It has been nearly five years since the Ponzi scheme perpetrated by Bernard L. Madoff came to light, and litigation surrounding the case grinds on.
The trustee seeking to recover funds for defrauded investors, Irving H. Picard, asked the Supreme Court to overturn a lower court decision barring him from pursuing banks for their role in helping perpetuate the fraud.
Meanwhile, the prosecution of five former employees of Mr. Madoff's firm began last week. The criminal trial is likely to expose more tidbits about the operation of the long-running fraud, including lurid details about sexual liaisons among staff members involving perhaps even Mr. Madoff himself. Yet, despite the titillating aspects of the case, it is really more of a footnote to his scheme.
(Watch: Did Madoff act alone?)
The more important case concerns Mr. Picard's efforts to recover funds from a number of banks, including JPMorgan Chase, UBS, HSBC and UniCredit. He accused them of aiding in the Madoff scheme by ignoring warning signs about the fraud that allowed it to grow. As time went on, the scheme cost investors about $17 billion, and wiped out billions more, as they were led to believe the money was safely in their accounts.
The trustee's claim against JPMorgan alone seeks nearly $19 billion, so recovering even a portion of that amount could add significantly to the $9 billion Mr. Picard has already gathered to compensate investors.
As is frequently the case, the issue is not about the banks' role in the fraud—at least not yet. Rather, it focuses on whether certain arcane legal doctrines will permit the lawsuits to move forward. The banks have been successful in obtaining dismissals of the complaints on the ground that Mr. Picard does not have the authority to pursue claims on behalf of the defrauded investors.
The initial problem Mr. Picard faced is a doctrine called "in pari delicto," or mutual fault, which prevents a firm from suing others for their role in its own misconduct. The New York Court of Appeals, the state's highest court, explained in a 2010 decision involving the failed futures firm Refco that this "principle has been wrought in the inmost texture of our common law for at least two centuries."
As the trustee for Mr. Madoff's failed securities firm, Mr. Picard took over its claims—in a sense, "stepping into the shoes" of the entity. That also means any defenses that could be asserted against Mr. Madoff also apply, so his wrongdoing is attributed to Mr. Picard for the purpose of deciding any claim. The in pari delicto rule is usually invoked on the ground that a court will not decide a dispute between two thieves about who gets the loot.
The United States Court of Appeals for the Second Circuit leaned heavily on this doctrine in upholding the dismissal of Mr. Picard's claims against the banks because the losses were equally attributable to Mr. Madoff. It found that the trustee's legal arguments to avoid the impact of the rule "are resourceful, but they all miss the mark."