Picard, has begun selling off other bits of Madoff's business empire and assets, the pot has swelled to just over $1.2bn.

How big does the totaliser target need to be? It is not an academic dispute: it is fast becoming a bitter legal battle pitting victim against victim. Mr Picard has calculated the net losses from the Madoff fraud not at $65bn but at $13bn or so, being the amount of cash that victims actually put with the fraudster minus the amount of cash they took out over the years.

He plans to compensate victims on that basis; that is, on the amount of actual cash they have lost, rather than the sum the investors thought their cash had grown to.

For Madoff clients who squirrelled away a relatively small amount almost two decades ago, who watched those fake statements report steady growth and who have been planning their future on the basis that they had become millionaires, Mr Picard's formula does nothing to repair their devastation.

At least three lawsuits are pending against Mr Picard and his partner in the rescue effort, the Securities Investor Protection Corp (SIPC), which provides compensation to fraud victims. In one suit, lawyers recount how a 73-year-old widow was forced to take a part-time job at Macy's when she learnt that two accounts, valued at $1.3m, had been wiped out, and how an elderly couple still caring for a disabled daughter are now living on food stamps.

There are, of course, heartbreaking stories – and logic – on both sides of the battle. Stephen Harbeck of the SIPC has consistently argued in favour of the official formula. Compensating victims on the basis of their notional accounts "allows the thief to determine who receives a larger proportion of the assets collected by the trustee".

There are other legal morasses to be waded through. The SIPC is also trying to claw back money from investors who took cash out of Madoff in the final months and years of the scam, something that can extend to withdrawals in the final six years under some laws. Those legal fights are so far being concentrated against institutional investors – including the so-called "feeder funds" that put their own clients' money with Madoff – but these clawbacks could prove the biggest additions to the totaliser, perhaps more than $10bn.

The victims who put money with Madoff unwittingly, via those "feeder funds", are still in limbo. Investors who put money directly with Madoff are entitled to up to $500,000 in compensation from SIPC (a cap that has been fixed at that level since 1978 and eroded in value by inflation ever since), but feeder fund investors claim they are being treated like a lower caste. Many are suing their funds – such as those run by Mr Merkin or Walter Noel, the Connecticut hedge fund grandee – for negligence, except that multiple regulators and the SIPC may also sue them in pursuit of the same money.

In short, it is a mess, and the legal fights could go on for up to a decade, according to some of those involved.

Law enforcement officials yesterday were indicating that their criminal investigations go on, and that perhaps as many as 10 other people could follow Bernard Madoff into court. It has long seemed implausible that Madoff could operate such a complex fraud – and generate so many hundreds of thousands of fake documents – without anyone else knowing or negligently failing to raise questions. Observers say that the feeder funds and Madoff family members who worked in the business are likely still to be under suspicion, although they and Madoff himself have all insisted that they were duped and are victims themselves. So far, only his accountant, David Friehling, is facing charges. Criminal convictions, particularly of the rich money managers in charge of the feeder funds, could allow the seizure of their assets, too, and make a noticeable addition to the totaliser.

Madoff and his wife, meanwhile, have agreed to the forfeiture of everything they own, bar $2.5m in cash for her. That settlement last Friday hands the government the keys to their homes in Montauk and Palm Beach and to the Manhattan penthouse in his wife's name, where Ruth Madoff still lives. The $45m in bonds and $17m in cash she originally said were hers alone have also been thrown into the pot; Madoff's yachts, his Mercedes-Benz and his Volkswagen, his Steinway piano and his collection of designer watches are all going towards the totaliser – but they will fetch tiny sums compared to the total losses.

Madoff was running a classic pyramid scheme. Money in, money out. The saddest fact about history's largest fraud is that it is not a straightforward theft of one person's money by another. In this huge, messy money-go-round of at least 20 years standing, at some point finding money for one victim means reducing the compensation for another.

Beyond that, it was a theft of fake money, profits they thought they had. As many of the victims said in court, it was a theft of their dreams. Unpicking the mess will be painfully slow – and plenty painful.