Madoff investors race to the courthouse
New York school sues Ascot Partners for entrusting investor money to Bernard Madoff. The case may be hard to prove.
301 Moved Permanently
NEW YORK (Fortune) -- Victims of Bernard Madoff's alleged Ponzi scheme sued three big names over their role in the estimated $50 billion fraud: a high-profile investment firm, its managing partner and its auditor.
Investors filed a federal lawsuit in Manhattan on Tuesday against Ascot Partners, a New York City money-management firm that acted as a middleman between Madoff and investors; the firm's managing partner, J. Ezra Merkel, who is also chairman of automotive and real-estate financing firm GMAC; and its auditor, BDO Seidman.
Ascot Partners disclosed in a letter to investors last Thursday that "substantially all of its assets" - reportedly about $1.8 billion - had been invested with Bernard L. Madoff Investment Securities and was presumed lost in the shocking scheme for which Madoff had been arrested earlier that day.
In a Ponzi scheme, money from new investors is used to pay off early investors - giving the appearance of returns - until no more recruits can be found and the scheme collapses. Madoff has said that his subterfuge, which lasted for decades, cost investors as much as $50 billion.
Though Ascot obviously feels like a victim - and its attorneys at Schulte Roth & Zabel have pledged to bring legal claims against Madoff in an attempt to protect Ascot investors' rights - one of Ascot's investors, New York Law School, believes otherwise. The school filed the lawsuit, arguing that Ascot, Merkel and BDO Seidman are also responsible.
The suit, filed as a class action, claims that the defendants failed to conduct due diligence before sinking all the money in Madoff, citing as proof the published reports of money managers at Acorn Partners and the Aksia fund, who have said they refused to invest with Madoff due to obvious red flags.
In addition, they claim that Ascot, by simply turning over all of its money to a single investment manager, violated the terms of its offering memorandum. The allegations are said to amount to securities fraud, negligence, and breach of fiduciary duty.
The complaint, written by attorneys at New York's Abbey Spanier Rodd & Abrams, is likely to serve as a template for many lawsuits to come, since neither Madoff nor his firm appears able to reimburse more than a tiny fraction of the losses they caused. (A judge ordered Madoff's firm into liquidation proceedings in bankruptcy court on Tuesday.)
The lawsuit against Ascot illustrates both the key arguments that will be made in such suits against middlemen and the serious difficulties they will likely encounter.
A spokesperson for Ascot was not immediately available for comment. Merkin's counsel, Andrew Levander at the Dechert law firm, was traveling, according to his secretary, and not immediately available for comment.
In a statement, BDO Seidman said that its audits of Ascot "conformed to all professional standards, and we will vigorously defend ourselves against these unfounded allegations."
Ascot also got blasted Tuesday by investor Mort Zuckerman, chairman and publisher of the New York Daily News, on both Fox's "Your World with Neil Cavuto," and, later, on PBS's Lehrer News Hour. Zuckerman's charitable trust lost $30 million it had invested with Ascot. Zuckerman said on the air that he had never heard of Madoff until Dec. 11, and that an unnamed Ascot representative had repeatedly misled him about the nature of the Ascot fund.
Ascot has also been named in an AmLaw Daily story as a likely target of litigation by Harry Susman, of Houston's Susman Godfrey. Similarly, another prominent fund that invested clients' money with Madoff, Fairfield Greenwich Group's Fairfield Sentry Fund, also appears to have a litigation bulls-eye painted on its back, according to the Wall Street Journal and New York Times on Wednesday.
Even without any comment from Ascot, it's not hard to see the significant hurdles that each claim that has been lodged against it will likely face.
As for the due diligence claim, Ascot was hardly alone in failing to realize that Madoff, a former NASDAQ chairman with a 40-year track record, was running a Ponzi scheme. Among others who failed to catch the red flags were the U.S. Securities and Exchange Commission, Spain's Banco Santander (STD), France's BNP Paribas, and the Tremont Group, a unit of Oppenheimer Funds, which is owned by MassMutual.
As for the alleged misrepresentations in the offering circular, the complaint mainly points to the assertions that Ascot would invest in a "diverse portfolio of securities," that it would engage in "index arbitrage," and that the general partner (Merkin) "intends to adopt a selective approach in evaluating potential investment situations, generally following fewer transactions so that he can follow more closely."
The potential problem is that the Ascot circular does disclose that Merkin will be managing the fund "through third party managers using managed accounts."
Since Merkin presumably believed that Madoff, a third-party manager, was doing what Madoff claimed to be doing - using index arbitrage and investing in a diverse portfolio of securities - it's not obvious that the representations in the Ascot circular were knowingly false, unless the fraud consists in the fact that Merkin was using only one third-party manager, instead of the plural "managers" referred to in the offering memo.
The claim against Ascot's accountant, BDO Seidman, is more tenuous still.
BDO Seidman is said to have been "grossly negligent" for failing to catch the fact that the fund in which Ascot was investing (but which Seidman was not auditing) was a fraud, or, alternatively, that Ascot was not complying with the terms of its own offering memorandum (which, as I've noted is not at all clear and, in any case, sounds more like a legal question than an auditing question).
These suits look like they will eventually tee up difficult issues for summary judgment motions - i.e., requests to the judge by the defendants asking him to dismiss the case without letting it ever even get to a jury.
On the other hand, should the judge - U.S. District Judge Deborah Batts is presiding in the case against Ascot - allow these issues to proceed to a jury, it's hard to imagine a jury, looking back with 20/20 hindsight and, on top of that, facing the heart-wrenching losses suffered by plaintiffs, not ruling for the plaintiffs.