Documents from New York University’s lawsuit against former GMAC non-executive Chairman Ezra Merkin and the hedge fund, Gabriel Capital LP, which Merkin is the general partner, were made public last week revealing that he was warned regarding the credibility of the returns from investments with Bernard Madoff. Merkin through Gabriel Capital invested $24 million of the NYU endowment with Madoff according to the New York Times.
I don’t know if the fact that the allegation about Merkin’s knowledge comes from a convicted felon detracts from the case or simply provides an added level of irony to this sordid episode but one thing is for sure, there will be many more lawsuits and there probably should be.
Rarely has there been a case where so many where fooled for so long all while credible evidence that a fraud was taking place was available to anyone willing to do a little due diligence.
And the mess will only grow more sordid as bankruptcy proceedings attempt to “clawback” ill gotten gains from those lucky enough to have pulled out fictitious profits from Madoff before the scheme blew up.
Brinker Biddle’s Hedge Funds Task Force has tried to make sense of it all in a paper the law firm released in March. According to Drinker Biddle, “Clawback is a nickname for several interrelated types of claims that can be asserted by a bankruptcy trustee to recover money paid out to investors in a Ponzi scheme before the scheme was revealed. Broadly speaking, the function of a clawback is to recover payments that were made out of the corrupt fund before the scheme was discovered and return those monies to the bankruptcy estate so that they can be distributed to creditors – i.e., the victims of the fraudulent scheme – in accordance with the priorities established by the Bankruptcy Code.”
The paper goes into great detail regarding bankruptcy law, priority and how far back a trustee may be allowed to go to recover monies. Given the length of time this fraud covered and the layers of investments: fund of funds, feeder funds, endowments and other intermediaries, this is a mess that will take years to unravel. Theoretically there may be thousands of people who have exposure and don’t know it.
Given that questions regarding the legitimacy of Madoff’s investment strategy were surfacing in 1999, there may have been several allocators who did well over several years with Madoff but decided to take their profits and move them when confronted with the numerous red flags surrounding Madoff’s investments. Monies from fictitious profits may have been allocated downstream through many investor layers for several years and will be difficult to clawback leaving some funds of funds holding the bag. Perhaps that would be appropriate.
I have spoken to someone who has a family friend who was wiped out financially by this. Not only did the retired individual have all of his investment money with Madoff but has been living off the profits for years and could possibly face clawbacks. If reasonable, no one should be able keep ill gotten gains but the people holding the bag should be those that had a fiduciary duty to perform due diligence on investments they allocated other peope’s money to.
