Fairfield Greenwich Fund Plans to Sue Madoff

Fairfield Greenwich, one of the big feeder funds, is planning a lawsuit against Bernard Madoff, the New York money manager accused of running what prosecutors say was a $50 billion Ponzi scheme.

CNBC.com Bernard L. Madoff

In the lawsuit, Fairfield is expected to say it was a victim of fraud and that Bernard L. Madoff Investment Securities didn't do enough due diligence when it marketed Madoff's investment business to clients.

Fairfield did its own due diligence, hiring auditors and checking trade confirmations.

Madoff had produced the confirmations but Fairfield claims it went to third parties to make sure trades took place and found out they did.

That could mean that this scandal is much bigger than previously thought.

Part of the defense of the feeder funds will be the extent of the involvement the Securities and Exchange Commission had with Madoff's investment activity that goes beyond what the SEC stated on Friday.

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Fairfield will claim that when the SEC recently looked into whether Madoff should be registered as an investment adviser, they made some inquiry into Madoff's investment activities and were fooled—as were the feeder funds.

Madoff sold himself as a solid investor who didn't shoot for huge returns, just stable returns.

He was able to capitalize on several converging forces: the tremendous amount of wealth created during the 1990s and into the current decade, how investors got burned in 1998 during the blow up of Long Term Capital Management and the implosion of dot-com stocks in 2001.

His 8 percent to 12 percent returns were a stark contrast to high-flying returns, which later blew up.

He used that as a marketing play, as well as the fact that his funds were technically closed—the exclusivity added to the appeal. Madoff would let people in, but only only after some consultation.

The more he did that, the more people wanted to get in.

Madoff complained to officials at Tremont, another feeder fund, about mass redemptions from Europe two weeks ago according to sources. It was around that time that he began contemplating hiring an attorney, the source adds.

According to people close to Madoff he contacted Ike Sorkin after his arrest when he was in FBI custody.

There is a rumor among Madoff investors that he has $1 billion stashed in an overseas bank account. Sorkin, Madoff's lawyer, would not comment on this.

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