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Yet another chapter has begun in the saga of the New York Mets organization’s financial responsibility in Bernard Madoff’s Ponzi scheme, which collapsed over three years ago. U.S. District Judge Jed S. Rakoff for the Southern District of New York ruled that Mets owner Fred Wilpon must pay to Irving Picard, the trustee of the bankrupt Madoff estate, as much as $83.3 million. This figure represents the amount withdrawn by Wilpon in excess of his total principal invested – funds which were presented to investors as legitimate profits – over the course of his “investment” with Madoff’s fictional investment project. Only $1.7 million of the $83.3 million in fictional profits is reportedly linked to the Mets financial portfolio. Judge Rakoff also ruled that the parties will go to trial this month regarding the additional $303 million in principal that Wilpon invested and withdrew before the scheme’s collapse.
It seems that Madoff updates have been consistently sprinkled throughout the news since late 2008. Indeed, you may ask yourself, why is this still lingering in court? Why are seemingly legitimate profits withdrawn by Wilpon / the Mets subject to recovery by the trustee? Moreover, why does the trustee find it appropriate that beyond the fictitious profits, he can recover Wilpon’s principal investment since contracting with Madoff? How are the Mets, as a team, going to be affected by these financial woes?
When a Ponzi scheme collapses, the defrauded investors become creditors of the bankrupt estate and can be divided into two main groups: net losers and net winners. Originally, the Wilpons asserted that they were losers in the scheme because their statements indicated that their portfolio amounted to roughly $500 million. The court in this case has already agreed to classify creditors under the Net Investment Method, whereby losers and winners are based on actual amounts invested and withdrawn, instead of the much less popular Last Statement Method, whereby net equity is calculated based on the amounts reflected on investors’ individual fictional account statements immediately before the collapse.
Under-the-limits net losers are compensated fully through individual claims against the Securities Investors Protection Corporation (SIPC), which functions similar to the FDIC or other insurance and provides up to $500,000 for securities losses to those who invested directly. Over-the-limits net losers, whose losses exceed SIPC compensation, rely on other sources of recovery. Liquidating the schemer’s estate ordinarily provides only a drop in the bucket; Madoff’s assets, for example, amounted to only $826 million, or under two percent, of the $65 billion total account value of the operation.[1]
Expectedly, the SIPC reimbursements and estate liquidation provide relief for only some investors and represent a small percentage of net investments, so trustees often turn to avoidance actions, known as clawbacks, as outlined in the preference and fraudulent transfer provisions of the Bankruptcy Code. This is where net winners, such as Fred Wilpon and his New York Mets, enter the picture.
Mets Owner Fred Wilpon (Courtesy: AP)
Fraudulent transfer law under the Bankruptcy Code effectively allows net losers to reach into the pockets of net winners, in an attempt to make themselves whole.[2] Congress set a reachback period of two years from the time of the bankruptcy filing based on the notion that it is within this time that most of the fraudulent transfers occur. The reachback period was previously another source of indigestion for the Wilpon family and the Mets. Picard originally tried to invoke a reachback period of six years, which could have subjected the Wilpons to repayments as high as $1 billion, though this argument was later rejected by Judge Rakoff.
Now the primary remaining question for the Wilpon’s case is whether any of their $303 million principal is subject to clawback. In order for Picard to recover such funds, he need not prove “actual fraud” by means of direct fraudulent involvement on behalf of Wilpon; still, he would need to prove the existence of “willful blindness” based on the objective, reasonable person. While there were many red flags in Madoff’s scheme – astronomical rates of return, consistency of success, key positions of a small-staffed operation held by family members, obscure auditing practices, limited access to investment status, and the secrecy commanded upon investors[3] – the fact remains that these attributes could have theoretically raised suspicions for all investors, whether net winners or losers. Accordingly, the standard to recover principal is quite high.
Bankruptcy court appearances for the Madoff fraud are not the only evidence of financial struggles for the Mets organization. “The Mets have been slashing payroll and selling $20 million minority stakes, each representing about 4 percent ownership of the team.” Despite the financial conflicts that the Wilpon family must deal with, Mets baseball fans can probably relax on this front (though they still have three consecutive fourth-place NL-East finishes from which to recuperate). As previously mentioned, Mets accounts will likely be held responsible for only the $1.7 million in fictitious profits. In terms of other team finances, that value is equivalent to paying Johan Santana for starting just two games, assuming he finds a way to start 30 times this season.
[1] Chad Bray, Madoff Lists $826 Million In Assets, Give or Take, Wall St. J., Mar. 14, 2009, at B1.
[2] 11 U.S.C. § 548(a)(1).
[3] Erin E. Arvedlund, Don‘t Ask, Don‘t Tell: Bernie Madoff is so Secretive, He Even Asks His Investors to Keep Mum, Barron’s, May 7, 2001, at 26.