Amicus Curiae in the Madoff Case

In a previous post, I discussed the problem surrounding hedge fund due diligence, and the complete lack of incentives to identify hedge fund frauds once an invest has chosen to invest.  The basic argument says that hedge fund investors have strong negative incentives to actually determine if the fund in which they invest engages in fraud because if they figure it out, they cannot take their money and run, hoping to reach the exit first.  The laws governing partnerships bring them back.  Several high profile frauds have made this outcome clear.

One of the many cases surrounding Madoff's fraud considers whether investors who did not actually lose money, all in, should receive their fair share of recoveries based on their final account balances.  For example, someone who gave Madoff $1 million, and every month took out the gains, over a period of many years, made a lot of money.  At the end, however, they lost $1 million. (Here's the full story.)

Irving Picard, the trustee of the funds in liquidation, argues that fairness dictates these investors should not receive recovered assets.  Karen Wagner, attorney for the net winners, argues that fairness has no place.  The law says they're entitled.

As a friend of the court, I'll argue the public policy.  If the net winners do not get their fair share of recoveries, they are punished.  They are punished for sound investing.  How is investing in a fraud sound investing?  They saw an attractive opportunity, and they invested, probably without enough due diligence.  However, they had the sense to question whether it could continue.  Maybe they thought it was a bit too good to be true.  So, they constantly took money off the table.  They always walked away with their winnings, taking absolute amount of risk, month after month, year after year.  They didn't get too greedy.

In some sense, they continued their due diligence.  They said "last month, investing $1 million looked okay.  This month, investing $1.05 million doesn't look okay.  I'm still at $1 million."

Their actions, relative to many fraud investors, should be lauded, not punished.