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Ponzi Schemes: The Implications for Defrauded Investors

Theft losses can be deducted under Sec. 165(a) but it gets complicated.

April 2009
by Dianne Odom and Michael David Schulman/The Tax Adviser

Do you have a client that lost money in the Bernard Madoff Ponzi scheme? A Ponzi scheme is defined as "an investment swindle in which some early investors are paid off with money put up by later ones to encourage more and bigger risks" (Merriam-Webster's Collegiate Dictionary 964 (Merriam-Webster 2003)). Madoff is alleged to have done just that until, in 2008, an increase in requests for redemptions from his investors caused his $50 billion pyramid to collapse.

If a client has lost money in the Madoff Ponzi scheme or another pyramid scheme, what are the client's options? The Securities and Exchange Commission (SEC) has frozen all the assets of Madoff's company as well as his personal assets. Although the Securities Investor Protection Corporation (SIPC) is handling investor claims and the investments of Bernard L. Madoff Investment Securities LLC in a liquidation of the company, usually a judge assigns a receivership to handle all the company's affairs.

The receiver is an officer of the court, not an SEC employee, and ultimately has to answer to the judge that appoints him or her. The receiver is compensated from the assets collected. Along with aggregating the assets for liquidation, the receiver is also in charge of determining who is entitled to the money collected.

This article has been excerpted from The Tax Adviser. Read the full article here (PDF).