Professor John Coffee Criticizes Attempts to Alter Compensation for Victims of Ponzi Schemes

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Professor John Coffee Criticizes Attempts to Alter Compensation for Victims of Ponzi Schemes

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New York, Sept. 23, 2010—In response to the Bernard Madoff scandal, proposed legislation to compensate victims of Ponzi schemes does more harm than good, according to testimony by Professor John Coffee.
 
Coffee, the Adolf A. Berle Professor of Law, appeared Thursday before a House Financial Services subcommittee hearing devoted to the limitations of the Securities Investor Protection Act.
 
Coffee serves on a task force that is examining ways to modernize the Securities Investor Protection Corporation, a broker industry group whose mission is to restore funds to investors with assets in the hands of bankrupt and otherwise financially troubled brokerage firms. However, Coffee was not speaking on behalf of the task force.
 
Legislation now before Congress would restrict the ability of the SIPC to recover “fictitious” profits, such as someone who initially invested $1 million in what turned out to be a Ponzi scheme, but who ultimately was able to withdraw $5 million.
 
Currently, an SIPC trustee can sue to recover the $4 million net profit and distribute it to the “net losers” in Ponzi schemes. Coffee criticized attempts to reduce that power and effectively disarm the trustee.
 
“The practical result is that a principal source of recovery to which the net losers in the Madoff Ponzi scheme can look will be denied them,” Coffee wrote in prepared testimony to the subcommittee.
 
Coffee also finds problematic another part of the legislation, which would make payments to “indirect” Ponzi scheme investors, such as those who lost money through a hedge fund that invested in the scheme. The bill enables investors to receive a maximum $100,000 payout from the SIPC trustee. But in doing so, they would waive the right to sue the hedge fund with respect to their losses.
 
“The rationale for requiring this election escapes me, because Congress has no conceivable reason to protect the ‘feeder funds’ in the Madoff scandal.
 
Coffee also called on the Securities and Exchange Commission to get tougher with registered investment advisers who use their own companies to serve as custodians for their clients’ funds, as Madoff did.
 
“But no one can be his own watchdog, and the continued toleration of self-custodians by the SEC invites future scandals,” Coffee said.
 
To read the full text of Coffee’s testimony, click here.
 
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