Compensation Fund Set for ‘Feeder Fund’ Victims in Madoff Scheme

The largest category of victims in the vast Ponzi scheme run by Bernard L. Madoff - those who lost cash through accounts with various middleman funds - will be first in line for compensation from a $2.35 billion fund collected by the Justice Department.

These “indirect investors” represent about 70 percent of all the claims filed after Mr. Madoff’s arrest in December 2008, and about 85 percent of the claims for out-of-pocket cash losses. But because they were not formal customers of Mr. Madoff’s brokerage firm, they are not eligible to recover anything from the $9 billion fund being paid out through the federal bankruptcy court.

However, the indirect investors â€" at least 10,000 people and possibly many times that â€" are eligible for compensation from the federal Madoff Victim Fund under criteria announced on Monday by Preet Bharara, the United States attorney in Manhattan.

Generally, anyone who withdrew less from their Madoff-related account than they paid in will be eligible to recover from the Madoff Victim Fund, even if they invested indirectly through the hundreds of “feeder funds,” investment groups and other pooled investment vehicles that poured cash into Mr. Madoff’s hands during his decades-long fraud.

“The process we have put in place opens the door for thousands of defrauded victims who otherwise might never have recovered anything,” Mr. Bharara said.

Mr. Madoff, once a respected figure on Wall Street, pleaded guilty in March 2009 to running a fraud whose cash losses exceed $17 billion and whose paper losses total almost $65 billion. He is serving a 150-year sentence in a federal prison in North Carolina. Peter Madoff, his brother and longtime business associate, pleaded guilty in June to federal tax and securities fraud charges, but denied he knew about his brother’s fraud; he is serving a 10-year prison term.

Including the Madoff brothers, 15 people have been charged in the historic fraud and nine have pleaded guilty. Five others denied the allegations and are currently on trial in federal court in Manhattan. Paul Konigsberg, the final defendant and a longtime Madoff investor and friend, was indicted in September; he had denied any wrongdoing.

A small part of the money in the Madoff Victim Fund came from the headline-making auctions of assets collected from Mr. Madoff and his family: three luxury homes, several expensive boats, a 10.5-carat diamond ring and other jewelry, along with personal memorabilia like a personalized New York Mets jacket and monogramed velvet slippers.

But most of it came from the estate of Jeffry Picower, a secretive investor who took more than $7.2 billion from his Madoff accounts during the life of the fraud. Mr. Picower died of a heart attack at his Palm Beach estate in October 2009. His widow settled litigation against him by paying $2.2 billion to the Justice Department and $5 billion to the fund being distributed through the bankruptcy process by the Madoff trustee, Irving Picard.

The Madoff Victim Fund is under the direct supervision of Richard Breeden, a former Securities and Exchange Commission chairman. Mr. Breeden said this process was designed to correct what seemed like the most “glaring” inequity in the Madoff compensation process.

“Feeder funds are a staple of Ponzi schemes,” he said, adding that “fully 85 percent of the people who lost cash in the Madoff scheme came in through those funds.” But the law governing Wall Street bankruptcies limits payments to Mr. Madoff’s direct customers â€" only about 15 percent of the victims who lost cash in the epic Ponzi scheme.

“There are literally widows and orphans who lost everything with Madoff but who will not get one thin dime from the bankruptcy process,” Mr. Breeden said. “Fortunately, this fund can define ‘victim’ more broadly than ‘customer,’ and it has.”

Details of how the new claims process will work have been posted on the fund’s website, www.madoffvictimfund.com, Mr. Breeden said, and claims must be received by the fund no later than Feb. 28, 2014, he added.

One category of Madoff investor â€" those who took more cash out of their Madoff accounts than they had paid in â€" remains ineligible for both the bankruptcy process and the new fund. While these investors saw billions of dollars in paper wealth vanish when Mr. Madoff was arrested, they had recovered all the cash they gave Mr. Madoff before the fraud collapsed.

“This should not have happened and it is a tragedy that it did,” Mr. Breeden said. “But the law doesn’t cover a loss of expectations, however devastating. It covers a loss of cash.”