Billionaire brothers Charles and David Koch have made plenty of good business decisions over the years. Placing millions of dollars with Ponzi-scheme mastermind Bernard Madoff may have been one of them.
Koch Industries Inc. invested an unknown sum with the con man's now-defunct securities firm years ago, and walked away with $21.5 million in profits before Madoff's arrest in 2008. But since 2012 the company run by the conservative-activist brothers, worth today a combined $109 billion, has refused legal demands to return the money.
Irving Picard, the trustee liquidating Madoff's firm, contends in a suit that the cash is fraudulent proceeds of the fraud and should be shared among the thousands of victims. Koch Industries, and dozens of other early investors named in 87 other lawsuits, argue the company can keep the profits because the money was sent overseas and is beyond U.S. jurisdiction. At stake: a total of $2 billion.
The battle is coming to a head in Manhattan bankruptcy court, where Judge Stuart Bernstein could rule within weeks on a key issue affecting Picard's suit. The defendants claimed a victory in 2014 when U.S. District Judge Jed Rakoff said that money transferred overseas is generally out of Picard's reach. In the Koch case, the $21.5 million was sent in 2005 to a fund based in the British Virgin Islands, and then to a Koch entity in Britain, filings show.
Picard is claiming the transactions were essentially domestic transfers made to appear foreign.
"The trustee is not crazy — he has a very decent argument," said John Pottow, a bankruptcy law professor at the University of Michigan Law School.
Koch Industries has said the suit lacks merit. "The Koch entity involved made an investment in an entirely separate fund," Koch spokesman Rob Carlton said in an email. "That Koch entity no longer exists, and its investment was redeemed in 2005, long before anyone knew of Madoff's fraud." The Koch brothers are controlling shareholders in the company, and have other investors.
Picard's spokeswoman, Amanda Remus, declined to comment.
Picard isn't accusing Koch and the other defendants of wrongdoing. As in his many prior suits to recover cash, he contends the returns aren't legitimate because Madoff used money from new investors to cover the fake profits of older ones. He has used that argument successfully in mostly domestic cases to claw back more than $11 billion for victims, who lost $17.5 billion in principal. (Some foreign defendants settled with Picard and moved on.)
Most of the $2 billion involves transfers from funds that were operated by Fairfield Greenwich Group — by far the biggest feeder fund that channeled investors' money to Bernard L. Madoff Investment Securities, or BLMIS. Several other suits involve funds run by Tremont Group Holdings. Both are based in New York and dealt with their shareholders from their offices in Manhattan, even though they had feeder funds based in the Caribbean to capture foreign investments for Madoff, Picard says.
"Regardless of where these feeder funds maintained operations, their transactions related to BLMIS were predominantly domestic," Picard has said in filings in federal court in New York. Moreover, the customers knew their investments were subject to U.S. law, he argued.
If Picard wins on this issue, his fight to recover the $2 billion isn't over. He must then prove that the transfer in each defendant's case was "domestic." Then, for transfers that occurred more than two years before Madoff's arrest, Picard must establish one more thing: that the feeder fund in which the defendant invested had "actual knowledge" of the fraud.
"We're strongly of the view that the extraterritoriality defense applies to the Fairfield Greenwich defendants," Mark Cunha, a lawyer for Fairfield, said in an interview. "We look forward to the judge's decision."
Koch Industries, an industrial conglomerate and one of the biggest private companies in the U.S., started investing with Madoff in the mid-1990s, court records show. At first, it invested with a Fairfield fund in the U.S., Greenwich Sentry.
In 2003, the company set up the entity in Britain, Koch Investment (U.K.) Co., to invest through a different fund that Fairfield set up in the British Virgin Islands that was exclusively for foreigners, called Fairfield Sentry. Two years later Koch Industries withdrew the cash that's now at the center of the trustee's lawsuit. (Koch also withdrew $58 million from Greenwich Sentry that same year, according to the fund's Chapter 11 filings.)
"Although registered in the United Kingdom, Koch Investment had no employees or operations in the United Kingdom, and was operated and managed entirely from the United States," the trustee said.
Picard's legal team has also cited the bankruptcy of Maxwell Communication Corp. in the 1990s. The judge in that case noted the "dangerous implications" of automatically labeling a transfer as foreign just because it involved foreign participants.
Picard's plan "makes sense since it's so easy to move money outside the United States," said Joelle Scott, of investigative due diligence firm Corporate Resolutions Inc. "I'd be surprised if the judge shut him down."
Madoff is serving a 150-year sentence in a federal prison in North Carolina for running the Ponzi scheme.