Category: Fraud

You’re a Victim of a Ponzi Scheme, But What About Your Taxes?

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You missed the warning signs and got suckered into a Ponzi scheme. Can the IRS help by giving you some tax relief? This is a critical issue for long-term Ponzi scheme investors (like some of the Madoff victims) who have paid taxes on gains from the investment. After all, they have been paying real taxes on fictional gains.

The IRS has stepped up with guidance on what to do. They clarified the federal tax law governing the treatment of losses in Ponzi schemes. They also set out a safe harbor method for computing and reporting the losses.

The revenue ruling (2009-9) addresses the difficulty in determining the amount and timing of losses from Ponzi schemes and the prospect of recovering the lost money.  Some of the older guidance from the IRS on these losses is somewhat obsolete.

The revenue procedure (2009-20) simplifies compliance for taxpayers by providing a safe-harbor for determining the year in which the loss is deemed to occur and a simplified means of calculating the amount of the loss.

The first question is whether a loss from a Ponzi scheme is a “theft loss” or a “capital loss” under IRC §165? With the criminal intent of a Ponzi scheme, it is a theft loss. That also results in it being an itemized deduction that is not subject to the deduction limits in IRC §67 or IRC §68. You can read further in Revenue Ruling 2009-9 for more information.

Even with the clarification in the revenue ruling there many factual issues that have to be addressed to properly take the deduction. Given the ongoing investigations, it is hard to know the facts. So the safe-harbor in the revenue procedure draws some bright lines around what you need to take the deduction.

The first thing you need to determine is whether the Ponzi scheme was a theft. The revenue procedure provides that the IRS will deem the loss to be the result of theft if:

    • the promoter was charged under state or federal law with the commission of fraud, embezzlement or a similar crime that would meet the definition of theft; or
    • the promoter was the subject of a state or federal criminal complaint alleging the commission of such a crime, and
    • either there was some evidence of an admission of guilt by the promoter or a trustee was appointed to freeze the assets of the scheme.

      That seems to work very nicely with the facts for the Madoff scheme.

      Now that you can claim the theft loss, you need to calculate the amount of the loss. It may take years to find any assets and distribute them to the victims. Therefore, you have a problem figuring out the actual amount of the loss and the prospect of recovery. The revenue procedure generally permits taxpayers to take a deduction in the tax year they discover the loss and to deduct 95% of their net investment (less the amount of any actual recovery in the year of discovery and the amount of any recovery expected). If you are an investor suing persons other than the promoter (like the Madoff feeder funds), then your deduction is reduced by substituting “75%” for “95%”.

      This new guidance seems to address the phantom income concerns, but are predicated on the victims not filing amended returns for prior tax years. Are there other concerns that the IRS did not address?

      See:

      Can You Prevent Ponzi Schemes?

      Charles Ponzi
      Charles Ponzi

      With Madoff, Nadel and Stanford in the news, people are wondering why the government does not prevent Ponzi schemes. The government should protect us from these frauds.

      How can they?

      Ponzi scheme sponsors are thieves. Common criminals. They just wear suits instead of black masks.

      The government has not been able to prevent bank robberies, car-jackings or pick-pockets. (I lump Ponzi schemes in with these.) What government can do is deter and punish. An effective detection and prosecution program may deter some bad guys. If you feel certain you will get caught and punished then you are less likely to commit the bad act. On the other side, if you feel certain that you will not get caught or punished, then you are more likely to commit the bad act.

      The inspiration of this post is an article from Tresa Baldas summarizing some of the current steps being taken: Wave of anti-Ponzi laws coming — but will they work? The US Congress has already introduced two bills in the last few weeks trying to increase transparency and registration of private investment funds: The Hedge Fund Transparency Act and the Hedge Fund Adviser Registration Act of 2009.

      Don’t forget that Madoff and Stanford were both registered with the SEC and subject to some form of SEC oversight. Clearly registration and transparency were not effective at stopping them. They will increase the paperwork. They will make it harder for private investment funds to execute their business plans.

      I guess as a compliance professional more regulation would be good for me. More regulatory oversight means more work for compliance. But I would rather focus my efforts on helping my company execute its business plan and making sure that nobody is cutting any corners to achieve that execution.

      But with a new administration and issues in the financial marketplace, I expect to see some form of new regulatory requirements. Will they prevent Ponzi schemes? No, the government cannot prevent Ponzi schemes.

      Investors prevent Ponzi schemes. If it sounds too good to be true, it probably isn’t true. Guaranteed returns with no risk? It better be a bank with FDIC insurance (or the equivalent).

      Thanks to Bruce Carton of Securities Docket for pointing out the Baldas article in his post: Wave of “Anti-Ponzi” Legislation May be Coming.

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      Madoff Goes From His Penthouse to the Big House

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      Bernie Madoff filed past a sea of reporters and camera flashes to enter his guilty plea in front of Judge Denny Chin. Several victims spoke, asking the judge to reject the plea and force a trial. They want grueling trial to make Madoff suffer and to bring more facts out to the public.

      Since he turned himself in to authorities back in December, Mr. Madoff has been living in his multi-million dollar penthouse. Back in December, the magistrate ruled that Mr. Madoff was not a flight risk and allowed him to stay confined in his palatial home.

      But now Mr. Madoff is guilty. Mr. Madoff’s attorney, Ira Sorkin, tried to argue for bail. But Judge Chin would have none of it. Judge Chin revoked Madoff’s bail, calling him a “flight risk” in light of the severity of the charges for which he just entered a guilty plea. He granted the government’s request for remand. The prosecution did not even have to rebut Mr. Sorkin’s argument for bail.

      According to the New York Law Journal’s Mark Hamblett, Mr. Madoff was taken out of court in handcuffs. I have not seen pictures of that yet, but I am sure there are many people looking to get a copy of that picture to frame. In handcuffs, he was delivered to Manhattan Correctional Center. (If you were thinking of sending some money to Bernie to help his cause, you should take a look at the Bureau of Prison’s Inmate Money Policy.”The deposit must be in the form of a money order.”)

      Fox Business takes us on a tour of his new home until his June 16 sentencing hearing:

      Presumably, Mr. Madoff’s lawyer will appeal the bail revocation. The chances of Mr. Madoff being released on bail are slim and none, and slim’s 401(k) has turned into a 201(k). After all, the appellate court gives lots of deference to the district court on bail decisions.

      The next question will be how much time will Mr. Madoff serve and where. Lets add up the charges:

      • Count 1: Securities fraud. Maximum penalty: 20 years in prison; fine of the greatest of $5 million or twice the gross gain or loss from the offense; restitution.
      • Count 2: Investment adviser fraud. Maximum penalty: Five years in prison, fine and restitution.
      • Count 3: Mail fraud. Maximum penalty: 20 years in prison, fine and restitution.
      • Count 4: Wire fraud. Maximum penalty: 20 years in prison, fine and restitution.
      • Count 5: International money laundering, related to transfer of funds between New York-based brokerage operation and London trading desk. Maximum penalty: 20 years in prison, fine and restitution.
      • Count 6: International money laundering. Maximum penalty: 20 years in prison, fine and restitution.
      • Count 7: Money laundering. Maximum penalty: 10 years in prison, fine and restitution.
      • Count 8: False statements. Maximum penalty: Five years in prison, fine and restitution.
      • Count 9: Perjury. Maximum penalty: Five years in prison, fine and restitution.
      • Count 10: Making a false filing with the Securities and Exchange Commission. Maximum Penalty: 20 years in prison, fine and restitution.
      • Count 11: Theft from an employee benefit plan, for failing to invest pension fund assets on behalf of about 35 labor union pension plans. Maximum penalty: Five years in prison, fine and restitution.

      That’s a maximum penalty of 150 years. Some of these may end up being concurrent sentences. But given that Mr. Madoff is 70, it would be a good guess that he will end up spending the rest of his life in prison.

      Where will he be spending that time? Jeff Chabrowe of the Blanch Law Firm told Esquire that he thinks it will be the Federal Correctional Institute in Otisville, New York because it is one of the few with a kosher kitchen. Sounds like a wild guess to me.

      It is good to see justice happening swiftly and effectively. After all the fear of prosecution is one of the better ways to stop Ponzi schemes. It seems like Mr. Madoff just wants this to end and accept his punishment.

      The compliance officer in me wants to hear more about the underlying facts of what made Madoff go bad. In his allocution Madoff states that:

      When I began the Ponzi scheme, I believed it would end shortly and I would be able to extricate myself and my clients from the scheme. However, this proved difficult, and ultimately impossible.

      What made him begin the scheme? What would have stopped him from starting the scheme? What lessons can learn from Mr. Madoff to deter the next Madoff from going to the dark side? How did he think he could extricate himself?

      See:

      The Subprime Boomerang: After the Writedowns Comes the Litigation

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      Securities Docket put on a great webinar on The Subprime Boomerang: After the Writedowns Comes the Litigation.

      Bruce Carton moderated a panel of Veronica Rendon of Arnold & Porter, Richard Swanson of Arnold & Porter and Jeff Nielsen of Navigant Consulting, Inc.

      Jeff started off my showing how much complicated the picture is for securitized lending compared to traditional lend hold lenders. There is now a dozen + parties involved with very different interests. There are lawsuits between many of these relationships with fingers being pointed in many different directions.  There are also lawsuits within the parties as shareholders are bringing securities class action suits against the investors. Some of the parties changed roles through the the lifecycle of the loan. (Such as the originator becoming an investor.) Here is a snapshot of the parties:

      securitization

      Jeff identified 866 subprime related federal filings, including borrower class actions, securities class actions, contract claims, employee class actions and bankruptcy related claims. Of those 576 are in 2008. California has 17% of the suits and New York has 33%. (California has some tough laws that are the basis of borrower lawsuits.) They are also seeing two new cases for every case that is resolved.

      Veronica pointed out that the securitization market grew from $157 billion in 200 to $1200 billion in 2006. That was staggering growth over a very short period of time.

      Now we are in a period of rising interest rates, declining home prices, rising unemployment and forced sales.

      Unfortunately 50% of adjustable rate mortgage originations over past four years have been subprime. There was some bad underwriting with lots of no-doc loans and high debt-to-income ratios.

      The current bulk of suits are now “stock drop” case because the institutions failed to disclose their exposure to subprime risk.

      Richard focused on some interesting aspects of the pleadings, hearings and decisions coming out of the cases.

      There are increasing suits by purchasers of subprime assets. Lots of the focus on misrepresentations in the offering documents and a failure to disclose risks. These are generally very sophisticated parties doing war including state law claims.

      There are also criminal investigations on the horizon. Both the FBI and SEC are looking at possibly bringing charges.

      You can listen to webcast and see the slides on the  Securities Docket Webcasts page.

      Corporate Compliance Fraud in Georgia, Florida and Massachusetts

      Just like the Corporate Compliance Fraud in Ohio, Compliance Services is also targeting companies in Georgia, Florida and Massachusetts.

      The Daily Citizen is reporting Georgia corporations warned about solicitations. The Georgia Secretary of State issued a warning:

      “Several corporations registered with the Corporations Division of the Office of the Secretary of State received a letter from Georgia Corporate Compliance, a private company offering to complete corporation meeting minutes on behalf of registered corporations.”

      The Attorney General of Florida also issued a warning:

      Over the past several months, the Attorney General’s Office has received numerous complaints against several of these companies. Last week the Attorney General settled a lawsuit against one such company, Corporate Compliance Center, over allegations that the company misled Florida businesses relating to the sale of corporate minutes reports. Two other companies, Corporate Minutes Compliance Service and Corporate Minute Services, were prevented from operating in Florida when the Attorney General’s Office threatened litigation.

      Bill Galvin, the Secretary of the Commonwealth of Massachusetts issued his warning:

      Recently, an entity calling itself “Compliance Services” mailed solicitations entitled “Annual Minutes Requirement Statement Directors and Shareholders” to numerous Massachusetts corporations. This solicitation offers to complete corporate meeting minutes on behalf of the corporation for a fee. Despite the implications contained in the solicitation, Massachusetts corporations are not required by law to file corporate minutes with the Secretary of State.

      Thanks to Corporate Compliance Insights: Compliance Scam Alert in Georgia: Corporate Minutes Hoax Not Limited to Ohio.

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      Corporate Compliance Fraud in Ohio

      logo_clevelandThe Cleveland Plain Dealer is reporting a fraud that uses the cover of corporate compliance: ‘Corporate Compliance’ form not from any government agency. According to columnist Sheryl Harris, businesses are receiving official-looking mailings with a form requesting a $150 fee to comply with the annual meetings under state law.

      As the story points out, not all companies need to have an annual meeting and even if they did, filling out a form is not a sufficient replacement for an annual meeting.

      The Ohio Secretary of State has posted an alert on her website: Alert: Annual Minutes Disclosure Solicitation. She has also published an example of the fraudulent mailing (.pdf).

      As with the fraudulent SEC Examiners stories we are hearing about, it is sad to see fraudsters using compliance to dupe their marks.

      Thanks to Corporate Compliance Insights for pointing out this story:Attention: Beware of Corporate Compliance Form Hoax Circulating in Ohio.

      SEC Warns Investors and Financial Firms of Government Impersonators

      sec-sealThe Securities and Exchange Commission issued a warning  about con-artists who may use the names of actual SEC employees to mislead potential victims. The SEC is already beaten down by the Madoff scandal. Now it has to deal with scam artists further dragging mud across the reputation of the SEC.

      Investors should be aware that the SEC never makes or endorses investment offers or participates in money transfers. Nor does the SEC send e-mails asking for detailed personal information, or financial information such as PIN numbers.

      Take steps to protect your self:

      If you have reason to suspect that a caller claiming to be an examiner or other member of the staff is not a member of the SEC’s staff, consider taking the following steps. You can ask for the caller’s name, office, and telephone number, and tell the caller that you will return his or her call. The telephone numbers of all SEC offices are available on the SEC’s web site at: http://www.sec.gov/contact/addresses.htm. Using the telephone number on the SEC’s website, call the main number of the particular office that the caller identified, and ask to speak to the SEC staff person.

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      SEC Charges Operators of Multi-Billion Dollar Real Estate Enterprise With Fraud

      sec-sealThe SEC charged Oregon-based Sunwest Management Inc. with securities fraud and is seeking an emergency court order freezing its assets.

      According to the SEC Complaint, the recent collapse of a real estate enterprise once valued at approximately $2 billion in assets, run by Sunwest Management Inc.and its CEO, Jon M. Harder, revealed a massive fraud that led to losses of hundreds of millions of dollars for investors. Sunwest, Harder and certain related entities operated several hundred retirement homes nationwide. From January 2006 through June 2008, they raised at least $300 million from more than 1300 investors, primarily through the sale of tenancy-in-common interests (“TICs”). The company represented that individuals were obtaining an interest in a specific property which would generate a steady income stream. Instead the defendants ran Sunwest as a single enterprise, commingling all investor funds and operational revenue into a single fund from which all operating expenses and investor returns were paid. Sunwest paid investors steady returns on their investments from cash generated in the operations of other facilities, from funds obtained in refinancings, and from funds raised through offerings to new investors. With the credit crisis, new funding sources began drying up. Despite the dire financial condition, defendants continued to raise additional money from investors. By June 2008, they operated Sunwest virtually as a Ponzi scheme. The money they raised in the final offerings (supposedly for new properties) was used to pay old investors their 10 percent return and fund operations at existing facilities. As of January 2009, over 100 retirement homes have been placed in foreclosure, receivership or bankruptcy, resulting in the effective elimination of the TIC investors’ interests in them. Approximately 32 facilities have filed for bankruptcy.

      The Commission’s complaint charges all of the Defendants with violating the antifraud provisions of the federal securities laws, including Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.

      On December 31, 2008, Jon M. Harder filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code (the “Bankruptcy Code”). The case was assigned case number 08-37225 (the “Bankruptcy Case”) and is currently pending before the Honorable Trish M. Brown in the United States Bankruptcy Court for the District of Oregon.

      The SEC complaint include a pleading to freeze assets and appoint a receiver to oversee Sunwest and related entities. According to a press release from Sunwest, both requests were denied by the court. Sunwest welcomes serious discussions with the SEC about a form of cooperative receivership that would allow the current Sunwest restructuring to continue.

      “The judge denied the temporary restraining order motion in its entirety including denial of the appointment of a receiver,” said Stephen English, special counsel for Jon Harder. “We see this as a big win for the restructuring work at Sunwest.”

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      Madoff and Markopolos on 60 Minutes

      markopolosOn Sunday night, 60 Minutes aired an interview with Harry Markopolos: The Man Who Figured Out Madoff’s Scheme. Last month, Markopolos supplied similar information to a Congressional panel.

      By its vary nature, the SEC does not stop a financial crime until happens. As with all prosecutions, the bad act needs to happen before there is a crime. The failure with Madoff is that the fraud appears to be so big and appears to have been happening for over a decade. Usually, the SEC stops fraud before it gets so big.

      If you think the SEC is ineffective, take a look at the SEC litigation releases. Quickly browsing through the list, you can see that the SEC is filing to stop a few securities fraud schemes every week.  Hardly ineffective.

      The SEC can no sooner prevent securities fraud than the police can prevent a robbery. You hope your patrols and effective prosecutions will deter potential bad actors. But people will always be enticed to take short cuts.

      Markopolos spotted the problem and the SEC blew it. Let’s move on and find out how Madoff did it so we can learn some lessons. The sound bites and preachings from Markopolos are not contributing to the prevention of future securities fraud.

      Thanks to Bruce Carton and Securities Docket for pointing out the interview: Sunday Night: Harry Markopolos on 60 Minutes.

      The Stanford Fraud

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      Yesterday, the SEC filed a complaint against R. Allen Stanford and three of his companies: Antiguan-based Stanford International Bank, Houston-based broker-dealer and investment adviser Stanford Group Company, and investment adviser Stanford Capital Management.

      Tuesday morning, the Wall Street Journal reported on Stanford Depositors head to Antigua or Redemptions. Word had gotten out that the authorities were investigating the Stanford International Bank and depositors were nervous.

      They should have been nervous when they first made the investments. According to item 31 in the SEC complaint, SIB was offering very high rates of return on CDs. On November 28, 2008 SIB was offering a 5.375% rate on a 3 year CD, while other US banks were offering rates under 3.2%. At the same time, SIB was saying the investments were safe and invested in very liquid assets. [Investing 101. The greater the risk the greater the rate of return you should expect.]

      Unfortunately it looks like the problem has been in place for years. According to the SEC complaint [item 4] , SIB had identical returns in 1995 and 1996.

      Bruce Carton points out that one of Stanford’s own lawyers has emerged as a key figure in the matter: Attorney for Stanford’s “Disaffirmation” of Prior Statements Was Red Flag for SEC. Bruce cites a Bloomberg report that Thomas Sjoblom, a partner at law firm Proskauer Rose doing work for Stanford’s company’s Antigua affiliate, told authorities that he “disaffirmed” everything he had told them to date.

      Felix Salmon, of Portfolio.com, first pointed the problems with Stanford International Bank on February 10: What’s Going On at Stanford International Bank? Felix noted that Stanford had very consistent returns that seemed to not be impacted by any of the gyrations of the market over the last few years. Feliz also dug up a report by Alex Dalmady that highlighted the problems.

      I see many similarities to the Madoff scheme. The principal was well respected. (Antigua even bestowed knighthood on him.) Investors were promised safety. Investors were shown reasonable, consistent returns. The investment technique was obscure.

      Unlike Mr. Madoff, it looks like Mr. Stanford took off in one of his private jets and authorities are still looking for him.

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