Inside the shadowy market for Madoff claims

January 14, 2012

One of the most intriguing offshoots of the mess Bernard Madoff created is the underground market for claims against the estate of his bankrupt securities firm. Last June, when the Wall Street Journal ran a revelatory story on big banks’ trading in Madoff claims, suits by Madoff trustee Irving Picard of Baker Hostetler seemed so promising that claims were trading at 75 cents on the dollar. But according to fascinating new litigation between Deutsche Bank and two Madoff feeder funds, the value of claims has been dropping ever since, and was down to 60 cents on the dollar last month. The billion-dollar declaratory judgment complaint by Kingate Global and Kingate Euro against Deutsche Bank doesn’t offer an explanation for the declining value of Madoff claims. But it’s not much of a leap of inference to guess that U.S. District Judges Jed Rakoff and Colleen McMahon of Manhattan federal district court have more than a little to do with it.

Some background: The British Virgin Islands-based Kingate funds channeled billions of dollars to Madoff before his Ponzi scheme was exposed in December 2008. When Madoff’s securities business collapsed, Kingate investors were out $3.5 billion, according to the funds’ complaint against Deutsche Bank. The funds asserted that they were net losers in Madoff’s scheme, meaning that their losses exceeded their withdrawals from Madoff accounts. They claimed more than $1.6 billion against the Madoff estate.

Picard had rather a different view of the Kingate funds, which he said ignored warning signs of Madoff’s fraud. He sued Kingate Global and Kingate Euro to claw back $1 billion in withdrawals the funds made in the run-up to Madoff’s collapse, as well as allegedly excessive compensation the funds paid top executives.

In April 2011 the Kingate funds solicited bids on their $1.6 billion in Madoff claims, according to a countersuit Deutsche Bank filed Wednesday. Deutsche Bank wasn’t Kingate’s first choice, but in July, after talks with another (unidentified) bidder fell through, Kingate and Deutsche Bank began negotiating a deal under which Deutsche Bank would pay 66 cents on the dollar for the Kingate funds’ claims, or about $1 billion. Interestingly, Rakoff’s enormously consequential ruling on Picard’s standing to sue the banks that allegedly abetted Madoff’s fraud came just as Kingate and Deutsche Bank talks heated up.

Deutsche Bank and Kingate both acknowledge that the bank had big concerns about two things: Picard’s claims against Kingate and Kingate’s ability to recover from a Justice Department forfeiture fund as well as from the Madoff estate. (The forfeiture fund controls about 20 percent of the recovery Picard has obtained for Madoff investors.) Kingate’s complaint, filed by Richard Werder Jr. of Quinn Emanuel Urquhart & Sullivan, asserted that the funds took the extreme step of bringing Picard – who, in addition to being the bankruptcy trustee, is special master of the forfeiture fund — into the talks in order to satisfy Deutsche Bank’s demands. The funds claim that the bank ultimately signed an agreement to buy their Madoff claims for about $1 billion.

But the bank said it signed a document that only guaranteed the Kingate funds would sell the claims, not that Deutsche Bank would buy them. Its lawyers, led by Thomas Arena of Milbank, Tweed, Hadley & McCloy, argued that Kingate failed to satisfy the bank’s conditions despite talks that continued through November.

Kingate said that’s a pretext. “There is no mystery why, in fact, Deutsche Bank is refusing to close on its obligations under the confirmation letter,” the Kingate complaint said. “The confirmation letter provides that Deutsche Bank will pay the Kingate funds 66 percent of the designated claim amounts in exchange for those claims. On information and belief, similar claims are now selling at a price below 66 percent, perhaps as low as 60 percent (or lower).” That represents a $90 million drop in the value of the Kingate claims, the complaint said.

Deutsche Bank’s countersuit, which rejected Kingate’s “pretext” assertion, attributed the decline in Madoff claim value to Rakoff’s September ruling limiting Picard’s reach on clawbacks to withdrawals made within two years of Madoff’s bankruptcy. The bank doesn’t mention Rakoff’s July decision on standing, nor McMahon’s parallel conclusion in November. That’s curious, because the Kingate funds potentially benefit, as defendants, from all three of those rulings, even as the value of their claims against the estate declined in the overall market for Madoff claims. The web between Madoff and his former feeder funds is tangled indeed.

Neither Kingate counsel Werder nor Deutsche Bank counsel Arena returned my calls for comment.

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