Madoff: 150 Years Are Just the Start

07/30/2009 05:12 am ET | Updated May 25, 2011

Judge Denny Chin sentenced Bernie Madoff to 150 years today. But the BM story is far from over. The next chapter will examine the Securities Investor Protection Corporation (SIPC). And there's one question for every American:

How can we tolerate the conflicts of interest between SIPC and court-appointed trustees?

The problem is the "success fee." Irving Picard is the trustee in the Madoff case. According to Time, he receives compensation tied to the assets he collects. There is debate whether the fee is formulaic, but trustees in similar cases have received three percent for their efforts. Picard could receive $60 million, for example, if he recovers $2 billion in assets.

Hey, $60 million sounds like the kind of pay package that gets bank CEOs in trouble.

Acrimoney endorses success fees. People work late when there are incentives. And the Madoff collection efforts -- international in scope -- are complex. They require long hours.

No one works for free. But this trustee sounds like the A-Rod of bankruptcies.

Picard's potential compensation is a red flag. When brokerage commissions total three percent, Acrimoney questions whether the underlying assets are toxic. We don't know if Picard will receive three percent, but the possibility made us probe further.

Things gets worse.

SIPC pays the trustee from their reserves of about $1.6 billion. The trustee's compensation, therefore, does not reduce the amount paid to Madoff victims.

This structure almost sounds generous -- at first.

The problem is the conflict. The trustee can make decisions, subject to court approval, that benefit SIPC to the detriment of some Madoff victims. Picard introduced a concept, for example, which he calls "net equity." If Madoff victims pulled out more than their initial investment, they have no "net equity." They are not entitled to SIPC's maximum payments of $500,000. Let's review two cases:

Case one: An investor deposits $1 million with Madoff. The account grows to $1.5 million over five years, and the investor takes zero in distributions. He or she is entitled to $500,000 from SIPC. It's 33 cents on the dollar. But it's better than nothing.

Case two: A different investor deposits $1 million with Madoff, which also grows to $1.5 million. At the last minute, he or she withdraws $1 million, leaving an account balance of $500,000. The investor is entitled to $0 from SIPC under Picard's definition of "net equity."

So the trustee is both A-Rod and umpire?

Here's the conflict: SIPC rewards the trustee, who makes decisions that can reduce SIPC's outflows. And presumably, payment reductions help SIPC.

Everybody wants to pay less, right?

The reduction more than helps SIPC. By limiting SIPC's payments through the concept of "net equity," the trustee is solving a problem. With $1.6 billion in reserves, SIPC can pay 3,200 claims of $500,000 each before it runs out of money.

There are 8,800 claims, and counting, in the Madoff liquidation. If SIPC paid $500,000 for every claim, they would be forced to seek a bailout from the US Treasury. If you're SIPC, it helps to have the trustee on your side.

The trustee's 3 percent success fee sounds cheap relative to $1.6 billion.

The Madoff case is big and complicated. There are many differences of opinion. Even Madoff victims differ over the concept of "net equity." But Acrimoney believes the system is broken, rife with conflict. It's immaterial -- from an ethical perspective -- whether "net equity" is just. But it's not right that a trustee can favor the institution that pays him.

If the system is broken, can Madoff victims expect just solutions? And since when do umpires share in the spoils of victory?

This Blogger's Books and Other Items from...