Law in Contemporary Society

Clawing Back for Justice


After the Madoff scandal, much media attention has gone to those investors whose current accounts were erased. There is another group of people, however, that may pulled into this situation: investors who earned “profits” and withdrew money before the fund’s collapse in December. The Bankruptcy Trustee, Irv Picard, has recently threatened “clawback” suits against these investors to recover withdrawn funds that exceed the principal investment. Although Mr. Picard has stated he would not file suit if such action would cause an “undue hardship,” there has been much uproar over the fairness of these actions.

This paper explores this debate and concludes that fights against such suits, especially if only pursued as Mr. Picard indicates, are misguided. Although facially troublesome, this legal action would help achieve some fairness in a situation nearly devoid of any justice.

A Clawback’s Perspective

Why The Outrage

Many of the 223 investors that have received notifications of potential clawback suits are outraged. It is easy to understand and empathize with such reactions. They (presumably) did nothing illegal and had no more reason to know of Madoff’s illegal scheme than any other investor. From their perspective, they were simply earning (unbelievably steady) returns and duly paying their taxes. These investors believe that they are upstanding citizens who acted legally and ethically, entitling the profits of their investments.

Why They Are Misguided

Even assuming these investors are morally blameless, their argument is fundamentally misguided. First, while they may profess their lack of fault, this does little to distinguish them from current investors who lost everything. Indeed, any distinctions likely indicate fault or are simply irrelevant. More importantly, the law in this situation must value justice and equity over some individual expectations. While empathetic, the arguments in response to such clawback suits are ultimately unpersuasive.

Lack Of True Distinction

Investors who withdrew profits prior to the collapse likely have only two distinguishing characteristics from those who did not - neither supports their claims. First, some early investors might have had knowledge of the fund’s illegality. Few would argue that these people, who knowingly took other clients’ principal investments as their own profits, should keep these funds. Admittedly, some later investors who were wiped out might also be keen to the scheme. In these instances, I would not advocate for a refund of their investments.

Those with no knowledge of Madoff’s scheme might claim that their business acumen or superior judgment entitles them to enjoy in their withdrawn profits. In a properly functioning system, I might agree. After all, those who sold at the height of any bubble – without improper knowledge – might rightfully claim that they deserve the gains. But those lucky enough to escape before the Madoff collapse were not part of a conventional structure. In reality, early investors received other clients’ investments in the guise of “profits.” moral luck was more dispositive than attuned judgment. Indeed, a functioning business acuity would probably detect the improbability of such steady returns.

Fairness Requires Clawback of Profits

Basic principles of justice and fairness endorse Mr. Picard’s decision to recoup some withdrawn “profits.” In the wake of such a disaster, our society must try to ease victims’ hardships through equitable means. These withdrawn profits are actually others’ investments. Although it is tempting to empathize with the perspective of an honest investor who is now being targeted, we must look at the situation from a distance, evaluating all points of view.

In doing so, it is apparent that recovering these profits is morally just. It appears that less than 2% of losses have been recouped. The contrast between those who lost everything and those who profited is too stark to allow. Distributive justice can, and should be met through these clawbacks. To give previous investors full protection from recovery would amount to an authorization of Madoff’s scheme. As Mr. Picard phrased it, “allowing claims for fictitious profits lets the thief – Mr. Madoff – determine who wins and who loses.”


I do not advocate increasing the number of victims by bankrupting previous investors. Nor would I suggest that early investors’ principal investments are subject to retrieval. Their profits, however, are by definition another person’s investment. Even assuming all funds can be recovered, later investors would, by necessity, not be fully refunded.

In the wake of a tumultuous disaster, no decision will be straightforward. There are always countervailing interests that must be respected. But the position of some previous Madoff investors is simply misguided. After such an implosion, the focus should not be on subjective fault, but on justice for all. The fight to keep fictitious profits, in cases where no hardship would incur, is improper.


-- KeithEdelman - 16 May 2009

  • This is a reasonably convincing summary of the arguments already advanced by Picard in justification of attempts to recover some funds from some people who withdrew more from the Ponzi scheme than they invested at an earlier period than the ordinary cutoff for recovery of presumptively fraudulent conveyances. But you don't address the primary legal argument raised by those who consider Mr Picard's whole approach to be wrong: that there is a relevant statutory definition of "net equity" which has been employed in the past. No doubt this argument too has difficulties, but no more than Mr Picard's curious argument in favor of the clawback recoveries that "otherwise the thief chooses the winners" (of course he does, which is part of what makes him a thief).

  • In truth, of course, Mr Picard has no value from spending resources to sue retirees who have spent what they withdrew. As a justification for seeking recovery from Merkin or the Fairfield Greenwich managers, Mr Picard hardly needs it, except as an easier evidentiary lift than proof of complicity. People don't really care what tool he uses on ol' Ezra and Noel, so long as he doesn't use it on Aunt Sadie. Their respective asset bases are probably enough to differentiate them for Mr Picard.

  • It seems to me, however, that the primary problem with the essay, for our purposes, is that it's hard for you to do more than restate positions that Picard has expressed at length and Joe Nocera has expressed both broad and thick. You're stuck pretty much restating what's been said. If you're going to do another draft, I think the way forward is to take another look at the Madoff situation overall, to see if there is now something new to say about one or another of its many facets.


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r4 - 08 Jan 2010 - 22:42:42 - IanSullivan
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