Ina previous blog post, Madoff’s Ponzi Scheme: Feeder Fund Liability, I discussed a Denver based investment firm who, as a feeder fund, found themselves tangled up in Madoff’s Ponzi Scheme. I would now like to look at some of the challenges of litigating these types of cases.
Colorado business litigation suits against feeder funds include claims
for fraud, negligence, and breach of fiduciary duty. But what are the
The biggest obstacle to claims against the feeder fund may be the protection
Congress bestowed upon investment funds more than a decade ago. In the
Private Securities Litigation Reform Act (PSLRA) of 1995, Congress determined
that the investor must not only prove negligent failure of the feeder
funds to investigate the Ponzi schemer, but also must prove that any feeder
fund advice bordered on intentional fraud. And for the most part, those
claims must be filed in a federal courthouse.
The typical investor is unaware of the detailed relationship between the
feeder fund and the Ponzi scammer, such as Bernie Madoff. As in other
technical cases where the factual basis of the misconduct is often known
only to the defendant, such as a medical negligence case, the investor
seeks to learn about the relationship between the feeder fund and the
Ponzi schemer through discovery rules. Investors begin taking depositions
of people with knowledge and use those depositions to establish the basis
of the wrongdoing.
Under the PSLRA, however, Colorado federal courts, including Denver, may
require detailed factual allegations against the feeder fund without the
benefit of discovery depositions. Congress essentially requires fraud
victims to “shoot in the dark.”.
However, while fraud claims in the federal courts may be difficult under
the PSLRA, breach of fiduciary duty claims can be filed in state courts.
Whether it stays there, though, without a transfer to the federal court
depends on complex procedural rules. A Washington Post article earlier
this year (“Madoff Investors Face Dim Prospects in Court”,
February 22, 2009, by Quinn) describes the difficulties in making claims
against feeder funds. Quinn acknowledges that these cases may “sound
like slam dunks” but:
“They are not. Congress and the courts have spent more than a decade
writing and affirming laws that protect companies from irate investors.
Those laws may turn out to be feeder fund protection acts.”
One final disappointment to an investor in a feeder fund is that its loss
may not be insured. Bank accounts are insured by the FDIC up to $250,000.
Investment accounts in a feeder fund that is registered under security
regulations are insured by the Securities Investors Protection Corp (SIPC)
up to $500,000. However, if the fraud or other misconduct was not perpetrated
by a licensed fund/broker, there is no coverage at all. Once again, this
gap in protection is a by-product of the anti-regulatory attitude part
For more information on litigating these types of claims, contact a Colorado
Business Litigation attorney.