With the prospect of nearly $2 billion in professional liabilityclaim payments looming from the litigation fallout of a Ponzischeme orchestrated by Bernard Madoff, directors and officersinsurers were eager to pinpoint potential sources of exposureduring a recent industry gathering.

"It's certainly going to have an impact on [insurers']underwriting procedures," said Stephen Mildenhall, head of AonBenfield's Actuarial and Enterprise Risk Management practice, whichdeveloped a $1.8 billon best estimate of direct insurance lossesthat could be paid out on behalf of asset management firms, banksand other firms being sued in the aftermath of the Madoffscandal.

"It is astonishing that something of this size and scale managedto proceed...for a number of years without being detected," Mr.Mildenhall said.

As a result, "I would imagine that there would be someheightened underwriting within this class," he added, referring tothe financial institutions D&O and errors and omissions classalready "pretty much under the microscope" as a result of thesubprime/credit crisis.

The Madoff case was a prime topic of discussion at theProfessional Liability Underwriting Society's D&O Symposiumlate last month, which took place before Mr. Madoff entered a plealast week to criminal charges. (On March 12, Mr. Madoff pleadedguilty to all fraud charges against him and was sent to prison toawait sentencing.)

During a discussion of developments in securities litigation,Boris Feldman, a partner with Wilson Sonsini Goodrich and Rosati inPalo Alto, Calif., asked plaintiffs' attorneys to gauge the odds ofrecovering lost investments through litigation.

"While these cases are very difficult, there are possiblesources of recovery," said Sherrie Savett, of Berger &Montague, P.C. in Philadelphia. She explained that the main sourceof recovery cannot be Madoff Investment Securities "because there'svery little left there and trustees will be collecting those assetsand distributing them."

Instead, plaintiffs' attorneys will have to find out, "How didsomeone get into a Madoff investment? Was it through a hedge fund?Is the hedge fund still solvent? Is the fund backed up by aninsurance company?"

"The theory is there was a lack of due diligence by those funds,and that they're responsible for that reason," she said.

Accountants that audited the hedge funds are another potentialtarget, she noted. "How could they have done a proper audit of theassets of a hedge fund if assets weren't really there? We now knowthat Madoff didn't even trade for the last 13 years, so there was areal lack of due diligence on the part of the hedge funds and theirauditors."

In the same vein, she said there are also good cases to bebrought against bank custodians that were supposed to make sure theassets were there.

While Ms. Savett said the parties with the dimmest hope ofsubstantial recovery are those that dealt directly with Madoffthrough brokerage accounts, Professor John Coffee of ColumbiaUniversity also foresees obstacles for those who invested in feederfunds that put assets in Madoff investments.

Direct investors, Ms. Savett said, are limited to a $500,000recovery from the Securities Investor Protection Corp. or a taxbenefit for writing off a theft loss.

Mr. Coffee, while agreeing that funds are the deep pockets to betapped in Madoff-related litigation, said the funds' defenses arebolstered by a 2007 district court ruling in South Cherry StreetLLC vs. Hennessee Group, currently on appeal in the SecondCircuit.

In that case, an investment advisory firm, Hennessee, gave asophisticated hedge fund known as Bayou Group "an absolutely strongrating," Mr. Coffee said, adding that Bayou was the last big Ponzischeme before Madoff.

Judge Colleen McMahon in the Southern District of New Yorkruled, however, that as long as Hennessee did not know that theBayou Group was a total fraud, and so long as they only mademisstatements about their own due diligence, they could not be onthe hook for liability, he reported.

Indeed, he said, the advisor may not have looked even at otherfunds when it advised investors to put all their money in Bayou,but the case is dismissed because the judge held that "the realloss causation event was the fraud at Bayou and not lack of duediligence of the advisory group."

Should the decision be upheld on appeal in the next few months,that could be a controlling force in limiting liability for theMadoff feeder fund litigation, Mr. Coffee predicted.

He said another obstacle to plaintiffs in New York, where manycases will be brought, is a state law known as the Martin Act,which preempts suits alleging breaches of fiduciary duty and doesnot permit private actions. The law gives exclusive jurisdictionover state law claims involving the purchase or sale of securitiesto the attorney general.

Mr. Coffee predicted that in spite of the obstacles, there willbe some recoveries against the feeder funds, although he noted thatsuch funds have limited assets--amounting to, at most, $200million, in his view.

Stuart Grant, managing director of Grant & Eisenhofer, P.A.in Wilmington, Del., whose firm is already representing "asubstantial number of people with losses of over nine figures" inMadoff-related cases, agreed that feeder funds are the "low-hangingfruits" among possible defendants.

"If you have a fund that's taking 1 percent of assets undermanagement and 20 percent of the profits, and you find out thatthey've done no due diligence [and] just acted as a conduit, that'sthe kind of thing that ticks people off," he said.

Embellishing his argument with potential stories of fundmanagers with houses in affluent areas like Greenwich, Conn., Mr.Grant said "that's the type of story I want to tell to a jury. It'san attractive case."

Countering Mr. Coffee's assertion about shallow pockets, Mr.Grant added that the funds have a surprising level of assets. "Idon't think we're talking about millions, but billions or tens ofbillions combined."

One interesting debate to be played out in the Madoff cases willbe over the issue of damages. "If you invested $10 million 15 yearsago, and thought you made $100 million, did you lose $10 million or$100 million?" he asked. "Had you put it in the stock market, youwould have $8 million now, so maybe the loss is only $8 million,"he said, giving an alternative view that defendants mightoffer.

At a separate conference, a Web-based event sponsored by NERAEconomic Consulting in January, another plaintiffs' lawyer, GerardSilk, a partner with Bernstein Litowitz Berger & Grossmann LLP,described legal hurdles facing limited partner investors in fundswhose investments were put into Madoff vehicles.

Those limited partners who file suit against general partners ofthe funds investing with Madoff "will have to demonstrate thatgeneral partners acted with a standard of conduct that is eithergrossly negligent or something beyond," such as recklessly orfraudulently.

In addition, he said, in most partnership agreements, there islanguage governing litigation against the general partner (GP),there are provisions for indemnification of the GP, and provisionsallowing the GP to use fund assets to defend againstlitigation.

"That presents an interesting twist because with limited assetsremaining, LPs could be suing the GP and, in fact, their own assetscould be going to defend the cases," Mr. Silk noted.

Beyond that, he said, for cases being filed as class actions,there are added hurdles. For example, class actions alleging breachof fiduciary duty against GPs could be subject to preemption underthe Securities Litigation Uniform Standards Act of 1998--a lawrequiring certain securities class actions to be brought in federalcourt.

To make a federal claim, he continued, plaintiffs cannot pleadthat GPs or others were grossly negligent. "You would have todemonstrate that they acted with scienter--a state of mind ofrecklessness or greater than that," he said. "You'd also have toprove that parties you're suing made false statements."

Mr. Silk said private lawsuits that are not brought as classactions will face fewer hurdles--allowing claims that plead onlygross negligence and allowing plaintiffs to bring third partiesinto suits as defendants for aiding and abetting.

Fund-of-fund investors "have more avenues for recovery thandirect investors," but "they are not easy avenues," heconcluded.

Discussing the challenges to direct investors on the sameWebcast (presented by Securities Docket atwww.securitiesdocket.com), Brad Friedman of Milberg LLP said thatbeyond the Securities Investor Protection Corp., the only otherreal avenue of recovery is as creditor in the bankruptcy of MadoffInvestment Securities.

SIPC, which maintains a special reserve fund authorized byCongress to help investors at failed brokerage firms, has alreadymailed out more than 8,000 customer claim forms to Madoffinvestors, SIPC announced in a Jan. 5 statement.

In a recent press advisory, Marshall Gilinsky, a policyholder'sattorney with Anderson Kill & Olick, suggested a thirdpotential avenue of recovery for investors. "Some blue-chiphomeowners policies...include limited coverage for losses likethose arising out of investments in Madoff's hedge funds," hesaid.

On the Webcast, Mr. Friedman also addressed concerns of someinvestors hesitant to file claims for recovery of amounts investedwith Madoff because they have redeemed money over the years andfear that trustees will come after them to return that money.

Mr. Friedman said he believes too much attention has been givento this issue in the business press, suggesting that only thelargest investors would be subject to demands--often referred to asclawbacks.

At Aon Benfield, Mr. Mildenhall noted that the maximum potentialinsurance limits exposed to the Madoff scandal are estimated atmore than $6 billion, but he said the range of direct insuredD&O and E&O losses will be a far smaller number--mostlikely somewhere between $760 million and $3.8 billion, with a bestestimate of $1.8 billion.

"The numbers all are derived from two dimensions ofuncertainty," Mr. Mildenhall said, highlighting "uncertainty aroundthe particular limits and attachment points that insured partieswould have purchased" as the first element of uncertainty, andquestions surrounding the degree of liability of differentpolicyholders as the second.

Separately, Kevin LaCroix, an attorney who authors "The D&ODiary," an Internet blog site with information on securitieslitigation trends and D&O insurance, is keeping track ofsecurities class-action lawsuits against Mr. Madoff, his firm, orthe feeder firms that invested their clients' funds with Madoff.Through March 3, Mr. LaCroix tallied 13 separate federal securitiesclass actions.

Mr. LaCroix also keeps a running count of state actions againstthe same parties and additional cases against relateddefendants.

These include a recent case filed against Tremont InternationalInsurance Limited. This case alleges that the insurer, an entityowned by Tremont Capital Management, breached its duties byoffering Tremont-related funds as investment options for thevariable investment account component of the policies, and that theTremont-related funds were heavily invested with Madoff, Mr.LaCroix explained on a blog entry.

In a Jan. 12 blog entry at www.dandodiary.com, Mr. LaCroix--apartner for Oakbridge Insurance Services, a Beachwood, Ohio-basedinsurance brokerage--also discussed potential obstacles lawsuitdefendants might face in securing coverage from their D&O andE&O insurance policies.

Conduct exclusions, particularly personal profit and fraudexclusions, may be asserted as coverage defenses by insurers, hesaid, noting that while the fraud exclusions might only apply toinsurance for Mr. Madoff, the personal profit exclusion could comeinto play in other cases.

"Investors have already claimed that the feeder fundsinappropriately exacted management fees or other compensationwithout conducting appropriate due diligence or otherwise earningtheir fees. However, an adjudicated determination of theseallegations would be required for the profit exclusion to precludecoverage," Mr. LaCroix wrote.

He said that based on his experience, he believes manyinvestment advisory firms and hedge funds buy relatively lowerlimits of insurance coverage. He pointed to a factor beyondexclusions that could restrict the total insurance losses.

"In many cases, the available insurance involved...could quicklybe exhausted by defense costs alone," Mr. LaCroix said.