Madoff, Clawbacks and Charities
Thursday, November 5, 2009
By: Jonathan Gudema, Esq.

For those in the philanthropic world, seeing stories in the press about the bankruptcy trustee in the Madoff mess, Irving Picard, and his attempts to recover assets has to make us wonder what will be with charities potentially involved in clawback suits

Reprinted from Planned Gift Blogspot

The Forward and Bloomberg have already started to mention this issue in recent articles (see below for links).

Unfortunately for Hadassah, over the summer they apparently admitted to withdrawing $130 million from an initial investment of $40 million, over the course of more than 20 years. Or, what about non-profits that divested their Madoff or Madoff feeder fund investments well before the discovery of the massive fraud? Or, what about charitable beneficiaries of Jeffry Picower's Foundation during the last few years? (Note: Jeffry Picower passed away Oct. 25, another sad chapter in the Madoff tragedy.)

Thanks to the law firm of Drinker Biddle, I now have some idea how claw back suits work (see below link to their article on the topic). Here is a summary of the rules based on the Drinker Biddle memo:

1. Charities have to be treated like any investor - there is no point in discussing the ethics of clawbacks against charities. The trustee has an obligation to recover funds for those defrauded, starting with the biggest and closest who benefited. Where is the logic or ethics in agreeing to allow a charity to benefit at the cost of other defrauded investors?

2. All withdrawals made within 90 days of a bankruptcy petition are subject to full recovery by the trustee, whether or not the money taken was from "principal" or "earnings." Insiders under some circumstances may be required to return any withdrawals within a year.

3. Next come withdrawals of "fictitious" profits made within 6 years of the filing (for Madoff, the date is 12/16/2008). Federal bankruptcy law actually proscribes 2 years but New York fraudulent conveyance law extends the clawback period to 6 years. Not being an expert in this area, I am guessing that attorneys may fight to get out of applying New York's law on jurisdictional grounds - possibly a way to save clients some money but for sure a serious legal battle.

4. How do we define "fictitious" profits? Very simple. Any penny withdrawn in excess of your original investment is fictitious profit. From reading the Drinker Biddle memo, it seems clear that if it can be established that you had already withdrawn your full investment in Madoff prior to December 16, 2002, then you would be obligated to return every penny withdrawn during the period of December 16, 2002 to December 16, 2008. That is pretty frightening for a place like Hadassah which all but admitted that they had long recovered their initial investments.

5. If you never reached the fictitious profit level, and you didn't withdraw any funds within 90 days (assuming you are not an insider), you should not have any clawback concerns. If you received a letter from Picard demanding return of funds, it would be time to seek legal counsel as soon as possible.

6. One last point for those who knew or should have known of the fraud taking place - the trustee in theory can seek to recover for even non-fictitious principal withdrawals in these cases. That will be a totally different kind of legal case and probably very weak if the trustee can't place you as a co-conspirator. If the SEC and the rest of the world didn't notice, how can the government claim that a non-conspirator should have known? My guess is that the trustee will not pursue these except for clear insiders who most likely knew something was wrong (ie..family).

With the sad passing of Jeffry Picower, a huge philanthropist, I am wondering about indirect charitable beneficiaries of the Madoff scheme. Bloomberg.com reported that Picower made a $50 million donation in 2002 to fund a brain-research center at MIT. Was it early in 2002 or after December 16? Can these funds somehow be traced to Madoff profits?

What about charities that had invested with Madoff indirectly (through one of the "feeder" funds)? And, what if they had wisely chosen to send their investments to other managers and taken along fictitious profits, too?

In the end, Picard the trustee will have to pick his battles carefully based on size and likelihood of success. Big targets, charities or not, watch out.

• Clawbacks” in the Aftermath of Madoff and Other Investment Frauds
• Should Madoff’s Winners Give Back to Losers?
• Charities Hurt by Madoff May Have To Return Funds
• Madoff Liquidator May ‘Claw Back’ Charities’ Profits

About the Author

Jonathan Gudema is a planned giving consultant with Changing Our World, Inc. a philanthropic services consulting firm. He has worked with some 200 nonprofit organizations in fundraising, planned giving, and/or law throughout his career. He blogs on these topics at Planned Gift Blogspot. He can be reached at jgudema@changingourworld.com.