Some of the same firms that were sued by the Bernie Madoff trustee have jumped into a multibillion-dollar OTC market involving Ponzi victim claims.  

On the sell side are defrauded investors who want immediate cash for what they are owed.  The buyers include some of the world's biggest banks who hope to profit by collecting a larger payout when the settlement is made final, which can take years. 

Investors were receiving offers of just 20 cents to 30 cents on the dollar a year ago, when it was unclear how much money would be recovered.  Now, with billions already extracted through settlements reached by a court-appointed trustee and the promise of billions more, deep-pocketed banks are moving in, pushing the offers on claims to roughly 70 cents to 75 cents on the dollar.

Even at the higher offers, the bidders are hoping to make millions of dollars on larger claims, prompting bankruptcy specialist Kenneth Krys to say, "It's like a circus out there, a feeding frenzy.  There's people buying and paying quite extraordinary prices."  Mr. Krys helped one fund sell its rights to a $230 million - money that it invested and lost with Mr. Madoff. 

The Arbitrage Angle.  Imagine the case of a bank that's being sued by trustee Irving Picard.  That bank sees a strong possibility that they'd lose the case if it went to court.  Accordingly, the bank enters into a so-called arbitrage play by purchasing a "forward contract" to receive payment on a $500 million claim, and agreeing to settle the Madoff lawsuit with a payment of, say, $750 million to $1 billion. 

If a significant number of banks and other financial institutions agree to such settlements, there's a good likelihood the bank will eventually collect close to its loss claim - thereby offsetting some of the money it agreed to pay in the settlement.

People familiar with the claims market said that Swiss-based UBS AG and Royal Bank of Scotland are among those that were sued and now are bidding on claims.  By defending the suits, the banks are in effect fighting off victims of the fraud, while at the same time seeking to profit from payouts based on other claims.

Other banks involved in the market for these claims include Deutsche Bank AG and Goldman Sachs - neither of which was sued by the Madoff trustee.

While perfectly legal, the situation reflects Wall Street's penchant for finding a way to profit from almost any upheaval.  During the financial crisis, big banks, hedge funds and other major investors made billions snapping up beaten-down bonds and by lending to strapped companies. Now, sorting out the huge Madoff fraud claims has become a mini-industry, with lawyers, investors and banks all seeking to squeeze the biggest check possible out of the trustee liquidating the business.in the Bernard Madoff Ponzi scheme, including two banks that have been sued in connection with the fraud.

Another Twist by Certain Feeder Funds.   Many feeder funds, which are expected to have $10 billion or more in claims, are helping to fuel the claims market because they need to raise cash.  Before their full claims can be approved, they must return money Mr. Picard is seeking under laws that enable him to "claw back" cash that was withdrawn from the Madoff firm right before its December 2008 collapse, or by people he says ignored signs of the fraud.

That's the trustee's way of forcing these feeder funds to pay into the pool to be split among all investors, before they take anything out. Since many of the funds have no assets, they are selling their claims as a way to make those payments. 

Under the deals, buyers pay funds such as one run by Fairfield Greenwich Group, where Mr. Krys is serving as a liquidator.  The funds take the cash they get for the claims and repay their past withdrawals from the Madoff firm.  Anything left from the claim sale can be used to pay off their own clients.  In this case, Fairfield's biggest fund agreed to pay back $70 million it withdrew from the Madoff firm.  Last month, Mr. Picard approved the fund's settlement claim.

For further details, go to:   [WSJ-online, 6/17/11, "Madoff Claims Lure Banks"]