Madoff's Ponzi Scheme A Peculiar Irony By:
Bill E. Branscum
In the wake of the Madoff case, widely touted as the
worst Ponzi investment scheme ever, I am struck by a peculiar irony
that nobody seems to have mentioned. It may turn out that investing
money with Madoff, and losing it, wasn't such a bad thing.
No, I really have not lost my mind.
We all know what the market has been like lately but,
other than the folks on Wall Street, most people don't realize that
there were many investments that actually lost more than ninety
percent (90%) of their value. The investor who bought $1M worth
of stock in R.H. Donnelley (RHD), the publisher of the Yellow Pages
phone directories, would have walked away with almost enough money
to buy a Happy Meal, and the investor who bet the farm on the recommendation
of CNBC's Jim Cramer, putting $1M in CROCS (CROX) shoes wouldn't
have fared much better. (CROX) stock values plummeted 95% in 2008.
While investing a million dollars in ugly rubber shoes may seem
silly, how about a bond insurer such as Ambac Financial Group (ABK).
Most people had no idea that the mortgage industry had gone completely
crazy, making mortgage-backed securities a treacherous investment.
The value of Ambac shares fell 94%.
If an investor was going to lose money in the stock
market, the best possible place to have lost it may very well have
been with Bernie Madoff. I say that for three reasons.
First, it has been widely reported that the Receiver
stands to recover a significant amount of money. Those who invested
in Madoff's Ponzi scheme will ultimately have some part of that
Second, Madoff was licensed and insured. It has been
widely reported that investor losses may be recoverable through
the insurance fund created by the Securities Investor Protection
Act which covers individual investor losses DUE TO FRAUD up to $500,000
each. The SIPA does not insure against losses due to market fluctuation,
no matter how dramatic.
Third, the IRS has published Revenue Rules and Revenue
Procedures establishing safe harbor guidelines regarding the application
of IRC 165(c)(2) to these cases. Since these will be treated as
fraud losses (casualty losses) as opposed to market fluctuation
related losses (capital losses), they will be completely deductible.
Compare that to the investor who lost his shirt due
to abysmal market performance. That money is gone beyond recovery,
there is no insurance fund to pay compensation, and the losses will
be treated as a capital loss by the IRS. Unless the investor had
significant capital gains to offset, the tax value of a capital
loss is nominal.
In the world of investors who suffered cataclysmic
losses in the stock market in recent years, the lucky ones are those
who entrusted their money to Madoff.