The Big Winners in Madoff’s Fraud Make a Deal

(Bloomberg Opinion) -- So far as I can tell, there are two winners in the Bernie Madoff Ponzi scheme, which surely ranks as the greatest financial fraud of all time.

The first is the law firm of Baker Hostetler. Headquartered in Cleveland, the firm had a tiny New York presence before a lawyer named David Sheehan lured his friend Irving Picard to the firm in December 2008 — which happened to be the exact moment Madoff was exposed as a crook.  Picard was quickly chosen by the government to be the trustee of the Madoff bankruptcy.

Over the ensuing nine and a half years, Baker Hostetler has recovered almost $13 billion,  most of which has been distributed to Madoff’s victims — while earning an astonishing $1 billion in fees. The firm’s New York office, with over 70 lawyers, is now a powerhouse.

The second winner? The former hedge fund manager J. Ezra Merkin, who for years shoveled his investors’ money to Madoff, while pretending to be investing in it himself.

On Wednesday, on the eve of a trial with the trustee, Merkin settled with Picard for $280 million. This was not his first big settlement: Merkin had settled in 2012 with then-New York Attorney General Eric Schneiderman for $410 million. Once viewed as a great philanthropist, Merkin has been forced off charitable boards. He has had to sell his prized collection of Mark Rothko paintings. He has few friends, because so many of them had put money into his fund — only to discover, to their horror, that they were Madoff victims.

Yet despite all that, Merkin can say something that almost no one else who did business with Madoff can say. He came out ahead.

Diana Henriques, in her definitive account of the scandal, “The Wizard of Lies,”  traces the roots of the Ponzi scheme to the 1987 market crash, when Madoff lost money for his investors but didn’t want to admit it. By 1992, the scheme was in full swing. Meanwhile, as a young fund manager, Merkin also saw his assets crumble after the 1987 crash. Searching for a way to redeem himself, he discovered Madoff — and began sending Madoff his investors’ money at the same time Madoff was giving up on legitimate investing.

Ultimately, Merkin managed three funds. Two of them had about 25 percent of their assets with Madoff; the third was 100 percent Madoff. In all, he put about $2 billion with Madoff, making him an important source of funds — something Madoff constantly needed to keep the scheme going.  And here’s the kicker: Most of his investors never knew he was outsourcing their money to Madoff. He pretended that he was a value investor, making them money the old-fashioned way.

Naturally, after the Ponzi scheme was exposed, Merkin claimed to be an unsuspecting victim. And I suppose that’s possible. But it’s not particularly credible. The red flags were everywhere, starting with the absurd steadiness of Madoff’s returns. (In 2002, Madoff was up his usual 13 percent when the S&P 500 was down 22 percent.) Madoff and Merkin didn’t just have a business relationship; they were close friends.

As the trustee pointed out in various legal documents, Merkin did zero due diligence. He was warned on several occasions that Madoff’s returns were too good to be true, and that his operation didn’t pass the smell test. One of those who warned Merkin was Jack Nash, the co-founder of Oppenheimer & Co. — who had money in Merkin’s funds not knowing that it was actually with Madoff. Finally, there’s this: Despite putting billions of other people’s money with Madoff, there is no evidence that Merkin ever invested a dime of his own.

After Madoff’s crimes came to light, hundreds of his investors were wiped out. Money they had given to Madoff, thinking it was safe, was gone. Money they had used as collateral for a big loan had never actually existed. Worse of all, the trustee was demanding that some of them — those who had taken out more than they had put in — return some of the money, because it had never been theirs in the first place. It was devastating.

Merkin, however, was not among those wiped out — not even close. He made more than $500 million in fees from the money he had invested with Madoff. When he settled with New York State, he put in a claim with the receiver of his own bankrupt funds for $210 million in deferred compensation. Incredibly, the receiver accepted it.

In addition, he sold his Rothkos for some $200 million. Of that amount, $100 million went to his wife, who was said to be the co-owner of the paintings. Between the Rothko sales and the deferred compensation, Merkin covered $310 million of the $410 million settlement. And his wife got to pocket $100 million for herself.

Merkin got another break in his settlement with Picard. Some years earlier, the trustee had fought in court to be able to claw back money going back six years. But he lost the case, and so could only go after two years’ worth of money. That’s why the amount announced Wednesday was only $280 million instead of $1 billion or more.

As part of the settlement, the trustee is allowing one of Merkin’s funds to put in a claim for — you guessed it — $280 million. Which means that the money Picard collects from Merkin will go to right back to his investors, rather than Madoff’s direct investors.

Merkin may have sold off his prized paintings, but he still lives in one of the most expensive buildings in New York: 740 Park Avenue. And he’s still rich — most likely richer than he was when he first started giving his investors’ money to Madoff. Many of those investors will never recover. But with Wednesday’s settlement, Ezra Merkin can start buying Rothkos again.

©2018 Bloomberg L.P.