Madoff Victims Look for Ways to Recover Their Money

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Douglas Healey / AP

The city of Fairfield, Conn., lost money in the Madoff fraud. Attending a meeting in Fairfield on Dec. 15 were (front row, from left) attorneys Robert Morris and Robert Saxl and Tom Bremmer, the city's chief of staff

Victims of the alleged Bernard Madoff investing scam are finding they have more legal options than usual to try to get back their stolen funds, but experts say that won't make recovering their losses any easier.

Besides suing Madoff and his firm, lawyers representing investors who lost tens of billions of dollars are looking into suing the numerous firms that sold access to Madoff's asset-management business. Also on the radar of lawyers are those firms' auditors and administrators, which include some of the biggest accounting firms in the country. (See TIME's top 10 financial collapses of 2008.)

"Some investment advisers did their due diligence and told their clients not to invest with Madoff," says Brad Friedman, a partner at the Milberg law firm, who is vetting suits for dozens of Madoff clients. "Others didn't do their research. I think there is a liability there."

Many of Madoff's victims never had an account with his firm. Instead, Madoff got much of the money he allegedly stole through so-called feeder funds. These hedge funds were set up by outside investment advisory firms, which marketed the funds to high net-worth individuals and pension funds based on Madoff's supposed long-term track record of positive returns. Other investors lost money through so-called hedge funds of funds, which invested with Madoff as well as with other asset-management firms.

Of the $23 billion in losses that have been reported by investors so far, more than half have come from those who invested in Madoff through the feeder funds. These investors may be in a worse position than those that were direct customers of Bernard Madoff Investment Securities. On Monday, a judge ruled that Madoff's direct customers would be covered by Securities Investor Protection Corp., which typically covers up to $500,000 in losses when a brokerage firm defaults. Investors in the feeder funds are not usually eligible for SIPC protection.

Lawyers, though, say investors in the feeder funds may have more legal options to recover their funds. That's because, they say, the firms that ran the feeder funds had a duty to their clients to verify that Madoff's returns were genuine. Many of the firms pocketed large fees and in return provided little more than access to what now appears to be a fraud. What's more, a number of large accounting firms signed off on the quarterly statements the feeder funds sent to clients.

"This is a guy that openly claimed he would not answer questions about his strategy," says Harry Susman, a Houston lawyer who is looking into bringing a suit against one of the feeder funds. "If you put all your eggs in one basket, you better be able to watch that basket well."

But legal experts say winning a case against the managers of feeder funds and funds of funds may be tougher than it seems. Last year a judge threw out a similar claim against well-known hedge-fund consulting firm Hennessee Group. That firm was sued for advising clients to invest in Bayou Management, a hedge fund that collapsed after its managers swiped hundreds of millions of dollars from investors. But the judge ruled that Hennessee, just like the SEC and the IRS, was duped and could not be held liable. The case is being appealed.

"My case shows that anybody who wants to sue these feeder funds will have a hard time," says Ted Poretz, the lawyer who brought the case against Hennessee on behalf of former Bayou investors.

Nonetheless, a number of investors who lost money are pursuing their legal options, and they say they are looking closely at suing the firms that led them into the Madoff fraud. One such investor is the city of Fairfield, Conn. In 1997 Fairfield's pension board hired advisory firm Tremont Capital Management to help manage its investments. Among the funds Tremont recommended was the Tremont Broad Market Fund, which was run by the firm and invested all its assets with Madoff. Fairfield's pension funds invested $22 million in the fund over the next three years. Broad Market was one of Madoff's largest feeder funds. Investors in the fund may have lost as much as $3 billion.

Three years ago, Fairfield moved its investment to a new feeder fund, MAXAM, which was started by Tremont founder Sandra Manzke, who had recently started a new firm. MAXAM, like Broad Market, invested all its money solely with Madoff. As recently as June 30, Fairfield officials received a statement from MAXAM saying the city's investment was now worth $42 million. That investment, along with the rest of the nearly $300 million invested in the MAXAM fund, is now gone.

"We were surprised that there wasn't more oversight by either MAXAM or their auditor," says Fairfield first selectman Ken Flatto. "Why didn't anyone question Madoff's accounting?" Despite the loss, Fairfield's pension plan is well funded. Yet, Flatto says, "we plan to seek recourse to try to recover the funds."

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