After $20 million in losses from an alleged Ponzi scheme, legal experts say it might be time for Tufts to dig in its claws.
While University President Lawrence Bacow said in an e-mail last month to the community that Tufts will work to recover its losses, he did not specify the methods the school would employ. Even so, experts have speculated that the university could have the help of the legal "clawback" doctrine.
Essentially, clawbacks allow the courts to demand that parties who make money in a fraudulent scheme return some of their earnings to the losers.
As such, even as most of disgraced financier Bernard Madoff's former investors scramble to recoup funds, not all are pleased by this prospect, since for a few, the money would come out of their own pockets. In this case, the so-called winners are those who withdrew their money before the alleged $50-billion Ponzi scheme fell apart.
"The fraudulent transfer law says even if the person who pulled the money out was not part of the fraud, if at the time they pulled it out, Madoff was insolvent … they may be forced to give it back," Harvard Law School Professor John Coates told the Daily. "The basic theory is that once a firm is insolvent, it shouldn't be able to prefer some of its investors over others."
If permitted in this case, clawbacks could serve as one prong of Tufts' legal approach, which remains in the planning stages. Other potential options include suing Ascot Partners, the firm that directed Tufts' funds to Madoff, and pursuing legal action directly against the former Nasdaq chief. Jacob Ezra Merkin, Ascot's general partner, is also a potential target for a lawsuit.
Regardless, the chances that the university will recover the full sum of its investment are "bleak," according to attorney Alfred Ellis of the Boston firm Zimble & Brettler.
Ellis represented investors duped in another Ponzi scheme uncovered in 2006, a multi-million-dollar fraud carried out by Wakefield, Mass., businessman Frank Russo. By their very nature, Ponzi schemes only come to light when they have run out of steam — and cash, he told the Daily.
"There was basically nothing left at the end of the day," he said of Russo's assets. "Nothing substantial — pennies on the dollar."
Meanwhile, the first lawsuit filed against Ascot Partners as a result of the Madoff scandal relies heavily on a legal strategy that appears to be unavailable to Tufts.
The New York law firm Abbey Spanier Rodd & Abrams has filed a class-action suit on behalf of New York Law School, which lost $3 million in the Madoff fallout, and other forthcoming investors. Submitted on Dec. 16, it charges Ascot, its auditor and Merkin with recklessness that might have risen to the level of "gross negligence."
In the suit, lawyers repeatedly argue that Ascot Partners deceived investors by not telling them the extent to which the fund was entrusted to Madoff.
"[Neither] the Offering Memorandum nor any other offering material used in soliciting investment in Ascot ever disclosed that virtually all of Ascot's assets were invested with … Madoff controlled entities," according to a copy of the suit provided to the Daily by Nancy Kaboolian, an attorney with Abbey Spanier Rodd & Abrams.
The suit alleges that investors were instead under the impression that Ascot Partners was following a diverse strategy.
"In fact, the General Partner … had abandoned diversity by giving a single third-party manager, Madoff, management responsibility and discretion over Ascot's funds," the suit reads.
"The allegations of the complaint speak for themselves," Kaboolian told the Daily. "The allegations … are that the investors in Ascot did not know that Ascot was invested in Bernie Madoff."
Not so in Tufts' case, according to Director of Public Relations Kim Thurler. "I can confirm that the university was aware of the extent to which Ascot Partners was invested in Madoff Securities at the time of the investment," Thurler told the Daily in an e-mail.
The fact that the university knew about Ascot Partners' strategy has the potential to restrict its legal grounds, according to Ellis.
Even so, Tufts still has some footing, he said, noting that Ascot Partners could be liable if the fund failed to do due diligence checks on Madoff's investments.
A lack of investing standards has emerged as a common thread among funds that depended heavily on Madoff, Ellis noted.
"None of these people did due diligence. They just used their access without doing any due diligence," he said.
Coates said that the sheer volume of poor investment decisions can — somewhat ironically — actually serve as a defense for Ascot. "One thing that Ascot will be able to use as a defense is that everybody was fooled," he said.
Still, Tufts' knowledge of the extent of Ascot's investments with Madoff might not be all that damaging if the hedge fund had a responsibility to investigate the destinations of its investments, Coates said.
"It will turn on the precise nature of the relationship between Tufts and Ascot," he said. "If Ascot was acting as a fiduciary for Tufts, it may have had obligations to investigate."
In that instance, a deception similar to that alleged by New York Law School would not be required to make a case against Ascot legally viable; instead, it would just add another element and open more doors.
"The fundamental nature of the relationship wouldn't be different based on disclosure," Coates said. "But [New York Law School] can have a separate claim based on investing in an unauthorized way, essentially."
Martin Oppenheimer, Tufts' senior counsel for business and corporate affairs, said that Ascot Partners did indeed have the responsibility to meet certain standards on behalf of the university.
Ascot is a Delaware limited partnership, according to Oppenheimer. "As a matter of Delaware partnership law, the general partner of a limited partnership owes a fiduciary duty to the limited partners," he told the Daily in an e-mail. "We intend to investigate all avenues of legal recourse that the university can pursue in connection with this investment; as part of that effort, we will need to determine whether the general partner of Ascot, Ezra Merkin, satisfied his fiduciary duty to Ascot's limited partners."
Even if Tufts is successful against Ascot, the question that remains is whether the fund, which invested almost all of its $1.8 billion with Madoff, will have any money left to pay out.
"Obviously, Ascot doesn't look like a good third party [to sue] if they don't have any other assets," Ellis said.
As for the first legal option, clawback, the real drama is likely to unfold in bankruptcy court. A ruling against the investors who profited from their involvement with Madoff would follow the precedent set by the collapse of the Bayou Group, a hedge fund that turned out to be a $400-million Ponzi scheme.
A court ruled in October that certain Bayou Group investors will have to forfeit their winnings, and those who lost money are expected to recover somewhere in the neighborhood of 20 to 40 percent of their original investments.
Ultimately, legal experts foresee investors pursuing a variety of strategies to win back some funds, but they caution that all those who were defrauded should brace themselves for losses.
"I think it's highly unlikely that they will get anywhere close to the amount that was invested," Coates said.
