Individual Customers Tended to Be Net Winners, While Transaction Patterns for Individuals and Institutions Were Generally Similar

In our analysis of information obtained from the Trustee, we identified  7,994 accounts with at least one transaction. We found that individuals held more than three-fourths (77 percent) of  accounts, while almost one-quarter (23 percent) of accounts were held by  institutions, such as charities, pension funds, and feeder funds. Using  these groupings, we further examined the account holders’ claims  outcomes—whether they were net winners or net losers—and the pattern  of their transactions leading up to the Madoff firm’s collapse. Accounts Held by Individuals Tended to Be Net Winners

As shown in table 2, our analysis indicates that a higher proportion of  accounts held by individuals (60 percent) were net winners that had  withdrawn more than they had deposited over the lifetime of their  accounts, compared to accounts held by institutions (50 percent). We  also found that more institutional accounts (40 percent) were net losers  than were individual accounts (29 percent). Individual and Institutional Accounts Had Similar Patterns of Deposits and Withdrawals

Our analysis found that individual and institutional accounts had similar  deposit and withdrawal activity throughout the 27-year period we  examined, including during the period immediately before the failure in  2008. Instead, they had invested in feeder funds or other  vehicles that owned the accounts at the firm. Of  the allowed claims, the majority were filed by net losers, meaning they  had withdrawn less from their account than they had invested. For example, 10 (less than 1 percent of  all claims) net winner claims were allowed. Trustee Has Been Pursuing Hundreds of Lawsuits to Recover Assets

The Madoff Trustee is pursuing various litigation to recover assets from  customers and others that can be used to reimburse those customers that  have allowable claims under SIPA. For those customers that withdrew  fictitious profits in excess of their investments—net winners—the Trustee  is pursuing more than a thousand lawsuits to recover these funds as  allowed under federal bankruptcy law and state law. The Trustee Has Filed Hundreds of Actions to Recover Excess Withdrawals from Customers Not Claimed to Have Known of the Fraud

According to our review, the Trustee has filed 1,002 actions seeking to  recover $3.5 billion from Madoff customers that were net winners but that  are not alleged to have had knowledge of the fraud or been in a position  to know about it—referred to by the Trustee as “good faith” defendants. As of April 2012, the Trustee had entered into 441  settlement agreements in which the opposing parties agreed to return  about $8.4 billion—an amount equal to about 49 percent of the  approximately $17.3 billion in principal investments lost by customers who  filed claims. This compares to a  typical claim taking 3 months or more. Effects of the Fraud on Income Tax Revenues Cannot Be Determined, and New Guidance on Clawbacks Could Reduce Taxpayer Errors

Because the Madoff fraud affects customers’ taxable income, it also  affects federal tax collections by the U.S. Treasury. Tax experts  expressed concerns about the lack of clarity over how payments  stemming from fraud-related avoidance actions, or clawbacks, filed by the  Trustee will be treated for tax purposes. After we identified concerns to  IRS that lack of guidance could lead to taxpayer errors resulting in over-  or underpayment of taxes, the agency issued such guidance. Other deductions. However, he said he did provide  information to IRS and the U.S. Department of Labor. Subsequently, IRS on September 5, 2012,  issued such guidance, in the form of “frequently asked questions” on how  to treat clawbacks, which were posted to the agency’s website. GAO staff who made  major contributions to this report are listed in appendix V.

Appendix I: Objectives, Scope, and Methodology

This report discusses (1) the extent to which account activity varied by  type of customer of the failed Bernard L. Madoff Investment Securities,  LLC firm; (2) the nature of claims filed, and rejected or approved, with the  Trustee for reimbursement of losses following the firm’s failure due to  fraud; (3) litigation and settlement activity the Trustee has pursued during  the subsequent liquidation of the firm, in seeking to recover assets for  distribution to customers; and (4) the effect of the Madoff fraud on  customers’ federal income tax liabilities, including the effect on amounts  that would have been due if investor losses had been based on  customers’ reported final statement holdings. These included: lawsuits  against net winners that are not alleged to have had knowledge of the  fraud or been in a position to know about it—referred to by the Trustee as  “good faith” defendants; lawsuits against individuals and entities the  Trustee argues knew or should have known about the fraud—referred to  by the Trustee as “bad faith” defendants; lawsuits against investment  vehicles that collected funds from investors and invested them with the  Madoff firm; and agreements the Trustee has reached to settle a number  of the actions he has filed as part of his asset recovery efforts. We also interviewed Securities and Exchange  Commission (SEC) officials and executives of the Securities Investor  Protection Corp. (SIPC) for their views on conduct of Madoff-related  litigation.
Why GAO Did This Study

After the collapse of Bernard L. Madoff Investment Securities, LLC--a brokerdealer and investment advisory firm with thousands of individual and institutional clients--the Securities Investor Protection Corporation (SIPC), which oversees a fund providing up to $500,000 of protection to qualifying individual customers of failed securities firms, selected a trustee to liquidate the Madoff firm and recover assets for its customers. In March 2012, GAO issued GAO-12-414 , which examined selection of the Trustee, his method for determining customer claims, and expenses of the liquidation, among other things. This report discusses (1) the extent to which account activity varied by type of Madoff customer, (2) the nature of claims filed, and rejected or approved, with the Trustee for reimbursement of losses, (3) litigation and settlement activity the Trustee has pursued in seeking to recover assets for distribution to customers, and (4) the effect of the fraud on customers' federal income tax liabilities. GAO reviewed transaction and claims data from the Trustee, lawsuits filed by the Trustee, IRS rules and guidance, and interviewed the Trustee, private sector tax experts, and officials from IRS, SIPC, and the Securities and Exchange Commission.

What GAO Found

GAO's analysis of Madoff account data shows that more than three-fourths of the firm's customers were individuals and families (individuals). The remaining accounts were held by institutions, such as pension funds and charities. A higher proportion of accounts held by an individual (60 percent) were "net winners" based on their net equity position--meaning they had withdrawn more from their accounts than they had deposited--compared to accounts held by institutions (50 percent). Correspondingly, 40 percent of institutional accounts were "net losers" that had deposited more into their accounts than they had withdrawn, compared to 29 percent of individuals' accounts that were net losers. However, individual and institutional accounts had similar deposit and withdrawal activity from 1981 through 2008, including increased withdrawals immediately before the firm's failure in December 2008.
GAO's analysis shows that the Trustee's decisions to accept or reject claims were similar for individual and institutional account holders. Of the more than 16,000 claims, about 66 percent were denied because the customers were not direct account holders of the Madoff firm, but instead had invested in funds or other vehicles that held accounts directly with the firm. For the remaining claimants who were directly invested, the Trustee generally used the customers' net investment positions--that is, whether they were net winners or net losers-- to determine claims. In examining claims decisions by customer type, GAO found the Trustee denied claims filed by individuals and institutions determined to be net winners in similar proportions. Similarly, most claims filed by individuals or institutions determined to be net losers were allowed.
The Trustee has been pursuing litigation to recover, or "claw back," assets from net winner customers and others that can be used to reimburse customers that did not withdraw all of their principal investments. For those customers that withdrew fictitious profits--net winners--the Trustee has been pursuing more than 1,000 lawsuits to recover funds, as allowed under federal bankruptcy law and state law. In about 60 suits, the Trustee has sought more than fictitious profits, to include principal or other funds received, arguing the parties knew or should have known of the fraud. Thus far, the Trustee said he has recovered about $9.1 billion of the $17.3 billion in principal investments lost by customers who filed claims, including $8.4 billion from settlement agreements.
Because the Madoff fraud affects customers' taxable income, it also affects tax collections by the Department of the Treasury. Under Internal Revenue Service (IRS) rules, Madoff customers can deduct lost principal and fictitious profits on which they paid taxes while holding their accounts. However, IRS does not maintain statistics on specific frauds or their impacts on tax collections, and the tax impact may be reduced because some taxpayers may not be able to fully use this tax relief, such as those that lack other income that can be offset by these deductions. Tax experts expressed concerns about the lack of clarity over how payments stemming from fraud-related avoidance actions filed by the Trustee will be treated for tax purposes. In response to a recommendation in a draft report that IRS provide guidance to help limit taxpayer errors resulting in over- or underpayment of taxes, the agency issued such guidance on September 5, 2012, in the form of "frequently asked questions" posted to its website.