Many other Madoff victims are trying to recover taxes they paid on what turned out to be false earnings from their Madoff investments. Last spring, the IRS extended the “carry back” period for tax-related losses for Madoff victims from three to five years. But certain states like New Jersey have not followed suit. And short-term extensions are of little help to those who had money in Madoff for decades. “The government collected untold billions in taxes on money that people never really earned,” one victim says. “This is about the government being the beneficiary of a fraud.” There are bills pending in the House that would provide more tax relief, but the Madoff victims have no money and little lobbying leverage.
Perhaps most maddening of all, victims say, is the possibility of the clawbacks. Richard Friedman and his wife, Cyndee, built a modest middle-class life together on Long Island. Richard learned about Madoff in the eighties, when some of the clients of the accounting firm he ran with his father began investing with him. Richard and his father began tracking the fund’s progress, eventually going all-in themselves. Richard had planned to retire in June of this year. Now he still punches in, struggling to keep his accounting practice afloat. Richard’s father died several years ago. His mother, now 84, and suffering from Alzheimer’s, had inherited her husband’s IRA. But her husband had been required to take out minimal distributions ever since he was 70. A lot of times, he’d use that distribution to pay the taxes on his taxable Madoff earnings. “He had to withdraw money by law!” says Cyndee. “And now she’s susceptible to clawbacks?”
Phyllis Molchatsky—born in Manhattan, raised in Brooklyn, now 62 and living in Rockland County—scrimped and saved her whole life, working as an administrative manager for a financial-services firm. Both her parents died before she was 22, forcing her to fend for herself. In her early fifties, she was diagnosed with Parkinson’s disease, and her doctor told her to avoid any stressful situations that might aggravate her condition. “He said it would not necessarily add years to my life,” she says, “but quality to the years that I have.”
Molchatsky took approximately $2 million, everything she had saved, and asked a stockbroker where she should invest it. The broker recommended a fund and showed her how it had fared recently. “The performance was nothing remarkable,” she said. “It was anywhere from 9 to 14 percent, but usually about 10 percent. What was remarkable was that there was virtually no volatility. It was just what the doctor ordered.” She invested half in October 2001 and the second half a month later. “I only have so much money,” she told her broker. “This has to keep me for the rest of my life.”
Molchatsky fell in love, moved in with her partner, and adopted a baby boy. Over the years, she had learned from chats with her broker that her fund’s money was being managed by someone named Bernie. On paper, her nest egg had grown to almost $4 million. Then came last December 11, when she got a phone call from her broker telling her to turn on the TV. He told her who Bernie Madoff was and delivered the news that her money had been invested in a Madoff feeder fund, and that she had just lost nearly every penny she’d ever earned. “My head exploded,” Molchatsky says. “I went crazy. I remember sitting down and mumbling, ‘I have nothing. Nothing.’ ”
A few days later, a friend put Molchatsky in touch with a lawyer named Howard Elisofon, who began his career as a trial lawyer for the SEC and went on to defend Wall Street companies from SEC scrutiny. Now at the law firm of Herrick, Feinstein, Elisofon began fielding dozens of calls from Madoff victims asking if it was possible to sue the SEC. “I said no to about the first nineteen people that asked,” he says. “Then when the twentieth person asked, and the 21st and the 22nd and the 23rd, I stopped saying no and I said maybe.”
Elisofon began researching the subject of sovereign immunity, in search of a precedent for suing a federal agency. He already knew that until 1946, the only way to obtain the right to sue the government was by an act of Congress. Then came the Federal Tort Claims Act, which allows an aggrieved person to sue the government for negligence and money damages. Under that act, the government still can’t be sued for bad policy—people swindled by a hedge fund typically can’t take action against the SEC just because the SEC decided as a matter of policy not to regulate hedge funds—but the government can be sued if it made a policy and then failed to carry it out.