Lose money to Madoff? Don't cry to Uncle Sam.

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Nearly three months into the Bernard Madoff scandal, the financier's investors are learning a tough lesson in financial management: Their best recourse may be asking for help from a tax accountant or lawyer – and forget about the federal government's anointed investor-protection group.

Mr. Madoff was arrested Dec. 11 and charged with defrauding thousands of investors of as much as $50 billion in what authorities say was the biggest Ponzi scheme in history. His clients included banks, hedge funds, charities, universities, and wealthy individuals.

The options for investors to recoup their losses are now shaping up. For some that means filing a lawsuit. Alan Cosner, an attorney in East Brunswick, N.J., and a former IRS agent, says he has fielded "daily" inquiries since he took out ads in the Palm Beach Post and elsewhere in late December seeking to attract investors burned by Madoff.

"I'd sue everybody, I'd sue the trust, I'd sue the feeder fund, for lack of due diligence," Mr. Cosner says.

But for now, the best option may involve taking advantage of the federal tax code.

"I've been telling people to renounce their claims," says Robert Willens, a tax attorney in New York. Closing out litigation and other investor-protection claims, he says, opens the door to a "theft-loss" deduction. This lets investors recoup the entire loss minus 10 percent of their gross adjusted income. "Otherwise you'll only get pennies on the dollar," says Mr. Willens.

The Internal Revenue Service allows investors to "carry back" losses against income reported on federal tax returns over the past three years. Those losses may also be carried forward for 20 years.

But one group of Madoff investors is pushing for more. Led by Howard Merson of Stowe, Vt., they are circulating a draft petition to Congress for "full restitution" of those implicated. They are seeking a five-year carry back, a deduction of losses against assets held in 401(k) and IRA accounts, and big changes to restitution rules at the Securities Investor Protection Corporation (SIPC).

Discovering just how strict SIPC rules are has been a disappointment for Madoff investors. Created by Congress in 1970, this nonprofit investor-protection group was designed to protect investors when a brokerage firm fails and cash and securities are missing from accounts.

Last month, the SIPC mailed out 8,000 claim forms to Madoff clients. But the number of people who lost money in the scam is probably far more. Some recipients represent pools of dozens or hundreds of investors – many of whom, though wealthy by national standards, now find themselves wiped out.

Initially, some Madoff clients had hoped to take advantage of SIPC guarantees of $400,000 in securities and $100,000 in cash in the event of a brokerage's failure. But owing to Byzantine rules of this congressionally chartered entity and the nature of the Madoff case, many have now concluded that they won't receive even that much.

Darlene, a design consultant in her 50s and a self-described "middle-class investor," is among them. She had never even heard the name "Madoff" when she learned in December that the limited partnership holding her $300,000 in savings – 75 percent of her total assets – had funneled the money through intermediaries to Madoff.

"I am not rich, and I was set back 25 years with one phone call," says the single mother, who asked that her real name not be used. She says she is embarrassed by her losses.

Darlene says that she was aware that the SIPC is touted on many brokerage statements and marketing materials as a means of protection. But she lost hope when her lawyer told her that even if the partnership is covered it will likely stand as a single "customer" before SIPC, meaning that the $500,000 compensation would be divided among the several dozen investors in the fund.

Under SIPC rules, limited partnerships, many of whom sent money to Madoff "feeder funds," are not covered. Nor, at least historically, are cases of fraud. The Madoff mess, as a so-called 'Ponzi scheme,' would be a classic fraud.

The SIPC website also warns investors: "SIPC could not keep its doors open for long if its purpose was to compensate all victims in the event of loss due to investment fraud."

Interestingly, the group has not yet made that distinction in its congressional testimony or public statements.

"We have not prejudged any claim, particularly until we see the claimant's paperwork," says SIPC President Stephen Harbeck through a spokesperson. "Anyone who believes they have a claim should do so." Claims in the Madoff case can be filed through March 4.

In Senate testimony two weeks ago, Mr. Harbeck revealed a dollar figure for the "missing securities" connected to Madoff: $600 million, implying that the SIPC will cover at least some investors. (It's an amount the SIPC can afford, given that it has $1.7 billion in assets and $1 billion in credit available from the US Treasury.)

But some doubt that means much in cases like Darlene's.

"I would be surprised if the customer dealing with a forwarding broker would be deemed to have an account with Madoff that is covered by the SIPC," says James D. Cox, a law professor at Duke University in Durham, N.C.


• From its inception in 1970 through 2007, the SIPC has liquidated 317 brokerage firms, returning more than $15.7 billion in cash and securities to customers.

• The SIPC's recovery fund now holds $1.7 billion in assets. Over 37 years, $322.5 million has been paid out of this fund.

• The SIPC has 5,435 broker-dealer members, including Merrill Lynch, AIG, and Ameriprise.

• A SIPC online quiz asks: "Which of the following organizations insures you against losing money in the stock market or as the result of investment fraud? The SEC, FDIC, or SIPC."

Answer: "None of these."

• Estimates of total annual losses from investment fraud in the United States range from $10 billion to $40 billion.

Source: Securities Investor Protection Corporation