Speculators Are Eager to Bet on Madoff Claims

The lawsuits filed by the trustee seeking money for Bernard L. Madoff’s fraud victims may be a blow for the defendants — but they are catnip for an obscure breed of Wall Street traders speculating on the outcome of the enormous Madoff bankruptcy case.

Bernie Madoff
Getty Images
Bernie Madoff

In recent months, hedge funds and other investment firms have been quietly contacting Madoff victims whose loss claims have been approved by the trustee, Irving H. Picard.

These funds — specialists in beaten-down assets known as distressed securities — are offering to buy those claims immediately for cash, but at a sharp discount from their face value.

With the latest round of big-ticket lawsuits, however, that quiet market has started to sizzle.

“Virtually every sophisticated distressed investor is looking at the Madoff situation,” said Thomas T. Janover, a lawyer at Kramer Levin Naftalis & Frankel who has represented clients who are considering buying claims.

“The uncertainty of the payout from the bankruptcy process creates an opportunity and potentially big returns.”

The chances that the trustee will be able to collect more than the $2 billion he has gathered to date have increased in recent days with the filing of lawsuits against deep-pocketed banks like JPMorgan Chase , UBS and HSBC , among others.

But bankruptcy lawyers expect those legal fights will take years to resolve, with no guarantee of that any of the billions being sought will be recovered.

Bankruptcy claims have traded on Wall Street for generations, and active markets have developed around other financial calamities like Enron and Lehman Brothers.

The explosion in hedge funds and their pursuit of unusual investment strategies has expanded that traditional market in recent years.

For small investors who were caught in the Madoff fraud and cannot afford to wait years for a recovery, the speculative buyers offer them cash now. Even larger investors may decide that it is prudent to take less cash upfront rather than hope for a bigger payoff in the future.

The distressed investors, however, are betting that the bankruptcy claims will be settled for more than what they appear to be worth now. And they are hoping that Madoff investors will allow them to take that bet.

One Madoff investor, who declined to be identified to protect his privacy, reported receiving letters from no fewer than six companies in the last two months. He provided copies of those letters, which offered to pay 20 to 34.5 cents for every dollar in claims.

The firms making those bids included Contrarian Capital Management, a large Greenwich, Conn., hedge fund; Fulcrum Credit Partners of Austin, Tex.; and the Hain Capital Group of Rutherford, N.J.

Another Madoff investor, Burt Ross of Englewood, N.J., said that 30 cents on the dollar was the highest offer he had received in recent months.

“People need to understand that people who are offering 30 cents are savvy professionals who fully expect to get 50 to 60 cents when the claims are finally paid,” Mr. Ross said. “They’re not offering 30 cents because they expect to get 35.”

And it is not just individual Madoff investors who are willing to cut deals with the speculators.

A large hedge fund recently paid about 30 cents on the dollar to buy a claim of roughly $50 million from a family that had invested with Mr. Madoff, according to a person with knowledge of the trade who was not authorized to speak about it.

Several prominent hedge funds have become involved in the Madoff claims trading process, including the Fortress Investment Group, Perry Capital, Silver Point Capital, the Baupost Group and Farallon Capital Management.

It is unclear whether any of these funds have bought claims, but all are actively exploring the market.

Other prominent distressed investors have decided not to participate in the market for Madoff claims, no matter how compelling the potential returns.

David M. Barse, president and chief executive of Third Avenue Management, an active investor in distressed bankruptcy claims, said in recent months his analysts had advanced the idea of buying Madoff claims.

When the investment idea was discussed in October, claims were trading at about 25 cents on the dollar, and an analysis showed potential recoveries in the range of 40 to 80 cents.

But after discussing the idea with his senior management, Mr. Barse said he had decided that even though the trade sounded promising, Third Avenue would not participate.

“The fraud is just so despicable that we felt that, from a moral perspective, it just didn’t make sense for us,” Mr. Barse said. “There are plenty of other ways to make money in this business.”

JPMorgan, which actively trades bankruptcy claims, has also shied away from being involved. The bank, which served as Mr. Madoff’s primary banker for many years, was among the several large global banks sued by the trustee.

JPMorgan has denied the trustee’s claims that it ignored clear signs that Mr. Madoff had been operating a fraud.

Mr. Picard, the trustee, has estimated that the total cash losses in the fraud are roughly $20 billion.

So far, he has collected about $2 billion in cash and approved claims totaling more than $5.9 billion, representing cash losses by investors who took less out of their Madoff accounts than they put in.

Many of those investors have already received up to $500,000 from the Securities Investor Protection Corporation, an industry-financed compensation fund. None of the $2 billion in cash has been distributed to eligible investors yet.

Mr. Picard has said that he expected several large settlements to be announced soon, which would allow him to make a partial distribution to investors early next year.

Some investors say they are not inclined to trade their claims because they believe they will recover more through the court process.

Mr. Ross, one investor, says he has not been tempted to sell his approved claim because he noticed that Mr. Picard has already been successful in settling several cases for substantial amounts of money.

Two were settled just last week, for a total of more than $1 billion, he added.

“Every time I read that there’s been a settlement, there is more hope,” he said. “And hope is a good thing to have — we need it.”