Velvel on National Affairs

Petition for Rehearing En Banc

2011-09-23T12:32:00.002-04:00

UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT

PETITION FOR REHEARING EN BANC

PRELIMINARY STATEMENT

Petitioner, Lawrence R. Velvel, is a customer and victim of Bernard Madoff. Velvel was an appellant in the above-referenced appeal and seeks a rehearing of the Court’s August 16, 2011 decision, annexed hereto as Exhibit 1.

Velvel joins in the arguments made in the two petitions for rehearing submitted by others under date of September 2, 2011, but writes because extraordinarily important information concerning the intent of SIPC, the Trustee and the SEC was disclosed on September 16, 2011 in a 118 page report issued that day by the SEC’s Inspector General, David Kotz. That just-disclosed, crucial information regarding the intent of SIPC, the Trustee and the SEC was denied to Petitioner when he sought it via discovery request in the Bankruptcy Court in September, 2009. The discovery request was vigorously fought by the Trustee, Irving Picard, and by SIPC, and, in accordance with their position, was denied by Bankruptcy Judge Lifland. Petitioner contested this prior denial of crucial information in his opening brief and his reply brief on appeal in the Second Circuit, but the Panel’s decision of August 16th does not deal with the matter. Now, however, the relevant crucial information sought via discovery was disclosed on September 16th in the Inspector General’s report, and Petitioner urges that there should be an en banc rehearing to consider the information.

Though, as said, other petitions for en banc rehearing were filed under date of September 2, 2011, the allowable time for filing a petition is 45 days, not 14 days, under FRAP 40. That rule provides that, if an agency or officer of the United States is a party to a civil action, the time for filing for rehearing is 45 days after entry of judgment. (Judgment was entered here on August 16th.) Here the SEC, a government agency, is a party. Also, the Trustee, Irving Picard, is a Bankruptcy Trustee as well as a SIPC Trustee (and is clawing back monies as a Bankruptcy Trustee). The Supreme Court has ruled that “Trustees in Bankruptcy are public officers and officers of a court.” Callaghan v. Reconstruction Finance Corporation, 297 U.S. 464, 468 (1936). Because the SEC is a party, and the Trustee is a public officer, the time period for seeking rehearing to bring up the crucial information that was not disclosed publicly until September 16th is 45 days from August 16th, not 14 days.

PROCEEDINGS BELOW

As pointed out in the Petitions For Reconsideration filed under date of September 2, 2011, the appeal and the decision of August 16th, involved the question of how to define “net equity” under the Securities Investor Protection Act. From the beginning, SIPC and the Trustee have argued that net equity is to be defined by the cash-in/cash-out (“CICO” or “net investment”) method, while the appellants/petitioners have urged that the final statement method (“FSM”) must be used, as in every SIPC case in the nearly 40 year history of SIPA prior to Madoff. The panel held that SIPC and the Trustee could use the CICO method.

ARGUMENT

From the very beginning, there has been well-founded suspicion that, whatever legal rationalizations SIPC and/or the Trustee might assert to the courts as justification for using CICO, the real reason they used CICO rather than the FSM was fear that the SIPC fund did not have sufficient monies to make the legally required payments to victims if the FSM were used. For this reason, it was thought, SIPC and the Trustee (ultimately supported by the SEC) ignored Congress’ intent -- oft-stated on the floor of Congress by many of the leading Senators and Representatives of the 1970s -- that victims be compensated up to $500,000 and that they be compensated promptly. Rather than adhere to Congress’ intent, SIPC and the Trustee (ultimately supported by the SEC), decided not to use the FSM, which was used in all other SIPC cases, but instead to use CICO, which they knew would dramatically lessen both the number of permissible claims against the SIPC fund and the amount of money that would have to be paid from the fund.

Plainly put, from the earliest days the well-founded suspicion was that the Trustee and SIPC (ultimately joined by the SEC) ignored Congressional intent to aid investors and substituted for Congress’ intent their own intent to save money for the SIPC fund.

Because of this well-founded suspicion, in September 2009 Petitioner filed a discovery request seeking information on why SIPC and the Trustee had chosen to use CICO. SIPC and the Trustee vigorously, even stridently, opposed the discovery request, and it was denied by the Bankruptcy Judge.

On appeal, Petitioner argued in his opening and reply briefs that the denial of a discovery request that would have led to exposure of the real reason SIPC and the Trustee chose CICO -- as opposed to the legal rationalizations they provided to the courts -- was reversible error. The appellate panel did not deal with this issue.

There the matter stood until the SEC’s Inspector General, on September 16, 2011, released his Report on the conflict of interest question involving the former SEC General Counsel, David Becker. In the course of that official SEC Report, it was made clear that a desire to save the SIPC fund had been, from the very beginning, the driving force behind the decision to use CICO. The driving force was not the intent of Congress so often expressed on the floor of the Senate and House by leading Senators and Congressmen of the 1970s when SIPA was enacted and amended. It was not to protect investors, especially small ones, and build confidence in markets, as Congress intended SIPA to do. Rather, it was, plainly and simply, to save SIPC’s finances, with legal rationalizations then being offered to courts to attempt to justify this departure from the intent of Congress. Little wonder that the relevant Congressional intent never rates even a mention in briefs filed in various courts by the Trustee, SIPC and the SEC.

Thus it is that, in his Report, the General Counsel, after extensive investigations described at the beginning of his Report, says (pp. 49-50 (emphases added) Exhibit 2, infra.):

In addition, Becker discounted SIPC’s perspective that it was important to consider the effect of the net equity approach on the SIPC Fund. For example, in a May 28, 2009 e-mail, NYRO Assistant Regional Director referred to Harbeck’s general “desire to ‘protect the fund.’” Ex. 95. [Harbeck is the President of SIPC.] See also NYRO Assistant Regional Director Testimony Tr. at 70-72. The Chairman’s notes [SEC Chairman Schapiro’s notes] of her preparation for a June 25, 2009 SIPC meeting where the net equity issue was addressed referred to SIPC concerns about “drain[ing] the fund,” “necessitate[ing] SEC going to Congress,” and “dramatic fee increases for broker-dealers.” Ex. 92; Schapiro Testimony Tr. at 38-39. Chairman Schapiro testified that she thought that her notes indicated that the SEC was “very concerned that [SIPC] will say that if we go with a final account statement view of what [its] obligations are, that it will deplete the SIPC funds.”(Fn. 31) Schapiro Testimony Tr. at 39.

Fn. 31: The Chairman’s notes also indicated, “This is a SIPC survival issue.” Ex. 92; Schapiro Testimony Tr. at 43. She testified that she did not know who made this comment, but that “it may be that somebody said that’s how SIPC views this, as a survival issue . . . because the fund would be depleted, and it set a precedent that would be very hard for them to meet over time given the fact that these liquidations had become so huge.” Schapiro Testimony Tr. at 43.

There can therefore be no doubt that survival of the SIPC fund, and of SIPC itself, was the driving force behind the use of CICO. It was not the oft-stated intent of Congress to aid and protect investors and build confidence in markets that motivated SIPC and its handpicked Trustee to use CICO instead of the FSM, but an intent to save SIPC even though they knew, as the IG makes clear, that CICO would eliminate Congressionally-intended payments to thousands of victims.

All of this raises the following question, which was never addressed by the Bankruptcy Court or by the Circuit Panel in its decision of August 16th. Is it lawful for SIPC (established under a Congressional statute (SIPA), for its handpicked SIPC Trustee and Bankruptcy Trustee (Irving Picard), and for the SEC to defy the Congressional intent to aid investors and build confidence in markets, and to substitute for Congress’ intent the intent of SIPC and the Trustee to save SIPC -- to save it by using a definition of net equity which causes thousands of often small and now impecunious investors to obtain no compensation from the SIPC fund or the fund of customer property? Petitioner believes that, notwithstanding the many legal rationalizations they have offered to support this substitution of their own intent for the intent of Congress, SIPC, the Trustee, and the SEC cannot lawfully substitute their intent to save SIPC for Congress’ intent to protect and compensate investors, and that it is a violation of separation of powers for the Panel to have judicially approved and adopted a definition of net equity which overrides Congress.

CONCLUSION

For the foregoing reasons, Petitioner urges that the full Circuit should follow one of two courses in en banc reconsideration. One course would be (i) to accept the IG’s investigation and statements as dispositive of an unlawful intent to override Congress by not using the FSM, and to thereby deny payments to those whom Congress intended to be helped and compensated and (ii) to reverse the panel decision because the decision has allowed this unlawful action to occur. The second course would be to vacate the panel decision and remand to the Bankruptcy Court for further investigation, via discovery, of why SIPC and its Trustee chose CICO and pressed this upon the SEC vigorously (as the Inspector General’s report makes clear). The discovery, the Court should make plain, must include full production of relevant documents and depositions of the relevant actors in SIPC, the Trustee’s office, and the SEC.

September 23, 2011 LAWRENCE R. VELVEL, ESQ.

Massachusetts School of Law
500 Federal Street
Andover, MA 01810
Tel: (978) 681-0800
Fax: (978) 681-6330
Email: Velvel@mslaw.edu

Comments on the Second Circuit's Decision on Net Equity

2011-08-23T10:04:00.002-04:00

COMMENTS ON THE SECOND CIRCUIT’S DECISION
ON NET EQUITY

August 23, 2011

I have been asked to state my views on the Second Circuit’s decision on net equity in the Madoff case. Some of the matters I shall discuss are relevant to a request for rehearing en banc to the Second Circuit and/or a subsequent petition for certiorari to the Supreme Court.

1. The Court’s decision is based on its acceptance of the statutory language relied on by the Trustee rather than the language relied on by the victims. The victims said they had a right to their “securities positions” as reflected in their final statements. The Trustee said he had to and should give them only what the “books and records” showed they had put in and taken out, so that a person who took out more than he put in had no net equity. In these regards (and others), the Court, like the Trustee as well as many people not connected with the Madoff affair, thought it overriding that everything Madoff did was a fake and the final account statements represented fakery, so it was better, and necessary, to look at the books and records rather than rely on the phony securities positions set forth in the final statements.

To me it seems self evident that, in a case where things were faked, and there is rival statutory language for the Court to choose from in determining net equity, it is essential to present a court with strong and repeated policy statements as to why it should choose the counter intuitive position of using the faked statements to determine net equity rather than the reality reflected in the books and records. Those policy reasons are found in the intent of Congress repeatedly stated in the legislative history. This author vigorously and repeatedly urged upon the New York lawyers who controlled the case for the victims’ side that the policy arguments, found in the intent of Congress expressed in the legislative debates on the floor of the Senate and House at the beginning and near the end of the ’70s, should be the linchpin of the case. For (with some relatively minor exceptions we can overlook here) true securities positions were zero, since Madoff did not buy or sell stocks for the victims.

This author’s urgings were unsuccessful. It was decided early-on in New York that the dispositive point was that the statute said net equity was the securities positions reflected in statements from Madoff (less indebtedness to him). This writer disagreed, saying, as did judges at oral argument, that “securities positions” were zero because the whole deal was a fake in which securities were not purchased. This view was unpersuasive to the lawyers on our side, who said victims’ securities positions were what was shown on the final statements: Such was required by state law, it was said, is admittedly what Madoff would have been obligated to pay victims had they sued him before December 11, 2008, and for all these reasons is the measure of net equity under the statute.

The foregoing argument about securities positions, an argument about which our side was warned, was, and proved, a loser because, as said, in reality the victims’ securities positions were zero.

2. It was, as said, this writer’s view, unsuccessfully pressed on the New York lawyers orally and in writing, that the only way to persuade a court to rule that the final statements should be the measure of net equity though they were faked was to rely extensively and repeatedly on the intent of Congress as reflected in floor statements, many of them made by the leading Senators and Congressmen of the 1970s. (President Nixon and Treasury Secretary Kennedy also weighed in.) Those extensive and repeated statements made plain that the Congressional intent would be vitiated if CICO were used instead of the FSM. It is not that the legislative history ever discussed net equity explicitly. It did not. It is, rather, that the floor statements repeatedly stated Congressional goals that will be vitiated by the use of CICO, goals such as protecting small investors, giving them confidence in markets, paying investors promptly, and protecting them against non purchase and/or theft of securities. And not to be forgotten is that it was known that investors would have to rely on their statements because the securities industry was switching, and SIPA was part of the switch, from giving physical securities to investors to holding securities in street name. (The Madoff scam could not have been done if Madoff had had to give physical securities to investors.)

As readers will know very well, and for reasons most readers will likewise know very well, the goals sought by Congress are stymied by CICO. The Second Circuit discussed Congress’ goals only very scantily and paid no heed whatever to the abundant floor statements setting them forth. Fundamentally, the Circuit relied instead on what it thought the best reconciliation of the statutory provisions, with little regard to the goals shown on the floors of Congress. In this regard, it adopted the Trustee’s position.

Was the Circuit told of Congress’ goals and was it given the floor statements reflecting them? Yes. But only by one lawyer. What was said by an unknown lawyer from the New Hampshire/Massachusetts border, far from the Court’s location in New York City, did not move the Court. Would the Court have been moved by the legislative history had it been the linchpin argument, or even a major argument, of the Wall Street firms -- firms well known to the Circuit and doubtlessly respected by it? One cannot know for certain, but one might consider it common sense to think it might have made a big difference to the Circuit if the legislative history argument had been pushed by prominent Wall Street firms whom the Court knows very well rather than solely by an unknown lawyer living far from New York City.(1)

When one considers that the Court has chosen to ignore the legislative intent -- has chosen to ignore Congress’ intent for prompt payment, has overridden Congress’ desire to protect small investors, has paid virtually no mind to the legislative desire to build confidence in markets -- the question arises of whether the Trustee and the judiciary have violated separation of powers and engaged in judicial legislation by doing what they think most appropriate while not even considering the Congressional purpose underlying the statute. This question comes up in regard to other matters too, as discussed below.

2. Relying solely on the statutory wording -- i.e., relying on the statute’s books and records clause -- the Circuit gave Trustees wide discretion to use whatever method of calculating net equity they deemed best in the circumstances of their cases. The Court appears to believe that there can be several ways of calculating net equity, depending on the particular facts of cases, and only if a Trustee chooses a method “clearly inferior” to some other method will the Court strike down a Trustee’s choice.

Paradoxically, while giving the Trustee wide discretion, the Court likewise said that as a matter of law CICO had to be used here. So I guess Trustees have wide discretion except when they don’t have wide discretion -- as here apparently, because the Court seemed to feel that the FSM method was “clearly inferior” to CICO on the facts of this case.

The grant of wide discretion to a Trustee in measuring net equity (unless and until a court rules there was no discretion in a case and only one method was permissible) will result in Trustees choosing measures that will save the most money for SIPC. Trustees, after all, make good livings by being SIPC trustees, and want to continue to get such assignments. So of course they will measure net equity in ways that save money for SIPC. Their likely varying choices of measurements of net equity will at times cause extended, long litigations on the subject, thereby insuring there will not be the prompt payments desired by Congress. The Trustees’ efforts likewise will mean there will be no confidence built up on the part of investors, and far less protection given them. Investors will again take it in the ear because of the Circuit’s decision.

There is also another crucial aspect to the ruling that Trustees are pretty much free to define net equity in any way they choose. The statute defines net equity essentially as meaning one’s securities positions minus one’s obligation to the broker. The statute also provides, in the section defining SIPC’s powers, that SIPC cannot change the statutory definition of net equity. Yet if SIPC and its Trustees can pick whatever definition of “securities positions” that suits them in the circumstances, for practical purposes is this not changing the definition of net equity? When you change the definition of a critical phrase in the definition of net equity, are you not thereby changing the definition of net equity itself for practical purposes? I would think you are, and that the Circuit’s decision is a plain violation of separation of powers and is judicial legislation overturning the explicitly expressed will of Congress.

Perhaps the Circuit felt it had to say there could be lots of definitions of net equity, depending on the circumstances. For if there could be only one definition of it, how to explain approving CICO now after the final statement method previously was used in something like 319½ out of 321 prior cases and, as the Court itself recognized, necessarily will be used in a host of future cases where CICO would be absurd? So, having to say there can be many definitions of net equity, the Court did say it. But what it said seems to me, as said above, a plain violation of separation of powers and a piece of judicial legislation, because it provides for SIPC and its trustees changing the definition of net equity to suit their purposes although Congress said the definition is not to be changed by SIPC.

3. The Circuit fully accepted the Trustee’s position that CICO was the only way to achieve fairness. Since there were those who took out more than they put in (net winners) and those who didn’t (net losers), the former would be unfairly advantaged if they received more (from the Trustee) while the latter have not yet fully recouped. Furthermore, the Court claimed, every dollar given by the Trustee to a person who had taken out more than he put in is a dollar made unavailable to one who has not gotten out all that he put in.

In terms of general fairness, the Court’s view -- its echoing of Picard -- is dubious. If one says that fairness is controlled solely by dollar figures (a very simpleminded view), than I suppose it makes sense to say that it is fair to insure that those who took out more than they put in (the net winners) should get nothing more unless and until there is complete recoupment by the others (the net losers). But is this fair if one considers more than just dollar figures, if one considers the complete situation? Those who took out more than they put in are, by and large I would think (pace Wilpons), the small people, the people who often are now remitted to poverty or something close to it. Those who didn’t take out more than they put in are, by contrast, usually huge and wealthy institutions such as hedge funds (or wealthy individuals). They are, moreover, the particular institutions, and the kinds of institutions, whom the Trustee himself has said enabled Madoff to maintain his fraud for years longer than it otherwise would have lasted. They did this by investing many, many billions of dollars without which the scam would have collapsed -- and without doing the due diligence of which they were financially and professionally capable and which would have caused the whistle to be blown on the fraud. And, by keeping the scam going, these institutions caused the losses of the small people to continue and to increase as the small investors put in more money year after year, took out more year after year in order to live, and thereby increased their losses and the potential clawbacks against them year after year.

Now, when one considers the complete situation, does it still look like using CICO rather than the FSM is the fair method? Not to me it doesn’t. I think it is no surprise that, unless he has sued them or entered a settlement with them which the Bankruptcy Court must approve, the Trustee has never been willing to identify the institutions (or very wealthy individuals) who have not taken out more than they put in, therefore have positive net equity under CICO, and will get SIPC advances and customer property. To reveal the identity of these institutions would be to disclose how unfair is the Trustee’s method of determining net equity, now approved by the Second Circuit.

There is another and extraordinarily fundamental matter pertaining to the Court’s claim that fairness requires use of CICO lest money given to net winners reduce, dollar for dollar, the funds available to net losers. The case in the Second Circuit involved two separate funds -- as the Court was aware because the matter of there being two separate funds was not only mentioned in briefs, but was discussed several times in the oral argument. One fund is the SIPC fund. That fund is created by contributions from the securities industry, and can be augmented by lines of credit obtained by SIPC and by requested appropriations from Congress. This fund is used to pay a customer up to $500,000, depending on her net equity, if a bankrupt broker’s coffers, as is usually the case, are insufficient to pay off. The amount of up to $500,000 is an advance against the customer’s share of the second fund, the customer property fund, but must be paid even if not one dollar of customer property is recovered. This further shows that, as I say, the SIPC fund is separate from the customer property fund, as Congress made clear -- though the Trustee and his counsel have tried, and in the Second Circuit have succeeded, in tricking this all up by their apparent claim that the SIPC fund is only a part of the customer property fund – and that the SIPC fund must be used to pay up to $500,000 of net equity even if there is no fund of customer property because no such property is recovered.

As I say, the Court was aware that there were two funds. From reading the oral argument several times, I think the Court also knew that payments to victims from the SIPC fund did not subtract one dollar from payments that other victims would get from either the SIPC fund or the fund of customer property. Yet though there were two funds, the Court appears to have deliberately treated the case almost exclusively as if there were only one fund, the customer property fund, and as if the SIPC fund were nothing but a specific branch of customer property, since payments from the SIPC fund are advances against customer property.

The nearly exclusive treatment of the case as involving only one fund, a customer property fund, is inherent in a number of the Court’s statements. Strikingly in this regard, the Court said that a dollar going to a net winner was a dollar denied to a net loser. That is simply untrue with regard to the SIPC fund, and I do not grasp how the Court could not have known it was untrue in regard to that fund. Yet the Court said it. I find this incomprehensible.

Maybe the Court thought the following, although it gave no indication of it. If net equity is measured by the Final Statement Method, then net winners will receive money from the SIPC fund and, having a positive net equity, will also be eligible for money from the customer property fund. Their eligibility for money from the customer property fund will take money that net losers would otherwise get from this fund, i.e., will take money from those who haven’t yet recouped all the money they put in.

But if this is what the Court thought, it told nobody about it in its opinion and was mistaken. For money from the customer property fund must be distributed “ratably” in accordance with respective net equities. Though the word “ratably” may sound like it means proportionally, and can mean proportionally, it doesn’t have to and doesn’t always mean that. It can mean merely that something can be rated or appraised or estimated. So . . . . . . if the FSM were used, it would be consonant with ratability to deny net winners any share of money from the customer property fund until net losers have received back all the money that they put in. This would allow net winners, who, as I say, often had to take out money to live and are now often impoverished, to receive advances from the SIPC fund in order to live, and would insure that they thereafter get nothing more -- get nothing from the customer property fund -- until all -- even the wealthy banks and hedge funds -- get back all the money that they put in.

It is noteworthy, in regard to finding some way to get money to the small investors whom Picard and the courts ironically call net winners (though they are often impoverished while hedge funds with scores of billions of dollars and near-trillion-dollar banks are called the net losers), that in hundreds and hundreds of pages of legislative history, Congress almost never discussed customer property. Congress was deeply concerned, rather, with the SIPC fund. It was the SIPC fund that was to provide the protection small investors needed, not the customer property fund. Yet Picard and the courts have focused entirely on the customer property fund, and to insure that so-called net winners get none of that fund, which Congress cared little about, have defined net equity in a way that insures that many small investors, so-called net winners, will get nothing from the SIPC fund, which Congress cared everything about because it was the SIPC fund that was considered the main protection for investors. To say that this is a distortion of priorities by Picard and the courts is mild. It is a point which should be one of the foci for petitions for rehearing or certiorari, I think. And while I myself, being a lawyer, would feel constrained from putting the whole matter the way it was recently put by a woman whom I believe is a leading member of the victims’ community, I think it is fair to quote to you what she recently wrote: “The court just rescued SIPC and Wall Street but condemned thousands of victims to poverty. You call that justice? These judges had the opportunity to come up with a little more creative solution to this problem but they chose the easy way out by regurgitating Picard’s lies. They had an agenda and it’s clear.” The statement about an agenda may be might be right or wrong, but it is, I think, the way lots of people feel, and the rest of the quote strikes me as right even if a lawyer would feel constrained from using some of its language.

4. Though Congress wanted SIPA to give confidence to investors, and to stimulate investment in the market, the Second Circuit’s opinion can only have the opposite effect. For now no investor can rely on his statement to know what he owns and to receive money from the SIPC fund accordingly. One cannot know in advance, of course, whether one is being victimized by a fraud -- if one knew there was a fraud it would be the rare case in which one would invest anyway.(2) And now the investor, who cannot know whether she is being subjected to a fraud, cannot depend on her brokerage statement to tell her what she has at her broker’s, cannot know whether she will receive up to $500,000 from SIPC, and has to reckon with the fact that a Trustee, on SIPC’s behalf, could (and will) deliberately choose a method of measuring net equity that may result in her getting nothing from SIPC. For the small investor this is entirely a disaster. One could just imagine what the situation would be if the FDIC were to tell depositors that it will not honor their bank statements because there was embezzlement which caused the bankrupt bank not to have the money shown on their statements. The situation here is no different.

In this regard, there are people who say that what Picard and the court have done is okay because investors, by definition, take risks. Of course, they take risks. That is inherent in investing. But the risk is of a decline in the market, a decline in the price of the securities one owns. The risk is (called) market risk. It is not risk of fraud. Fraud happens -- both in securities houses and banks. But both the FDIC and SIPA are supposed to protect against the fraud risk, albeit not against market risk.

5. There are many of us who believe that SIPC and Picard chose to use CICO because SIPC thought it did not have enough money in its SIPC fund to handle the Madoff problem if it used the FSM. The Trustee and SIPC have always resisted providing any information about the deliberations which led them to choose CICO. Defacto their position has been -- although they of course would never put it this way -- that no information need be given about such deliberations, and there can be no discovery into the deliberations, even if CICO thwarts the intent of Congress to protect investors. In taking this position defacto, they have violated separation of powers and have engaged in judicial legislation.

The Second Circuit has now done the same by ignoring the will of Congress, upholding positions which it deems fair in the circumstances regardless of what Congress wanted, and declining to address the fact that one party asked it to order the discovery necessary to learn why SIPC and Picard chose CICO. It has thereby eliminated the possibility of learning, through the judicial process, why CICO was chosen. Such elimination will also be the consequence of the Circuit’s (contradictory) statements that, even though trustees have discretion in selecting the method for measuring net equity, CICO is the only proper method here. The Trustee will quote the latter half of the contradictory statements to argue, yet again, that discovery of the real reasons why CICO was chosen -- discovery of whether it was chosen because of SIPC’s lack of funds even though it thwarts Congressional intent -- is improper because, after all, the Second Circuit said CICO is the only proper method for determining net equity here.

There may, however, be non judicial ways of determining what many of us think are the real reasons CICO was chosen. Congress could find out through legislative subpoenas and investigation or through the inquiries that now have been undertaken by the GAO. And what would happen if Congress were to learn that a concern over lack of sufficient monies in the SIPC fund was the reason, or an important reason, that caused CICO to be used instead of the FSM? Would the Second Circuit’s decision still stand because it said CICO is the only proper method here and this remains true regardless of the reason CICO was used? Or, contrariwise, would the Circuit’s opinion have to fall because it is the product of a bill of goods sold to the Court as the reasons for using CICO and because the Court focused entirely on the effect of net equity on the customer property fund while entirely ignoring its effect on the SIPC fund, about which Congress was far more concerned? My own view would be the latter, but there will be others who feel differently.

I should add that this problem is another one that stems from the basic nature of the procedure that was used here. Lawyers will immediately grasp my meaning when I say that this case, from the Bankruptcy Court through the Second Circuit, was a summary judgment without any opportunity for discovery, a procedure I believe very rare if known at all. So called summary judgments, which end a case before trial, are given only when each side has had discovery to learn the facts supporting and opposing it. But here no discovery was allowed or had on crucial matters such as the underlying reasons of SIPC and the Trustee for using CICO, the extent to which huge banks and hedge funds are helped and small victims are hurt by using CICO rather than the FSM, and other matters. The judiciary denied discovery, simply took one side’s (the Trustee’s) word for things, and then ruled against the victims who were not permitted discovery. This is, I think, a pretty astonishing method of proceeding where anybody on the losing side has sought discovery, and in this case one victim did. Guess who that was. His requests for discovery were rejected in the Bankruptcy Court and ignored in the appellate court. And again, common sense causes one to believe the requests for discovery might have received more respect from the courts had they been made by the large Wall Street firms the Circuit knows and respects -- but who were so convinced of the infallibility of their argument from the words of the statute that they thought discovery irrelevant -- instead of by an unknown guy from the far-off New Hampshire/Massachusetts border.

6. There are three points, which I shall very briefly allude to, that caught my eye in studying the opinion.

One is that the Circuit accepted the idea that, though no securities were bought or sold (with minor exceptions), still the victims had a claim for securities, as reflected in their final statements, because they gave Madoff money to purchase securities. Yet, though victims had a claim for the securities shown in their final statements, the value of those securities was not the value for them shown in the final statements. This has always been Picard’s position, and has always struck me as bizarre. After all, have you ever heard of a person who thought he owned securities because they were shown on his statement but (barring a mistake) has not thought the value of the securities was what was shown on the same statement? As I say, bizarre.

A second point is the alleged concern -- the bill of goods sold to the Second Circuit by the SEC and SIPC in New Times and repeated in Madoff -- that, unless CICO is used, the fraudster will dictate who gets what; in particular he will dictate huge sums for his cronies and will break the SIPC fund. The Madoff case is in itself proof that this is untrue. Madoff’s cronies -- e.g., Levy, Picower, Chais -- have been caught and have been forced already to disgorge huge sums or have been sued for huge sums. Moreover, as I’ve said many times before (but as the Circuit did not care), it has been customary in the financial world for decades to use surrogate measurements to determine what would have been or will be made -- here what would have been made if the deal had been honest.

7. Finally, it must be noted that the Trustee is seeking huge sums from large institutions that should have known Madoff was a fraud because they knew of serious red flags but ignored them in order to reap profits from the Madoff fraud. If the courts allow the Trustee to sue for those sums, and if he wins them at trial or by settlement, then the victims will ultimately be made whole because they will recoup fraud damages from the general estate. The Trustee’s and the Circuit’s denial of net equity, and therefore of a share of customer property, to small victims who have a negative net equity under CICO, will ultimately not deny full recovery to the victims. But, and it is a very big but, for this to occur the courts will have to allow the Trustee to sue the huge institutions for the damages they caused, which at least currently is not looking all that likely after Judge Rakoff’s recent decision on the matter in the HSBC case. Also, the courts would have to agree that the huge banks will be liable if they, as charged, knew of but ignored red flags in service of making profits. How the courts will rule on this question is unknown. And finally, ultimately might be a long time -- it could possibly be years before the Trustee defeats or settles with the large banks (though one hopes for faster results).

(1) At an early point, before the legislative history had been researched, one of the major New York City lawyers told me definitively that it contained nothing helpful. The subsequent research showed the contrary to be true, but the New York lawyers stuck with the doomed statutory argument they had selected early on.

(2) Some such possibly rare cases are currently in litigation.

Amicus Curiae Brief of the Network For Investor Action and Protection

2011-08-18T18:14:00.003-04:00

AMICUS CURIAE BRIEF OF THE
NETWORK FOR INVESTOR ACTION AND PROTECTION

STATEMENT

The Network For Investor Action And Protection (“NIAP”) is a two year old organization with about 1,200 members which arose because of the Madoff debacle and seeks to protect against frauds that victimize investors. It especially seeks to protect small investors, who comprise almost its entire membership.

During the course of its existence, NIAP has been active in both legislative and judicial matters, and was allowed to file amicus curiae briefs in the Second Circuit on the question of net equity. NIAP has had the benefit of study of extensive writings on the economic, financial, legal and political aspects of the Madoff fraud, including the role played by large financial institutions in enabling that fraud.

In this amicus brief NIAP seeks to present its views regarding the question of red flags known to large financial institutions that facilitated Madoff’s Ponzi scheme. The question of red flags is before the Court in this case, and NIAP has a deep interest in the question because, if the Court decides the question, as it may, the decision could have a major impact on cases that will be brought by members of NIAP.

ARGUMENT

Large Financial Institutions, Like JPMC, Which Knew Of Red Flags But Ignored Them In Service Of Reaping Large Profits, Should Not Be Permitted To Escape Liability.

It has long been understood that the Congressional purpose underlying the Securities Investor Protection Act is to protect the small investor and thereby build his confidence in markets. The protection of investors and of the integrity of securities markets was likewise the goal of the 1933 Securities Act and of the 1934 Securities Exchange Act. Congress’ repeated purpose of protecting investors and markets requires that frauds, including Ponzi schemes, be detected and stopped as early as possible, thereby lessening and at times even perhaps eliminating the losses caused by the frauds.

As the Madoff and Stanford cases have taught yet again, we cannot rely solely on governmental and quasi-governmental agencies to detect fraud early-on. The failure of the SEC (once a premier governmental body) and FINRA to detect Madoff’s Ponzi scheme while it grew to be the largest fraud in financial history is proof enough that we cannot rely on government or quasi-government alone. The same is true with regard to the huge Stanford fraud. To stop fraud as early as possible, and thereby protect investors, we must, rather, as in so many other areas of economic and social life, enlist the cooperation and assistance of knowledgeable private professionals who discover the existence or possibility of fraud during the course of their professional work. Again as in so many areas of professional and economic life, we must marry those professionals’ economic interests to the stopping of fraud when they learn of its existence or possibility.

To rely on knowledgeable private parties to root out illegality even though there also are governmental agencies devoted to the same purpose, and to marry the private parties’ economic interests to this, is nothing unusual. It is one of the purposes behind antitrust treble damage suits, behind suits for discrimination in the workplace, and behind whistleblower suits. The principle is as applicable here, in the securities fraud area, as it is there.

The worst possible thwarting of Congress’ goal of protecting investors, especially small ones, would be to do the opposite of marrying professionals’ economic interests to the rooting out of fraud. For such opposite would be to permit professionals to take advantage of known or suspected frauds, including Ponzi schemes, by making large profits from frauds at the expense of unsuspecting innocent investors. When a financially expert institution learns of facts giving rise to the suspicion of fraud, fidelity to the intent of Congress, and fidelity to plain honesty and decency, require the institution to try to determine the truth -- the expert institution is on inquiry notice because it suspects fraud -- and also require the institution to report the unhappy facts to government agencies charged with maintaining honesty in investments -- the SEC, FINRA and state securities commissions -- so that wrongdoers can both be stopped and brought to justice.
The idea that one cannot remain silent and take advantage of a possible problem -- here the idea that large financially expert institutions which learned of facts that, given their knowledge and expertise, should have put them on inquiry notice that Madoff was a fraud and they should not use the Madoff fraud to reap huge profits without investigating the situation first -- is not a new or novel idea in American or English law. For scores or hundreds of years knowledgeable parties have not been permitted to remain silent while making fortunes because of innocent victims. A manufacturer of airplane parts who reasonably suspects possible defects that could cause a plane to crash cannot with impunity sell the parts to an airplane manufacturer without providing notice of the possible defects, and make fortunes from doing so. Rather, the manufacturer must take steps to determine whether the defects exist and must correct them if they do exist. The parts manufacturer who fails to take these remedial steps will be liable to persons (or their heirs) who are injured or killed in crashes caused by the defective parts. The same obtains with regard to the manufacturer or seller of car parts, and with regard to companies which manufacture medicines. To speak of impunity from suit by injured third parties for such culprits would be considered ludicrous. To speak of them as having no duty to foreseeably injured or killed third parties, and as being able to benefit financially to the tune of hundreds of millions or even billions of dollars from their failure to seek to detect the truth and make corrections, is similarly ludicrous, since it is just another way of granting immunity from suit for reprehensible and immoral conduct.

Yet it appears that here, where the same principles are applicable, certain large financial institutions -- which are said to have made enormous sums from or because of Madoff while suspecting that a fraud was in progress -- are claiming that they had no duty to investigate and are not liable to third parties whose injuries were not only foreseeable but were certain to occur at some point. It is also claimed that this is demanded by the banking law of the Second Circuit -- which has never faced a problem of such magnitude as the current one, a problem involving a fraud that is by far the largest in history and was enabled by large banking institutions, the same kind of institutions and sometimes the very same institutions whose reckless conduct caused the current devastating recession.(1) Why these large institutions should be able to make fortunes while evading Congress’ repeatedly implemented desire to protect small investors escapes us. And why these large institutions should escape the principles of duty, investigation and corrective action applicable to, say, manufacturers of airplane or car parts or manufacturers of pharmaceuticals, likewise escapes us. Evasion of responsibility for failure to investigate reasonable and sometimes strongly-held suspicions while making fortunes because of the crime seems to be the result of limitless greed.

The attempted evasion of responsibility for failure to investigate in the face of red flags, while making giant sums because of Madoff’s fraud, is an unconscionable device for enabling the large institutions to escape from liability scot-free. It will cause innocent small investors not to recoup their losses because, without recovery from the culpable institutions which made fortunes while ignoring badges of fraud -- i.e., while ignoring red flags -- the losses of the innocent investors cannot be sufficiently recouped. This untoward, anti-Congressional-intent result is only the more indefensible when one considers the nature of the red flags themselves, all of which -- or nearly all of which – were generally unknown to the small investor, but many of which -- sometimes most or all of which -- were known to the large institutions or investors whose cases have been brought to the District Court for the Southern District by withdrawals of references. So powerful and well known to institutions were these red flags that it is proper to regard the institutions as having actual knowledge that some kind of fraud or illegality was in progress and that its precise nature might very well be a Ponzi scheme. Some of these oft-flagrant red flags apparently were known to all the large professional financial institutions whose cases are now before the District Court for the Southern District, and the Trustee has mentioned most or all of these red flags in complaints and briefs. Others of the red flags, also mentioned by the Trustee, were known to some but not all of these large institutions. But rarely if ever were any of them known to small investors. Here are some of the more important ones that have been talked of since Madoff’s fraud was revealed on December 11, 2008 -- since Madoff got busted, one might say:

1. Because of the amount of money he supposedly was running, the execution of Madoff’s split strike conversion strategy required more options than existed on exchanges or, apparently, in the world. Nor would Madoff identify the supposed counterparties from whom or to whom he supposedly was buying and selling options over the counter.

2. Madoff appeared to have an uncanny, and impossible, ability to buy stocks at their lowest price on a given day and to sell them at their highest price on a given day.

3. Madoff did his own custodial and clearing functions. There was no way to know whether the assets he claimed to be holding really existed.

4. Madoff was extraordinarily secretive: he would not meet with experts who wished to do due diligence, would refuse to respond to crucial questions when he did meet with them, and forbade his feeder funds from mentioning that they had put their money with him.

5. Though the 703 Account at JPMC was supposedly for the purpose of buying and selling securities (by the scores or hundreds of millions of dollars at a time), no money went out of the account to securities dealers from whom stocks would have been bought and no money came into it from securities dealers to whom stocks would have been sold.

6. Though Madoff supposedly was buying and selling huge quantities of stocks, his supposed trading could not be “seen” in the market and never seemed to move the market.

7. Madoff’s accountant was a one-man shop. Nor was it registered with the Public Company Accounting Oversight Board or subject to peer oversight.

8. So called FOCUS reports that Madoff filed with the SEC were false. They vastly understated cash and loans.

9. Wall Street was rife with rumors that Madoff was a fraud -- that he was illegally front running or a Ponzi scheme. People on Wall Street knew of these rumors but kept the rumors to themselves.

10. Family members held the highest positions at Madoff’s firm.

11. Experts were unable to replicate his results.

12. Madoff obtained his compensation in a way that experts found incomprehensible because he left vast sums on the table.

13. Regular transfers of huge sums went back and forth scores of times between Madoff and Norman Levy for no observable business purpose, thus indicating that the 703 fund was being used for some unknown nefarious purpose.

14. Experts though Madoff’s results were too good to be true.(2)

15. Various characteristics of Madoff’s scheme appeared to ape those of other schemes which had been exposed, such as the Petters, Bayou and Refco frauds.

There were other red flags as well as those listed above, but the foregoing list illustrates that there were major badges of fraud, observable to Wall Street experts, which should have resulted in them investigating Madoff’s scheme, refusing to do business with him (as a few did refuse because of suspicions raised by red flags), and blowing the whistle on him to state and federal authorities. In fact, knowledge of particular red flags -- such as the lack of sufficient options to support Madoff’s purported trading, his ability to always sell at a day’s highest price and buy at it’s lowest, the inability to “see” his supposed buying and selling in the market, the failure of monies in the 703 Account to be used to buy securities or to flow in from the sale of securities, and Madoff’s false reporting to the SEC -- were not only badges of fraud that should have resulted in banks refusing to continue doing business with Madoff, but were proof that some form of fraud was in process and that it likely was a Ponzi scheme. Indeed, if one knew the foregoing facts relating to monies in the 703 Account not being used to buy securities and not stemming from the sale of securities, one had to conclude the fraud was a Ponzi scheme.

That the existence of some form of fraud was self evident, or should have been, to financial professionals is reflected in quotations in the Trustee’s amended complaint against J.P. Morgan Chase dated June 24, 2011. The amended complaint quotes one Wall Street figure, “Robert Rosenkranz of Acorn Partners, a fund of funds manager and an investment adviser to high net worth individuals,” as saying that Accorn had performed due diligence on Madoff years before December 11, 2008, and had “concluded [on the basis of only a few of the red flags, not nearly all of them or even half of them] ‘that fraudulent activity was highly likely.’” Trustee’s Amended Complaint Against JPMorgan Chase dated June 24, 2011, pp. 67-68. Acorn had thought that even the relatively few badges of fraud it observed “‘were not merely warning lights, but a smoking gun.’” It had believed “‘that the account statements and trade confirmations [it had managed to get access to] were not bona fide but were generated as part of some sort of fraudulent or improper activity.’” (Id., p. 68.)
The huge financial institutions whose cases have been removed from the Bankruptcy Court to the District Court via withdrawal of references did not do the due diligence which they could have done -- and that a few professionals like Acorn did do --and which their knowledge gave them a duty to do. Instead, for their own massive financial benefit, these institutions, whose cases are now in the District Court, sucked small investors into Madoff’s fraud and/or facilitated the fraud, thus indicating that the Trustee is right when he repeatedly accuses these gigantic companies of forgoing their responsibilities to others in service of making huge sums of money for themselves.

Amici believe that financial institutions which ignored red flags known to them should not be allowed to escape liability, and particularly should not be allowed to escape it by arguing that they have no duty to inquire into the existence of a fraud that would devastate thousands of persons, could thus facilitate the fraud and make hundreds of millions or billions of dollars with impunity from suit, and can be liable only if they had actual knowledge that a fraud was taking place. To allow financial institutions to escape liability to innocent victims if the institutions did not have actual knowledge of fraud here, but only knowledge which they ignored of red flags indicating the possibility of fraud or, as Acorn thought, the virtual certainty of fraud, would be like allowing airplane parts manufacturers to escape liability to victims if they did not have actual knowledge, but only suspected, that there were defects in parts which then caused crashes that killed dozens, scores or hundreds of people. It would be like allowing drug manufacturers to escape liability to victims who are seriously sickened by or die from a drug which the manufacturers only suspected was defective but did not actually know to be defective.(3)

And it would frustrate the Congressional intent to protect investors, particularly small ones -- a Congressional intent repeatedly stated in the Congressional reports and rife throughout the floor debates on SIPA and its amendments. The only way to carry out that Congressional intent in the case of a giant fraud like Madoff’s is to recover ill gotten money from those who facilitated the fraud -- a fraud whose size, devastation and facilitation by huge banking institutions has never before confronted the courts.

Here, as the Trustee has repeatedly said, the efforts of the large institutions whose cases have been withdrawn from the Bankruptcy Court to the District Court -- the large institutions that ignored red flags known to them -- were instrumental in enabling Madoff’s fraud to keep going from about 1999 or 2000 to December 2008 -- to keep going even when Madoff’s Ponzi scheme would otherwise have run out of funds and failed. By enabling the fraud to continue, the large banks’ efforts caused there to be thousands of additional victims, caused a vast increase in the losses of investors who were in Madoff from the 1980s or 1990s and who innocently kept putting in more money or taking out (for living purposes) funds which they thought they had every right to but which the Trustee now seeks to claw back from them, and enabled the institutions to make nearly unimaginable sums of money. The protection of small investors envisioned by Congress, and fundamental long-standing principles of law long applicable to large companies, require that the culpable institutions here be liable to recompense the innocent investors, who sometimes are people of advanced age, and whose finances were blasted or destroyed by a fraud which the institutions greatly facilitated for their own multibillion dollar benefit.(4)

(1) The claim being made about what allegedly is demanded by Second Circuit banking law is very dubious at best. The subject is discussed in Lerner v. Fleet Bank, 459 F.3d 273 (C.A. 2, 2006).

(2) To the unsophisticated small investor, Madoff’s results seemed explicable for several reasons. There were highly successful mutual funds which made more than he did over 10 and 15 year periods. His investment results also were no better than and sometimes were below, even far below, the amounts made by recognized investment leaders like Bill Miller of Legg Mason, who finished ahead of the S&P for fifteen straight years, Warren Buffett, Bill Gross of PIMCO, Julian Robertson and George Soros. These people were (and are) recognized as having unusual financial acumen, and to small people there was no apparent reason why Madoff wasn’t another such individual. As for the consistency of his returns, and the sparse periods of losses, this seemed plausible to average investors because Madoff did not seek large gains but only small incremental gains, which is a technique for avoiding losses, and, very importantly, he supposedly bought options that provided downside protection. Not to mention that his technique appeared to conform to Warren Buffett’s three well known (and oft proven right) rules for investment success: (1) Don’t lose money. (2) Don’t lose money. And (3) never forget rules 1 and 2. Experts on Wall Street, however, regarded Madoff’s results as inexplicable and too good to be true, but kept their opinions largely to themselves and certainly did not make their opinions public, so small investors never knew of them.

(3) Just as is true in the examples regarding defects known to parts or drug manufacturers, whether any particular financial institution had enough knowledge of red flags to be culpable is a question for the trier of fact. Our point is simply that the financial institutions, like manufacturers, cannot automatically escape from liability, as they are attempting to do.

(4) The principles concerning red flags set forth in this amicus brief are applicable regardless of whether a lawsuit is permissibly brought against a large financial institution by the Trustee in order to recoup money for investors or is brought by the investors themselves. Whether the Trustee can permissibly bring third party claims to obtain money for investors is an issue that is currently before the Court. As the Court knows, the Trustee lost on this issue before Judge Rakoff.

2011-06-22T10:32:00.001-04:00

AMICUS CURIAE BRIEF OF LAWRENCE R. VELVEL ON THE APPLICATION HERE OF THE SUPREME COURT CASES --FROM TUMEY v. OHIO TO CAPERTON v. MASSEY COAL -- THAT BAR GOVERNMENTAL LEGAL DECISIONS FROM BEING MADE BY PERSONS WITH A FINANCIAL INTEREST IN THE DECISIONS.

STATEMENT

Lawrence R. Velvel is a victim of Bernard Madoff. Velvel, who is a lawyer, has participated in the briefing on the net equity question (and other questions) in the Bankruptcy Court in the Madoff case, and has filed two briefs on his own behalf on the net equity question in the Second Circuit Court of Appeals. In this amicus brief, Velvel elaborates the question -- raised on pages 15-17 of the motion for a withdrawal of reference filed by Helen Chaitman on behalf of James Greiff and others -- of the applicability to the question of the Trustee’s fees of the Supreme Court’s line of cases running from Tumey v. Ohio, 273 U.S. 510 (1927) to Caperton v. Massey Coal Co., Inc., 556 U.S. ___ (2009). The applicability of this line of constitutional law further supports the withdrawal of the reference sought by Ms. Chaitman.

ARGUMENT

1. Introduction: Due Process Requires That Legal Judgments Must Be Made By Officials Who Do Not Benefit Financially From Their Decisions.

It is a fundamental principle of due process that, when a legal judgment is made by a judicial, executive, administrative or quasi-governmental official, that official must not benefit financially from the decision. Nor can there be financial benefit to a governmental institution or function under the official’s purview. This principle of due process has been powerfully enunciated by the Supreme Court in Tumey v. Ohio, 273 U.S. 510 (1927); Ward v. Village of Monroeville, 409 U.S. 57 (1972); Gibson v. Berryhill, 411 U.S. 564 (1973); Aetna Life Insurance Co. v. Lavoie, 475 U.S. 813 (1986); Caperton v. Massey Coal Co., Inc., 556 U.S. ___, 129 S. Ct. Rep. 2252, 173 L.Ed. 2d 1208 (2009). The principle of no financial benefit, the Court has repeatedly said, is necessary in order to ensure that “the balance [is held] nice, clear and true.” Tumey, 273 U.S. at 532; Caperton, 556 U.S. at ___, 129 S. Ct. at 2260, 173 L.Ed. 2d at 1218 (quoting Tumey v. Ohio).

In this case Irving Picard is the Bankruptcy Trustee, the SIPC Trustee and a special master appointed by the Department of Justice to distribute billions of dollars forfeited to it by Carl Shapiro and Jeffry Picower. In these capacities he is an officer of the Bankruptcy Court (as has been explicitly held by the Supreme Court with regard to the position of Bankruptcy Trustee) (Callaghan v. Reconstruction Finance Corp., 297 U.S. 464, 468 (1936)), a functionary of the Department of Justice, and exercises governmental and quasi-governmental power to make and/or participate in legal decisions that affect thousands of people and involve literally billions of dollars, e.g., initial decisions on how net equity shall be defined and from whom clawbacks shall be demanded.

Unfortunately, it has recently been discovered that the Trustee, and perhaps also his counsel, David Sheehan, with whom he works very closely, may benefit personally and financially, to the tune of millions of dollars, perhaps scores of millions of dollars, from the decisions the Trustee makes and implements. (The amounts of money involved here dwarf the amounts in the Supreme Court’s cases.) Though it is already pretty certain (as will be described below) that financial benefits will accrue to the Trustee from the decisions he makes (and may accrue to his colleague David Sheehan also), the precise details of the relevant financial arrangements under which the Trustee will receive major financial benefits are still not known. There must be discovery to flesh out the precise details of the arrangements; plaintiff will subsequently discuss and request the needed discovery.

2. The Supreme Court Cases Holding That Legal Decisions Cannot Be Made By Persons Who Will Benefit Financially From Them.

In Tumey v. Ohio, a village mayor had the power to try and fine persons accused of possessing intoxicating beverages in violation of state law. The mayor himself received a portion of the fines; he received $696 dollars in fees, compensation and costs from such fines in an eight month period. The Supreme Court ruled this system unconstitutional. Pointing out that such a pecuniary interest rendered it unconstitutional for the mayor to decide on the defendants liability, the Court also said, “With his interest as mayor in the financial condition of the village and his responsibility therefore, might not a defendant with reason say that he feared he could not get a fair trial or a fair sentence from one who would have so strong a motive to help his village by conviction and a heavy fine?” Tumey, supra, 273 U.S. at 533.

In Ward v. Monroeville, supra, a village mayor determined guilt or innocence in cases of alleged traffic violations and imposed fines and costs on parties he convicted. Roughly forty percent of the village’s annual income (or between $16,000 and $23,000 per year) came from the fines and costs he imposed. (Unlike in Tumey, the mayor did not himself receive any money; it all went to Monroeville.) The Supreme Court ruled this system unconstitutional too, saying that the fact the mayor in Tumey had “a direct, personal, substantial pecuniary interest” and “shared directly in the fees and costs did not define the limits of the principle” forbidding legal decisions from being made by interested parties. Ward v. Monroeville, 409 U.S. at 60. Rather, the Court said, there must be no “possible temptation to the average man” that “might lead him “not to hold the balance nice, clear and true . . . .” Ibid. “Plainly,” said the Court, “that ‘possible temptation’ may also exist when the mayor’s executive responsibilites [sic] for village finances may make him partisan to maintain the high level of contribution from the mayor’s court.” Ibid.

The Court also rejected the argument that the arrangement at issue should be upheld because, after the mayor’s decision, an erroneous decision “can be corrected on appeal and trial de novo in the County Court of Common Pleas.” 409 U.S. at 61-62. The Court said, “Nor, in any event, may the State’s trial court procedure be deemed constitutionally acceptable simply because the State eventually offers a defendant an impartial adjudication. Petitioner is entitled to a neutral and detached judge in the first instance.” 409 U.S. at 61-62. (Emphasis added.)

In Gibson v. Berryhill, a state Board of Optometrists, comprised exclusively of optometrists in private practice for their own account, was going to hold hearings against optometrists employed by a corporation. The charge was that Alabama law was violated when practicing optometrists worked for a corporation. The Supreme Court upheld a lower court decision that the Board members were biased by personal self interest because half the optometrists in the state were employed by corporations, so that “success in the Board’s efforts would possibly redound to the personal benefit of members of the Board” (who were, as said, in private practice for their own account, and would benefit from elimination of competition from optometrists employed by corporations). 411 U.S. at 578. “It is sufficiently clear from our cases,” continued the Court, that those with substantial pecuniary interest in legal proceedings should not adjudicate these disputes. Tumey v. Ohio, 273 U.S. 510, 47 S.Ct. 437, 71 L.Ed. 749 (1927). And Ward v. Monroeville, 409 U.S. 57, 93 S.Ct. 80, 34 L.Ed.2d 267 (1972), indicates that the financial stake need not be as direct or positive as it appeared to be in Tumey. It has also come to be the prevailing view that ‘(m)ost of the law concerning disqualification because of interest applies with equal force to . . . administrative adjudicators.’ K. Davis, Administrative Law Text s 12.04, p. 250 (1972), and cases cited. (411 U.S. at 479.)

Here again the fact that the aggrieved parties could receive a favorable decision from a higher Alabama body than the Board (from the state Supreme Court) did not warrant a refusal by the lower court to adjudicate the case. 411 U.S. at 580.
In the fourth of the cases, Aetna Life Insurance Co. v. Lavoie, a state Supreme Court Justice named Embry participated in and wrote a per curiam opinion in an insurance bad faith case whose outcome affected, and aided, a wholly separate case filed by Justice Embry against Blue Cross. (Judge Embry later settled his own litigation for $30,000. (475 U.S. at 824.)) The Supreme Court ruled that Justice Embry’s work in the Aetna case “undoubtedly ‘raised the stakes’” for Blue Cross in Justice Embry’s own suit, “to the benefit of Justice Embry. Thus, Justice Embry’s opinion for the Alabama Supreme Court had the clear and immediate effect of enhancing both the legal status and the settlement value of his own case,” and he unconstitutionally “acted as a ‘judge in his own case.’” 475 U.S. at 824.

Whether Judge Embry’s view and decision in Aetna was actually influenced by his own case was irrelevant. The Court said:

We conclude that Justice Embry’s participation in this case violated appellant’s due process rights as explicated in Tumey, Murchison, and Ward. We make clear that we are not required to decide whether in fact Justice Embry was influenced, but only whether sitting on the case then before the Supreme Court of Alabama” ‘would offer a possible temptation to the average … judge to … lead him to not to hold the balance nice, clear and true.’” Ward, 409 U.S., at 60, 93 S.Ct., at 83 (quoting Tumey v. Ohio, supra, 273 U.S., at 532, 47 S.Ct., at 444). (475 U.S. at 825.)

Finally, less than two years ago the Supreme Court decided Caperton v. Massey Coal Co., Inc., 556 U.S. ____, 129 S. Ct. at 2252, 173 L.Ed. 2d 1208 (2009). In that case the Chairman of Massey Coal contributed a major sum of money -- three million dollars -- to the campaign of a candidate running for a justiceship of the West Virginia Supreme Court, Brent Benjamin. Benjamin won. Shortly afterwards, a major appeal by Massey Coal was heard in the West Virginia Supreme Court. Massey won. Justice Benjamin voted in its favor.

Justice Benjamin said in several opinions that he had no direct or substantial financial interest in the case. 556 U.S. at ___, 129 S. Ct. at 2262-63, 173 L.Ed. 2d at 1221. The Supreme Court nonetheless reversed the decision below in favor of Massey Coal.

The Court said that the rule against pecuniary interest exists because ‘“no man is allowed to be a judge in his own cause’” and “because his interest would certainly bias his judgment, and, not improbably, corrupt his integrity.” 556 U.S. ___, at 129 S. Ct. at 2259, 179 L.Ed. 2d at 1217, 1218. There are circumstances, it continued, “in which experience teaches that the probability of actual bias on the part of the judge or decisionmaker is too high to be constitutionally tolerable.” Ibid. (Emphasis added.) The Court then canvassed, among others, the Tumey, Ward, Gibson and Aetna cases, among others, saying inter alia that it was concerned not just with pecuniary interest, but also with adherence to neutrality (556 U.S. at ___, 129 S. Ct. at 2261, 173 L.Ed. 2d at 1218) and that it was necessary to avoid even “‘possible temptation.’” (Ibid.) (Emphasis added.) Thus, it is not necessary to decide whether influence is in fact present, because it is enough that there could be possible temptation. 556 U.S. at ___, 129 S. Ct. at 2260, 173 L.Ed. 2d at 1218.

Turning to the facts of the case before it, the Court did not question the assertions of impartiality and propriety in Justice Benjamin’s opinions. 456 U.S. at ___, 129 S. Ct. at 2263, 173 L.Ed. 2d at 1221. Rather it “asked whether, ‘under a realistic appraisal of psychological tendencies and human weakness,’ the interest ‘poses such a risk of actual bias or prejudgment that the practice must be forbidden if the guarantee of due process is to be adequately implemented.’” 456 U.S. at ___, 129 S. Ct. at 2263, 179 L.Ed. 2d at 1222. The Court “conclude[d] that there is a serious risk of actual bias -- based on objective and reasonable perceptions -- when a person with a personal stake in a particular case had a significant and disproportionate influence in placing the judge on the case by raising funds or directing the judge’s election campaign when the case was pending or imminent.” 456 U.S. at ___, 129 S. Ct. at 2263-64, 173 L.Ed. 2d at 1222.

The risk of possible bias, said the Court, is a question of the circumstances. The Court recognized that “Not every campaign contribution by a litigant or attorney creates a probability of bias that requires a judge’s recusal, but this is an exceptional case.” 456 U.S. ___, 129 S. Ct. at 2263, 173 L.Ed. 2d at 1222 The large size of the contribution (three million dollars), the fact that it was 300% larger than the amount spent by Benjamin’s campaign committee and “eclipsed the amount spent by all other Benjamin supporters,” the fact that the contribution was made when Massey’s forthcoming appeal to the West Virginia Supreme court would be before Judge Benjamin if he were elected to that court, and the fact that Massey’s Chairman had a personal stake in the case caused there to be a violation of due process when Judge Benjamin sat on the case, even though there would be no such violation in a run of the mill case of contributions to a judge’s election campaign. Thus “under all the circumstances” of the case -- which were exceptional, as was also true in some prior cases where the Constitution required recusal -- due process required the recusal of Judge Benjamin lest there be temptation ‘“not to hold the balance nice, clear and true.’” 456 U.S. at ___, 129 S. Ct. at 2263-65, 173 L.Ed. 2d at 1222, 1223-1224.

The risk of actual bias, the Court reiterated, is not the test. 456 U.S. at ___, 129 S. Ct. at 2265, 173 L.Ed. 2d at 1224. The relevant “standards may also require recusal whether or not actual bias exists or can be proved.” Id. (Emphasis added.) There must be no “possible temptation” not to hold the balance nice, clear and true. Id.

* * * * *

The Supreme Court has thus ruled that decisonmakers of many types, from judges to members of boards to political figures making legal decisions, can have no financial interest in their decisions. This is so whether the decisionmakers will receive money themselves, whether money will go to their agencies or towns, whether they will shed themselves of competition. It is true across the board. There need not be proof of actual bias, for even possible temptation, possible bias, must be avoided. Nor need there be giant sums of money involved. Far smaller sums such as hundreds of dollars, or $20,000 dollars, are sufficient to involve the principle of no financial interest.

3. The Trustee Appears To Have A Vast Financial Interest In His Legal Decisions.

A. For a couple of years very little if anything was known about how Irving Picard came to be the SIPC Trustee in the Madoff matter, or what his arrangements with his law firm, Baker & Hostetler, might be with regard to Madoff. It did become known that Picard was SIPC’s number one Trustee, its “go to guy” so to speak, who had been appointed the SIPC Trustee in ten or so cases over the years, including some of SIPC’s most important ones, and that he had been criticized by a federal court for overzealousness in pursuing SIPC’s interest. But the details of Picard’s arrangements with Baker & Hostetler regarding the Madoff case remained in the dark.

In 2011 a New York Times financial reporter, Diana Henriques, published a book on the Madoff case in which she shed some light on the hiring of Picard. Henriques, The Wizard of Lies, Henry Holt & Co., 216-218 (NY, 2011).

On December 11, 2008, the date Madoff was arrested, Picard had been a partner for many years in the Gibbons Del Deo firm. One of his partners there had been David Sheehan, with whom Picard had worked on many brokerage liquidations but who had recently moved to Baker & Hostetler. Sheehan and Picard had discussed a possible move to Baker & Hostetler by Picard, and planned to discuss it further after January 1, 2009 (more than three weeks after the Madoff fraud was disclosed on December 11, 2008). Ibid.

On Thursday, December 11th SIPC called Picard to ask whether he could be its Trustee in the Madoff case if necessary. Picard said he would check to see if the Gibbons firm had any conflicts. Also, at some point between Thursday, December 11 and Sunday, December 14th (Henriques does not make clear exactly when), SIPC asked Sheehan if he would be counsel to whomever was appointed Trustee. Ibid.

The Gibbons firm did have a potential conflict because it had long represented the family and interests of Senator Frank Lautenberg, who were Madoff victims, and it might represent them again in the Madoff case. A statement by a Gibbons partner led Picard to believe he had to choose between becoming the Trustee in the Madoff case and remaining at Gibbons. Ibid.

On Sunday afternoon, December 14, just three days after Madoff had been arrested on Thursday, December 11, a group of Baker & Hostetler partners interviewed Picard and immediately offered him a job. On Monday, December 15, the next day, he accepted Baker & Hostetler’s offer, resigned from Gibbons, and was appointed Trustee by Judge Stanton. Ibid.

Thus, according to Henriques’ book, Baker & Hostetler made an instantaneous decision to hire Picard after the Madoff fraud was disclosed and he had been given to understand that he might be the Trustee, and Picard instantly accepted Baker & Hostetler’s offer and resigned from the Gibbons firm.

B. Subsequent to Picard’s appointment as Trustee, he long gave people to believe that he would not receive any portion of the fees awarded to Baker & Hostetler in the Madoff proceeding. Thus at the hearing on his first interim fee application, he said:

As noted at paragraph 33 of my application and contrary to the implication of certain objections that have been filed with the Court and before the press, the amounts that will be awarded either today or at another time are going to be turned over to Baker & Hostetler, the firm of which I am a partner. I want to emphasize I will not retain any portion of the award. Transcript of August 6, 2009, p. 14, annexed as Exhibit I to Helen Chaitman’s Declaration in Support of her Motion of June 2, 2011for 313 Defendants Seeking Withdrawal of the Reference. App., infra, p. 6. (Emphasis added.)

In recent weeks, however, it has become known that Trustee Picard -- and perhaps his counsel David Sheehan also -- appears to have reached an arrangement with Baker & Hostetler under which he will obtain a percentage of the fees garnered in the Madoff case by Baker & Hostetler. A prominent lawyer for Madoff victims, Helen Chaitman, reported that a lawyer friendly with Picard informed her that Picard said his deal with Baker & Hostetler was that he would receive 50 percent of the fees taken in by the firm in the Madoff case. To no avail Chaitman informed the Bankruptcy Court by letter of May 31, 2001 that Picard might be receiving between 33 and 50 percent of the fees obtained by Baker & Hostetler. (App., infra, p. 7.) The next day, at a hearing before Bankruptcy Judge Lifland, Mr. Sheehan lambasted Ms. Chaitman for raising the matter (Tr. of Hearing of June 1, 2011, pp. 28-29 (App., infra, pp. 11-12.)), said her allegations reflected ignorance of law firm economics, and said that under her claims Baker & Hostetler would be “getting zero.” (Tr. of Hearing, pp. 28, 29, (App., infra, pp. 11-12.)) Trustee Picard then accused Ms. Chaitman of making an “unfounded allegation about my compensation” and said “She is way off the mark. I don’t receive any percentage near thirty-five or fifty percent.” (Tr. of Hearing, p. 32 (App., infra, p. 13.)) When Ms. Chaitman rose to address the Court, Judge Lifland lambasted Ms. Chaitman for raising the matter, and he did so again at the end of the hearing. (Tr. of Hearing, pp. 39, 46-48 (App., infra, pp. 15, 16-18.))

Regardless of the criticisms levied at Ms. Chaitman by Sheehan, Picard and Judge Lifland, it appears that Picard implicitly admitted that he is receiving some percentage of the fees obtained by Baker & Hostetler. That is the plain implication of Picard’s statement to the Bankruptcy Judge that Ms. Chaitman’s claim that he receives 33 to 50 percent of Baker & Hostetler’s fees “is way off the mark. I don’t receive any percentage near thirty-five or fifty percent.” Well, what percentage does he receive? Even a “mere” ten percent would be worth in nearly 18 million dollars already and likely would ultimately be worth several score of millions of dollars.

The percentage Picard receives, and the percentage that Sheehan possibly receives, are not known. There must be discovery to determine such details of the arrangements between Picard and Baker & Hostetler (and Sheehan and Baker & Hostetler too). For Picard, aided by Sheehan, is participating in very unusual governmental and quasi-governmental decisions that are denying a total of billions of dollars to thousands of people. He may even be making these unusual decisions by himself if certain statements made by the Chairwoman of the SEC and the President of SIPC (and cited in Helen Chaitman’s Memorandum In Support of Withdrawal of the Reference, at p.16) are to be believed. (Picard, of course, denies this.) The decisions he has been making have already included such crucial ones as the decision to measure net equity by cash-in/cash-out (CICO) instead of by the final statement method (FSM) though this has never or almost never been done previously in hundreds of SIPC cases, and the decision to seek clawbacks from hundreds or thousands of persons whom the Trustee concedes are completely innocent, even though this too apparently has never been done before in SIPC cases. These two unusual decisions alone have and will continue to produce scores of millions of dollars in fees for Baker & Hostetler because they reduce the money SIPC owes to innocent investors (by billions of dollars), increase the monies the Trustee will get from innocent investors (again by billions of dollars), are therefore being fought tooth and nail by innocent investors, some of whom are employing major law firms, and are thus running up, by scores of millions of dollars, the fees obtained by Baker & Hostetler in carrying out Picard’s decisions and, accordingly, are likewise vastly running up the amount of such fees to be turned over to Trustee Picard and perhaps to David Sheehan. Had the Trustee not decided, very unusually, to use CICO and demand clawbacks, the fees received by Baker & Hostetler, and thus by the Trustee under his agreement with Baker & Hostetler, would have been incomparably lower -- one might estimate as much as 60 or 80 percent lower.

What we have here, then, is not a run of the mill SIPC case in which a law firm for which a Trustee has worked for years will make somewhat more or somewhat less depending on the vagaries inherent in any SIPC liquidation. Rather, what we have here, as existed in Caperton and in cases it cited on the point, is an exceptional situation. It is a situation in which the Trustee changed law firms in order to get the case, apparently received extraordinarily lucrative financial arrangements from his new firm, and then made or participated in making very important and perhaps wholly novel legal decisions which have increased not only his new firm’s fees by scores of millions, but also his own compensation too by, apparently, tens or scores of millions of dollars that will be turned over to him by the firm. In these exceptional circumstances, the fact that, in the run of the mill SIPC case, a firm’s fees will fluctuate with the vagaries of the case is irrelevant, just as in Caperton it was irrelevant that in most cases there will be nothing wrong with the fact that lawyers contribute to judges’ election campaigns. In an exceptional case like this one there is a violation, in a wholesale way, of the principles, established in the Tumey through Caperton line of cases, that a governmental decisionmaker should not have a financial interest in his decisions; that even the possible temptation created by such an interest cannot be countenanced, so that it is not necessary to determine whether personal financial interest was or was not the spring of action; and that the legal decisions made by persons with such an interest cannot be allowed to stand lest adversely affected individuals believe they have been victimized by the decisionmakers -- which is precisely what hundreds or thousands of persons defrauded by Madoff believe has been their fate at the hands of the Trustee.

4. The Trustee’s Arguments Against Application Of The Tumey-Caperton Line Of Cases Are Invalid.

There are a number of arguments the Trustee self evidently can be expected to make in opposition to application of the Tumey-Caperton line of cases. He mentioned two of them in passing before Bankruptcy Judge Lifland at the hearing on June 1, when he said “I am not a decisionmaker for SIPC. And I am not a quasi-governmental agency or act in a quasi-governmental capacity.” (Tr. of June 1, 2011, pp. 32-33 (App., infra, pp. 13-14.))

To begin with the Trustee is not just the SIPC Trustee but is conjointly the Bankruptcy Trustee. His demands for clawbacks are made as Bankruptcy Trustee under provisions of the Bankruptcy Code. As Bankruptcy Trustee, Mr. Picard is not a “mere” quasi-governmental body; he is, rather, an officer of the Court -- a full fledged governmental figure. As ruled by the Supreme Court, “Trustees in bankruptcy are public officers and officers of a court.” Callaghan v. Reconstruction Finance Corporation, 297 U.S. 464, 468 (1936).

The same would appear to be true of the Trustee in his capacity as SIPC Trustee, under which he made or participated in the extraordinarily unusual decision to define net equity by the CICO method rather than by the final statement method. For here too he was appointed by the Court in exactly the same way as he was appointed Bankruptcy Trustee, at exactly the same time, to fulfill functions which, just like the bankruptcy provisions he enforces as Bankruptcy Trustee, are imposed by federal statute.

If the Trustee were not a full fledged governmental officer, he would at minimum be a quasi-governmental officer. For he was selected by, is paid by, and works on behalf of a quasi-governmental body, SIPC. SIPC’s quasi-governmental character was stressed in a report by the highly regarded Congressional Research Service.

The CRS explained several reasons why SIPC is a quasi-governmental body.
Of the seven-member board of directors, one is appointed by the Secretary of the Treasury from among the Department’s officers and employees; one is appointed by members of the Federal Reserve Board from among its officers and employees; five directors are appointed by the President subject to the advice and consent of the Senate. The President designates the chairman, who is also the corporation’s chief executive officer.

(Report, p. 20 (App., infra, p. 20.)) The CRS further said in regard to SIPC’s quasi-governmental nature that SIPC is “effectively a subsidiary of the SEC. The Corporation’s bylaws are subject to the SEC’s adoption or rejection . . . . [T]o the extent that the bylaws and rules of the SIPC are approved or disapproved by the SEC, they are subject to the Administrative Procedure Act (5 U.S.C. 551 et seq.). The corporation also has borrowing authority and a line of credit from the Treasury.” Id.

SIPC, said the CRS, is “a hybrid organization” created “to implement government policies and regulations. Ultimately, the SPIC (sic) and the PCAOB are agents of and accountable to the government through the SEC.” (Id.) (Emphasis added.)

Thus, the Trustee, who is selected by an agent of the government, paid by an agent of the government, works on behalf of this agent, by his own repeated admission seeks to protect the finances of this agent of the government, and makes or participates in making the legal decisions for this agent of the government, is at minimum a quasi-governmental functionary.

In further denial of quasi-governmental status, the Trustee, as said, stated in open court on June 1 that “I am not a decision maker for SIPC.” (Tr. of Hearing, p. 32. (App., infra, p. 13.)) Given his exceptionally prominent role for 2½ years in the Madoff case, his announcement and vigorous implementation of highly unusual policies, and statements by SIPC and SEC officials stressing the importance of his role, the idea that the Trustee does not make, or at minimum participate extensively and importantly in, decisions which carry out SIPC’s role appears ludicrous on its face. If the Trustee seriously wishes to maintain this facially ludicrous position, there must be discovery into the way that decisions (such as those involving net equity and clawbacks) have actually been made in this case, and this Court should order the necessary discovery.

The Trustee is also likely to claim that he is not subject to the Tumey-Caperton line of cases because others, particularly including courts, review his decisions. But this reasoning has been rejected twice by the Supreme Court, in Ward v. Monroeville (409 U.S. at 61-62) and Gibson v. Berryhill (411 U.S. at 580). Thus, in Ward the Court said that the fact the mayor’s decision on violations “can be corrected on appeal and trial de novo in the County Court of Common Pleas” did not make the system of mayoral trials constitutional “because the State eventually offers’” an impartial adjudication.” Rather, the defendant was entitled “in the first instance” to a decisionmaker who was “neutral and detached.” 409 .S. at 61-62.

In the Madoff case, decisions of the most enormous consequence -- and often wholly destructive financial consequence -- to thousands of individuals have been made and implemented by the Trustee. These decisions were not made by a person who is “neutral and detached,” but by a person who stood to make tens or scores of millions of dollars because of the decisions. As the Supreme Court said, this cannot be justified on the ground that erroneous decisions could be corrected later by courts (after individuals have been devastated for years -- sometimes rendered penniless -- by the Trustee’s decisions).

Relatedly, the Trustee is very likely to claim that the Tumey-Caperton line of cases must be confined to situations in which persons are acting as judges in some way, and that he is not doing so. This is not a tenable position. The essence of the Supreme Court’s line of cases is that governmental legal decisions must be made by persons who do not have a financial stake in the decisions. That is why the Supreme Court has repeatedly stressed that the principle of no financial interest extends beyond direct sharing in fees and costs, extends even to quite small financial interests, and is intended to insure there is no “possible temptation to the average man” that “might lead him not to hold the balance nice, clear and true.” The principle of no financial interest is a principle of clean government (of government that is different from many of those we deal with elsewhere in the world, e.g., the Middle East). Were the principle confined to those acting as a judge, then, for example, a city solicitor could permissibly make a legal ruling (e.g., a decision on real estate matters) because he or she would receive extensive financial benefit from the ruling but not from a contrary one, or an attorney general, state or federal, could take one legal position rather than another because he or she would benefit financially from the one taken but not from the one rejected. This is simply not an admissible interpretation of the Tumey-Caperton line of cases, since it would allow governmental legal decisions to be made by and in the interests of the financially interested, often to the detriment of large numbers of citizens, as in the Madoff case.

CONCLUSION

Though discovery is needed to fully flesh out the Trustee’s financial arrangements with Baker & Hostetler in regard to the Madoff case, enough is known already to make it appear that the Trustee’s arrangements put him in serious violation of the Tumey-Caperton line of cases. Because of the violation, the Trustee cannot be allowed to continue in the case, nor can the law firm which fostered the violation for its own financial benefit remain in the case. (With regard to its financial benefit, one notes that its fees thus far are between 175 and 180 million dollars, and are expected to eventually total somewhere in the neighborhood of a billion dollars.) The Trustee and the firm are tainted by the violations they fostered.

As well, the decisions of the Trustee must be revisited by a new and completely independent Trustee, so that the crucial decisions in the case will be made by an official who does not have a financial interest in them. The one exception to revisiting the decisions may ultimately be the decision to use CICO. That decision was argued in court by the Trustee mainly on the basis that CICO was permissible, not that it was mandatory. But at times there were overtones of mandatoriness. If the Second Circuit were to rule that either CICO or the FSM are mandatory, then the Trustee’s decision for CICO could not be revisited by a new Trustee. But if the appeals court were to rule that a Trustee is free to use either CICO or the FSM at his or her discretion, then the decision for CICO should be revisited by a new, independent Trustee because he or she might decide differently than did the present Trustee, who will benefit personally to the tune of millions or scores of millions of dollars from the decision to use CICO.

Finally, this Court should order discovery into the financial arrangements between the Trustee and Baker & Hostetler, and, if the Trustee continues to deny his decisiomaking role, into the process of decisonmaking involving the Trustee and SIPC.

Respectfully submitted,
Lawrence R. Velvel, Esq.

Dated: June 17, 2011

Discursive Comments On The Oral Argument In The Court of Appeals In The Madoff Case On March 3, 2011. Part 5.

2011-04-04T13:05:00.001-04:00

April 4, 2011

Discursive Comments On The Oral Argument In The Court of Appeals
In The Madoff Case On March 3, 2011.

PART 5

Next up was Helen Chaitman for rebuttal. Before detailing her argument, let me describe some events that preceded the oral argument.

As said at the beginning of this essay, the question of who would argue for us was very contentious. Roughly two or two and one-half weeks before the oral argument, Helen asked me whether I would give up to her any claim I possessed to time to argue. I said I would be happy to do so if, as part of her presentation, she would agree to give a short oral argument on legislative intent that I had drafted and, on February 4th, had sent to the controlling group of NYC lawyers who were running the show. Helen agreed to this, and I notified the NYC group of our agreement. And, since legislative intent has been spoken of so much here, let me now set forth the draft argument that I wrote on this subject. Barring interruptions, the argument takes between three and four minutes to deliver orally. (Our side had a total of 20 minutes.)

The legislative history is dispositive in favor of the appellants. For the hearings, the reports and, very importantly, the scores of floor statements on the 1970 Act and the 1978 Amendments reveal Congressional intent completely at odds with the use of CICO. These Congressional statements, particularly the scores of statements on the floor which the Trustee, SIPC and the Court below do not mention, repeatedly make clear:

• That the purpose of SIPC is to protect small investors -- who are here being devastated even when innocent;

• By protecting small investors, confidence and investment in markets were to be built;

• That the reasonable expectations of investors are to be satisfied;

• That account statements and confirmations are the measure of reasonable expectations and net equity, especially because the change to holding securities in street name left investors no other way to know their holdings;

• That investors are to be paid promptly, which is inherently impossible under CICO because of the need to reconstruct complex accounts over many years;

• That investors are to receive securities where they can be acquired in a fair and orderly market, as can be done here where the securities are S&P 100 stocks that can be acquired in blocs over time. SIPC ignores this requirement, though it was a “principal purpose” and “essential feature” of the 1978 amendments;

• That investors are to be protected against theft, which occurred here on a massive scale;

• That SIPA creates an insurance program modeled after the FDIC. Here counsel for the Trustee has stated that Senators who made this point did not know what they are talking about, saying “They are wrong . . . .”

The legislative history comprised of scores of statements on the floor revealing Congressional intent are nowhere cited by the Trustee, SIPC or the SEC. Yet the statements were by many of the leading Senators and Congressmen of the 1960s through the 1980s: by two men who ran for President, Senator Muskie and Congressman John Anderson, by legislators prominent with regard to economic, financial and tax matters, such as Senators Cranston, Harrison Williams, and Proximire, and Congressman Rostenkowski, and by other leading legislators such as Senators Hartke and Bennet and Representatives Staggers, Eckhardt, Moss and Boland. Identical statements were made by President Nixon and Secretary of the Treasury Kennedy.

The statements of the Senators and Representatives cannot be ignored without substituting the intent of SIPC and the Trustee for the intent of Congress. For the actions and desires of SIPC and the Trustee are antithetical to the points made by leading Senators and Congressmen (as well as by President Nixon and Secretary Kennedy). Little wonder SIPC and the Trustee never mention the statements of Senators and Representatives.

For the convenience of this Court, the relevant statements in the hearings, in the Congressional reports, and on the floor of the House and Senate are collected in the brief of Appellant Lawrence Velvel, with the relevant pages set forth in their entirety in the Addendum to his brief.

In conclusion, let me add that the decision below was a summary judgment on which no discovery from SIPC or the Trustee was allowed even when crucial discovery was requested and would have been followed by further crucial discovery. Examples are discovery on whether a deficiency of money in the SIPC fund was one reason for the use of CICO notwithstanding its ravaging of Congressional intent, and discovery on why investors’ accounts were not credited with at least half a billion dollars of earnings from short term Treasuries and money market funds. The decision below must be reversed because of a denial of all discovery even were the decision otherwise to be upheld.

As made clear many times in this essay, I think the foregoing argument on legislative intent is the key to this case. Others don’t, including, I believe, two of our oral advocates. The argument was not delivered.

What happened, I at least believe, was this: It was finally decided who the advocates for our side were going to be. After hearing about a moot court held on March 1st, and that Helen was doing the rebuttal, I wrote the group to express my best wishes and to say that, although Helen told me she would make the points about the legislative history on rebuttal if at all possible, I knew that this might not prove possible due to the unforeseeable exigencies of rebuttal, and that I hoped the legislative history would be presented by one of our other two advocates. It wasn’t. And because of the exigencies of rebuttal, where she had to fill a lot of holes, Helen, who had only six minutes if I remember correctly, had no time to present it on rebuttal either.

So, in short, I agreed to a deal which was not carried out because other advocates were not, I think, enamored of the point and, Helen, being the “rebuttalist” and having to desperately try to fill holes, had no time to carry it out. If any of this is wrong, I am willing to stand corrected.

But what I do hope is wrong is my view that the legislative intent is the key to winning the case, a view I believe not shared by certain colleagues, and that was not presented to the Court. One can only hope that we win without having presented the legislative history to the Court (except for a very few comments made by Helen Chaitman on the run so to speak (because she lacked time).

Let me turn now to Chaitman’s rebuttal argument. She began by saying she represents roughly 500 victims, some of whom began investing with Madoff in the 1960s and some in the 1980s. The Trustee she said is “tak[ing] the position that no statement that my clients received over a period of up to 50 years is binding, because the Trustee, ignoring the Statute of Limitations, is netting out deposits and withdrawals going back 50 years. There is no basis in the law to do that.” (Tr. 72.) “If you look at New Times,” she continued, the Court there “recognized that the purpose of SIPA” was to protect investors -- who were giving up the right to obtain security certificates (because SIPA was part of the movement to holding securities in street name) -- by giving them up to $500,000 in insurance (from the SIPC fund). (Tr. 72-73.) The SIPC fund is thus different from the customer property fund, although “It was Congress that decided that a customer’s net equity claim would be determined for both purposes in exactly the same way.” (Tr. 73.) But “Congress didn’t say that any SIPC Trustee has the right in his discretion to determine whether that’s the fair way. It’s not a question of fair.” (Tr. 73.)

Helen’s brief opening was very important. It is a serious shame that her points were not developed previously and that she had no choice but to put them so quickly and with so little explication. She was pointing out that there are people who were Madoff investors for nearly 50 or nearly 30 years, but who woke up one day to find that the Trustee refused to honor statements they had received for over four decades or for three decades. That in itself is preposterous. It is only the more preposterous because time and again the SEC investigated Madoff, repeatedly gave him a clean bill of health, specifically made a public statement in the Wall Street Journal in 1992 that there was no fraud, and many people relied on the SEC’s repeated clean bills of health and its 1992 statement. Yet SIPC, the Trustee, and the SEC, all of whom are supposed to be protecting victims, are instead deeply injuring people who relied for decades on statements and on the SEC’s investigations. I repeat: This is preposterous, and the Trustee cannot have discretion to do such a thing. As for the Trustee’s claim that what he is doing is fair, in reality he is substituting his view for Congress’ view of what should be done, as Helen was saying.

Not to mention that customers were given insurance of up to $500,000 because they were surrendering the right to physically obtain their securities as proof of owning them, and would have to be able to depend on brokers’ statements to show ownership of securities held in street name. It has always been implicit in the street name argument, but I have never seen it actually said (maybe it goes without saying), that the Madoff fraud would not have been possible if Madoff had had to deliver stock certificates to investors. For he had no certificates to deliver and would have been exposed instantly. As a practical matter, SIPA made street name holdings possible, to the great benefit of Wall Street, but now the administrators of SIPA are trying to screw over those whose securities are necessarily held in street name.

Chaitman was then asked by Judge Jacobs whether, if we had cash claims here, not securities claims, the Trustee could permissibly consider what was withdrawn and what was deposited. Helen said no; the Trustee must still use the last statement because it is irrelevant whether the securities were ever purchased. The statute, she said, “was enacted precisely for a situation where the broker didn’t purchase the securities.” (Tr. 74.) She was right. The legislative history specifically says, in a number of places, that the statute covers the situation of theft or loss of securities. This point too should have been made earlier in our side’s argument, and often.

Judge Raggi responded that the Trustee says “the reality of a Ponzi scheme, for purposes of a payout that’s going to be treating net equity the same whether it’s the customer account or the SIPA fund, is that one customer’s profits can only be a function of another customer’s loss. Do you want to respond to that argument and why you don’t think it ought to inform our decision here today?” Chaitman said, “I think it can’t inform your decision because we have a statute which defines net equity as what is owed to the customer. And 8B provides that the Trustee should look at the books and records to determine what is owed to the customer. What is owed to the customer is the balance on the customer’s account.” (Tr. 74-75.) She continued that Charles Ponzi’s scheme occurred in the 1920s, it was well known to Congress when it enacted SIPA, and “If they had wanted to make a Ponzi scheme exception, they would have put it in the statute. There is no exception for a broker who decides to not buy securities for all of his customers. There is no exception for a broker who buys and sells, rather than buys and holds. The contemplation was to provide a limited amount of protection to a customer, just like FDIC insurance. When President Nixon signed the statute into law, he said, I am signing a statute which will provide to securities customers the same kind of protection that the FDIC provides to bank depositers. Can you imagine a liquidator of a bank coming into this Court and saying, I’m only going to pay up to $250,000 based on the net investment in a bank deposit going back 50 years? I’m going to eliminate all interest on which that depositer has paid taxes? That’s the situation we have here.” (Tr. 75.)

These points were also very important. That the statute defines net equity as what is owed to the customer has been discussed previously. And the ideas that Congress knew all about Charles Ponzi, could have but did not make an exception for a Ponzi scheme or for a failure to buy securities, and could have made an exception for situations of buying and selling instead of buying and holding, are very important ideas which should have been brought up by our side much earlier. So too -- and especially -- the idea that Nixon said SIPA provided “customers the same kind of protection that the FDIC provides to bank depositers,” and that it would be unthinkable for the FDIC to act as SIPC is acting here. I can only wonder (in amazement) that our attorneys did not stress all these things early and often, and one can only hope that the Court grasped their full import though Helen appeared to have to race through them because of the number of holes she had to plug on rebuttal in so little time.

At that point Helen made the following comment. “I would ask the Court to consider what SIPC is really doing is saving approximately $1 billion because the number of customers whose claims have not been allowed based on this net investment hearing, who coincidentally are all the people who were the long-term investors, like my 91-year-old client who retired in 1970 and took mandatory IRA withdrawals out of his account for 21 years. Of course he took out more money than he put in. But that’s the purpose that people invest in the stock market.” (Tr. 76.) It was trenchant to say that of course long term investors -- old people, sometimes in their 90s -- took out more than they put in, for that is the purpose of investing. Implicit, but I hope clear to the Court, was the point that the Trustee and SIPC are vitiating one of the very purposes of being in the stock market. It is hard to imagine what could be more contrary -- to Congress’ desire to promote investing in the market -- than to vitiate a basic purpose of such investing.

Judge Jacobs then asked Helen to respond to the Trustee’s argument that “SIPA just provides you an advance on what you will be entitled to in the bankruptcy proceedings, and that in the bankruptcy proceedings there’s not going to be any payday based on these hypothetical investments?” (Tr. 76.) Helen replied that the statute requires SIPC to “promptly replace the securities in a customer’s account, not two years after $200 million have been spent on forensic accountants. Promptly replace the securities. The legislative history indicates the purpose is, get that investor right back in the stock market. This is an investor who gave up the right to certificated securities which benefited the Wall Street firms which were funding the SIPC insurance. It’s not a question that SIPC doesn’t have the obligation to make the advance unless and until it’s satisfied that it will be repaid on its subrogation claim. That’s nowhere in the statute. It’s simply like any other insurance company to the extent that they pay, they stand in the shoes of the insured, once the insured is paid in full. But that SIPC advance has to be made promptly. That word is throughout the statute. And this is what Congress intended. This is a remedial statute to compensate victims who rely upon a broker’s obligation to purchase securities reflected on his statement.” (Tr. 76-77 (emphases added).)

Helen’s answer was both correct and clever, even if perhaps somewhat opaque (which was understandable in the hurried circumstances). As I understand it, she was saying that because there must be prompt payment from the SIPC fund in order to accomplish the legislative purpose of getting the investor right back into the market, you cannot wait to see what will ultimately be available from customer property before paying victims their advance of up to $500,000 from the SIPC fund. So in reality, the advance is not an advance on customer property. The putative “advance” from the SIPC fund would have to be given, and given promptly, even if there ultimately proved to be not one dollar of customer property. This is what Congress intended. “This is a remedial statute to compensate victims who rely upon a broker’s obligation to purchase securities reflected on his statement.” (Tr. 77.)

Helen’s position receives further support in the legislative history, which was covered in a footnote at pages 15-16 of this writer’s brief-in-chief to the Second Circuit but which I do not recollect being covered elsewhere. (Am I wrong?) For simplicity’s sake I shall simply set forth the footnote from the brief:

Because SIPA established an insurance fund, the SIPC fund was intended to be separate from the fund of “customer property.” Thus, the 1977 House Report emphasized the distinction between customer property and the SIPC fund by saying that a customer “may file a claim against the general estate to the extent that his net equity exceeds his share of customer property plus SIPC protection, (Addnd., p. 65) (emphasis added). The Report quoted Chairman Owns of SIPC as follows: “In order to protect customers of failed broker/dealers against financial loss and, thereby, restore investor confidence in the securities markets, Congress passed the 1970 Act. That statute, which was signed into law on December 30, 1970, created SIPC and established a program whereby monies from the SIPC Fund would be available for the purpose of protecting customers of broker/dealer firms which encountered financial difficulty.” (Addnd., p. 66.) Chairman Owens of SIPC said, in the 1978 Senate Hearings, that “customer property, briefly explained, consists of all cash and securities (other than SIPC advances and customer name securities) available to the trustee for the satisfaction of customer claims.” (Addnd., p. 76 (emphasis added).) The 1978 Senate Report reiterated that “A customer may file a claim against the general estate to the extent that his net equity exceeds his share of customer property plus SIPC protection.” (Addnd., p. 81) (emphasis added).) The Senate Report also said the legislation “provides that all cash and securities, exclusive of SIPC advances . . . shall be deemed to be customer property.” (Addnd., p. 83 (emphasis added).)

The final colloquy of the oral argument began with Judge Raggi saying, “Let me ask you the question that we’ve dealt with with other counsel” (a statement which may in part reflect the fact, discussed at the very beginning of this essay, that our side did not divide up the argument by issues). (Tr. 77) Raggi continued that the books and records provision “says that you pay those obligations only to the extent they’re ascertainable from the books and records of the debtor or otherwise established to the satisfaction of the Trustee. When the Trustee goes into these books and records he finds out that there was never any transaction done on a particular day. Rather, it was post hoc representations that transactions had been done in order to relay profits that had never been realized, and that that is not really a securities transaction. So, to that extent it’s not finding a net equity position in that. Why isn’t that within the Trustee’s discretion?” (Tr. 77-78 (emphasis added).)

What Raggi was bringing up, at bottom, was the question of whether the Trustee has discretion to decide that CICO should be used instead of the FSM. Helen’s answer was that “the Trustee has an obligation to honor the net equity, which is the obligation of the broker . . . .” (Tr. 78 (emphasis added).) To which Judge Raggi responded that this is true only “insofar as these two things are satisfied” (Tr. 78), by which I think she meant that the obligation is ascertainable from the books and records or is otherwise established to the satisfaction of the Trustee. Chaitman’s trenchant reply was, “There’s nothing in the books and records of Madoff that indicates that he doesn’t owe to each investor the November 30th, 2008 account balance.” (Tr. 78 (emphasis added).) What Helen was alluding to, I believe, is that, as was established earlier in the oral argument, Madoff owed each investor what was shown in the statement and would have had to pay each investor that amount if sued for fraud. QED.

Raggi replied, however, that Madoff’s purported transactions were “reported after the fact and concocted because it was profitable.” (Tr. 78.) This is riskless and accordingly is different from the situation where “the customer takes a risk.” (Id.) Chaitman's answer was that the situation is exactly the same as in New Times, where there was “no evidence in the debtor’s books and records that the customers whose statement showed existing securities, that the debtor had ever purchased those securities. It’s exactly the same thing here. And there is nothing in this record which indicates that any of the prices for the securities were invalid. If someone in 1960 bought IBM stock and sold it and then bought it again and sold it and bought it again, it would have appreciated in value. There is no reason to disallow -- ” (Tr. 79.) I would add, with regard to risk, that, as said earlier, the victims didn’t know they had no risk: they thought they had risk.

Raggi responded to the last part of Helen’s statement with the cynicism that “That’s like my telling you today that ten years ago I bought Intel and then I would have a huge profit in it.” (Tr. 79.)

Chaitman replied by beginning a well taken defense of the victims’ conduct, saying “How can a customer -- the people standing before you invested in Madoff through seven investigations conducted by the SEC of Mr. Madoff over an 18-year period. If the SEC -- ” (Tr. 79.) Before Helen could present the horrendous negligence/incompetence of the SEC, the agency on which so many victims relied, Judge Raggi interjected that “There’s not a suggestion that your clients are in any way culpable for this. The question, though, is whether or not the Trustee in paying pursuant to this statute has some discretion about how to calculate net equity.” (Tr. 79.)

This interjection caused Helen to have to turn away from bringing out some or all of the very important points that the SEC missed Madoff’s fraud in approximately six investigations, that victims who are small people rather than being huge institutions with the resources to do extensive due diligence could not be expected to know or find out what the SEC missed, and that victims relied on the SEC, which time and again gave Madoff a clean bill of health, even saying publicly in 1992 that there was no fraud. Instead of being able to say some or all of these things, Chaitman had to answer Judge Raggi’s question whether the Trustee had discretion. She said he had none, and continued on with what I think are some of the more important points made by our side at the oral argument. She said the Trustee had no discretion “for purposes of the SIPC payment. The SIPC payment has to be based upon the last statement. There is a provision in SIPA which says that SIPC cannot change the definition of net equity. That’s how important this definition was to Congress. In order to induce confidence in the capital market so that people would give up the requirement of holding certificated securities. And there is nothing in the statute which says it only protects customers who have a buy and hold strategy or customers who fail to delegate to their manager or their broker the right to invest in his discretion. There is no limitation in the statute. So it covers every one of these Madoff investors who had a legitimate expectation that they owned the securities on their statements.” (Tr. 79-80.)

This statement, as indicated, made crucially important points -- points which should have been made early in our argument. Chaitman said that under a specific statutory provision, SIPC cannot change the definition of net equity, a definition of great important to Congress. She said this was so -- at least as I understand the transcript -- because Congress wanted to create confidence in markets -- one of our side’s few allusions to all-important Congressional intent -- so that people would agree not to receive physical securities (and would instead agree to a street name system). She said the statute says nothing indicating that it protects only those investors who follow a buy and hold strategy instead of giving their brokers discretionary authority to buy and sell, an authority that so many do give to brokers. And she said the statute covers every Madoff investor who legitimately expected, as all innocent investors did, that they owned the securities shown on their statements.

Chaitman’s statement was the end of the oral argument.

* * * * *

Because this essay took a godawful long time to complete, and was therefore posted in installments, during the course of the posts a couple of victims emailed to ask what is my assessment of our chances of victory. It is very difficult to say. My assessment is that the oral argument was very close, perhaps 52-48 or 55-45 in our favor, but who can say really? The Court was plumbing what it considered the weaknesses in each side’s arguments, and who can really say how the judges feel about the explanations each side offered.

My own two major impressions are ones stated earlier. The first is that our side’s failure to stress, or even mention Congressional intent -- which the other side has for practical purposes never mentioned because the intent is so adverse to its position! -- was a mistake of the first magnitude. A close colleague, whose opinion I respect greatly, believes the failure to stress Congressional intent on oral argument will not matter. He feels the Court will read about it fully in the brief this writer filed. Because briefs filed by other lawyers were dealing so extensively with other matters, my brief took an unusual tack. It ignored other matters (except for the need for discovery into why SIPC and the Trustee chose CICO, discovery of whether this was done in defiance of Congressional intent in order to save SIPC from financial difficulties or even bankruptcy), and simply presented all the relevant statements in the Congressional history from 1970 to 1978, importantly including the floor statements by Senators and Congressmen. My colleague believes the Court, its clerks and its relevant staff members will read the brief (and presumably the attached addendum containing the relevant pages from the Congressional Record, from hearings, and from Congressional Reports). To my concern that this might not happen, he replies that it will happen because the Second Circuit, he says, is the nation’s most prestigious Court of Appeals, with the most competent law clerks and staff. This answer sounds to me like local New York provincialism, of exactly the same kind that one often reads of and hears of coming from Washington, D.C., where it is regularly proclaimed that the U.S. Court of Appeals for the District of Columbia is the most important federal Court of Appeals in the land, as shown by the fact that a number of its judges have been elevated to the Supreme Court (Ginsberg, Scalia, Roberts, Thomas. And Bork was nominated.) So parochialism about one’s local Court of Appeals (wherever it is) does not impress me. And I note, with regard to the claim that the Second Circuit will read and heed the Congressional intent, that the Circuit did not so much as mention the Congressional intent at the oral argument, that Judge Raggi made a remark implicitly disparaging its importance, and that it is hard to think that the Court will pay attention to it or properly think it crucial when our oral advocates did not think enough of it to mention it on oral argument (except for Helen’s brief allusion to it), and when it is the focus of only one party’s briefing, with that party not being one of the big shot New York City law firms but only a New England lawyer unknown to the Court. Maybe my colleague will prove correct, and maybe my skepticism will prove unfounded, as I surely hope, but I will believe it when I see it.

My second major impression is of the dire need to hire a true appellate expert -- presumably a major Supreme Court lawyer who also does extensive work in the federal courts of appeal -- to participate extensively in the writing of future appellate papers and to make the oral arguments on appeal. I extensively commented early-on in this essay on the terrible shortcomings that resulted when this was not done, and on the upcoming events for which it would be essential -- for a possible rehearing en banc sought by one side or the other on the net equity question, for a petition to the Supreme Court, by either side, for a hearing there on the net equity question, and for appellate arguments on other crucial issues (especially omnibus issues) which will be briefed and argued in the Bankruptcy Court this Spring and Summer. The hiring of a qualified, prestigious appellate counsel to represent us on Court of Appeals and Supreme Court matters seems to me to be a first order of business if the victims who have been reading this essay want to see their chances of success maximized rather than lessened.

Of course, maybe I’m all wrong. Maybe, despite the shortcomings I’ve alluded to, we will win on net equity in the Court of Appeals and/or, even without special, qualified appellate counsel, we will win on net equity in the Supreme Court too. And maybe, even without hiring special, qualified appellate counsel, we will win on other issues too in the Court of Appeals and the Supreme Court. All I can say is that after decades of observation and experience, including a stretch spent helping to prepare lawyers for oral arguments in the Supreme Court, I believe the victims’ chances will be much better if experienced, qualified appellate/Supreme Court advocates are hired. This is a matter which, I think, should concern every victim, because every victim (myself included) has so much at stake.

Discursive Comments On The Oral Argument In The Court of Appeals In The Madoff Case On March 3, 2011. Part 4

2011-04-01T13:43:00.001-04:00

April 1, 2011

Discursive Comments On The Oral Argument In The Court of Appeals
In The Madoff Case On March 3, 2011.

PART 4

The final opponent to argue was Michael Conley of the SEC.

At inception Judge Jacobs asked him to distinguish the SEC’s position, to the extent it is distinguishable, from the position of SIPC or the Trustee. Conley replied that the SEC is in agreement with them with regard to whether you look solely at the account statement or to all the books and records, but believes you must value the net equity claim in “constant dollars.” (Tr. 63.) The Bankruptcy Court, he said, decided to consider the constant dollar issue after the “initial determination” of net equity is made. (Tr. 63.) Thus, in the words of Justice Leval’s question, “that issue of the constant dollars or the inflation adjusted dollars is not before us now.” (Tr. 64.) It could be something to subsequently be decided below depending on how the Circuit rules, but it has not been briefed or decided and the Court is not called upon to decide it now.

Conley then reiterated the oft-made point that the Trustee must “discharge all obligations” of Madoff to a customer and said “that’s exactly what the Trustee did” here after an extensive investigation. (Tr. 65.) In so saying, Conley was necessarily adopting the position, first advanced by Sheehan, that Madoff had no “obligation” to pay victims the fake profits that his own statements showed he owed them (and which Sheehan ultimately admitted would be recoverable in a fraud suit). It strikes me that it is nothing short of amazing for the SEC -- which was created to protect investors -- to take the position -- deeply injurious to investors -- that the crook does not owe investors what the statements he gave them showed they were owed (and what Madoff did give to people who closed out their accounts). For the agency created to protect investors to instead injure them in this way is further evidence of what has now been known for over two years: the SEC has abdicated its responsibilities, is incompetent, and is completely under the thumb of SIPC instead of supervising it as Congress intended. It is completely understandable that some people -- actually quite a few people, I believe -- think that Mary Schapiro, on whose watch this position was taken, should be dismissed.

None of this came up in the argument, however.

Judge Raggi responded to Conley by saying that “I don’t mean to scare anyone by suggesting that this should be treated as cash, but on the one hand that does seem to be what you’re calculating and concluding that you can’t decide what the value of the security positions is. All you can decide is what’s the cash they put in and took out. Then why isn’t this a cash position?” (Tr. 66.) Conley’s response was that there is a securities position here because the Court had held in New Times “that when a customer gives cash for the purpose of buying securities and then receives confirmations and account statements that suggest that that’s what happened, the customer has a legitimate obligation to believe that that’s how the cash was being invested.” (Tr. 66-67.) Judge Raggi then asked “If that’s the case, why isn’t the receipt of each account statement something that the customer could reasonably rely on? I mean, to use the old maxim, a decision to hold is a decision to buy. So, you know, if you get told you hold x number of shares in this account statement worth such and such and you don’t tell the broker to do anything, you’ve got that reasonable expectation. Why isn’t that this case?” (Tr. 67.) Judge Raggi’s question goes back to a point made earlier in this essay: if receipt of a statement creates a legitimate expectation that an investor owns the securities shown in the statement, why doesn’t it simultaneously create a legitimate expectation that the securities were purchased at the price shown in the statement? After all, except in the case of a suspected mistake in price, have you ever heard of anyone who thought she owned the securities shown in her statement but that they had been acquired at a different price than shown in the statement?

Conley’s answer essentially was that this was done in New Times (where people who bought non existent securities and received statements and confirmations had claims for securities, but there was no basis or evidence for valuing them, so the relevant investors received only their cash-in). To which Judge Raggi said the SEC was “not suggesting that any account holder didn’t rely in good faith on what the statement said,” and if the statement said a victim owned 200 shares of AT&T, “why isn’t that a securities position that can be valued?” (Tr. 68-69.) Conley’s response was that it can’t be valued because it’s the result of fake trades: it cannot be valued because “it’s completely divorced from any reality of market trading.” (Tr. 69.)

In reply Raggi asked whether the investor would be credited with the amounts shown in his statement if he had bought and held, so that the statement reflected not profits from trades, but profits from the market increase in share price of the stock plus reinvestment of dividends. (Tr. 69.) Conley’s answer was that this was “quite akin to the folks in New Times” who had bought securities existing in the real world. (Those investors were not parties to the New Times case -- the parties were the persons who bought securities which did not exist in the real world.) SIPC and the Trustee recognized that the value of the real world securities which people invested in but which the fraudster did not actually buy, plus reinvestments of dividends, could be valued (by looking at real world prices). (Tr. 70.)

Judge Jacobs then said “So the distinction you draw between New Times and the circumstances of this case is in New Times with respect to some of the people who were put into real stocks, you can, looking at folks’ records, account statements and market prices, you can actually calculate -- a real number for them.” (Tr. 70-71.) Conley’s answers were “Precisely,” and “That’s right.” (Tr. 70-71.) Jacobs then said, in further explication of Conley’s position, “Whereas if you have a fake stock that never had any value, or if you had real stock that’s put through machinations and transactions that are impossible, then you can’t calculate that value, and you’re in the same situation as the people in New Times who couldn’t recover because they had -- their holding of securities was impossible to calculate.” (Tr. p. 71.) Conley replied, “That’s exactly our position in this case, Your Honor.” (Tr. 71.)

Judge Leval then added that in New Times there was no manipulation of account values, and, no “imaginary profits” for those who bought and held, for the duration, securities existing in the real world. (Tr. 71-72.)

As obvious, Conley is maintaining that New Times, and ability or lack of ability to value securities in the market, are controlling. He also maintained that a strategy of fictitious trading must be distinguished from a strategy of buying and holding. These positions are contrary to Congress’ oft-previously-stated intent to protect investors, they take no account of Judge Jacobs’ comment that perhaps New Times was not fair to the investors who bought the non existent securities to which Conley is comparing non existing trades in Madoff, and they deny protection to and thereby punish persons who give their broker discretion to trade for them instead of merely buying and holding -- even though so many investors do give in fact brokers such discretion and there is not a scintilla of evidence that Congress did not want to protect those investors just as much as those who buy and hold.

Discursive Comments On The Oral Argument In The Court of Appeals In The Madoff Case On March 3, 2011. Part 3

2011-03-31T09:00:00.002-04:00

March 31, 2011

Discursive Comments On The Oral Argument In The Court of Appeals
In The Madoff Case On March 3, 2011.

PART 3

The next to argue for our opponents was the Trustee’s Counsel, David Sheehan, who has made himself the bête noire of many victims by what they consider his pit bull attitudes, insults, and sometimes outlandish comments (such as that no legislator would think the FSM should be used).

Sheehan began by saying that by using CICO the Trustee had reasonably followed the statute in a reasonable exercise of discretion, since this was a Ponzi scheme with no profits. (Tr. 51.) The customer fund, he said, is “the money that went in,” i.e., the cash in. To which Judge Jacobs said, “The SIPC fund is not the customer fund,” and then said, perhaps very importantly, “the SIPC fund is what we’re talking about here today.” (Tr. 51.) At that point Sheehan, as best I can tell, began trying to say -- I think -- that the SIPC fund and the customer fund are at least intimately related because the payment from SIPC is “an advance. It’s an advance against the money owed to you by the broker.” (Tr. 52.) If the broker owes you nothing, said Sheehan, there is no advance. (Tr. 52.)

At that point Judge Raggi interjected the following incredulous comment. “Well, you don’t think the broker who told people over the course of 30 years that they had a statement that increased at the rate of 15 percent a year or whatever owes them only what they put in at the start of the 30-year investment? You think that’s all the broker owes these people?” (Tr. 52.) Sheehan’s answer to this question was, I believe, outlandish. “In a Ponzi scheme, yes. Absolutely. Why would he owe them anything more.” In short, Sheehan was saying that even Madoff himself, had he been sued by an investor at some point for the amounts shown on the investor’s statement, would have owed the investor only what the investor had put in, not what the statement showed.

Raggi then interjected. “But fraud.” (Tr. 52.) Sheehan replied that “Fraud is a general creditor claim.” (Tr. 52.) There are two funds, Sheehan said, one being the customer fund of property [which] is the cash and securities deposited with the broker. The broker has an obligation to pay that.” (Tr. 52-53.) The implication here was that the broker would not have the legal obligation to pay an investor the false profits shown on the statements the investor received. If this were the only argument the other side had, I would have to think they would be sure losers.

Judge Raggi seemed unable to accept Sheehan’s argument, saying that” Even the government of the United States, the SEC thinks it’s the current value of the money, not just what they put in 30 years ago.” (Tr. 53.) Sheehan contested this position, saying “I don’t know if I agree with that. I think it’s only what they put in. If in fact it was never invested, if in fact there’s no profits, no transaction, how did the fund grow? Where does it come from?” (Tr. 53.) Judge Raggi responded “That the injury from the fraud, is that if the individuals had known it wasn’t going to be invested, they would have put it somewhere else and hoped to profit from it.” (Tr. 53.) Sheehan’s response was that this is a general creditor claim. (Tr. 53.) The answer put him in the contradictory position of arguing on the one hand that the broker would not owe the victims, and would have no obligation to pay them, the fake profits, but that there is a claim for fake profits that should be leveled against the general estate.

Sheehan then undertook a more elaborate explanation of his position. He said the Trustee is trying “to recover the monies that belong in the [customer property] fund” because it had been “other people’s money.” (Tr. 53.) For example, from Picower they got “$5 billion . . . that wasn’t profits . . . . Mr. Picower had “$5 billion of other customers’ money, and he gave it back.” (Tr. 54.) Once the Trustee gets back about $20 billion and pays it out, everyone will have received their principal back and all will be on an “equal footing.” (Tr. 54.)

The Trustee, he said, has instituted suits to “recover not just the $20 billion but the damages” also. (Tr. 55.) The hope is that there will then be a “general creditor fund” and “then, but only then” “all of these appellants here will have the opportunity . . . to participate.” This, said Sheehan, “is the only reasonable construction of the statute, it’s the only reasonable exercise of discretion.” (Tr. 55.) “Anything short of that,” he said, “leads to the absurd result” Judge Raggi had alluded to. (Tr. 56.)

In the foregoing colloquy Sheehan took the position that the only reasonable position is to use CICO because it would be absurd for people who have already received back their principal or more to participate in customer property when there are those who have not yet gotten back what they put in. This position has in effect been extensively discussed and refuted previously in connection with what Congress intended, small investors’ necessities for living, and the fact that under CICO most of the money will go to the very rich. To me, as indicated before, it is Sheehan’s position that is ridiculous because ignores all the dynamics of life and economics except one -- how much cash did a person put in and take out -- and it thereby destroys Congressional intent.

Sheehan also argued -- amazingly, I think -- that Madoff himself would have owed defrauded investors nothing except repayment of their cash. But Sheehan contradicted himself by saying there would be a fraud claim against Madoff for the fake profits shown on the investor’s statement. At least one judge seemed to be incredulous at Sheehan’s claim that Madoff would have been obligated to victims only for their cash-in, and Sheehan appeared to me to backpedal defacto by admitting that victims would have a fraud claim against the broker for lost profits damages, a claim he says for some reason that they can recover here only out of the general estate, not customer property.

As well Sheehan took the position that all the trustee was seeking from people whom he has or will sue was the amount they received in other people’s money, not damages for failing to put a stop to a fraud they should have realized was occurring or which they should have been aware was possible and should have investigated. This strikes me -- and I think one or two others with whom I regularly discuss matters -- as possibly a bizarre false claim and, if a true claim, as very questionable. Though the Trustee has said he has sued some malefactors only for what they received in other people’s money, has he not also sued various huge institutions for damages for being complicit in a fraud because they ignored red flags? A lot of us think he has. This, if true, would make Sheehan’s explanation to the Court quite misleading. If we are wrong, and the Trustee hasn’t sued culpable institutions for damages, then shouldn’t he do so?

At this point Judge Leval asked Sheehan what SIPC would do in a hypothetical situation in which a broker gambled away some investors’ money, so it is no longer there, but other people’s money was legitimately invested and there are securities and cash in their accounts. Sheehan said the people with cash and securities in their accounts would get this back, and the others would get a SIPC advance. (TR. 57-58.) But in Madoff the whole thing is a Ponzi scheme, and people who did not get their principal out are getting advances and will receive customer property. They are getting “priority” but this is “not going to work” if money is also given to people who did withdraw more than their principal. (Tr. 59.) Why this would not work when the Trustee has recovered ten billion dollars already and may recover tens or scores of billions more was not explained. Nor was this question asked. To me Sheehan’s claim of nonavailability in the Madoff case sounds dubious.

Judge Leval then asked, “How do you reconcile it with the obligation of the debtor . . . if the debtor owes each customer what is on their statement, what the SIPA statute speaks of is the obligation of the debtor, that the Trustee shall promptly discharge all the obligations of the debtor.” (Tr. 59.) Sheehan’s reply was that this is “why there is the [books and records provision]. You can’t just use the statement.” (Tr. 59.) To which Judge Leval said, “But you don’t dispute that those statements represent the obligation of the debtor?” (Tr. 60.) Sheehan replied that “No, I do dispute that. I think they are one piece of evidence that evidences the obligation of the debtor. That’s it, one piece, one of many, all of which we have to look at. We have to look at the entire books and records. This Trustee is mandated by this statute to do a complete and thorough investigation. That’s what he’s done. And that complete and thorough investigation yielded the truth that what we have here is no trades, no profits.” (Tr. 60.)

Judge Jacobs then expressed doubt about Sheehan’s position, saying “I’m not sure I understand how the statement doesn’t represent the obligation of the debtor assuming, under the facts that we have here, that people were permitted to rely upon this and a defrauder undertook to pay them that and in reliance they left their money in his hands.” (Tr. 60.) Sheehan said, “I didn’t say it didn’t represent it. I said standing alone it’s not determinative. You cannot just take, as Your Honor said earlier -- ” (Tr. 60-61.) Judge Jacobs retorted that, “Standing alone it would work fine at a fraud trial, it seems to me.” (Tr. 61.) Sheehan admitted this. (Id.)

Judge Jacobs then said “the debtor would be Madoff Securities and at a fraud trial they would be a defendant and they would owe that.” (Tr. 61.) Sheehan tried to wriggle out of this by saying that at a fraud trial the victims would nonetheless end up with nothing because Madoff had no money left. Judge Raggi wouldn’t let him get away with this dodge, saying “No, no, but that’s a separate question.” (Tr. 61.)

Judge Raggi continued her thought by saying that Sheehan’s answer “avoids or doesn’t address our concern, that you are asking us to conclude that the obligation for SIPA purposes is different from the debtor’s obligation. And I speak only for myself, I’m having some trouble understanding why you think that is a different obligation.” (Tr. 61 (emphasis added).) Sheehan’s answer was that the statute supposedly “says” (Tr. 62) -- in fact it certainly does not “say” anything like what he claimed it supposedly “says” -- that “once you have a SIPA proceeding, these rules go by the board, and the reason is because the SIPA rules dominate that. They have to. It’s a salutary statute designed to provide certain relief under certain dire circumstances. It isn’t business as usual, it isn’t dealing with your broker on a daily basis. This is a catastrophe and it’s only in that catastrophe that the Trustee can operate the way he does, by not being bound by simply the statement itself, but by what the statute suggests, you look beyond that to the books and the records.” (Tr. 62.)

This colloquy would seem to be revelatory and important, hopefully for our side. The judges appeared concerned with how to reconcile the statutory requirement that SIPC pay the obligations of the debtor -- which they seems to agree was the amount shown on the investor’s final statement and would be owed the investor in a fraud suit -- with the Trustee’s claim that cash-in was all that was owed. After first appearing to deny and dispute that what the statement says is owed is the obligation recoverable in a fraud suit, and apparently somehow claiming the support of the books and records provision in this connection, the books and records of which the statement is only one part -- Sheehan ultimately had to admit that the statement is the measure of the damages in a fraud trial. (Tr. 61.) At that point, confronted by Judge Raggi’s statement that he was asking the judges to say “that the obligation for SIPA purposes is different from the debtor’s obligation,” Sheehan was forced to admit the truth: that the Trustee’s (wholly invented) position is that the normal rules go by the board in a SIPA case. There the SIPA rules (as invented by SIPA and the Trustee) must predominate so relief can be provided in dire, unusual and catastrophic circumstances. Or, put differently, if the Trustee -- or any Trustee in any case -- decides a situation is dire, and that there is a catastrophe, the Trustee can do what he wants. This is the antithesis of being required to do what Congress intended. It is license, not law.

What Sheehan claimed the statute supposedly “says” (but in reality doesn’t say) puts SIPA and the Trustee in a position directly opposite of Congress’ intent to protect small investors, build confidence, insure prompt payment and so forth, all as discussed here previously. Unfortunately, this did not come up when Sheehan was arguing, nor was it presented at any point in the argument. This is sad. I shall say more about it later in this essay. But for the moment, let me merely reiterate that the Trustee’s claim is a claim of unfettered license (as some of us have thought for nearly two years).

Discursive Comments On The Oral Argument In The Court of Appeals In The Madoff Case On March 3, 2011. Part 2

2011-03-30T09:00:00.001-04:00

March 30, 2011

Discursive Comments On The Oral Argument In The Court of Appeals
In The Madoff Case On March 3, 2011.

PART 2

As readers know, I had originally intended to do this essay in two parts. But it is proving so long and difficult to do that I shall divide it into more parts, and shall post them as I do them. This Part 2 will deal with the oral argument of the first opponent to argue, the General Counsel of SIPC, Josephine Wang.

Beginning by saying Madoff’s statements are fictitious, Wang was immediately interrupted by Judge Raggi’s comment that if victims had sued Madoff, he would have had to pay them what the statements showed they were owed. (Tr. 36.) Wang admitted this would have been true if Madoff had remained in business. The judge then asked why it should be different in regard to what SIPC has to pay. Wang said it is because SIPC is bound by a federal statute and that statute does not authorize a trustee to benefit certain customers at the expense of other customers; because the prices on the statements were back-dated; and because the profits or so-called profits, were fictitious. (Tr. 37.)

Judge Leval then asked “How is it at the expense of other customers when you’re talking about . . . the funds coming from SIPC that measure for each customer independently how much that customer is entitled to?” (Id.) Wang’s answer was that we’re not talking just about the money coming from the SIPC fund, but about “customers who are all eligible to share pro rata in a fund of customer property.” (Id.) Some withdrew their principal plus fake profits, which were other people’s money, and others did not withdraw their principal, which was used to pay other investors.

Judge Raggi then wanted to know “where is this customer property coming from.” (Tr. 38.) Wang said it’s “all [the] property that was held . . . for customers,” and includes what the Trustee initially found in the possession of Madoff and what he recovers by actions against third parties. (Tr. 38.) It is, said Wang, “shared pro rata among customers.” (Id.) This means, she said in a confused way, that people who did not yet recover their principal will be sharing with people who already recovered their principal and will be receiving fake profits, which is unfair. (Tr. 38-39.)

Judge Leval said that this “part is very clear. But it’s the part that relates to the money coming from SIPC” that needs clarification. (Tr. 39.) To which Wang responded that SIPC would have to advance far more because the cash-in is 17 to 20 billion dollars whereas the final statements showed approximately 64 billion dollars.

Judge Jacobs then expressed confusion, saying he thought Wang’s argument would be that, to the extent of its advances, SIPC would be subrogated to a claim against the estate. (Tr. 39.) Wang said SIPC is subrogated to the claim of any customer who is fully satisfied out of a SIPC advance, in order to avoid double recovery by the customer. (Tr. 40.) To which Jacobs replied that this suggests that SIPC advances can have an impact on other investors simply by virtue of the claims SIPC would have by subrogation. (Id.) Wang then said she wasn’t following Jacobs.

At that point they began going through the matter again. In the midst of it Raggi said that all this means that if a customer receives an advance from the SIPC fund, this will not affect the amount of an advance that is received from the fund by another customer. (Tr. 40-41.) Wang admitted this is true, but said that the fund of customer property is affected because of SIPC’s right of subrogation. (Tr. 41.) Leval responded by saying that it therefore is the case that if SIPC pays an advance to one customer because of his fictitious profits, this will reduce monies available to other customers from customer property because SIPC itself will have a claim against the estate via subrogation. (Tr. 42.) Wang said “That’s correct.” (Id.)

What, then, was the meaning of this colloquy? Well, the judges wanted to know why SIPC’s obligation shouldn’t be the same as Madoff’s and, in this connection, why using that obligation, expressed by the final statement, would cause some victims to benefit at the expense of others. Wang’s answer, first, was that the statute doesn’t authorize having some victims benefit at the expense of others and this is what would happen if the final statement is used, because people who took out more than they put into a Ponzi scheme would be sharing “pro rata” in a fund of customer property, would be sharing in customer property with people who have not yet received all their principal back. (Tr. 37.) Wang’s view of what the statute authorizes seems to me just another verbal formulization of the (wholly invented) position of the Trustee and SIPC, discussed and for many reasons rejected in Part 1, that fairness allegedly requires that all be paid in proportion -- that all be paid “pro rata,” Wang said.

Interestingly, the statute does not say that all must be paid “pro rata.” It says victims must be paid “ratably.” SIPC, the Trustee, and everyone else, including me, always seems to have assumed that paying victims “ratably” means paying them “pro rata.” The words “pro rata” and “ratably” sound and look as if they should mean the same thing. But “ratably” is not necessarily the same thing as “pro rata.” “Pro rata” means proportionally. “Ratably,” I gather from the dictionary, can mean proportionally but does not necessarily mean it. Instead, it can mean only that something is “capable of being rated, appraised or estimated,” as one of the dictionaries puts it.

Either meaning of “ratable” would seem to fit the statute, and I do not know which meaning Congress intended. In the legislative history, Congress paid infinitely more attention to the SIPC fund, which was a major subject of the statute, than to customer property, which received little attention. Yet, if Congress had intended that people necessarily should be paid proportionally, one wonders why it used the ambiguous word “ratably” instead of the plain, unambiguous words “pro rata” or “proportionally.” One also wonders whether there is anything in bankruptcy law which might shed light on this.

If one takes the position that the word “ratably” means, in the statute, only that a victim’s share can be appraised or estimated, then the position of SIPC and the Trustee largely collapses in favor of good judgment and sound policy, I would think. The door would be open for the Court to give differing orders of payment to victims who have different economic positions, even though the final statement is used as the measure of net equity and net equity establishes one’s ultimate share of customer property as well as one’s right to an advance from SIPC. One possibility, for example, would be that under the FSM victims would get advances from SIPC, but those who took out more than they put in would not get money from customer property until others who did not take out their principal received it back from customer property. This kind of an arrangement could be capable of estimation and appraisal in advance, and would thus fit a meaning of “ratably.” It would also enable the Court to provide differing treatments under the SIPC fund than under customer property, as a lot of people think it seems to want to do. The idea is also one that has in effect been put forth by the Trustee, though he would use it in connection with the so-called general estate. And the idea also, of course, whether founded on statutory definitions or for other reasons, could be part of the basis for an overall resolution of the Madoff problem.

Wang also in a sense let the cat out of the bag during the colloquy, in answer to a question from Judge Leval about the SIPC fund. She conceded that if the FSM were used, “SIPC would of course have to advance that much more.” (Tr. 39.) I literally know of no person who is not part of the Trustee’s or SIPC’s entourage who does not think that SIPC’s desire to pay out less from its fund, lest it have to raise billions of dollars more very quickly or face bankruptcy, was not the reason that CICO was used here in the face of nearly uniform use of the FSM in nearly 320 prior SIPC cases. Discovery on the question was vigorously resisted by SIPC and the Trustee, was refused by Lifland (who seems to do pretty much anything our opponents want), and was not discussed by the Second Circuit though the need for discovery on this matter lest Congressional intent be flouted with impunity was raised in briefs.

When Wang said that the impact of the FSM meant SIPC would have to pay out more from its fund, Judge Jacobs was surprised because he thought Wang would have said the impact was that, if the FSM were used, SIPC would pay more from its fund, would therefore have more claims against customer property by virtue of subrogation, and this would lessen the amount available to other victims from customer property. Judge Leval, subsequently in the colloquy, made this point quite precisely, saying that “Then to the extent that SIPC pays one customer based on that customer’s inflated long-term position that grew much, much larger than the customer’s initial investment, notwithstanding withdrawals, SIPC’s payment of the full $500,000 to that customer will reduce another customer’s entitlement because SIPC then becomes a claimant against the estate.” (Tr. 41-42.) Wang’s answer to Leval was “That’s correct, Your Honor.” (Tr. 42.)

Wang’s answer to Judge Leval was seriously misleading, wholly aside from the fact that nothing forces SIPC to exercise any rights of subrogation it may have. Helen Chaitman has submitted a letter to the Court pointing out the misleading nature of Wang’s reply, our opponents have opposed her submission, and at this point there is no telling whether the Court will learn the truth either on its own or through submissions.

SIPC’s right of subrogation will not, under the statute, lessen the amount of customer property available for payment to victims. For the statutory order of allocating customer property -- after ignoring the first section, which is irrelevant here -- is that payment is allocated, second, to customers of the broker -- i.e., Madoff’s victims -- and third to SIPC as subrogee for customer claims that it paid. In other words, under the statute SIPC will get nothing from customer property until all the victims are fully paid off. Therefore SIPC’s payments from the SIPC fund to victims will not reduce any victim’s payments from customer property, because SIPC does not recover from customer property, via subrogation, until after all the claims of victims are paid off. The judges were trying to find out whether use of the FSM for SIPC advances will, due to SIPC’s subrogation rights, lessen the amount available for payments to victims from customer property. Wang told them the answer is yes. The answer in truth is no.

Of course, SIPC appears to have been doing something of dubious legality, appears to have been pulling a fast one, that would make the answer yes instead of no. It has been taking assignments from victims to whom it gives advances from the SIPC fund. While our side seems to have been unable to find out (or at least I haven’t found out), it appears that the assignments may put SIPC into the second statutory category of victims of the broker, i.e., by the assignments from victims SIPC recovers as part of the second category, which gives payments to victims, rather than recovering as part of the third category, in which SIPC gets money only after the victims are paid in full. If SIPC is taking assignments which do this, then its rights under the assignments, rights which arise because it advanced monies from the SIPC fund and took assignments of the victims’ rights, will lessen the monies available to other victims. But for SIPC to do this is probably illegal, is probably outrageously illegal. For it does lessen the amount of customer property (i.e., money) available to victims, whereas Congress’ intent was to help and provide money for victims, not to help and provide money for SIPC. SIPC, by assignments, is grabbing for itself money which Congress wanted victims to receive.

The next colloquy started with one of the bench’s semi bizarre, difficult mathematical hypotheticals, this one put by Judge Jacobs. It involved theft, account statements, actual market value, etc., and was not understood by Wang -- and to read it is to sympathize with her confusion. Jacobs’ question was what would SIPC say the customer should get in his hypothetical. Wang’s ultimate answer was that he gets “whatever his account statement shows that reflects market reality.” (Tr. 46.)

Wang further reiterated, in answer to a question from Judge Raggi, that SIPC’s obligation is to insure that the “statute is correctly enforced” -- by use of ideas that have been invented by SIPC and the Trustee, in my opinion. In this regard, she said it would have been error to use the account statements here because, I gather, they do not reflect reality as reflected in the books and records, which show that no trades occurred and therefore precludes the use of the fake FSM as the measure of net equity. (Tr. 48-51.)

According to Wang, in a statement widely belittled by victims, SIPC’s one and only concern is correct enforcement of the statute, not the extent of SIPC’s liability under the FSM, which “is probably the last of our concerns.” (Tr. 47.) Right, and we were all born yesterday. No doubt the reason that SIPC and the Trustee vigorously resisted discovery into the reasons they chose CICO is that SIPC’s potential liability under the FSM was the last of its concerns. Sure. Tell me more.

Unfortunately, there was no mention in the oral argument of the need for discovery, which would blow the lid off SIPC’s and the Trustee’s phony claim that concern for SIPC’s finances had nothing to do with choosing to use CICO.

Discursive Comments On The Oral Argument In The Court of Appeals In The Madoff Case On March 3, 2011. Part 1

2011-03-24T12:46:00.001-04:00

March 24, 2011

Discursive Comments On The Oral Argument In The Court of Appeals
In The Madoff Case On March 3, 2011.

PART 1

I was in Florida on March 3rd, when the oral argument was held in the Second Circuit, in the Madoff case, on the question of how to determine net equity. So I did not see the argument. I read the transcript on an IPod twice, but reading a complicated document on an IPod is, to me at least, next door to not reading it at all. After getting the hard copy of the transcript, I have now read it three times. So I didn’t write anything about the argument until after getting the transcript, reading it in hard copy, and marking it up.

The oral argument was, I think, the most complex one it has ever been my misfortune to have to read, but I feel I now have a reasonable, if imperfect, grasp of most of it. So I shall now set forth some views.

I should say preliminarily that, based on the transcript, it is hard to agree with those in attendance who felt the judges did not know the case. On the other hand, it does seem that the argument, for whatever reasons, generally focused on a relatively small number of points in comparison to the total picture, and that several points that should have been prominent received little or no attention (as I shall discuss below).

I also wish to say preliminarily that I hope this essay on what transpired is as inoffensive as possible. Unless you have done it yourself, or at least have worked closely on an oral argument with the advocate, it is hard to understand just how stressful an appellate oral argument is. Even a trial court oral argument is no picnic, and oral arguments in federal courts of appeal or the Supreme Court are very difficult. For they often, even usually, consist, as did the one on March 3rd, of a continuous barrage of questions designed to trip you up, questions often delivered in the hostile tone for which the legal profession is infamous. The courts, and professors, call this testing the limits of your argument to see how far it can be carried and what results it may lead to in a variety of differing circumstances. The advocate is confronted with question after question, some with ramifications that he or she may not have considered, and with the need to find ways to bring out the points he/she wishes to make in answer to an unending stream of questions, often hostile ones. So it is not easy, and there is a reason why great appellate advocates tend to be unusually smart men and women. And, of course, extensive preparation, including moot courts -- at which persons unconnected with the case should play a role and at which advocates should practice getting out their points in answer to questions, often hostile sounding questions, which do not obviously seem to call for the points the advocate wishes to make -- are essential preparation if there is to be excellent performance. (In case anyone is wondering, I emphatically do not think I am nor ever was a great or even a good oral advocate -- I have the wrong personality for it in a number of ways -- and in my old age I also reject the inhuman idea of facing a battery of hostile siege guns firing at me in rapid succession from the bench. That is for younger people (I am 71) who want to make a mark. But I do know a lot about appellate oral arguments because I spent a part of my life helping to prepare people for oral arguments in the Supreme Court and setting up moot courts for this purpose. (For reasons I will not get into here, I recently breached my “never again engage in oral argument” principle by appearing before Lifland -- this was my first oral argument in I don’t know how many years, though it was a lower court argument, not an appellate one, and after appearing before Lifland, I once again recognized the wisdom of the principle of “never again engage in oral argument,” lest one be savaged from the bench without any fair opportunity to reply.)

So, as said, appellate oral arguments are hard to do, and the oral argument here was, I think, particularly difficult to do. And I do wish to say that I think Helen Chaitman did an excellent job, a very good job.

Let me also say that this essay has been divided into two parts. There are several reasons. One is that it has taken a very long time to write, and will take me considerable additional time to finish, has proven to be godawful long in terms of numbers of words, and I have not been intelligent or perceptive enough to figure out in advance how to reduce it to a shorter string of essences, so to speak, without using organizational techniques that would themselves require extensive time to employ. Also, I now have to largely turn my attention to some other important, non Madoff matters for four or five days. So, in order to begin putting the essay’s views into the public forum for Madoff victims who might wish to know those views, I have divided the essay into two parts, am posting the first part now, and will finish and post the second part, I hope, in about ten days or two weeks from now. The first part deals with some general matters plus the oral arguments of our first two advocates. The second part will deal with the arguments of the three advocates who opposed us, plus the rebuttal argument of Helen Chaitman.

* * * * *

Let me cover some of the pre-oral argument maneuvering, insofar as I know it, before turning to the argument itself. (This essay, as you can see, is discursive rather than the tightly written, all-excrescences-removed work that a good brief should be. Once, about a year ago, a lawyer on our side called me on the phone to lambaste me for opposing a direct appeal to the Second Circuit. This person told me I was a lousy lawyer, incompetent, and merely an academic because I favor a discursive style when writing essays. The person was so rude that I have not spoken to him or her since, and don’t intend to in the future. And let us hope that we win in the Second Circuit, thus proving wrong the views I held about a direct appeal.) My knowledge of the pre-argument maneuvering is necessarily limited because I am not part of the relatively small group of New York City lawyers who seem to be in charge. Indeed, not being a part of that group -- two of whom, including the one who later called to tell me I am an incompetent, made clear on an early phone call that my presence was not desired -- I know little in advance about anything. Right now, for example, some among the NYC group are dealing with the Trustee in regard to which issues should be briefed as part of the so-called “omnibus briefing” of important issues this Spring, and I for one, and I know that some others too, are completely in the dark as to what is going on.

With regard to the pre-argument maneuvering about which my knowledge is limited, I have heard that the NYC lawyers exchanged memos, had conference calls, and had one or two moot courts, though I don’t really know how the moot courts were handled except that I’ve heard that in the last one all the non-arguing lawyers were collectively the judges (which, if true, is, in my experience, not the way to hold a moot court). During the period February 25-March 1, I did, however, send the lawyers’ group, in part at the invitation of one of its members, three memoranda of possible questions from the bench and possible answers, and one memo stressing the need for a short, persuasive opening argument of two or three minutes that would quickly tell the Court what our main points are before the Court got into the barrage of questions which many of you saw in person or read on the transcript. I included an example of such an opening argument. Though there is of course no guarantee, if you tell a Court at the beginning of your argument that you will begin with a brief listing of your points, the judges will sometimes let you do this because they know you will be brief (they will hold you to brevity), and in this way your major ideas will be set before the Court before the guns start firing at you. Such a short introductory opening argument briefly stating our major points was not attempted here.

Nonetheless, to my surprise, one of the group of NYC lawyers who are in charge told Dave Bernfeld that material I sent had been helpful. That was nice of him. But I do not really think my memos did much good or proved terribly helpful. The transcript shows that a large number of the points I stressed -- very important points, I think, which could be made in answer to questions if the argument proved a barrage, as it did -- received little or no mention. The points included that there were extensive statements of legislative intent in our favor, and the specific items of legislative intent that the statements established; that some of the leading legislators of the day -- not back benchers -- delivered these statements; that CICO has almost never been used before in nearly 320 SIPC cases; that the use of CICO utterly destroys Congress’ vigorously and repeatedly stated intent that victims receive money or securities promptly from SIPC because CICO necessitates years-long forensic accounting to establish whether a customer can receive anything from SIPC; that there are well established financial techniques which limit the extent to which a Bernie Madoff can just make things up; that there should be discovery into why Picard and SIPC chose to use CICO; and that while SIPC and the Trustee claim they are being fair, the truth, as SIPC’s letters to Congress reveal, is that almost all the money Picard is clawing back is going to the fabulously wealthy (at least in the short run) while the now newly impoverished will get little or nothing.

I should also say that the very first answer given to the Court by our advocates surprised me greatly. At the very beginning of the argument Judge Jacobs asked whether our three successive advocates were “going to divvy up issues in any way?” (Tr. 3.) The answer was “We’re not really, Your Honor.” (Tr. 3.) I have worked with advocates on lots of appellate cases in which more than one lawyer argued for my side: But I never have seen an instance where there was more than one lawyer arguing on a side and the lawyers did not divide up the argument by issues. The reasons for such division are obvious. With such division a lawyer can focus deeply on the issues he/she is responsible for, there will be less duplication of argument and therefore a larger number of important points can be covered, etc. Yet our side did not divide up the issues. (Perhaps I should add that an experienced appellate lawyer on our faculty was thunderstruck when told that the argument was not divided by issues.)

How did this occur? Well, I really don’t know but believe I can likely make a good guess. With regard to rebuttal, you can’t divide up the issues in advance because you cannot know in advance what points will be crying out for rebuttal when your rebutter rises to rebut. To select Helen Chaitman for rebuttal was in my view a good idea because, I would bet, she probably knows more about the case than anyone else. She would likely be best able of anyone to think of the best rebuttal points on many topics. And, proving the point, she did a good job on rebuttal.

But aside from rebuttal, where you can’t divide up the issues in advance because you don’t know what the rebuttal will have to focus on, why was there no division of issues to ensure deeper focus on crucial points and presentation of a larger number of points? My guess, which unhappily may sound harsh but for which I have a basis that I will partly keep to myself, is this: each of several lawyers thought they should do the oral argument, and would be best at it. This had an effect on cooperation -- I know, for example, that who would be the oral advocates was in contention, apparently bitter contention, until nearly the very end -- and at least possibly was a reason why the lawyers were perhaps unable to, and in any event did not, split up the argument by issues.

Ron Stein of NIAP, Dave Bernfeld and I discussed this question of who would argue for a couple of weeks, although Ron and I were wholly out of the loop and David was only somewhat knowledgeable about what was occurring. The reasons for our discussions were that we could sense what might occur and had qualms about the appellate experience and appellate expertise of the lawyers. Given my own prior experience with numerous expert Supreme Court advocates and given what is sometimes written on this subject in the Times or the National Law Journal, we knew that there are major league Supreme Court specialists who in the last ten to twenty years or so have headed, or who are part of, special appellate sections of major law firms, sections of law firms that specialize in both Supreme Court work and federal court of appeals work. The idea of trying to hire such a lawyer for the appeal (and then for later Supreme Court work that will arise) seemed a good one. But there wasn’t enough time left to do it and we believed the NYC group of lawyers were likely to object strongly to the very idea of being displaced on appeal by an appellate specialist, even one of (deserved) national reputation.

The idea we were discussing, however, should be resurrected. There are at least three reasons. First, if we lose in the Second Circuit, we might wish to seek a rehearing en banc, i.e., a rehearing from the entire Court, not just the three judges who heard the case on March 3rd. (The other side might do the same if it loses.) In seeking or opposing such a rehearing, and in orally arguing if rehearing is granted, it would be wise to have an appellate specialist of the type I’m discussing.

Second, regardless of which side wins in the Second Circuit, the loser will ask the Supreme Court to hear the case and the other side will oppose this. No one can doubt the wisdom of having our side represented in such proceedings by a high Court specialist who is expert in gaining and opposing Supreme Court review and, if a Supreme Court hearing is granted, in arguing cases before the high Court. This is only the more true when one considers that in Supreme Court proceedings the SEC may well be represented by, and likely will at minimum receive the advice of, the Solicitor General’s office, the U.S. Government’s highly expert office of Supreme Court lawyers. (Most, and maybe even close to all, of the Supreme Court experts in private practice spent time in the SG’s office.)

Finally, the entire problem is going to repeat itself -- beyond question. As said, there is soon going to be omnibus briefing before Lifland on vital issues. While I am not privy to the details of what the Trustee and the group in charge are determining those issues to be and what the schedule of briefing will be, on January 10 I did receive a preliminary memo about this and do believe the issues will include such crucial ones as whether the CICO calculation of net equity should incorporate the time value of money. My personal opinion is that the omnibus briefing should include certain other issues that I doubt will be included, such as whether victims should receive credit, in their net equity calculations under CICO, for the approximately half billion dollars (I believe it is) that Madoff admittedly earned on monies from the 703 Account that were invested every single night of the scam in short term instruments, Treasuries, money market funds, etc., and whether the Trustee can lawfully demand that victims repay him tax refunds they receive from the U.S. Treasury (an expert tells me that there is precedent against this, and I shall read the cases he cites as soon as possible). In any event, the omnibus issues will be important ones, and the losing side will appeal them -- perhaps to the district court (the trial court) and then to the Second Circuit, or perhaps directly to the Circuit -- and the losing side in the Circuit will seek Supreme Court review. The situation which existed with regard to the appeal on net equity will almost certainly affect us again with regard to the omnibus argument on appeal unless our side hires appellate experts of the kind discussed here. Tomorrow would not be too soon, so that whoever is hired will have ample time to acquaint him/her/their selves with the omnibus questions. Not to mention the need to acquaint him/her/their selves with the net equity part of the case for purposes of a possible en banc rehearing in the Second Circuit and requested Supreme Court review.

Writing discursively, before moving on let me briefly discuss the relationship to David Becker of a point adverted to above: the time value of money. Much probably remains to be learned about the Becker situation, but one thing I have not yet heard is what I consider the real conflict of interest from the standpoint of victims.

As far as we now publicly know, some of the victims’ lawyers -- including ones from large law firms -- wrote a memo asking the SEC to require use of the final statement method rather than CICO. The SEC could have done this because, as was said by the Second Circuit in the first New Times case, quoting the Supreme Court, Congress gave the SEC “plenary” authority to supervise SIPC, even though, as the Circuit also recognized, the SEC has failed to exercise the authority Congress gave it. (What else is new?) The memo the lawyers wrote to the SEC was very good -- I read it at the time; it was an apt forerunner of later briefs submitted to Lifland by the same lawyers, which also were very good. The lawyers then, I believe, met with Becker (as others did too). When they met with him, they were meeting with someone who would have had to be chary about requiring SIPC to use the FSM even had he agreed, honestly and on the merits, that use of the FSM was the only legitimate course. For, were he to push the FSM upon SIPC, he could have been accused of doing so to feather his own nest by possibly eliminating clawbacks against him and his family. (If the FSM is used, then the money he took out for his mother’s estate might well be considered real profits and not subject to clawbacks (though Picard later determined to deny this, and to say that monies taken out in excess of monies put in are “clawbackable” even if the FSM is used. This will be an issue if the Second Circuit rules in favor of using the FSM.)) Because he could rightly be accused of feathering his own nest if he forced the FSM upon Picard, Becker could not do so even if he had completely agreed that the FSM, not CICO, was proper. So, unbeknownst to them, the lawyers and others from our side who met with Becker were meeting with someone who was ethically disabled from implementing their view even if he thoroughly agreed with it. From our standpoint, that is where the appearance of conflict lies.

As I’ve said to a few, were I one of the persons who met with Becker, and had I known he would benefit from the FSM, I would have been horrified and would have demanded that he recuse himself immediately. For, as said, he could not propound for our side without opening himself to charges of misconduct, and nobody wants to be trying to persuade an official who will be subject to ethical misconduct charges if he rules your way. Those who say that the conflict was no big deal because Becker decided against his own interests have not thought of or have failed to grasp the critical point discussed here. Yet would they want to be judged by a judge who cannot decide in their favor, no matter how right he may think they are, lest he be accused of serious ethical misconduct?

Of course, though the SEC claims it agreed with SIPC because it favors the use of CICO, it is also true that the SEC, apparently because of Becker, favors including the time value of money in some way when calculating net equity. Depending on how it’s calculated, the time value of money could amount to a considerable sum (e.g., if New York’s 9 percent interest rate is used). To this extent it could be said that Becker did act in his own interest (and other victims’ interest). In my mind this does not change the situation regarding the conflict, however. Lawyers and victims meeting with Becker were not seeking, and as far as I know had never at the time considered, using CICO augmented by the time value of money. They were seeking use of the FSM. Not to mention that, if Becker persuaded the SEC to use the time value of money, he was acting to feather his own nest, and he was engaging in an actual conflict, which cannot be good for the victims. And this is not even to mention that it might have been easier to persuade SEC staffers to include the time value of money in CICO than to persuade them to overturn an apparently already made decision in favor of CICO and substitute the FSM. For the time value of money is nothing but interest by a fancy name, and everybody understands the common garden variety appropriateness of paying interest. (Indeed, Picard is demanding interest from victims.)

So, to repeat, the real conflict from the standpoint of the victims is that Becker could not require the use of the FSM even if he had thoroughly agreed on the merits that it should be used, because he would have been accused of feathering his own nest by possibly evading clawbacks.

* * * * *

I have struggled unsuccessfully with how to present most of the details of the oral argument. The problem is that, prior to rebuttal, the argument seems to often consist of complex statutory and case exegeses, and mathematical examples that sometimes were difficult, all following each other in quick succession or strings, with the logical succession of ideas not always being apparent to a crystalline degree, and with all being designed to test or explain attorneys’ positions on the pertinent question of the case; whether an innocent victim’s net equity must be measured by his final account statement (under the section of the statute which defines net equity as being (in my own plain language) the obligation owed to the customer by the bankrupt broker, or whether the Trustee has discretion, because of the so-called books and records provision of SIPA, to look at the bankruptcy broker’s books and records to determine that the account statements are all wrong, and accordingly has discretion to determine that the statements therefore should not be the measure of net equity because they are fake (though the customer had no way to know this). Both the net equity provision and the books and records provision, it will be useful to add, speak in relevant part of securities. In plain language, net equity is defined in relevant part as what the broker would have owed the customer if, on the date of bankruptcy, the broker would have liquidated the “securities positions” of the customer (minus certain other amounts of money), while the books and records provision says the Trustee “shall promptly discharge” “all obligations” of the broker to “a customer relating to, or net equity claims based upon, securities or cash . . . insofar as such obligations are ascertainable from the books and records of the [broker] or are otherwise established to the satisfaction of the Trustee.”

Having sought unsuccessfully to think of a feasible better way to present the oral arguments on the ever present question, to present the to-ings and fro-ings on it, I shall, defeatedly, present the arguments “chronologically,” so to speak, and therefore shall present, in a dull and pedestrian manner, what I think are the more important aspects of the oral hearing. There are a lot of them.

Near the very beginning, our first advocate said that the way you calculate net equity is a matter of “simple statutory application.” (Tr. 3.) You “calculate[e] what would have been owed by the broker had the customers’ securities positions been liquidated on the “[bankruptcy] date.” To this Judge Jacobs immediately made a comment about which I have been unsuccessfully warning colleagues for a long time, and about which I wrote the NYC lawyers just prior to the argument. Jacobs commented that “Of course if the positions had actually been liquidated on the filing date, there would have been nothing there,” which is a way of saying no victim would have been owed anything. Very creditably, our lawyer came up with an excellent answer, telling Jacobs that the absence of securities is irrelevant because, if they are not there, the Trustee “is obligated to go into the market to try to purchase” them in accordance with the ownership of them shown in the customer’s statement. (Tr. 4.)

What our lawyer said was excellent, true, and shows that the absence of securities is irrelevant. But what was not said is that the legislative history specifically says, repeatedly, that securities which are missing or stolen -- which are not there -- must be bought and given to customers (something SIPC somehow gets away with never doing apparently, though its failure to do it is a serious, continuous violation of the statute).

The failure to insist that the legislative history says replacement securities must be obtained is symptomatic of a larger point. Early on most or all of the lawyers on our side in New York, and maybe even all the lawyers on our side except this ignorant writer, appear to have concluded that the language of the statute is dispositive in our favor. I have never understood this, precisely because of Jacobs’ comment: if you merely follow the abstract language of the statute and look at the actual “securities” or “securities positions,” there was, as Jacobs said, “nothing there.” So you must in actuality look at the abstract words of the statute in the light of the legislative intent and the overall Congressional purpose, or in light of the general meaning of those words in law, or both. If you do, an important answer to Jacobs’ comment, in addition to what our advocate said, was that you must use the final statement method to measure a customer’s net equity position because the legislative history shows that Congress intended investors to be protected and said so many times; that the statements they receive from brokers are usually the only way customers know what they have after introduction of the street-name-holding system in conjunction with the passage of SIPA, which was requested by Wall Street; that Congress wanted SIPC to pay investors promptly, but this is impossible under CICO due to the necessity of years-long forensic analysis to determine what each investor put in and what he or she has taken out, so that CICO necessarily destroys a main pillar of Congressional intent; that Congress wanted to build investors’ confidence in markets and protect investors’ reasonable expectations and this is impossible, nor will investors be protected, if investors cannot rely on the only information they get as to the nature of their holdings -- cannot rely on it, no less, because a Trustee can ignore the information they received whenever he thinks it is fair to do so. And, in addition to Congressional intent, it is widely accepted law that a broker owes a customer what is shown to be owed in the statements he sends the customer, and neither the Trustee nor SIPC has shown even a scintilla of evidence that Congress desired to change this.

If these points had been set forth, which would have taken between one and two minutes (or longer, of course, if the Court continuously interrupted), much of our case would have been stated in answer to the very first comment made by the Court. Such is among the kind of answers we used to coach inexperienced lawyers to give in the Supreme Court. It is the kind that I believe should have been extensively prepared in advance here. It also was the precise subject of the very first potential question and answer set forth in a memo emailed to the NYC lawyers on February 28th.

After the foregoing colloquy between them of our side’s view that the wording of the statute is all that matters, Judge Jacobs put to our attorney one of the bench’s complicated mathematical hypotheticals testing each side’s position. The point of this one was that, when our lawyers said the victim should get $20,000, the judge retorted that “that’s not what’s on the account statement. You just said the account statement is the beginning and the end of it.” (Tr. 5.) Our attorney then backed and filled a bit, finally saying that there are “certain circumstances where you could look behind account statements . . . . But that’s when the statutory framework doesn’t work, but the statutory framework works for Madoff victims’ (Tr. 6.) This, it seems to me, was a way of saying the statute requires the use of the FSM because it is good for us victims, but something else could be used if it is good for victims. Unfortunately, such one-sided application of a statute is generally not well thought of by lawyers and judges; they tend to say it is politics rather than law.

Yet there are reasons cognizable in law why the FSM should be used here. They are largely reasons discussed above. Congress wanted SIPA to protect and help investors, to insure innocent investors up to $500,000, to build investors confidence in markets and spur investing itself. As a statute intended for these purposes, SIPA’s fundamental reasons-for-being require use of the FSM here even if the final statement cannot be used in some hypothetical cases where, contrary to Congress’ intent, it would harm investors rather than help them, as in the hypothetical put forth by Judge Jacobs. This is the answer that I believe should have been given.

The next major questions were asked by Judge Raggi. She said that the lower Court’s decision was largely based not on statutory definitions, but rather on the assumption that net equity must be based on the totality of the circumstances. (Tr. 7.) She asked whether this assumption was flawed. Tr. 7.) Our lawyer’s very apt answer basically was that this assumption was flawed because the statute has no exceptions for Ponzi schemes or for the size, nature or effect of the scam. Thus, “The one issue is whether you can follow the definition of net equity, which this Trustee could have.” (Tr. 7-8.) To which Raggi replied that our lawyer was urging absurd results because people who had previously withdrawn money from Madoff would recover proportionally more than those who never had done so. And this, she indicated, would be an absurd result, whereas “the law abhors an absurd result.” (Tr. 8-9.) To which our lawyer responded, again quite aptly, that the result here is not absurd, and that what is absurd is that half of the Madoff victims of the worst SIPC liquidation in history didn’t receive SIPC protection. (Tr. 9.)

Now, I think, as said, that our advocate’s responses were good. Ponzi schemes had been known for about 45 years, since the mid ’20s, when SIPA was passed. Yet Congress made no exception in regard to how to treat them, and it is absurd that half of Madoff’s victims got no protection from the agency Congress set up to protect people who lost their securities. But there is so much more that could have been said. To wit: Congress intended not only to help investors, but, as the legislative history shows, to help small investors, who are suffering disproportionately here under CICO and associated clawbacks. Indeed, at the time SIPA was under consideration, President Nixon -- who was not famed for being on the side of the weak or poor -- said that he supported the bill because it helped the small investor. It therefore is the very opposite of absurd that small investors who had to take money out of Madoff to live could, because of that fact, end up recovering more (proportionately only) than wealthy hedge funds and banks which, speaking anthropomorphically, did not have to take money out to buy food, pay for their kids’ education, pay for houses, etc. Though I would not have said it to the judges lest they be offended, the idea that it is absurd for proportionally more to go to people who took out money to buy food and to live than to go to the fabulously wealthy, is a notion of absurdity that perhaps only lawyers and judges and bankers and SIPC Trustees could hold. But I would say to judges that it is an idea that is not followed, and distinctly does not resonate, in the real world. We have progressive taxation, don’t we, under which the wealthy pay more? We have welfare, don’t we, under which the poor get money and food, but the rich get nothing? The notion that equality and fairness demand that the newly poor, who could get up to a $500,000 advance under the FSM should instead get nothing because that advance plus their share of customer property would cause them to get proportionately more than a wealthy hedge fund which will get scores or millions of dollars strikes me as beyond the pale, strikes me as a bill of goods that the Trustee has sold to courts, media and others who have not given thought to this country’s long tradition symbolized by progressive taxation, welfare and the like.

We know, from answers in letters SIPC has sent to Congress, that the people who are recovering from the Trustee under CICO, at least in the short run, are mainly the fabulously rich -- hedge funds and banks who will be getting scores and hundreds of millions of dollars. As well, the Trustee has conceded that it was the investments of these huge entities, from about 1999 or 2000 onward which kept Madoff’s scam going, thereby increasing the losses and the amounts demanded by the Trustee from small people, who for years kept investing more money and kept taking out money to live, which they wouldn’t have been doing if the huge entities, which had the capacity to do but did not do the due diligence that would have caused the whistle to be blown on Madoff many years ago. Does fairness consist of giving the huge investors scores and hundreds of millions of dollars under CICO while not giving, say, one or two million dollars to people in their 70s or 80s who have been wiped out and have little or nothing to live on, and whose losses and assessed clawbacks would have been far smaller but for the incredible negligence of the big entities who will receive scores or hundreds of millions of dollars?

These are the answers which could have been added in response to the judicial claim of absurdity, a claim which was just a different method of expressing Picard’s and SIPC’s continuous and preposterous two year old refrain that they are doing what is fair. These answers could have been prepared in advance, and a memorandum emailed to the NYC lawyers on March 1 extensively discussed them.

After Judge Raggi’s comment about the law abhorring an absurd result, there was a colloquy which was hard to follow. It almost surely has to be one of the things that caused some attendees, some writers of web traffic, to think badly of the oral argument. The colloquy was somewhat unclear and reasonably long. Bear with me.

The colloquy started with Judge Raggi commenting that our lawyer seemed to be saying that there could be no exceptions when calculating net equity; no flexibility when calculating it. (Tr. 9.) I would guess the reason she said this was that our lawyer had said the statute provides no exceptions for the size, nature or effect of the scam. Yet, said Judge Raggi, “New Times did treat two different forms of investment differently,” so our argument might not be maintainable. (Tr. 9.) Our lawyer responded that victims here are in “the exact same situation as those New Times customers that received account statements,” apparently referring to New Times investors who bought securities existing in the real world. (Tr. 10.) The lawyer continued, now apparently referring to New Times customers who bought securities that did not exist in the real world, that the Trustee in New Times could not purchase the pertinent securities, and there “was [therefore] no legitimate expectation on behalf of customers that they actually own those securities,” whereas here the Trustee “could go out and buy IBM, Google, Microsoft,” etc. (Tr. 10.) To which Raggi said that a difference between Madoff and New Times is that here there were fraudulent trades done in hindsight, and this was different from the customer “investing” in New Times, which I take to mean that the strategy of continuous trading in Madoff is different from the buy and hold strategy in New Times (it has been assumed by all, but never verified, that in New Times there was solely a buy and hold strategy). (Tr. 10-11.) A buy and hold strategy, of course, allows you to look at what happened in the real world in order to gauge what the customer should get. Our lawyer responded to this by saying there is no cognizable difference between giving a broker discretion to trade for you, discretion to determine when and what to buy or sell, and telling the broker what to buy. (Tr. 11.) Then Raggi put to our attorney one of the mathematical examples that tricked up the oral argument, and our attorney responded by saying “if you can go and look and see if your security increased in value, then you would have legitimate expectations in that increase in value.” (Tr. 10-11.)

You got all that? It is perhaps more clear in import here, after I have in a sense “cleaned it up.” After reading the transcript several times in hard copy and marking it up, I think I finally figured out what was going on, and here’s my take on it.

The point of Judge Raggi’s initial comment was that maybe you can, as was done in New Times and as the Trustee and SIPC desire here, determine net equity in different ways depending on the circumstances. Maybe you don’t always have to use statements (at least where they exist). Our lawyer’s reply, which didn’t really respond to the point, was that the Madoff victims are in the same position as the New Times customers who got account statements, by which he must have meant the New Times customers who bought securities existing in the real world. Continuing on the theme of the situation of investors in New Times, he then switched implicitly to the New Times customers who bought securities that did not exist in the real world, and said that because the Trustee could not buy those securities, customers had no legitimate expectations regarding them, whereas here the securities could be bought in the real world -- so that here, he was saying implicitly, there are legitimate expectations. (Why there should not have been legitimate expectations for owners of non existing securities in New Times who received account statements showing ownership, is something that was not explained as far as I can see. The idea seems implicitly to rest on the fact that the securities could not be bought. Yet if, and because, account statements are the be all and end all, so to speak, it is hard to understand why the New Times investors in non existent securities shouldn’t have been able to rely on such statements. So it may be, as Judge Jacobs later commented, that the investors who bought non existing securities in New Times might have been treated unfairly -- as I personally believe to be the case. Of course, from the standpoint of argumentation in the Court of Appeals, it was not desirable to tell the Court that it had been wrong in New Times with regard to persons who bought securities that did not exist in the real world, and that in this regard it had been sold a false bill of goods by the SEC and SIPC in New Times. Rather, our side tried to work within the dichotomy set up by New Times, even if that dichotomy was incorrect.)

Judge Raggi’s response to the claim that Madoff investors are in the same position as New Times investors who bought securities existing in the real world rather than investors who bought securities that did not exist there, was, in effect, the claim of SIPC and the Trustee. To wit, here the trades did not exist in the real world, just as the securities did not exist in the real world in part of New Times. And because the trades did not exist here in the real world, you cannot measure what occurred in Madoff’s fictional world against real world results, whereas you could do so in New Times with respect to investors who bought securities existing in the real world and who simply held them (as is assumed to have been the case with respect to existing securities in New Times). There is thus a difference for SIPA purposes between a strategy of repeatedly buying and selling (a so-called trading strategy) as was purportedly done in Madoff, and a strategy of merely buying and holding, as was purportedly done in New Times.

Our attorney responded that there cannot be such a difference for SIPA purposes because there is no cognizable difference (in law) between telling a broker to buy a particular stock and giving him discretion as to what to buy and sell and when. Either way (I think he was saying) you have legitimate expectations of an increase in value if you can observe such an increase in the real world. So therefore, the argument would run, it is of no moment whether you simply bought and held securities or they purportedly were bought and sold, bought and sold. The main point is that in either case you can see in the real world that the price shown on statements is correct.

So there you have it (I think). The argument seems to have been about whether, especially after New Times, net equity must always (or almost always) be determined in the same way, or whether a Trustee can have discretion to determine it differently if something fake is involved, and, if so, in what circumstances of fakery does the Trustee have such discretion. The whole argument makes me think, as I have previously said to people, that we have allowed the entire question of net equity to get too complicated instead of simply saying, as discussed above, that Congress had certain intents, CICO destroys them, the FSM preserves them, and that is the end of the story here and in nearly all cases (except, perhaps, in some of the bizarre hypotheticals posited by the Court where, contrary to Congress’ intent, an investor is not protected, but harmed, by use of the statement in a case involving fraud).

Of course, in opposition to my sense of things, one could say the other side has put forth arguments and we must answer them even if this complicates matters. Yes -- but we should answer them in ways that do not further complicate matters, but which instead go back to our simple, fundamental arguments about what the statute is supposed to achieve and which say the other side’s arguments destroy the desired statutory achievements, as they do.

And, before turning from the complex colloquy, let me also elaborate a little, in a discursive exercise, on the reasons why the Trustee was allowed not to use statements to determine net equity with regard to people who bought non existent securities in New Times. It involves a point I have put forth many times but that has gained no traction. In New Times SIPC and the Trustee told and convinced the Court that, since the securities under discussion did not exist in the real world, the Trustee couldn’t determine their value, the fraudster could thereby give them whatever value he wanted to, and the SIPC fund would thus be endangered. The idea is one expressed by Judge Jacobs when he said Madoff would have been able to determine value by “chewing on his pencil and looking at the ceiling.” (Tr. 18.) But the idea, while attractive to the instinct, is significantly untrue in fact. Some of the supposed victims are complicit, can be caught, and can be denied SIPC payments, all of which Picard himself has shown. For others, there are well established, oft-used financial techniques to judge and place limits on the fraudster’s “generosity.” One can rely, for example, as here, on measuring returns by comparison to the S&P 100, to mutual funds, or to other funds using the same financial strategies as Madoff. Indeed I have often thought exactly the same could have been done in New Times where, given the facts as I understand them, the nonexisting funds could appropriately have been assigned an ultimate increase in value not far from that of the funds which did exist in the real world. The claims made by the SEC and SIPC in New Times with regard to inability to know what the value of securities might have been are hooey. (This was covered in a memo sent to the lawyers on March 1st.)

Let me now continue this dull, pedestrian writing by turning to the oral argument of our second lawyer.

In an immediate colloquy with Judge Leval, the attorney said we are not relying on the provision requiring the Trustee to discharge obligations insofar as they are ascertainable from the bankrupt’s books and records, but on the net equity definition, which, the attorney said, is consistent with the language of the books and records provision. (Tr. 12-13.) Aside from SIPA, it was said, in law your statement reflects what you own, and SIPA does not change this. So normally, as here, your statements control, except when the statement would result in the investor getting less than is proper.

Judge Leval then put forth one of the bench’s mathematical hypotheticals testing the argument that the statement is all one looks at and, after the lawyer began to respond, quickly pointed out that the present situation “is whether peoples’ accounts should be valued on the basis of fictitious trades that never occurred, on the basis of statements that were simply figments of the imagination and never involved any real securities whatsoever.” (Tr. 15-16.) The lawyer’s relevant response just a bit later was that Madoff’s customers received statements showing ownership of securities “And under all nonbankruptcy law those statements give them ownership rights and I think SIPA also gives them ownership rights.” (Tr. 16-17.) Otherwise, SIPA’s protection does not work for the investors. The statement therefore controls “when the customer believes rationally that the statements that they’re getting are consistent with what they own. And the reason . . . is because you never know when your broker is engaged in a Ponzi scheme or some other nontrading of securities. You don’t have physical securities anymore in your possession. You have no idea what’s going on behind the scenes. You must rely on your statements. (Tr. 17-18 (emphasis added).) At this point Judge Jacobs made his remark about Madoff chewing on his pencil and looking at the ceiling, while making up amounts, and the lawyer responded that “customers are entitled to rely on their statements and I believe the fund [the SIPC fund?] is obliged to honor their expectations unless it can be shown that . . . they actually knew something was going on.” (Tr. 18.)

The colloquy had several significant points for our side. One is our claim that the situation under SIPA conforms to the non SIPA law. A second and very important one is that, in answer to the point that the statements were just figments of imagination -- a point which seems to have a magnetic attraction for judges -- our lawyer quite rightly made the crucial point that the innocent investor didn’t know that Madoff was a Ponzi scheme, and therefore was entitled to rely on his/her statement if it conformed to the market. A third is that you have to rely on the statement, and SIPC must honor expectations arising from the statement, because you no longer receive physical securities, which are held in street name today (because this was more advantageous for Wall Street). So some crucial points were made, even if not always in a crystalline way.

Judge Jacobs next picked up on our lawyer’s reference to legitimate expectations and said this refers to New Times’ method of determining whether an investment “will be classified as one for cash or an investment in securities.” (Tr. 18.) Every victim here has received the benefit of his investment being classified as one for securities, but he was “not sure legitimate expectations govern . . . the precise amount of money” a victim gets. The lawyer replied, surprisingly to me, that “I’m not sure it’s legitimate expectations exactly either,” but then said, in effect, that the statement determines what one would get in a non SIPA lawsuit (e.g., for fraud) and therefore must determine the amount you have for SIPC purposes too unless, for example, the customer was complicit. For again, as the attorney was quite right to emphasize, the statement is the only way an investor knows what he owns and “the whole system is dependent” upon the statements issued by the broker “saying this is what you own.” (Tr. 19.)

The attorney’s answer to Jacobs as to why you have to rely on your statement was good. It would have been even better if the lawyer had crisply said to Judge Jacobs that the legislative history shows that SIPA was to protect investors and giving effect to the statements they receive is the only way to carry out the legislative intent to protect them. I would add that I have never understood the idea that a statement saying you own X security which was bought at Y price gives you a legitimate expectation that you own X security but does not give you a legitimate expectation that its price was Y. Have you ever heard of someone who received such a statement and (barring a known or suspected mistake in price) thought that she owned X security but that its price had not been Y?

The next significant colloquy involved valuation. Judge Leval asked whether there was a challenge in New Times to the valuation of securities that existed in the real world. (Tr. 20.) The attorney correctly said no. (Id.) Leval then said that New Times therefore was not a precedent for using the account statement for determining valuation. (Id.) Our attorney responded that this is correct, but New Times means that the statute must be followed where it can be, as here. Judge Jacobs then chimed in that, as we’ve heard, and has been discussed above, in New Times it was not possible to determine the real value of the securities that never existed (so CICO was used), and isn’t the analogy here that the transactions in Madoff were as fictitious as the non existing securities in New Times. (Id.) Our lawyer responded very aptly that the system is “set up to protect the customer, so . . . you need look at it from the customer’s perspective . . . .The customer provided funds to a broker and said, please invest this, it’s your discretion, you invest it. The broker kept issuing statements that looked like they were consistent with the market, that told the customer this is what you own. This went on for 30 years, it seemed to work pretty well for a pretty long time. The customer had every reason to assume that the protections of the securities laws of Article 8 and finally of SIPA would govern in this case.” (Tr. 21-22.)

Judge Jacobs then said, “Well, then it does seem awfully unfair to the people who were credited with having fake securities in New Times that they shouldn’t get the benefit of exactly the same expectations. After all, ordinary investors don’t really have the ability to go out and find out whether, you know, Blue Sky Corporation actually exists or has a certain capitalization or is traded here or there. It just seems, under your argument, it seems to prove too much because then New Times is wrong. All of those people were unfairly treated, according to you. And they may indeed have been unfairly treated in the overall scheme of things. The question is were they unfairly treated under the statute?” (Tr. 22.)

Our lawyer replied that in New Times the owners of non existent securities were entitled under the statute to what their statements showed, but the problem was that the non existent securities didn’t exist, and therefore couldn’t be bought and couldn’t be valued. Judge Raggi interjected that nobody “is going to give your client 20 shares of AT&T.” Only money is involved here, so why does the money from phony transactions deserve SIPA protection any more than the money from phony securities in New Times? (Tr. 23.) Our lawyer replied that the fake securities in New Times could not be bought or valued and therefore SIPC would be “exposed to risk which there was no way to tether in any way to the market.” (Tr. 23.) Whereas here there were “real securities that were traded, according to the statements, at prices you would expect in the markets.” (Tr. 23.) To which Judge Raggi said, “But that assumes that the customer took risks in the market,” though Madoff investors never did since everything was concocted by Madoff after the fact, “always to show gains.” (Tr. 23-24.) (I frankly don’t understand the logical relationship of Judge Raggi’s comment to what came before, since the issue was can you determine price, not did you have actual market risk.) Our lawyer responded, quite aptly, that (once again) you must look at it from the standpoint of the customer, who does not know what the broker is doing except for what the broker tells him in the statement which he receives and who has relied on that information month after month and acted in accordance with it. (Tr. 24.) To which Raggi, replied that this is the same for both the non existent securities in New Times and the non existent trades in Madoff. (Tr. 24.) Our lawyer replied that the question is whether the statute can be applied. Our attorney agreed that “SIPC is not going to go out and buy the AT&T, but SIPC can tell you how much the AT&T was worth” on the pertinent date. This could not be done in New Times with regard to the non existent securities, our lawyer said. (Tr. 24.)

Whew! What is the meaning of all this extensive to-ing and fro-ing? What at least is the meaning of important parts of it. Well, it starts with the lack of challenge to valuation of existing securities in New Times, which Judge Leval said had no precedential value because there was no challenge. Our lawyer responded that you have to use the statements, which were consistent with the markets. Moreover, the fact of the matter is that the New Times Trustee used, or used the equivalent of, the final statement method in New Times for securities that existed in the real world -- and the question was whether buyers of non existent securities should be given the same treatment. This, I think, cuts against the claim of lack of precedential value, a point which is especially true since the Court in New Times, which was an appeal by the owners of non existent securities, said “To be clear -- and this is the crucial fact in this case -- the New Age funds in which the Claimants invested never existed.” (First emphasis added, second emphasis in original.) So I think that, even if Judge Leval’s point may be technically true, in reality it is a bit overmuch.

As for Judge Raggi’s comment that Madoff victims experienced no risk, none of them knew they had no risk, since none of them knew Madoff was not actually in the market. They thought they had risk, and it seems quite wrong to deprive them of SIPA benefits on the ground that they had no risk when they did not know they had no risk and honestly thought they did have risk. And, as our lawyer said, the customer had to rely on the statements she received; she had no other information, after all.

Then the foregoing turned to our opponents’ fundamental assertion, which has been the subject of previous discussions: that there is no difference between a situation of faked securities and a situation of faked transactions. Our lawyer’s response was the very appropriate one that you must look at it from the customer’s perspective, because “the whole system is set up to protect the customer.” (Tr. 21.) Amen -- that is exactly what the all important legislative intent was.

Judge Jacobs noted that, looked at this way, the people who bought non existent securities in New Times had the same expectations and therefore our lawyer’s argument proves too much because it means New Times was wrong and the investors there may have been treated unfairly. Exactly. They were treated unfairly, and New Times was wrong with regard to them, unless you say that in New Times they could at least have checked out whether the fake funds even existed -- and maybe they could have, though I don’t really know and cannot remember ever reading anything about this. Our attorney said the people in New Times were entitled to what was on their statements, but the problem was that it couldn’t be valued. Here, of course, as our lawyer repeatedly said, the securities could be valued in the market.

In the colloquy, Judge Raggi said the only question involved was money because “no one is going to give your clients 20 shares of AT&T.” (Tr. 23.) This remark was not gainsaid. It reflects a SIPC invention that completely destroys Congressional intent, yet somehow has taken hold and is never even challenged. As I have written in essays and briefs, Congress amended SIPA in 1978 precisely so that SIPC would go into the market and acquire missing securities to give to victims. Congress considered it very important for people to get back into the market quickly, and knew that there were important investment and tax consequences involved. And here, as also explained in essays and briefs, the missing securities could have been obtained and given to victims; they were S&P 100 securities that constituted only a fraction of the number of shares of each issue that are traded each day or week. It would have made a huge difference for victims to get securities here, because the stocks have risen dramatically in value since Madoff went under on December 11, 2008.

This brings me to the last important colloquy involving our second advocate. Judge Leval, in words that seemed to gum things up though his meaning was clear enough, asked/said that our lawyer was saying there are two different pies, meaning the SIPC fund and the customer property. (Tr. 26.) He asked whether the size of “that pie [which pie?] will vary according to how this question [the question of net equity, one gathers] is determined?” (Tr. 26.) Our lawyer said no. The judge asked the relative sizes of the two funds. Our lawyer didn’t know, but did know that the SIPC fund was big enough to cover everyone up to the $500,000 per individual that SIPC could be liable for. The lawyer didn’t know (naturally) what the ultimate size of the customer property fund might prove to be. (Tr. 27.)

At that point Judge Leval presented an idea that subsequently has been the subject of much talk. Perhaps using incorrect words but with his meaning being unmistakable, he said. “It seems to me that the argument that you’re making makes better sense in the SIPC application than it does in the division of the pie. As to the division of the estate pie, who gets more and who gets less would be entirely a function of, as Judge Jacobs was saying, Mr. Madoff’s imagination.” (Tr. 27.) Our advocate replied in part that “the question of who gets more and who gets less” is thought “the motivating factor in what the Trustee is doing.” (Tr. 27.)

Leval then asked a question he and the other judges appear to be focused on: whether, with regard to the SIPC fund, “are any of the Madoff customers harmed by the last statement approach.” (Tr. 28.) “They definitely are harmed,” he continued, “in the division of the estate pie, the ones who are more recent investors are harmed because a larger percentage goes to the earlier investors whose accounts built up and built up over the years. But how are customers harmed with respect to the part that comes from SIPA?” (Tr. 28.)

Answering the obverse or converse question from the one put by Leval, our advocate said victims are harmed by CICO because CICO means they will get less from the SIPC fund by invalidating all the statements received by an investor.

This question of whether the use of the FSM lessens the return of some investors is one that the Court returned to when questioning our opponents. Suffice to say here that it appears to be very much on the Court’s mind and conceivably could prove important in the case and in efforts to settle the entire Madoff matter outside of litigation. Some people think, as will be discussed later, that the Court is looking for a way to use the final statement for purposes of SIPC advances but, at least initially, not for purposes of distributing customer property. And, regardless of this, the idea is an obvious one for purposes of trying to work out an overall resolution of the Madoff matter, a resolution in which it could play at least some role.

Next Judge Raggi asked why the Trustee “did not have the discretion to proceed as he did under . . . the section that says he’s obliged to discharge net equity claims only insofar as such obligations are ascertainable from the books and records of the debtor or are otherwise established to the satisfaction of the Trustee.” Judge Raggi asked “Do you agree that that controls his determination here, that that is the relevant section or not?” (Tr. 30.) Our lawyer did not agree, and said the definition of net equity governs what the broker owes, which generally speaking is determined by the final statement (except, for example, where there are no statements). (Tr. 30-31.) Raggi responded that the statute says “you pay obligations only insofar as they are ascertainable from books and records of the debtor,” that here the books and records show that purchases were never made and fake purchases were concocted after the fact, that the FSM therefore would not be a reliable way to calculate net equity, and why do we say the Trustee does not have discretion to make such a decision. (Tr. 31-32.) To which the lawyer responded, quite commendably, that “to go back to my first principle here, this should protect customers. That’s the name of the statute and the customer should be the focus. (Tr. 32 (emphasis added).)

Judge Raggi then made a comment that induces apprehension, and that received an answer very surprising to me. She said “I understand we’re interested in statutory purpose, but we are limited by statutory language.” To which the lawyer replied, “Absolutely, absolutely.” (Tr. 32.) I will say right now that the lawyer’s answer should instead have been, “Yes, we must conform to statutory language, but the statutory language must be interpreted in the light of the Congressional intent.”

Anyway, the attorney then answered that the statutory section does not allow the Trustee to ignore the statements, which are records of the broker. Again our lawyer correctly said that you must “look at it from the customer’s perspective, and under the UCC and securities law the customer can sue the broker on the basis of the statement.” (Tr. 33.)

Judge Raggi seemed unsatisfied by this answer, and among other things said, in effect, that the Trustee does not have to accept transactions which the books and records show never happened. The lawyer said a customer’s rights derive from the statement under non SIPA law (which the Judge said she understood), and the situation is the same under SIPA, which is to protect the customer, since the “SIPC fund is there precisely for a situation in which the broker did not buy the securities he was supposed to buy.” (Tr. 34.) [QED] The statement is the measure under other laws than SIPA, and SIPA law does not “reduce the customer’s claim.” (Tr. 35.)

This colloquy had some important points in it. To begin with, the judges appeared to understand that there are two different funds, the SIPC fund and the customer property fund, and seemed to think that it might make sense to use the final statement method for the first fund, but not the second. (As will be discussed in the second part of this essay, our opponents claim, in effect, that there is only one fund.) Also, and again as will be discussed in the second part of this essay, many think the judges are looking for some way to treat the two funds differently, so that, for example, even if the FSM governs payments from the SIPC fund, it might not govern, or might not exclusively govern, payments from the customer property fund. Whatever the judges might be thinking, it is plain that the idea of treating the two pools of money somewhat differently is one that a lot of people find attractive and that conceivably might be part of the basis of a non judicial solution to the Madoff mess.

The colloquy was also concerned with whether the Trustee has discretion to calculate net equity on the basis of what Madoff actually did as shown in hindsight by the books and record section but was unknown to innocent victims when it was happening, or whether the Trustee must use the final statement method in order to carry out the purpose of protecting innocent victims. And, though our lawyer surprisingly agreed that Congressional purpose was not pertinent when in fact it is crucial and when the language of statute must be interpreted in light of Congressional intent, she did say, very importantly, that the purpose of protecting victims has to be honored and that SIPA cannot be thought to treat the customer’s financial rights less favorably than other law -- such less favorable treatment, I note, would be antithetical to Congress’ intent to protect investors.

The Effect Of The Garrett Bill On Indirects

2011-02-21T14:41:00.000-05:00

Dear Colleagues:

Allow me to make some points that, as far as I know, no one else has made with regard to the beneficial effect of the Garrett bill on indirects. These effects exist though the bill does not mention indirects.

The indirects have, of course, invested through intermediaries - - through funds, banks, etc. Under Garrett’s bill, as I understand matters, those funds and banks are customers and will be as eligible as any other customer to get back money from customer property. That money, under the Garrett bill, will be calculated under the final statement method, if the funds, banks, etc. are innocent. If they are not innocent, Picard could, I think, choose to calculate it under CICO, though I wonder if he would do so if the funds, banks, etc. agreed in advance to return all the money to defrauded indirect investors, as they should. Thus, if the indirects’ funds are innocent, and the Trustee is anywhere near as successful as he claims he will be - - he claims he may recover $45 billion - - the indirects, under the consequences of the Garrett bill, would get [all] their money back from customer property, up to the amount of their final statements, even though they would not get advances. If the banks are not innocent, they may get back and distribute only their cash-in, unless investors can prevail upon Picard - - as I actually think may be possible for a variety of reasons - - to use the FSM for funds that agree in advance to return to defrauded indirects all the money the funds get from customer property.

What if, however, a fund is potentially one of those which Picard claims is not innocent, i.e., the fund knew or should have known something was wrong. Well, if the fund took no money out (or took out less than is shown in its final statements), then, I believe, it will still get back money from customer property, although (i) the amount it receives may be based on CICO unless, as said, Picard can be persuaded to use the FSM if monies recovered by the fund will be forwarded to the indirects, and (ii) the fund likely will be subjected to clawbacks to the extent it took out money. In connection with such funds getting money back, it is my belief (not a recollected certainty, but only a belief) that Picard or his minion have said that the claims of funds against customer property will be recognized unless the fund was one of the truly egregious culprits in terms of aiding the fraud though it should have known there was a fraud.

But what if a non innocent fund took out more money than is shown on its final statement? Well, assuming the fund was not one of the truly egregious ones, I believe that although Picard will seek to claw back from it, the fund will still have a claim against customer property. (This, as I remember (I am in Florida without access to the relevant papers), was what occurred in the settlement with UBP (or was it UBS?), where the claim Picard recognized was, as I recollect, about 250 million dollars greater on a CICO basis than the payment to Picard from the bank.) So, at least where the fund or bank is a large one with the resources to pay Picard (as many likely are), it will get back from customer property sufficient monies to pay back their Madoff losses, on a CICO basis and maybe on an FSM basis, to its indirect investors (who (unlike directs) would have lawsuits against it, in all likelihood, if they are not paid by it).

But what if a non innocent fund or bank is one of the egregious ones? I suspect Picard may not recognize its claim for customer property, so its indirect investors will not be able to recover in this way.

If my views are correct about the necessary effects of Garrett’s bill on indirects, the bill will prove beneficial to many of them even though it does not mention them. Many of them - - perhaps even most? - - would end up receiving either the full amount shown on their final statements or the amounts they actually invested. The questions which should be inquired into, therefore, are these: (1) Will Picard in fact recover 45 billion dollars so that he can pay everyone in full from customer property under the FSM? (I am assuming (and could be wrong) that $45 billion will do the trick, since I believe the Trustee claims the total ESM losses to now be only $45 billion because he has subtracted the no longer extant huge claims of persons and institutions with whom he has settled, e.g., the Picowers, the Shapiros, etc.) (2) When will the Trustee’s recoveries reach somewhere around $45 billion? (3) When will the Trustee start passing out money - - he has said, if I remember correctly, that he will be submitting a plan of payment this spring, but when will payments start under that plan? (4) Will Picard agree to use the FSM method for non innocent funds that agree to pass through to innocent defrauded indirects all recoveries from customer property? (5) What funds and banks will be regarded as so egregious that the Trustee will seek to avoid paying them anything - - i.e., he will refuse to recognize their claims against customer property - - so that their indirect investors will not be able to recover from customer property via their intermediary funds?

I think it would behoove everyone, especially including the indirects who presently are threatening to try to scuttle the Garrett bill, to focus on these questions rather than on trying to destroy the Garrett bill. For the consequences of the bill could be very favorable for the indirects even though it does not mention them.

Comments On SIPC’s Answers Of January 24th To Questions Asked By Congressman Garrett.

2011-02-11T09:45:00.001-05:00

February 11, 2011

A couple of people have asked for my reactions to SIPC’s January 24th answers to questions posed to it by Congressman Garrett. Because SIPC’s answers have now been made public, I am posting some slightly redacted comments I sent on January 28th to colleagues who are in or are working with NIAP.

1. Pages 2, 13-14: In discussing Picard’s “compassion” and his hardship program, SIPC, as it often does, speaks in generalities (which courts, Congress, etc. too often accept without question). Here it is pretended that the hardship program is perfectly reasonable. Yet many victims, speaking of the information demanded of them, find the program deeply intrusive and violative of privacy. I think we should try to get an application to see for ourselves what is demanded and how intrusive the program is. Maybe some victims have and would give us “clean copies” of the applications that victims need to fill out.

2. The Trustee has reached settlements with some large institutions in which he has agreed to recognize their claims in return for payments to him of monies the institutions took out of Madoff. Yet these institutions would seem to be ones that at least “should have known” there was a fraud. Why did he agree to recognize claims of institutions which should have known something was wrong? Picard is implicitly saying that SIPA allows him to recognize the claims of the culpable, whose continuous shoveling of money to Madoff kept the fraud alive from 2000-2008 and thereby caused tremendous increased injury to a huge number of us. And why did Picard, conversely, refuse to recognize a claim on behalf of the Picowers? (I think it likely was because Picower himself was subject to criminal charges; also, his estate could have been sued under RICO.) And why did Picard not recognize a claim for Norman Levy, who, as the January 24th answers show, was a major Madoff player financially.

3. Page 2: Picard will need approval from Lifland to distribute funds to customers and an application is being prepared. We know, however, that the impoverished will get little or nothing from customer property (and indeed will be subjected to clawbacks), and that the customers who will get money are mainly the very wealthy and hedge funds -- while Picard and SIPC claim all the while that this is equity. We should try to find out who the funds and banks are who will be receiving money. Intimately related to the distribution of money is the question of when will enough money be in Picard’s coffers so that possibly he could declare that a certain amount of it exceeds the “needs” of customer property and can be considered part of the general estate and used to pay fraud damages to victims.

Also intimately related to the forthcoming request to distribute money, I am sorry to say, is the question of the identity of the judge. We should have every expectation that as long as Lifland remains the judge, anything Picard wants to do will be approved -- and quickly. He is, I think, totally biased in Picard’s favor -- Picard has, in fact, won everything in front of him as far as I know, except for some very minor aspects of major matters that Picard won, e.g., enlarging the number of potential mediators and removing Adele Fox’s name from an injunction that applies to her anyway. If Picard says it is equitable and legally required to claw money from the now-poor to give to the still-rich, and that this is equity, Lifland will agree. (My experience with Lifland last Tuesday only reconfirms my views about his unshakeable bias in Picard’s favor.) Similarly, Lifland will automatically rule in Picard’s favor on such crucial issues as the (lowest possible) interest rate to be used in calculating fraud damages, the Trustee’s demand for interest from the dates of withdrawals, which can double or triple the amount owed, defacto liens against monies refunded by the IRS, not crediting victims with earnings from short term investments, and other crucial issues. If Lifland continues to be the judge, it will almost certainly be deadly for our people.

In this regard, how did the case come to be assigned to Lifland? Was it a result of some completely random assignment process (of the kind used by District Courts)? Or, as Chief Judge of the Bankruptcy Court, did Lifland -- as we occasionally hear of in District Courts (with accompanying complaints) -- insist on taking the case himself? The answers to the question of how the case came to be assigned to him could be quite important.

4. In explaining why innocent investors are not usually the subject of avoidance in a SIPA case, SIPC -- as it has done since the beginning -- uses numerical examples carefully crafted to provide the answers it wants, while ignoring that the answers would be different if you use different numbers. This constitutes a form of lying with figures.

Moreover, SIPC’s examples depend upon (i) there being enough customer property for everyone to be paid off without an avoidance action (a situation which Lifland told me at the oral argument is not germane to whether there should be a stay of proceedings against small innocent victims -- can you believe that?), and (ii) ignoring that its examples work only because it habitually turns down most claims -- about 90 percent of them, perhaps? If it didn’t turn down most claims, there is no way, I believe, that it would have enough money to pay back all claims without avoidance actions. This is another example of SIPC failing to tell the real truth.

In this regard, SIPC should be asked to state what percentage of claims it has turned down over the years and what percentage it has granted.

5. SIPC’s explanation of the logic behind its claim that investors have unsecured creditors’ claims for fraud against the general estate is on pages 5-6.

6. On page 5 SIPC says if the Trustee is left “unfettered, he will be in the best position to help all of the victims.” Of course, in the meanwhile, he will be desperately hurting the small now-impoverished so-called “net winners” -- which seems not to bother him at all. And he will be hurting them even though clawbacks from them are not necessary to pay off people.

7. Page 6: The SIPC fund is currently $1.23 billion. That is shockingly low. It shows SIPC has learned nothing and is still not listening to Congress. It also shows that the strategy is to pay victims (if at all) with money from other victims.

8. Pages 7-8: Their explanations of why so much time was needed to calculate accounts does not mention that this, as oft remarked, was due to the fact that they used CICO rather than the FSM. In any but the simplest, smallest case CICO will require extensive time, thus frustrating Congress’ desire for prompt payments to victims. CICO is, in other words, a built in frustrater of Congressional intent. This is a powerful reason, I think, why CICO is inherently improper under SIPA.

9. The answers constantly use the phrase “fake profits.’ This is a legalistic and psychological ploy to try to make readers forget that to protect people against being harmed by theft by crooks like Madoff was a specific purpose of SIPA. In this regard, of course, the thieves will provide false statements showing fake profits -- how else would they prevent victims from learning what is happening? It is thus inherent in Congress’ explicitly expressed desire for SIPA to protect against theft that there will be phony statements showing false profits (as occurred, by the way, in Bayou and Visconti and, I would imagine, in New Times).

The continuous use of “fake profits” is also a psychological ploy to make people forget that Picard is taking money from the now-poor to give to the rich. The now-poor are being required to give up what SIPC’s answers continuously call their “fake profits,” so it supposedly is alright to take money from them to give to hedge funds and banks.

10. Pp. 11-12: The answers make claims about assignments, but we’ve never seen one and can’t judge the veracity of what the answers say.

11. P. 12: Their answers to the question on disbursements state the “Number of Disbursements in Excess of Deposits.” (Emphasis supplied.) But the question did not ask for the number of disbursements in excess of deposits (whatever that means), but rather for “the number of disbursements.” Why have they answered a different question than what was asked? What is their game here? Am I missing something?

12. On p. 11 they provide their justification -- in reality, their excuse -- for not crediting customers with short term earnings under CICO. Their excuse is pure balderdash, and, were it true, no fund or bank would have to credit customers with interest on funds the institution has “parked” in short term instruments, since it all would be considered the institution’s money, not the money of customers. I have discussed this matter in a lengthy footnote to a brief, as follows:

The only thing SIPC or the Trustee has publicly said about all of this to date is that Mr. Harbeck told NIAP that the short term earnings were not credited to victims because they are customer property. This is a transparently disingenuous answer which seeks to avoid the issue. The question is not whether such earnings, under SIPA, are customer property after the Madoff bankruptcy. For all Madoff property became customer property under SIPA after the bankruptcy, and under Harbeck’s transparently disingenuous, so-called logic, customer accounts should have been credited with nothing for SIPA purposes after the bankruptcy. The question, is not what is or is not customer property, but is, rather, how much should victims’ accounts have been credited with under SIPA after the bankruptcy.

This question leads in turn to the question of why did SIPC and the Trustee not credit the victims’ accounts with the “cash-in” accruing from interest on short term instruments -- interest which is credited to customers who hold earnings-bearing accounts by every financial institution in the country. Is the answer to the last question that SIPC and the Trustee did not credit interest to the victims because they knew that SIPC did not have the money to pay all the advances which would be required even under CICO if the interest was credited to victims and thereby gave many or most victims a positive net equity? (The interest, whose total amount neither SIPC nor the Trustee has disclosed, could amount to many hundreds of millions or even billions of dollars over the twenty or so years during which the fraud is known to have been ongoing, and thus could easily have made the difference between a positive and a negative net equity under CICO for hundreds or thousands of people.) Is part of the answer to the question that SIPC and the Trustee knew the failure to credit victims with the interest, thereby causing them to have a negative net equity under CICO, would fly in the face of Congressional intent to protect victims, especially small ones, but SIPC and the Trustee decided to do this anyway because otherwise SIPC did not have enough money to pay advances to victims? Is the answer that SIPC and the Trustee simply made a mistake and then refused to own up to it when victims learned and pointed out that there had been short term interest earnings which should have been credited to them?

Whatever the answers to these questions, it is obvious -- obvious -- that the answers (i) can make all the difference in this case as to what customers’ net equity should be even under CICO – can be material and controlling on that score, (ii) can make all the difference on whether victims are subject to clawbacks since properly crediting customers with the interest earned on their accounts -- interest which is defacto cash-in for customers -- may cause customers not to have taken out more than they put in, and (iii) should be subject to discovery, including discovery via deposition of the two people who likely best know the answers, Messrs. Picard and Harbeck.

13. They estimate on page 22 that another $1.1 billion will be spent on lawyers and consultants. Wow!! This, of course, is SIPC money that would otherwise be available to victims.

14. P. 24: They say they in part gave effect to the final statement method -- so that customers would be eligible for advances of up to $500,000 rather than advances being limited to $100,000 (where a customer has only cash at the brokerage) -- because customers had a “reasonable expectation that securities were being held for them.” ($500,000, not $100,000, is the limit for securities.) But they didn’t use the FSM “beyond that” -- i.e., to measure net equity -- because the profits were fake. Yet it is preposterous to say (as they have said explicitly in briefs) that customers had a reasonable expectation that they owned securities because they got statements saying this, but did not simultaneously have a reasonable expectation that the value of the securities was as shown on the same statements. Has anyone ever heard of a customer saying, for example, “I expect I own securities because my statement shows this, but I don’t expect the value of the securities are as shown in the very same statement.”

15. Pp. 24-26: they list cases in which, they say, the final statement method has not been used to determine net equity. Based on my recollection of what was said in briefs filed on the net equity question in the Bankruptcy Court and in the Second Circuit, I think that some of these cases are not SIPA cases. They are, if memory serves, “straight bankruptcy” (i.e., non SIPA) cases. This should be checked out with lawyers who have focused on some or all of the cases in their briefs. They would include attorneys like Karen Wagner of Davis Polk and Jon Landers of Milberg. To the extent that I am right -- to the extent that these cases are not SIPC cases -- the answers provided on pages 24-25 are deliberately misleading because the question asks for cases in which SIPC used the CICO method, and the answer does not tell you that it lists cases which are not SIPC cases (and indeed implies falsely that the listed cases all are SIPC cases).

16. Pp. 25-26: On these pages they list four cases out of more than 314 (or about 1.3 percent) in which, they say, SIPC trustees brought avoidance actions. The number is tiny yet, necessarily, implicitly hearkens back to their prior assertions, discussed above, as to why there are few avoidance actions under SIPA -- assertions which depend on the fact that the reason they have enough money to pay off all claims in a given case without avoidance actions is because they deny most claims, so that there is only a small percentage of claims that they need to pay off. As far as I know -- and in reality I don’t claim to really know -- they are right in claiming that avoidance actions were used in 1.3 percent of SIPC’s cases, but again the accuracy of their claim that the listed cases involved avoidance actions should be checked with the lawyers who discussed the listed cases in their briefs, especially Wagner and Landers. (Such lawyers distinguished the cases and said they are inapplicable here, though inapplicability here would not seem to change the fact, if it is a fact (which should be checked), that trustees used avoidance actions in the cases.)

Larry Velvel

Appellant Briefs and Addendums Filed in Second Circuit.

2011-02-11T09:35:00.002-05:00

Below is the link to my appellant brief and reply brief and addendums which were filed in the Second Circuit.

Larry Velvel

http://goo.gl/QmW7t

The Trustee’s Complaint Against JP Morgan.

2011-02-09T09:20:00.004-05:00

The Trustee’s Complaint Against JP Morgan Chase.

February 9, 2011

A few days ago, when I was just beginning to read the Trustee’s complaint against JP Morgan Chase, I posted the fairly dramatic introduction to the complaint. Having now read the entire complaint, I would like to add a few comments.

The factual allegations of the complaint are essentially divided into three parts: facts related to JPMC’s sale of so-called “structured products” that would put investors’ monies into Madoff, facts related to the 703 account, which was the account into which and from which purported investment monies flowed, and loans made by JPMC. There were different JPMC groups and persons dealing with differing aspects, but the complaint says, and illustrates, that they were in touch with each other. Information, it seems, was not rigidly compartmentalized, but shared.

Of course, due to the heavy redaction which still exists in the complaint, especially of names, it can sometimes be a bit challenging to track what is going on or who was talking to whom, but still it all seems fairly comprehensible.

I shall not discuss the question of what was known by the developers and sellers of structured investment products, whose knowledge, if I understand the complaint, was at appropriate times passed on to JPMC people in charge of the 703 account and of loans. This knowledge was pretty much, or even entirely, of the same kinds of red flags first publicly revealed by Harry Markopolos and subsequently revealed to have been known by lots of people on Wall Street, though not to us innocent dupes. I speak here of such matters as concern, or potential concern, over the identity and competence of Madoff’s auditor, over Madoff’s refusal to be interviewed thoroughly or to permit thorough due diligence, over the fact that he self custodied and there was no way to know whether purported trades actually took place, over Madoff’s refusal to name counterparties and funds’ consequent lack of knowledge as to who their alleged counterparties were, over the fact that the business was operated at every level by members of Madoff’s family, over the lack of knowledge of how Madoff secured his results and the inability of any experts on Wall Street to “reverse engineer” those results, and over a possible connection of feeders to Colombian drug gangs.

As well as the foregoing red flags that were widely known on Wall Street, there were some other points relating to Morgan’s structured investments business. A Morgan executive was specifically told at lunch that there was a large cloud over Madoff because he was suspected of a Ponzi scheme. There also was concern because other investment schemes -- Refco and Petters -- had been exposed as Ponzi schemes, and, as has been said elsewhere, JPMC got sufficiently concerned about Madoff that it redeemed the money from its structured investments, taking a loss that would not have made sense but for its concerns. It also sought secrecy for this redemption from funds involved with its structured products -- which cannot have been a good sign; notified a British regulatory agency about its suspicions that Madoff was a fraud; and warned off its private bank customers from Madoff -- while continuing to service and make gazillions off the 703 account into which and from which we dupes were putting money and withdrawing what we thought were legitimate profits.

There equally are a raft of allegations regarding the 703 account, which started at Chemical Bank (my first checks went to Chemical), became part of Chase when Chase and Chemical merged, and became part of JPMC when Chase merged with J.P. Morgan to form JPMC. As said by Picard’s lawyer, David Sheehan, the bank -- and therefore this account -- were critical to the fraud; without them, there could not have been a Ponzi scheme. The complaint’s allegations regarding the 703 account are especially interesting to me for two reasons. One is that, as written here on June 16, 2010, JPMC and its predecessors had to know that, although the 703 account was the one used for Madoff’s purported advisory business, no monies ever went out of it to pay brokers or others for securities or options bought by Madoff, and no money ever came into it from brokers or others to pay Madoff for securities or options sold by him. As was written on June 16th:

Chase and Morgan knew, in short, or assuredly should have known, that the account showed no transactions of the kind required by the investment advisory business that the account supposedly was servicing. They thus knew or certainly should have known -- probably since at least the mid or late 1980s -- that a fraud was in progress. Indeed, since there were no monies from securities dealers or options dealers being deposited in the account, yet investors were receiving monies from it, they certainly should have known, if they did not in fact know, that the exact nature of the fraud was that it was a Ponzi scheme. How else but through the operation of a Ponzi scheme, after all, could Madoff be paying billions of dollars to investors if he was not engaging in securities transactions from which he was making money that would have come into the account?

This point is made in Picard’s complaint: I noticed it at least twice. E.g.:

Billions of dollars flawed through BLMIS’ account at JPMC, the so-called ‘703 Account,’ but virtually none of it was used to buy or sell securities as it should have been had BLMIS been legitimate.” Para. 2.

* * * *

JPMC was aware that BLMIS was operating at least two businesses: a market making business and the IA Business. But the activity in the 703 Account did not match up with either of these enterprises. Para. 219.

If JPMC had believed Madoff was using the 703 Account for market making, the bank would have likely seen regular transactions with other brokerage firms with which BLMIS was trading. If Madoff had been using the 703 Account for the IA Business, JPMC would have seen billions of dollars leaving the 703 Account and going to purchase stocks and equities, and corresponding multi-billion dollar inflows as BLMIS sold those securities. In the interim, JPMC should have seen tens of billions of dollars -- nearly all of the IA Business’s assets under management -- moved into T-bills, as that was part of BLMIS’s purported investment strategy. Para. 220.

Instead, what JPMC saw was massive outflows of money that were in no way linked to customer accounts or stock and options trading. Money would come into the 703 Account as customers invested additional funds with BLMIS. An overwhelming majority of funds would then go directly back out to customers in the form of redemptions. Any balance that remained in the 703 Account was invested in short-term securities such as overnight sweeps, commercial paper, and certificates of deposit. Para. 221.

The complaint also cites a host of other reasons why, because of the 703 Account, JPMC (and its banking predecessors) should have known that Madoff was operating a fraud. Several of these other reasons shall be mentioned below, and one might even say the Trustee has an embarrassment of riches on this score. But to me, the lack of payments into or out of the account from brokers and others for Madoff to buy and/or receive payment for securities and options is the absolute and unmistakable key. Because of this, JPMC and its predecessors had to know, and certainly should have known, that something was very wrong.

The other reason why the allegations regarding the 703 Account are particularly interesting to me is that to a significant extent they flesh out how a bank’s oversight of accounts works or at least is supposed to work. This is particularly germane because we dupes sent money to and received money from the 703 Account; it was the vehicle through which JPMC and its predecessor banks directly dealt with us.

Early on after the fraud was exposed I was dimly aware, both from general knowledge and from talking to a major league banker who is a graduate of MSL, that specific persons in a bank are charged with overseeing specific accounts, at least large ones. How the oversight process works within a bank is amply discussed in the complaint. And though the complaint does not detail how or whether information got to the very top of the bank -- to Jamie Dimon, for example, who is discussed extensively in Gillian Tett’s highly regarded “Fool’s Gold” -- it does show relevant processes reaching to a very high level in the bank.

Let me, then, list some of the points made in the complaint in relation to the 703 Account (allegations which incorporate material reiterated in the section on loans).

1. Banks often assign a so-called “sponsor” to an account. The sponsor has the duty of learning enough about “the client’s business to identify suspicious activity.” (Para. 190.) The sponsor for the 703 Account was a person identified only as “JPMC Employee 9,” who retired in the Spring of 2008. Here is what the complaint says regarding old number 9 (emphasis in original):

The sponsor for the 703 Account through 2008 was [redacted] [JPMC Employee 9]. When asked about his duties as a client sponsor at his Rule 2004 bankruptcy examination, [redacted] [JPMC Employee 9] responded that he did not even know what a client sponsor was, much less that he was the sponsor for BLMIS’s accounts. He had received no training regarding his duties as a client sponsor and had taken no action to discharge those duties. When shown a document in which he had recertified that he had performed his duties as a client sponsor, [redacted] [JPMC Employee9] stated that he did not have any recollection of the duties of a sponsor or of the recertification process. (Para. 191.)

192. JPMC utterly failed to “know its customer” when it came to Madoff and BLMIS. Shockingly, after decades of hosting BLMIS’s checking account, [redacted] [JPMC Employee9], the client representative who had been in charge of the 703 Account for more than ten years, admitted, “I don’t know what the checking account was used for.” He did not know whether it was used for market making activities, investment advisory services, both, or neither.

193. [Redacted] [JPMC Employee 9] did receive financial statements from BLMIS on a regular basis. These statements included FOCUS Reports. A quick review of those reports by JPMC would have revealed irregularities that required further investigation.

2. As indicated, banks have a duty to ‘“know your customer’” (KYC) -- to understand the business in which a customer is engaged, so that they can tell whether account activity is suspicious. (Para. 185.) The KYC rule is standard industry practice, existed before the Patriot Act, was reinforced by the latter, and is a common rule of regulatory bodies. Under KYC a bank must determine what the customer’s “normal business activity would look like” (Para. 189), so that it could spot suspicious activity. Many banks, including JPMC, have an entire department devoted to KYC. The problem, however, was that, though it gave lip service to the KYC rule, that is all that JPMC gave it. It did not in fact know its customer and ignored deeply suspicious matters related to the 703 Account.

3. The 703 Account did “not look like a normal broker-dealer account -- customer funds would be coming in, but those funds would not be segregated or transferred to separate sub-accounts.” (Para. 174.)

4. Both before the Patriot Act and as reinforced by it, banks are to have monitoring systems in place to detect whether there may be money laundering. JPMC had such purported systems, but they did not work even though billions of dollars were being laundered -- they did not give a warning except once, when the warning was ignored.

5. JPMC had obtained thirteen quarterly so-called FOCUS Reports (the earliest stemming from October 2001) and annual audited reports; both types of reports are filed with the SEC. Often the FOCUS Reports, and sometimes the annual reports, failed to correctly show assets and liabilities JPMC knew of, and “consistently underreported the amount of cash” held by Madoff, “a fact to which JPMC was privy by virtue of its maintenance of BLMIS’s bank accounts.” (Paras. 201-202.) In addition, the FOCUS Reports did not show any bank loans outstanding owed by BLMIS, although JPMC itself had made large loans to it. The Reports also understated the collateral on the loans, and did not include customer receivables or payables, which would have been shown in the financial reports of a broker-dealer.

6. There were also a number of activities -- some of them distinctly odd -- that should have created suspicions of illegal activity. For example, a customer identified only as Customer 1 -- who almost surely was Norman Levy if one compares what is said in the complaint with what is said at pages 14-15 of SIPC’s January 24, 2011 answers to Congressman Garrett -- received nearly $76 billion from the 703 Account between December 1998 and September 2005; in 2002 Madoff sent 318 checks to Customer 1 for precisely $986,301 each, sometimes sending multiple checks on a given day; for over two years the monthly amount of money going into the 703 Account from Customer 1 was almost always equal to the amount going out to him from it, with no clear economic purpose for repetitive transactions that “had no net impact” on Customer 1’s account; in December 2001 Customer 1 sent the account checks for, “90 million, on a daily basis – a pattern of activity with no identifiably business purpose” (Para. 231 (emphasis added)); from 1998 to 2008 “BLMIS transferred $84 billion out of the 703 Account to just four customers,” representing “over 75% of the wires and checks that flawed out of the 703 Account.” (My bet would be that three of the four were Levy, Picower, and Shapiro. Who might the fourth be?); and there was repeated “wire activity with offshore banking customers or financial secrecy havens.” (Para. 222.)

From the above you can see why I say the Trustee has almost an embarrassment of riches vis-à-vis JPMorgan Chase. To many the evidence will bring up the question -- there has already been chatter on the websites regarding it -- of why JPMC does not become the object of private suits by victims for aiding and abetting a fraud and aiding in a breach of fiduciary duty by Madoff. (The Trustee is alleging these among numerous other causes of action.) As some readers may know, a small group of us has been working on obtaining counsel to sue JPMorgan on behalf of investors, who suffered enormous damages because of Morgan’s aiding and abetting of Madoff’s fraud. We believe JPMC is liable notwithstanding a silly decision in its favor delivered long before most of the facts were known by a federal judge who appeared to be ignorant of how banking works and how it worked in this case. We have moved very slowly in seeking counsel -- far too slowly to suit me personally -- because to some extent one had to see what the Trustee came up with and what he did, so that a suit could be brought on the basis of far more knowledge than existed before the complaint against Morgan was unsealed a few days ago. Now that the Trustee’s complaint is unsealed, and what Morgan did is known to a far greater extent -- and will be known yet more after discovery -- the effort to obtain counsel should be sped up.

There will be two interrelated problems, however, problems that arise from the Trustee’s past and expectable future actions. The Trustee opposes and has obtained injunctions stopping suits against persons and institutions whom he is suing or settling with. He says that only he can represent the claims of victims against defendants. Correlatively, although he of course offers no proof or even hints as to how it will be done, he now claims he may recover $45 billion, which is enough, I gather, to pay victims amounts of money approximating the sums shown as theirs on the final statements of November 30, 2008. On these interrelated grounds (for one of which he of course offers no evidence), the Trustee will ask Judge Lifland to enjoin any suit not filed before Lifland in the Bankruptcy Court.

The Trustee will win before Lifland. He has but to file a brief, or walk into court, before Lifland and he automatically will be the winner on any significant issue (at least against any little person or little people). One has known this for awhile, but it was strongly reinforced on me when I argued before Lifland two weeks ago. I have been a member of the bar for nearly 47 years, but never before in the 47 years was I insulted and assaulted like I was two weeks ago. Lifland lived up to his at least two decades old reputation. To believe anyone can defeat the Trustee before Lifland on any important point seems to me naïve. (The only question, really, is how did the Madoff case come to be heard by Lifland -- the Chief Judge -- out of all the judges in the Bankruptcy Court. Was it purely the result of random chance -- purely the result of the random “wheel” used in federal courts?*)

So, to bring a lawsuit against JPMC in a court other than Lifland’s is to accept at the very beginning that one will have to file and win an appeal from a Lifland decision barring the case, before the case can go forward. This will take time. And whether one could file a suit against JPMC in Lifland’s court, and ride the coattails of the Trustee in that court, is something I do not know.

There are highly competent lawyers who think that victims have causes of action that cannot be “taken over,” as it were, by Lifland in the Bankruptcy Court, and that accordingly can be filed elsewhere. There is, I believe, at least one appeal pending from a Lifland decision barring a suit alleging such causes of action. A decision in that case could alleviate much of the problem under discussion if the decision is in the plaintiff’s favor, or could make the problem nearly insuperable if it is in the Trustee’s favor. There also are highly competent lawyers who believe it possible to file a suit that rides the Trustee’s coattails in the Bankruptcy Court itself. Again, I don’t know the answers here, but one does know that these are matters which will have to be thought about when considering, as we must, a suit against JPMC.

*After completing but before posting this essay, I read an article on the Wilpon/Katz case, in the New York Times of February 8th, which quoted “George Newhouse, a partner at Brown, White & Newhouse, who is a white-collar litigator who has worked on many fraud cases.” The article said:

The stakes are steep for defendants who roll the dice in bankruptcy court because of the often close relationship between the trustees charged with recovering money and the judges who appoint them, Newhouse said. Judges tend to know the relatively small number of trustees, and they assign the biggest cases like the Madoff fraud to trustees that they have become comfortable with over many years.

As a result, ‘you’ll get a fair hearing, but it will be subjectively biased in favor of the trustee,’ he said. ‘Most bankruptcy judges tend to be as pro-trustee as federal judges tend to be pro-prosecutor.’

It is, I think, unusual for a lawyer to go on the record – in a newspaper read by hundreds of thousands or millions, no less -- saying that a court system is biased. That Newhouse publicly said what he did in the Times is, to me, a measure of the problem faced before Lifland by those of us who are small innocent victims being assailed by the Trustee in Lifland’s court. That the problem of inherent bias in favor of the Trustee exists here has been known from the beginning of the case, but lawyers have not commented on it -- out of general fear and fear of making things worse, I suppose. I myself do not know what to do about the problem, or even whether there is anything that can be done. But I equally think there can be no doubt that we have a most serious problem.

Trustee's Complaint on JP Morgan

2011-02-04T11:57:00.004-05:00

February 4, 2011

Dear Colleagues:

I have begun to read the newly unsealed complaint filed by the Trustee against JP Morgan Chase. When finished, I may or may not write about it -- I haven’t yet decided. But I do think that all of you should be given an opportunity to read the complaint’s (fairly dramatic) introduction, especially since the media seems to have missed (as usual) some significant aspects of it. I have therefore appended the first five pages of the complaint.

Larry Velvel

Irving H. Picard (“Trustee”), as trustee for the substantively consolidated liquidation of the business of Bernard L. Madoff Investment Securities LLC (“BLMIS”) under the Securities Investor Protection Act, 15 U.S.C. §§ 78aaa, et seq. (“SIPA”), and the estate of Bernard L. Madoff, by and through his undersigned counsel, as and for his Complaint against JPMorgan Chase & Co., JPMorgan Chase Bank, N.A., J.P. Morgan Securities LLC, and J.P. Morgan Securities Ltd. (collectively, “JPMC” or “Defendants”), states as follows:

NATURE OF THE ACTION

“‘But the Emperor has nothing on at all!!!’ said a little child.”

Hans Christian Andersen, The Emperor’s New Clothes

“For whatever it[’]s worth, I am sitting at lunch with [JPMC
Employee 1] who just told me that there is a well-known cloud over the
head of Madoff and that his returns are speculated to be part of a [P]onzi
scheme.”

[JPMC Employee 2], Risk Officer, Investment
Bank, JPMC, June 15, 2007

1. The story has been told time and time again how Madoff duped the best and the
brightest in the investment community. The Trustee’s investigation reveals a very different story—the story of financial institutions worldwide that were keen to the likely fraud, and decidedly turned a blind eye to it. While numerous financial institutions enabled Madoff’s fraud, JPMC was at the very center of that fraud, and thoroughly complicit in it.

2. JPMC was BLMIS’s primary banker for over 20 years, and was responsible for
knowing the business of its customers—in this case, a very large customer. JPMC is a
sophisticated financial institution, and it was uniquely situated to see the likely fraud. Billions of dollars flowed through BLMIS’s account at JPMC, the so-called “703 Account,” but virtually none of it was used to buy or sell securities as it should have been had BLMIS been legitimate. But if those large transactions that did not jibe with any legitimate business purpose triggered any warnings, they were suppressed as the drive for fees and profits became a substitute for common sense, ethics and legal obligations. It is estimated that JPMC made at least half a billion dollars in fees and profits off the backs of BLMIS’s victims, and is responsible for at least $5.4 billion in damages for its role in allowing the Ponzi scheme to continue unabated for years, with an exact amount to be determined at trial.

3. In addition to being BLMIS’s banker, JPMC also profited from the Ponzi scheme
by selling structured products related to BLMIS feeder funds to its clients. Its due diligence revealed the likelihood of fraud at BLMIS, but JPMC was not concerned with the devastating effect of fraud on investors. Rather, it was concerned only with its own bottom line, and did nothing but a cost-benefit analysis in deciding to become part of Madoff’s fraud: “Based on overall estimated size of BLM strategy, . . . it would take [a] . . . fraud in the order of $3bn or more . . . for JPMC to be affected.” JPMC also relied on the Securities Investor Protection Corporation (“SIPC”) to protect its profits: JPMorgan’s investment in BLM . . . is treated as customer money . . . and therefore [is] covered by SIPC.” By the Fall of 2008, in the midst of a worldwide economic downturn, the cost-benefit analysis had changed. JPMC, no longer comfortable with the risk of fraud, decided to redeem its $276 million in investments in BLMIS feeder funds. JPMC also received an additional $145 million in fraudulent transfers from BLMIS in June 2006. The Trustee seeks the return of this money in this Action.

4. JPMC allowed BLMIS to funnel billions of dollars through the 703 Account by
disregarding its own anti-money laundering duties. From 1986 on, all of the money that Madoff stole from his customers passed through the 703 Account, where it was commingled and ultimately washed. JPMC had everything it needed to unmask the fraud. Not only did it have a clear view of suspicious 703 Account activity, but JPMC was provided with Financial and Operational Combined Uniform Single Reports (“FOCUS Reports”) from BLMIS. The FOCUS Reports contained glaring irregularities that should have been probed by JPMC. For example, not only did BLMIS fail to report its loans from JPMC, it also failed to report any commission revenue. JPMC ignored these issues in BLMIS’s financial statements. Instead, JPMC lent legitimacy and cover to BLMIS’s operations, and allowed BLMIS to thrive as JPMC collected hundreds of millions of dollars in fees and profits and facilitated the largest financial fraud in history.

5. In addition to the information JPMC obtained as BLMIS’s long-time banker,
JPMC also performed due diligence on BLMIS beginning in 2006, using information it obtained from those responsible at JPMC for the 703 Account, as well as information provided by various BLMIS feeder funds. At some point between 2006 and the Fall of 2008, if not before, JPMC unquestionably knew that:

a. BLMIS’s returns were consistently too good—even in down markets—to be true;

b. Madoff would not allow transparency into his strategy;

c. JPMC could not identify, and Madoff would not provide information on, his purported over-the-counter (“OTC”) counterparties;

d. BLMIS’s auditor was a small, unknown firm;

e. BLMIS had a conflict of interest as it was the clearing broker, subcustodian, and sub-investment adviser;

f. feeder fund administrators could not reconcile the numbers they got from BLMIS with any third party source to confirm their accuracy; and

g. there was public speculation that Madoff operated a Ponzi scheme, or was engaged in other illegal activity, such as front-running.

6. JPMC looked the other way, ignoring the warning signs, even in the aftermath of other well-known frauds. In response to those who, prior to Madoff’s arrest, found it “[h]ard to believe that [fraud] would be going on over years with regulators [sic] blessing,” Risk Officer of JPMC’s Investment Bank responded, “you will recall that Refco was also regulated by the same crowd you refer to below and there was noise about them for years before it was discovered to be rotten to the core.”

7. JPMC’s due diligence team was further concerned about fraud at BLMIS in the
wake of another well-known fraud, the Petters fraud. Some of these concerns centered on BLMIS’s small, unknown auditor, Friehling & Horowitz (“Friehling”):

The “DD” [due diligence] done by all counterparties seems suspect. Given the scale and duration of the Petters fraud it cannot be sufficient that there’s simply trust in an individual and there’s been a long operating history . . . . Let’s go see Friehling and Horowitz the next time we’re in NY . . . to see that the address isn’t a car wash at least.

8. In or about September 2008, as JPMC was re-evaluating its hedge fund investments in the midst of the worldwide financial crisis, [JPMC Employee 3], of JPMC’s London office, had a telephone call with individuals at Aurelia Finance, S.A. (“Aurelia Finance”), a Swiss company that purchased and distributed JPMC’s structured products. During the course of that call, the individuals at Aurelia Finance made references to “Colombian friends” and insisted that JPMC maintain its BLMIS-related hedge. That conversation triggered a concern that Colombian drug money was somehow involved in the BLMIS-Aurelia Finance relationship, which led to an internal investigation at JPMC of BLMIS and Aurelia Finance for money laundering. Significantly, it was only when its own money was at stake that JPMC decided to report BLMIS to a government authority.

9. As reported in the French press, by the end of October 2008, JPMC admitted in a filing of suspicious activity made to the United Kingdom’s Serious Organised Crime Agency (“SOCA”) that it knew that Madoff was “too good to be true,” and a likely fraud:

(1) . . . [T]he investment performance achieved by [BLMIS’s]
funds . . . is so consistently and significantly ahead of its peers
year-on-year, even in the prevailing market conditions, as to
appear too good to be true—meaning that it probably is; and
(2) the lack of transparency around Madoff Securities trading
techniques, the implementation of its investment strategy, and the
identity of its OTC option counterparties; and (3) its unwillingness
to provide helpful information.

None of this information was new to JPMC—it had known it for years. It was only in an effort to protect its own investments that JPMC finally decided to inform a government authority about BLMIS. JPMC further sought permission from SOCA to redeem its Aurelia Finance-related investments and admitted that “as a result [of these issues with BLMIS] JPMC[] has sent out redemption notices in respect of one fund, and is preparing similar notices for two more funds.”

10. Incredibly, even when it admitted knowing that BLMIS was a likely fraud in October 2008, JPMC still did nothing to stop the fraud. It did not even put a restriction on the 703 Account. It was Madoff himself who ultimately proclaimed his fraud to the world in December 2008, and the thread of the relationships allowing the fraud to exist and fester began to be revealed as well. JPMC’s complicity in Madoff’s fraud, however, remained disguised, cloaked in the myth that Madoff acted alone and fooled JPMC. But that is the fable. What follows is the true story.

The President Who "Makes Nice" And Lacks Judgment.

2010-11-04T14:14:00.001-04:00

November 4, 2010

The President Who “Makes Nice” And Lacks Judgment.

For nearly two years the Madoff affair has made it very difficult for me to find time to write political blogs. That still remains true. But I shall write a short one here because of longstanding concerns, which can only become worse in view of the smashing victory for arch conservatism on November 2nd.

Two years ago I thought Obama was one of the smartest men, and conceivably the best speaker, ever to enter the White House. Today my main impression is that, for all his intellectual smarts, he is horribly lacking in judgment. Crassly put, he is a fool.

The conservative wing of the “national” Republican Party -- which today is a major share of that party if not all of it -- made clear early on that it had but one overarching goal: defeat Obama’s plans. To that end the national wing of the Party was willing to say and do almost anything. Obama’s response was to try to “make nice,” to say he wanted to work with and cooperate with people who did not give a fig for cooperation, but wanted only to savage him and his policies in order to get back into national power and who therefore said that failure to do what they wanted done on the national scene was ipso facto a failure to allow them to participate in structuring policies. Apparently being a prisoner of his own background, in which his golden tongue enabled him to overcome opposition and to get ahead at least from the time he entered law school at Harvard, Obama failed to understand the obvious, failed to understand what anyone who has ever faced bitter, unyielding opposition would understand immediately: there are people with whom it is profitless to try to “make nice” because they wish to fight you bitterly no matter what, no matter how much you wish to “make nice” with them and to compromise with them.

Now that the national Republicans have handed him his head, Obama still wants to “make nice” with them. For all his intellectual smarts, Obama just didn’t get it and doesn’t get it. He lacks judgment.

Of course, he and his acolytes will say he is simply trying to be politically cooperative and to achieve his ends that way. Forget it. The Republicans who lead the national Republican Party want his derriere out. They will savage him and his policies, and blame him and his policies for everything wrong in the country, until, as they just did for the last two years, they have the country angry at him (as at present) and are able to “diselect” him in 2012. That is their goal and all else -- including the good of the country -- is secondary to them, even if Obama doesn’t understand this.

Then there are his policies, which too often lack good sense, although the points on which they lack good sense are usually not the ones on which the national leaders of the Republican Party assail him. I used to think that a lot of the opposition to him was pure racism, no matter how much people denied this. I still think that, with regard to a lot of his opponents, racism is deeply involved. But it is pretty plain that racism is a long way from being the whole story, because some of his most important policies simply lack sense. He has listened to fools like Summers and Geithner, to Wall Street and big business, and to the generals, instead of taking the obviously sensible courses.

Take the bailouts, for example. Money has gone by the hundreds of billions and trillions to Wall Street and big business, where profits and bonuses are again astronomical while common folk have no jobs and are being foreclosed out of their homes because of unpayable mortgages that they were hornswoggled into. People understand all this and are, if you will excuse the expression, well and truly pissed. And how is it possible that -- as occurred -- Obama and his ship of fools did not understand that, if you want people to spend money, and need this to be done to revive a sinking economy, you must put money into the hands of the poor, the lower middle class, the middle class, who will spend the money because they have to spend it. They have no choice but to spend it because they need to do so in order to live. Obama, however, carried forward the Bushian program of giving the money to banks, who did not need to spend it (i.e., in their case, to loan it), and instead put it in their vaults, saying this would rebuild capital and that anyway there were not enough good loans to make in order to warrant lending out the money (as probably was true in view of our catastrophic economic situation). Are we to understand that giving money to those who don’t need to, and won’t, and didn’t spend it, instead of giving it to those who would have to spend it, is a way of getting out of an economic catastrophe that requires spending in order for the economy to revive?

(Now, of course, the Fed has announced it will pursue a similar stupidity by buying up fantastic quantities of government securities in order to encourage spending by lowering interest rates that in important segments are already down pretty much to zero. Without getting into the asserted claims, including the differences between long and short term rates, the announced policy seems pretty stupid when you consider how cheap money already is, including long term rates on things like houses.)

Then there is the war. Obama didn’t have the judgment -- or brains -- to get out of Iraq and Afghanistan pronto. Instead he listened to the generals and let himself get sucked into Bush/Cheney wars that cost scores (hundreds?) of billions per year which we cannot afford. He reprised Nixon who got sucked into Johnson’s wars (with the difference that Nixon loved those wars and Obama at least claims not to feel the same about Iraq and Afghanistan).

And then there is the Supreme Court’s evil opinion in the Citizens United case, which Obama criticized to the faces of the Justices but did nothing to eviscerate statutorily, so that fantastic piles of corporate money could be and were used to sink him.

So this is where we stand. The leaders of the national Republicans, who care only about smashing Obama and the Democrats in order to win and will say and do anything to accomplish this, have smashed him. Their general lack of concern for the small man and for the country will increasingly manifest itself. They will spend the next two years savaging Obama in order to defeat him in 2012, and are likely to succeed, because they care only about gaining power, will say and do anything to do this, and will thereby succeed in causing the country to be just as much against Obama two years from now as they succeeded in the last two years in turning the county against him to the point that he received a smashing in 2010. Meanwhile, Obama, and because of him other Democrats, will try to “make nice” with people who want only to politically kill them and who will not “make nice,” will not be placated, and want only to destroy him and regain the Presidency. Anybody who has ever faced bitter enders who opposed them can see this coming, because bitter enders never quit and cannot be placated.*

*This posting represents the personal views of Lawrence R. Velvel. If you wish to comment on the post, on the general topic of the post, you can, if you wish, email me at Velvel@VelvelOnNationalAffairs.com.

VelvelOnNationalAffairs is now available as a podcast. To subscribe please visit VelvelOnNationalAffairs.com, and click on the link on the top left corner of the page. The podcasts can also be found on iTunes or at www.lrvelvel.libsyn.com

In addition, one hour long television book shows, shown on Comcast, on which Dean Velvel, interviews an author, one hour long television panel shows, also shown on Comcast, on which other MSL personnel interview experts about important subjects, conferences on historical and other important subjects held at MSL, and an MSL journal of important issues called The Long Term View, can all be accessed on the internet, including by video and audio. For TV shows go to: www.mslaw.edu/about_tv.htm or www.youtube.com/user/mslawdotedu; for conferences go to: www.mslawevents.com; for The Long Term View go to: www.mslaw.edu/about¬_LTV.htm.

The Information Provided To Congress By SIPC. Part II.

2010-09-24T08:59:00.001-04:00

September 24, 2010

The Information Provided To Congress By SIPC.

Part II.

D. SIPC was not asked, and nowhere does it say, how much money was earned in interest from Treasuries and money market funds into which Madoff put the money in the Chase/JPMC account, or how much, if any interest, was earned from Chase and JPMC themselves. To learn these numbers is essential because the interest, as explained above, is the equivalent of cash-in and must be credited to investors’ accounts under CICO, which Picard has not done. If the Second Circuit upholds the use of CICO, there should be attempts to obtain these numbers via discovery. If Lifland again denies discovery, as he denied it previously, this would form one basis for appeal from his next decision on the net equity question.

The amount of interest could, in toto, be a very significant sum. Though the chart of annual cash-in and annual cash-out provided by SIPC from 1992 onward gives rise to certain speculations discussed below, it nonetheless makes clear that there sometimes had to be many billions of dollars -- even tens and scores of billions of dollars -- in Madoff’s account, especially from 1995 onward. The total amount of interest earned could have been quite large (and was surely stupendous if Chase and JPMC were themselves paying interest on the account). If the Second Circuit decides in favor of SIPC and Picard on the net equity question, and Congress does not enact a provision that net equity must be gauged by the FSM, it will be essential to seek discovery on this question upon remand to Lifland’s court. If Lifland refuses discovery, which seems to be his want (he is after all deeply biased in favor of SIPC and Picard*), this could, as said, be a basis for appeal. (In fact, the interest earned from Treasuries, money market accounts, etc. should be added to investors’ accounts under the FSM too, because it was earned with their money. Victims could justifiably demand this money from customer property, and seek discovery about it, if the FSM is used, just as they can under CICO.)

E. SIPC says there were “90,000 disbursements totaling $18.5 billion made to Madoff investors in excess of their investments.” (P. 5.) Whether this means during the entire course of the scam, or only during the six year period prior to December 11, 2008 -- the maximum possible period for avoidance actions -- is not said. If the latter, this would mean that on average there were 15,000 such disbursements per year, or an average of 1,250 per month. If the former, it would mean there were on average about 5,300 per year, averaging about 450 per month. I find it hard to say which is more likely, and, if SIPC is referring only to the last six years before December 2008, there also would obviously be many disbursements above investment before the last six years.

Thus, regardless of which SIPC means, there are likely to be many current or prior Madoff investors who, by December 11, 2002 (six years before the fraud was disclosed) had taken out more than they put in. Yet, because of statutes of limitations this “excess” is beyond the reach of avoidance suits unless the investors were negligent or complicit -- and it is probable that only wealthy investors and/or institutions were negligent because they had sufficient money to do due diligence that would have uncovered the fraud, and therefore can be sued for “excess” monies they took out before December 11, 2002.

It is quite important to try to find out just how much in “excess withdrawals” were made before December 11, 2002 and are not subject to avoidance suits. For SIPC and the Trustee claim that “fairness” -- at least their crabbed, narrow-minded concept of it, under which fairness requires that advances and customer property be denied to people now living in poverty so that more from customer property can be given to the rich -- requires the use of CICO, which, as just indicated, denies advances and customer property to the small person so that more customer property will be available to wealthy persons and rich institutions. SIPC and the Trustee are thereby placing a major financial burden of the fraud on small innocent investors who withdrew more than they put in, while leaving untouched investors who did the same and got out of Madoff more than six years before December 11, 2008. In other words, their concept of “fairness” is that if you got out in time you’re safe, and if you didn’t get out in time you’re screwed -- and this in addition to their anti Robin Hood conduct of taking from the poor to give to the rich.

In combating this distortion of values arising from the use of CICO, it would be useful to learn how many investors took out all their money before December 11, 2002 and by how much did their withdrawals exceed the amounts they put in. If necessary -- if the Second Circuit rules for SIPA and Picard on net equity and Congress does not enact a statute mandating that net equity be determined by the FSM, the information should be sought in discovery.

F. There are a number of points in SIPC’S answers that relate to the adequacy of its planning. To wit: SIPC says that since April 1, 2009 it has been assessing members one-quarter of one percent per year to build the SIPC fund. (This after a decade of assessing them only $150 per year -- even if they were Goldman Sachs or Merrill Lynch.) Its “target” is to build the fund to $2.5 billion dollars, and “assessments based upon a percentage of net operating revenue will remain in place until” then. (P. 2.) When the fund is built to $2.5 billion, SIPC will have access to $5 billion by combining the $2.5 billion fund with another $2.5 billion line of credit available from the Government. Before March 1, 2009, SIPC had two revolving commercial lines of credit of $500 million dollars each (or a total of $1 billion) available from a consortium of banks, but the banks, says SIPC, were “unwilling to renew the credit lines, due to the developing financial crisis.” (P. 2.) And SIPC says that “SIPC, under current law, has demonstrated that it has sufficient resources for its statutory mission.” (P. 3.)

Many questions arise from this. Just how and why does SIPC calculate that a $2.5 billion fund, combined with an equal sized Government line of credit is enough? In 2003 some important Congressmen told SIPC, after a GAO report, that it should think about increasing the funds available to it, but it declined to do so, claiming privately, as I gather it, that actuaries had told them it had access to enough money. Did actuaries tell it in 2009, after Madoff and Stanford, that $5 billion in available money was enough? If so (or even if not), were the requisite calculations based on a continuation of SIPC’s now 40 year old policy of attempting -- successfully until now -- to screw investors by fighting tooth and nail against paying them -- by pulling out all the stops in negotiations and litigation to successfully avoid paying all but a small percentage of claimants? What if SIPC is somehow forced by the courts or Congress to change this fight-them-to-the-death policy which destroys the intent of Congress? Will $5 billion still be enough? (Personally, I think that, if there is to be a change in SIPC’s conduct, its entire management and Board must be replaced. They have all been complicit in SIPC’s conduct, and, without a clean sweep, one must fear that nothing the courts or Congress can do will cause those who have been part of SIPC for 35 years -- or have been associated with and influenced by such persons -- to dramatically change their mindset and conduct. Unfortunately, though, in Government or quasi government people don’t get fired for performing their jobs terribly or destroying Congressional intent.)

Moreover, if $5 billion is sufficient, why does half of it have to come from the Government, which already has lots of calls for money? Why shouldn’t it come entirely from the fabulously wealthy investment business, which may have benefitted to the tune of hundreds of billions or even many trillions of dollars from the existence of SIPC insurance -- for which industry members paid the farcical sum of only $150 per year per member for a decade or more? How big would the SIPC fund itself get if, say, investment houses were required to pay one half percent of net revenues into the fund, or one percent of net revenues into it, for, say, ten years?

And just how has SIPC “demonstrated” that it has “sufficient resources for its statutory mission”? Hasn’t any such demonstration been dependent upon the policy of screwing investors out of advances, so that relatively little money is paid out? Moreover, has SIPC told us the full story of why a consortium of banks refused to renew a line of credit to it? Did the banks possibly have concerns over what might happen in the markets and over SIPC’s ability to repay them if disaster struck?

G. Here are two quick “semi-logistical” points.

SIPC says the average time period between the filing of a claim and the determination of the claim, for the 13,189 claims that have been determined already (out of a total of 16,374) is 7.55 months. It then gives a bunch of excuses for taking 7½ months. But as you can see for yourself by reading the excuses (on pp. 6-7 of its answers), the lengthy time period, which contravenes Congress’ intent for prompt payment, is due to use of CICO. CICO requires extensive calculation and work that is unnecessary under the FSM.

Moreover, to a certain extent -- actually to a major extent -- SIPC is lying with figures here. It says it has determined 13,189 claims. But it also says later that there were 8,489 claims (of the 13,189) that were denied because the claimants had no accounts at Madoff, i.e., were indirects. It should have taken about one day to determine an indirect claim, since they are denied out of hand. Since the average period for a determination is 7½ months, and the indirect claims that are currently deniable out of hand -- in a day -- are roughly two-thirds of all the claims that have been determined, this further evidences how much delay there has been in determining direct claims -- even where they have been determined. And one would bet that most of the 3,185 claims remaining to be determined are directs’ claims.

Beyond this, SIPC’s answers give the average period between the filing of a claim and the determination of the claim, not the time between the filing of a claim on which SIPC admits it owes some amount and the payment of the claim. If we were to learn the average time between filing and payment, you can bet it would be more than 7½ months. Ultimately it is likely to be years. This is what Congress meant when it said it wanted SIPC’s payments to be prompt?

SIPC also says, in an effort to show how caring it is towards people who are suffering greatly, that “Hundreds of customers filed hardship applications” seeking quick payments, and ‘many” of these were granted. (P. 7.) “Many” is a lawyer’s weasel word. (Twenty would be “many.”) SIPC does not say how many were granted. It does not give a specific number, which it obviously knows. Instead it weasels. This is a sign that the number of hardship applications it granted isn’t very high.

H. Finally, SIPC has set forth a chart showing the annual cash put in and the annual cash taken out for each year from 1992 through 2008. Most of the time the annual cash-in and cash-out are pretty close, although there were a few years when cash-out exceeded cash-in by (usually) a small amount, so that a certain amount of the cash-out had to come from “reserves” from prior years. But discrepancies between annual cash-in and cash-out appear to have become significant, sometimes in one direction and sometimes in the other, from 2003 onward, with about $2.8 billion more in cash-in in 2007 and $4.25 billion more in cash-out in 2008.

But eyeballing the chart as a whole (eyeballing, rather than carefully comparing all numbers), one gets the impression that much of the time the cash-in and the cash-out were reasonably close. This likely indicates that in the years of reasonable closeness Madoff was taking out for himself and his cronies -- Picower, Chais, probably Norman Levy -- an amount that was approximately equal to the difference between the year’s cash-in and the final total of cash-out for the year. Otherwise, could there have been the degree of correspondence which often existed between annual cash-in and annual cash-out?

I don’t know what this never-previously disclosed information in the chart tells us of importance about Madoff’s scam, except perhaps that it reinforces a point that is prevalent throughout the Madoff case, is very important, and is almost never remarked. It could well by my own ignorance, but I don’t ever remember another major crime as to which so little underlying information has been publicly disclosed and was publicly known nearly two years after the crime and over a year after the major culprit went to jail. The Trustee, SIPC, and the U.S. Attorney are keeping things secret as much as they can, sometimes claiming secrecy is necessary for their success, a bovine defecation claim that government and quasi government bodies often make, usually falsely. But victims are being really hurt by this common bovine defecation because they do not have access to information they need to further their efforts to recover lost funds -- as shown by the usefulness to victims of other information discussed here that was revealed only in SIPC’s (sometimes hide-the-ball) answers of September 7, 2010. I have written many times in blogs, books and elsewhere that secrecy (and associated falsity) is the most serious problem human beings face, since people are usually able to figure out what to do when they know the facts. It is no different here.

*Thus, Lifland instantly approved Picard’s staggeringly huge requests for fees and expenses. Fees are now up to somewhere around 88 or 90 million dollars as of four months ago (as of May 31, 2010).

2010-09-23T12:21:00.002-04:00

September 23, 2010

The Information Provided To Congress By SIPC.

Part I.

As many of you know, this lawyer asked for discovery before Judge Lifland in the Bankruptcy Court. Lifland denied the requested discovery in terms that made clear he would allow no discovery on anything, although a complete denial of any and all discovery on what lawyers call a “summary judgment” proceeding is, I think, unheard of -- literally unheard of. The purpose of discovery is, of course, to find out what the actual facts are, so that neither an opponent nor the court will have to depend upon a party’s self interested, unplumbed claims of what the facts are.

After making clear that there would be no discovery to learn what the actual facts are, Lifland then accepted and used versions of the facts put forth by SIPC and the Trustee. This too has been discussed in blogs and briefs, as has the fact that, even without discovery to learn the truth, we already know that various of the factual claims of SIPC and the Trustee are flat wrong and others are dubious, and that there is other vital information that we do not yet know because SIPC, the Trustee and the U.S. Attorney are keeping it secret.

To my embarrassment, however, I must say that I failed to identify what is one of the most important points yet mentioned in regard to matters that could have been brought out by discovery. Thankfully, David Bernfeld identified it. The monies that came in from his scam were in Madoff’s Chase (and then JP Morgan Chase (JPMC)) bank account. These monies were sometimes invested in Treasuries and money market funds, which earned interest. (They may have obtained interest from Chase and JPMC also -- I do not know.) The interest should have been credited to Madoff’s investors. Because these monies belonged to investors, they were defacto -- and even de jure, I think -- the equivalent of cash-in, of cash put into Madoff by investors. But in calculating investors’ cash-in, SIPC and Picard did not credit investors with these monies which they had a right to be credited with. To make it simple, think of it this way: had Madoff actually invested investors’ monies in stock which paid dividends and appreciated in value, the dividends and appreciation would have to be credited to investors. The same is true of earnings from Treasuries, money market funds, and interest from JPMC.

Almost a year after Lifland, in serious violation of law, denied discovery, the Kanjorski Subcommittee submitted questions to SIPC. Many of those questions not only elicited what Congress needs to know, but also bore on what litigants wanted to know and to present to courts, since it is quite common for Congress and the courts to need and to seek the same information in order to properly perform their duties and make proper decisions. (Think Watergate.) The Subcommittee sent its questions to SIPC on August 30th. SIPC answered them on September 7th. SIPC’s answers, which also state the subcommittee’s questions can be accessed by clicking here: http://bit.ly/9HwWCZ

As you will see by reading them, SIPC’s answers are filled with self justifying verbal explications -- often identical to what SIPC and the Trustee have said in briefs -- intended to put a gloss on facts it has presented. As well, the answers omit certain important information -- sometimes because the questions it received did not request it -- and make it clear that additional information is needed with respect to some of the answers SIPC gave. Nonetheless, the answers do provide significant, important, often previously undisclosed information that should be discussed in presentations to Congress, to the courts, and to the media.*

A. To begin with, SIPC’s answers show that it has, or has ready access to, nearly double the amount of money it would need to pay direct investors under the final statement method (FSM). SIPC’s fund, as of August 1 (the date as of which the subcommittee sought answers), stood at $1.2 billion. It also had access to a $2.5 billion line of credit. So its total available funds were $3.7 billion. Under the FSM it would have to pay $2.01 billion in advances. So it has access to $1.6 billion more than, or about 180 percent of, what it would have to pay in advances under the FSM.

Moreover, SIPC expects that during the remainder of 2010 and 2011 it will take in another $500 million for its fund from the industry. This will bring its available monies to a total of $4.2 billion, or precisely double what it would have to pay directs in advances.

When the imbroglio with SIPC and the Trustee began, some of us thought they were using cash-in/cash-out because of fear that otherwise SIPC would not have enough money for advances. Our view may or may not have been true, but in any event it has now been overtaken. SIPC already has and/or will have nearly twice the amount or twice the amount (depending on the date one uses) that it would need under the FSM to pay advances to all direct investors.

Moreover, by continuing to use cash-in/cash-out (CICO) even though it has way more than enough to cover directs under the FSM, SIPC is attempting to save itself another $1.130 billion. For the amount of advances to which it has already committed under CICO is $713 million, and it expects to pay another $175 million in advances for a total of $888 million. $888 million is $1.130 billion less than the $2.01 billion it would have to pay under the FSM. SIPC appears to be trying to enrich itself by this amount instead of paying it to devastated investors: as discussed in an email of August 26th, Picard said, on page 50 of his Third Interim report, that he is trying to recover money to give to SIPC. This is further discussed below.

(I do not know what the changes in the numbers would be if indirect investors received advances under the CICO or FSM. All I can say for sure is that SIPC’s answers say it disallowed 8,489 claims of “claimants who had no account at Madoff,” and an additional 2,094 claims (or a total of 10,583) are tentatively in this category, but conceivably could be recategorized. (Anybody wanna bet on that?) Since there were “only” 4,459 claims by direct investors, the changes in numbers would likely be dramatic if indirects are eligible for advances from SIPC. But the information needed to know the amounts of the changes was not asked for by the subcommittee nor given by SIPC.)

B. Although the celebrity-driven media has focused on the rich and famous who lost gazillions with Madoff, it is clear that a significant percentage of Madoff’s investors were small investors. Many of them are being hurt terribly. Under CICO, 1,204 of 2,319 accounts potentially eligible for a SIPC advance, or over half, are less than $1,000,000, with an average account value of about $318,000. (A combined value of $382 million divided by 1,204 accounts equals about $318,000 per account.) Another 626 of the 2,319 accounts, or another 25% of them, are between $1,000,000 and $3,000,000, with the average account value being approximately $1,751,640. (A combined value of $1.96 billion divided by 626 accounts.) There are only 138 potentially eligible accounts worth more than $10 million. So plainly, as said, most investors were small or reasonably small, with averaged figures showing that half are worth $318,000 or less.

The same story is told if one looks at the numbers of accounts potentially eligible for an advance from SIPC under the FSM. Here 1,485 accounts out of a total of 4,450, or about one-third, are worth less than $1,000,000, with an average value of about $456,000. (A combined value of $670,889,986 divided by 1,485 accounts.) Another 1,372 accounts, or about another 30 percent, had a value between $1,000,000 and $3,000,000, with an average value of about $1,860,129 dollars. (A combined value of $2,552,097, 200 divided by 1,372 accounts.) Thus a total of 63 percent, or nearly two-thirds, were small or reasonably small investors, with one-third the accounts on an averaged basis being worth $456,000 or less. Only 499 accounts are larger than $10 million.

Thus it is plain, as said, that most accounts were those of investors who ranged from very small to what might be considered the upper edge of small ($3,000,000), with a reported average per all allowed claims, according to SIPC, of $375,671 -- which means that on average SIPC is not paying out even the full maximum of $500,000 per claim. Of the allowed claims under CICO, 1,330 were for more than the maximum payment of $500,000 and 845 were for less. The average allowed claim, as said, is $375,671, or over 20 percent less than the maximum allowed advance from the SIPC fund.

As well, the allowed claims number only 2,175 under CICO. Under the FSM they would number 4,459, or 2,284 more. So in addition to paying, under CICO, more than twenty percent less than the maximum allowable, by using CICO rather than the FSM SIPC has shed itself of over 50 percent of the otherwise allowable claims of direct investors.

C. SIPC says there were “approximately 90,000 disbursements totaling $18.5 billion made to Madoff investors in excess of their investments” (P. 5). It says the Trustee has brought 19 avoidance actions seeking to recover about $15 billion, and it then says, in answer to the subcommittee’s inquiry about future avoidance actions, that the Trustee (i) is considering “approximately 1,000 possible avoidance actions,” against persons who had no knowledge of the fraud, “that could result in the recovery of approximately $4,800,000,000.00 for the benefit of creditors who have yet to recover their principal,” and (ii) is considering another approximately “100 avoidance actions,” against persons who “had enough information to be on inquiry notice of the fraud,” “seeking the recovery of at least $2,000,000,000.00 for the benefit of customers who have yet to recover their principal.” (P. 5.)

These statements have some crucial implications. One is that, despite any past protestations indicating the possible contrary, the Trustee is thinking about going after small investors who had no idea that there could be a fraud here. For as said above, very large percentages of the accounts are small fry, and it was small fry who were most likely to not have a breath of suspicion that there could be a fraud. Also, although the Trustee’s figures play hide-the-ball on the question, I think it is possible that someone more adept at mathematics than I could pierce the ball-hiding and, by putting together various figures which appear in different places, could calculate how many of the 1,000 potential avoidance suits against innocent people would involve small investors. We can feel pretty confident it would be a lot.

Of course, it would be very valuable to have exact figures from SIPC, figures such as precisely how many of the 1,000 people who are innocent had accounts of less than one million dollars, how many had accounts of between one and three million dollars, how many had accounts of three to five million dollars, and ditto for five to ten million dollars and over ten million dollars. SIPC could produce this with the touch of a computer button, and it is probably a sure thing that the results would show that a major preponderance of the 1,000 persons are small fry.

As well, if the same exercise were performed for Congress by SIPC with regard to the possibly non innocent 100 who may have avoidance suits brought against them, it is dollars to doughnuts that the result would show that a large percentage of them are big investors: are hedge funds or banks or wealthy individuals with tens to scores of millions of dollars that were invested. It is after all, large players -- hedge funds, banks, etc. -- that had the capability to figure out that something must be wrong.

All of this brings up a curious point. SIPC says that from the 1,000 innocent people whom the Trustee may sue and who are likely to be small investors, he could recover $4.8 billion dollars; while from the 100 persons with possible knowledge, many of whom are likely to be large investors, he may recover at least $2 billion -- or only a bit over 40 percent of what he could get from the smaller investors. Even understanding that the Trustee’s 19 avoidance actions to date are mainly or exclusively against large investors, the imbalance between seeking another $4.8 billion from mainly small people but only another $2 billion from mainly large people, when coupled with the idea that very large investors were often so wealthy that they did not have to take cash out of Madoff to pay taxes, to live, etc., gives credence to those who have said in recent months that the Trustee, contrary to Robin Hood, is taking money from the poor to give to the rich.

Here is another matter of consequence stemming from SIPC’s points about additional avoidance actions. Picard is currently seeking $15 billion in such actions and may seek another $6.8 billion (or a total, rounded off, of $22 billion). What would happen if he obtained all this? Or even if he obtained only half of it? -- he has said he thinks he’ll get 9 or 10 billion. Well, one thing that would happen is that SIPC might get filthy rich (or filthier rich). Picard has said that his working number of the amount of cash-in to Madoff from victims was, at the end, $19 or $20 billion. Let’s call it $20 billion for ease of figuring. SIPC’s answers say that the already allowed claims under (CICO) total 4.55 billion. (P. 3.) The Trustee, SIPC says, expects to ask SIPC to give him money to pay another $175 million in advances, but as near as I can see does not tell us the total amount of the claims for which he will seek $175 million for advances. But we know that 2,175 allowed claims had a total account value of $5,556,299,243, and involved a total of $713 million in advances. For horseback purposes we can figure that advances of $175 million will involve roughly $1.2 billion in total claims, since $175 million in advances is roughly one-fourth of $713 million in advances and 1.2 billion in total claims is roughly one-fourth of $5.55 billion in total claims. Thus, the total claims under CICO will be about $6.75 billion ($5.55 billion plus $1.2 billion).

$6.75 billion is considerably less than the nine or ten billion Picard said he expects to recover, and even considerably less to a far greater extent than the amounts he could recover under SIPC’s figures, amounts ranging up to $22 billion. What will happen to the extra money? Well, SIPC will get a bundle of it. Under the statute, customer property is allocated first to SIPC “in repayment of advances . . . to the extent such advances recovered securities which were apportioned to customer property.” I long thought SIPC was very dubiously interpreting this provision defacto to mean SIPC recovers advances even when the advances were not made “to recover securities,” but only to pay victims in cash. But SIPC’s brief in the Second Circuit does not interpret it this way, at least not now. If the first allocation provision were to be interpreted as I thought SIPC previously was doing, then, out of the recovered customer property that can range anywhere from about $6.75 billion to $22 billion, SIPC would get $888 million dollars that it will have paid in advances.

Next in line under the statute - - the beneficiaries of the second allocation provision - - are customers who have a positive net equity. Their claims will amount to $6.75 billion ($5.55 billion plus $1.2 billion) minus the amount they would already have received in advances (or $888 million), or $5.862 billion.

So, thus far $6.75 billion in customer property is accounted for ($888 million in advances plus another $5.862 billion to cover the remainder of the total value of the accounts having positive net equities). What about the remainder of the nine or ten billion dollars Picard expects to receive (or the amounts up to $22 billion that he could conceivably recover)? Well, I gather SIPC would obtain either $6.75 billion to cover all the money it paid to customers if it did not get money under the first allocation provision, or another $5.862 billion if it did (for a total of $6.75 billion). For under the statute, after the customers are repaid, SIPC now gets money as “subrogee for the claims of customers.” I assume this must mean the claims of customers who received money -- i.e., those with a positive CICO net equity -- because how could SIPC be a subrogee to a claim of someone who did not receive money? So SIPC will, as said, get either $6.75 billion or another $5.862 billion.

SIPC is also fourth in line, for allocations though this time its position seems meaningless. Here SIPC is reimbursed for delivering “customer name” securities (I presume as opposed to street name securities) to a customer. But SIPC hasn’t delivered any customer name securities to anybody as far as any of us know, so being fourth in line is irrelevant.

Any money remaining from customer property will then go into the general estate. Who will get this money from the general estate is unknown to me and, as far as I know, neither SIPC nor Picard have ever said. Customers (i.e., investor victims) can share in it only to the extent they have unsatisfied net equities. So the general estate is in this regard irrelevant to directs because they either have negative net equities under CICO or, if they have positive net equities, their entire claim will have been satisfied under CICO. So who will get the money?

I know no bankruptcy law, which I presume would govern the question, but, though admittedly ignorant in the field, would assume the money would go to creditors to the extent that there are creditors. Would the indirects have claims as creditors although they are not currently regarded as customers? Would directs have a claim as creditors even though they have a negative net equity? And if indirects or any or all directs have claims against the general estate as creditors, is the claim for the amount shown on their final statements? After all, Madoff owed them the amounts on their statements, as was shown by the fact that before the fall he would pay the amount shown on the statement to an investor who closed his account.

The bottom line is that who may get what from the general estate is unknown. But, with regard to recipients of money in categories that come before the general estate, SIPC will get a bundle while penurious, wiped out small investors will get, as it is said, bupkis.

Of course, if the FSM were used instead of CICO, then SIPC would have to pay $2,010,467,854 in advances, and might recoup that as first in line for customer property if SIPC can recover for advances not used to recover securities. If this assumption, which I thought was previously indulged by Picard and SICP is wrong, as SIPC’s brief seems to implicitly admit, then SIPC might very well get nothing rather than two billion dollars. For the customer property would go to victims – at least it would go to direct investors; the direct investors may represent a very large dollar amount of the $57 billion that SIPC’s analysis says is the total amount owed to customers (which “excludes the potential results of settlements”); and there might therefore be nothing left for SIPC. (P. 6, n.1.) So SIPC’s situation would be far less favorable to it under the FSM than under CICO, a fact which you can bet has not escaped either Harbeck or Picard.**

*Parts I and II of this posting were both completed before the Kanjorski Subcommittee hearing of September 23rd. If that hearing requires any additions or changes to the post, I will try and discuss such points in a later posting after receiving the transcript of the hearing.

**SIPC’s figure of 57 billion dollars in potentially eligible claims under the FSM does not in terms include indirects. For the claims of indirects are not currently eligible for SIPC benefits. The questions asked of SIPC by the subcommittee inquired as to how many claims were disallowed because they were indirect (Question 9), but did not ask what the aggregate size of those claims is. On the other hand, to the extent that claims were submitted to Picard by the banks, hedge funds, pension plans, etc., in which the indirects invested, the indirects’ claims are part of the 57 billion dollars because the claims submitted by each of the investment vehicles (each fund, bank, etc.) would presumably include all the indirect monies invested in the vehicle, turned over to Madoff, and lost when the Ponzi scheme collapsed.

Addendum to Post of September 21, 2010

2010-09-22T10:11:00.001-04:00

ADDENDUM TO POST OF
SEPTEMBER 21, 2010

I have just received, from the Syracuse Athletic Department, the figures on the points scored by and against Syracuse in 2008, the last year Greg Robinson, who now coaches Michigan’s defense, was Syracuse’s head coach. The awful tally is 217 points scored by Syracuse and 392 scored against it.

As I keep saying, oh God.

Larry Velvel

The One (or Two) Dimensional Coach.

2010-09-21T10:42:00.001-04:00

September 21, 2010

The One (or Two) Dimensional Coach.

Here is a trick question: How many Michigan quarterbacks are starters this year? The answer is at least three. There is, of course, the fabulous Dennard Robinson. But Steven Threet (speaking of three), who left Michigan after being a starter some of the time in Rich Rodriguez’s first year if memory serves, starts for the Arizona State team that just lost to Wisconsin by only one point, and the strong armed Ryan Mallett, who left Michigan as soon as Rodriguez was named its coach, starts for the Arkansas team that just defeated Georgia. Their presence on these other teams is a tribute to the havoc caused by Rodriguez when he took over Michigan. (Some major lineman whose name escapes me also left and became a starter for Ohio State -- not exactly a small time team.)

But so what, you say. It took Rodriguez awhile to recruit his kind of players, now he has done so, and look at the results. Well, the results are a marvelous offense, at least so far, and I would think that success likely to continue even when Michigan starts playing Big Ten teams. But the defense, oh my God, the defense. Perhaps the best way to describe the defense is to ask, what defense? Not to mention what appears to be the complete absence of any kickers whatever.

The defense has been awful ever since Rodriguez began at Michigan, and it remains awful. One has to believe that, notwithstanding its offense, Michigan is going to lose a number -- even a lot -- of Big 10 games because of the sheer horribleness of its defense. Even given the likely continued excellence of the offense, how can Michigan beat, say, Iowa, Ohio State, Wisconsin, Penn State or perhaps Michigan State, with a defense that stops nobody. And what if, heaven forefend, Dennard Robinson were to be injured and unable to play, so that there might be little offense because his backups are not nearly as capable as he, at least not at this point and maybe never. If that were to happen, Michigan might be lucky to win any Big Ten games.

And who did Rodriguez hire to run his defense. Greg Robinson, a guy who compiled such a bad record as head coach at Syracuse that he got fired after four years there. Now the defense is in its second year under Robinson and should have learned something, but apparently is worse than ever.

If you want to really grasp the unbelievable coaching ineptitude of the guy hired to run Michigan’s defense, listen to this: Robinson was the head coach at Syracuse from 2005-2008. His wins and losses, and the points scored by and against Syracuse, are posted on the Syracuse Athletic Department’s website from 2005-2007. (For some reason 2008 is not posted but we found the 2008 won/lost record elsewhere.) Robinson’s record was one win and ten losses in 2005, four and eight in 2006, two and ten in 2007, and three and nine in 2008, for a total of ten wins and 37 losses. Equally to the point since this coach with such a terrible record was hired to be Michigan’s defensive coach was the record of points scored by Syracuse compared to the points scored against it. Here the totals from the website in 2005, 2006, and 2007 respectively were 152 by Syracuse and 295 (almost double) against in 2005, 219 by Syracuse and 285 against in 2006, and 197 by Syracuse and 418 (more than double) against in 2007. And Robinson is the guy who is in charge of Michigan’s defense? Oh, my God!!

A few years ago, when the underperforming Lloyd Carr was still head coach, I heard the panelists on ESPN’s college football show -- particularly the highly accomplished ex-coach Lou Holtz -- do something that such panelists rarely do. I heard them criticizing a head coach, in this case Carr. But that may have been as nothing compared to what Holtz and the adroit Mark May (didn’t he play at Notre Dame?) said about Michigan’s defense this Sunday, right after the UMass game. They both savaged Michigan’s defense, which they found abominable, with Holtz saying, among other things, that this is not the Michigan defense he used to warn his teams about. And it was May, I believe, who specifically blamed Greg Robinson for the problem, saying he had installed a new defense -- if, as I say, Michigan’s defense can even be given that name. (Maybe it should be called “Michigan’s non defense,” or “Michigan’s porous”).

And who is it that hired Robinson after he was fired at Syracuse because he had performed so ineptly -- and had so many more points score against his team than it scored -- and who is it that put him in charge of the Michigan defense? Well, it was the West Virginia genius, Rich Rodriguez, who now has a great offense but no defense -- and is likely to pay the price in the Big Ten for having only half a team in his third year. And who allowed Rodriguez to hire Greg Robinson? Why the Michigan athletic department, of course, thereby showing no sign of competent thinking.

So Michigan’s football future does not look too bright in the Big Ten this year, unless a miracle happens and Greg Robinson somehow teaches Michigan’s porous to play defense within, say, less than two weeks, when Michigan plays Michigan State.

And lest one forgets, let me reiterate that Michigan has no kickers. It simply cannot make field goals and, perhaps with some exaggeration, I would say it seems hard pressed to kick kick-offs more than two thirds of the way to the end zone. How could Rodriguez have failed in three years to recruit even one player who can kick off and kick field goals? You can bet your sweet bippy, as I think Artie Johnson or somebody or other used to say on Laugh-In forty years ago, that in the Big Ten Michigan will pay the price for this ineptitude at kicking.

Humorously enough, Michigan’s best kicking play of the season was a pooch kick on a punt, (not, of course, on a kick off or field goal attempt) that ended up on the opponent’s five or seven yard line if I remember correctly. Although, few media personnel commented on this marvelous play in view of his running and passing, will it surprise you to learn that the pooch punter was Dennard Robinson? He must be Michigan’s best all around player since Tom Harmon (or at least Ron Kramer or Charles Woodson).

So, considering everything, it has to be said that Rich Rodriguez has thus far proven himself the one dimensional man, or maybe the two dimensional man. In his first two years he proved that he excels at losing. Michigan never before had a coach so successful at losing, not even Chalmers (Bump) Elliot, God help us. Now he’s proven that, given time, he can build a terrific offense, at least if he gets a smashingly great running and passing quarterback like Pat White at West Virginia or Dennard Robinson at Michigan. But so far at least, he also has shown that he knows nothing about and cares not a whit about defense, kicking or hiring competent assistants. And all he ever seems able to come up with when reporters ask him about his team’s deficiencies on television is “We have to work harder.”

Oh boy. It could end up being another long season for Michigan fans.*

*This posting represents the personal views of Lawrence R. Velvel. If you wish to comment on the post, on the general topic of the post, you can, if you wish, email me at Velvel@VelvelOnNationalAffairs.com.

VelvelOnNationalAffairs is now available as a podcast. To subscribe please visit VelvelOnNationalAffairs.com, and click on the link on the top left corner of the page. The podcasts can also be found on iTunes or at www.lrvelvel.libsyn.com

In addition, one hour long television book shows, shown on Comcast, on which Dean Velvel, interviews an author, one hour long television panel shows, also shown on Comcast, on which other MSL personnel interview experts about important subjects, conferences on historical and other important subjects held at MSL, and an MSL journal of important issues called The Long Term View, can all be accessed on the internet, including by video and audio. For TV shows go to: www.mslaw.edu/about_tv.htm or www.youtube.com/user/mslawdotedu; for conferences go to: www.mslawevents.com; for The Long Term View go to: www.mslaw.edu/about¬_LTV.htm.

SIPC Task Force

2010-06-23T13:36:00.000-04:00

June 23, 2010

Dear Ron:

Because of the major brouhaha raised by SIPC’s announcement of a special review committee, I have decided to put my initial views in writing.

It seems to me that eight out of thirteen members of the review committee appointed by SIPC come from SIPC, the SEC or the industry, and should not be regarded as friends of the victimized investors. The powerful committee chairpersons (Bowen and Johnson, who also are partners in major law firms) are also the Chairman and Vice Chairman of the Board of SIPC. They are the people on whose watch disaster has occurred, yet now they are to oversee a committee which is supposed to investigate the very things which they allowed to happen on their watch.

A third member (Heyman) is also on the Board of Directors of SIPC, so it is on his watch too that the disasters occurred. Moreover, he is from a major institution in the financial industry (Travelers). Since the industry will likely have to pay for major necessary changes that will be proposed, e.g., with regard to net equity and coverage of indirects, etc., he should not be expected to be favorable to small, powerless investors who would benefit, such as those who belong to NIAP by the hundreds.

A fourth member (Macchiaroli) is from the SEC, which ostensibly has supervisory authority over SIPC, but allowed the SIPC disasters to occur and now has an interest in diminishing their importance.

A fifth member (Hammerman) is from a major securities industry association. As with Heyman, since his is the industry which would likely have to foot the bill for major necessary changes that will be proposed, Hammerman should not be expected to be favorable to small, powerless victims who would be beneficiaries.

A sixth member (Giddens) is from a major Wall Street firm and is well known as a Trustee for SIPC. Doubtless he makes a nice piece of change from SIPC, and can hardly be expected to favor anything that would be contrary to SIPC’s desires.

A seventh member (Coffee) is a professor, parts of whose testimony before Congress have been strongly criticized by small victims.

An eighth member (Chen Gongyan) is not American but rather is an official in the Chinese financial industry. He is Chair of an agency which was set up with the assistance of SIPC (apparently, I have read, with the assistance of Harbeck personally). As well, it is hard to understand why a Chinese official would be on the Committee.

There are two Committee members (Aidikoff and Caruso) whom SIPC seems to claim are plaintiffs’ lawyers (the claim appears to be correct), and three (Borg, Lubin and Smith), who are state securities officials. I know little about any of these five, although it has been claimed that some of the relevant states have not been active in protecting investors, unlike New York and Massachusetts -- whose relevant officials were not picked for the Committee. It probably is fair to assume, however, that these five might be open minded on crucial issues.

It is important, I would think, that SIPC’s statement of the task force’s mission says “SIPC staff” will be involved in the work of the Committee (which SIPC calls a “Task Force”). This means that the very staff which created the recurrent disasters, and which therefore has vast self interest to protect, will be deeply involved in the work of (in the mission statement’s words) “identify[ing] key issues, provid[ing] assessments . . . suggest[ing] reforms and the means to their implementation” . . . [and] discuss[ing] any impediments and the estimated costs of reform to SIPC, its members . . . .” The staff and the three Review Committee members who are directors of SIPC (including SIPC’s Chair and Vice Chair, who head the Committee) have every interest in defending, minimizing and not having to explain the reasons behind their prior SIPC actions that have wreaked disaster upon victims. So it seems fair to say that the fox has been put in charge of the hen house. And this entirely aside from the fact that several other members of the Task Force come from the industry that likely would have to pay for changes and are therefore likely to be unfavorable to them.

Needless to say, SIPC has provided no information that I know of on how the task force members were selected. And given the interests of the staff, SIPC Board members and industry personnel in defending, minimizing and not having to explain prior bad actions, we cannot expect deep address, or sometimes even any address, by the Task Force of vital issues such as the sudden, unexpected use of cash-in/cash-out and SIPC’s refusal to say whether lack of funds to cover the final statement method was the underlying reason for such use, litigating for decades for a very narrow definition of customers, a definition which has been very harmful to indirects, explaining whether the same lawyers are constantly picked to be the Trustee in major cases because they do what SIPC desires and thereby save it money by finding alleged reasons to turn down large percentages of applicants for payments from the SIPC fund, explaining why SIPC charged so little to brokerage houses for so many years, which proved disastrous, the failure of SIPC to pay with promptness despite Congress’ repeatedly stated intent that payment should be prompt, SIPC’s use of cash-in/cash-out as a method of circumventing normal rules of bankruptcy regarding alleged preferences, explaining what SIPC was told by actuaries when it failed to heed Congressional demands that it increase the size of its fund in the early 2000s, how SIPC managed to dissuade the SEC from supervising it although the SEC was supposed to supervise it, and other crucial pertinent questions which defenders of SIPC have every reason to try to evade.

There are some other problems also. As shown by the work of a similar, perhaps identical, committee in the 1970s, the new committee’s work is likely to take years before anything comes of it. And even if one thinks that this might be alright for the long term, especially when it deals with matters mentioned in the mission statement as being of interest but which are nonetheless of little concern to current victims (like “corporate governance” and international affairs), work that takes years before it is completed and has effect will not solve the problem that there are thousands of innocent, injured investors who desperately need certain changes now, not years from now, as occurred in the 1970s. (It is much like the Gulf oil spill: whatever might be decided about offshore drilling in the long term, the gushing of oil needs to be stopped now.) That people need help now cannot be stressed enough. People in their 70s and 80s cannot wait until 2015 or 2020 for specific needed reforms. They need help immediately.

As well, as shown in the 1970s, it is too easy for people whose careers are invested in the industry to ignore the real problems. You may remember that the record of Senate hearings in the 1970s contained a memorandum of about 40 pages from a constituent that Senator Cranston put into the record. That memo identified many, many of the already existing problems that Gretchen Morgenson wrote about twenty-five years or so later, in 2000, and that were again brought to consciousness by the Madoff scandal in 2008. Yet the 1970s committee ignored these already existing problems, as then did the Congress, so the problems are still with us. The new task force, comprised heavily of SIPC and industry insiders with deep interests to protect, and with its staff work to be done by the very SIPC staff who likewise have much in the way of heavily criticized actions to protect, can all too plainly be expected to repeat the 1970s performance of ignoring vital matters, or at minimum soft pedaling them.

Larry

The Foreign And Domestic Indirects.

2010-03-30T14:08:00.001-04:00

March 30, 2010

The Foreign And Domestic Indirects.

The Trustee has moved for a hearing on who is a customer. In his Motion he said he had denied about 8,500 claims of people who did not have an account with Madoff in their own names (i.e., were indirects in one way or another) and that about 2,000 objections had been filed to his denials. In an exhibit listing “Confidential Claimant Notice Parties” that accompanied the Motion he provided a list of accounts involved (apparently ones as to which objections were filed to his denials). There are 49 pages of accounts, each page but the last has over 50 accounts listed, and in total there are about 2,600 accounts listed. (These accounts must cover investors through hedge funds, banks, partnerships, etc.)

Next to those accounts which are foreign, the Trustee has put down the nation from which the accounts came. I have counted the foreign accounts only once, and probably made a few mistakes in counting, but have not bothered to recount because the mistakes are necessarily small and, due to the sheer magnitude of the numbers, do not matter with regard to the overall points I wish to make.

First, here are the relevant numbers with regard to accounts and countries.

Austria 95
Israel 63
Hong Kong 22
Switzerland 16
China 10
Germany 6
Brazil 4
Japan 3
Liechtenstein 3
Peru 3
Mexico 2
Taiwan 2
Singapore 2
Monaco 2
Germany 2
Spain 2
Uruguay 1
Argentina 1
Bahrain 1
United Kingdom 1
Canada 1
France 1
Egypt 1
United Arab Emirates 1
Thailand 1
Australia 1

This kind of information is very vital to American victims of Madoff for a whole variety of reasons. Like most information of great importance to victims, the Trustee does not (and did not) release it, no matter how crucial it is to victims, until for some (here indecipherable) reason he thinks it in his interest to do so. Victims are the losers, as inevitably must be the intent, or at least an intent, behind keeping the information secret until the Trustee sees some advantage to his side in releasing it.

Here are some of the reasons why the question of the total number of indirects, and of foreign indirects, is important.

To begin with, the higher the number and percentage of indirects relative to directs, the less the Trustee is obligated to pay in toto under current law and, correlatively, the more financially capable is the Trustee of paying the directs. This bears on the accuracy of what surely was the Trustee’s and SIPC’s initial theory, in late 2008 and early 2009, that they must use cash-in/cash-out in order to avoid paying directs at all, or in order to pay them far less, lest use of final statements drive SIPC into bankruptcy. It now appears likely, and various parties on our side believe, that use of the final statements received by directs will not drive SIPC into bankruptcy, and the higher the number and percentage of indirects vis a vis directs, the more true this is likely to be.

The situation could alter if Congress, which is or will be considering various relevant bills, chooses to provide for indirects as well as directs, a result many are working for and which may or may not be accompanied by provisions for payment. But right now the situation (if memory serves) is that over 40 percent of claims are indirects currently ineligible for SIPC payments, over three out of every four indirects are not contesting their ineligibility in court, and, very roughly speaking therefore, something over 30 percent of victims are not seeking SIPC payments. This would make it easier for SIPC to pay victimized direct investors under the final statement method were it, or the courts, disposed to follow the law.

A related possibility -- and one on which the Trustee has of course provided no information whatever -- is that indirects in general, and foreign indirects in particular, had (by far?) the lion’s share of the money in Madoff, both over many years and at the end. It is known that the hedge funds, banks, etc., that invested with Madoff each put in huge sums -- up to hundreds of millions of dollars or more each. As well, Harry Markopolos has opined that there were about 340 hedge funds and about 60 asset managers that invested with Madoff. Picard’s exhibit shows that about 2,600 indirects are contesting denials of their claims to be customers. If each of these indirects averaged only ten million dollars of investment -- which would be peanuts for hedge funds and asset managers -- that would amount to $26 billion dollars, or even more than the Trustee says was the sum of cash-in on December 11th. If each showed only 25 million dollars on its final statement, that would be $78 billion, or more than the Trustee says the final statements show in toto. If what apparently are a total of 8,500 indirects each invested an average of $5 million, that would be a total of $42.5 billion of cash-in, and, if their final statements showed $8 million on average, that would total $68 billion.

These kinds of possible numbers make it evident that it is essential to obtain the truth from the Trustee -- to obtain accurate numbers from him -- if victims, courts, Congress, or anyone else outside of the Trustee’s office and SIPC is to be able to assess the truth about SIPC’s ability to pay. My hypothesized numbers may be wrong in various respects -- certain of them must be wrong -- but they make clear the necessity of compelling the Trustee to disclose the accurate numbers.

Currently, as indicated, we cannot know the truth of these matters, because the Trustee is keeping all the relevant information secret and the Bankruptcy Court was obviously disposed not to allow discovery on these important topics or to itself require the Trustee to provide evidence that would prove or disprove anything the Trustee said. The Bankruptcy Court, rather, wanted to accept the supposed validity of the Trustee’s unsupported assertions. Nonetheless, there can be little doubt that hundreds or thousands of directs were only a small part of Madoff’s supposed fund: there can be little doubt that many of the people who are among those suffering most -- small people who invested directly with Madoff for 20, 30 or 40 years and are now wiped out -- were only a small part of the overall financial picture. (The only other people suffering as much are equally small indirects who are mixed in with the royalty and rich of the indirects.)

Then there is the question of foreign indirects, a question on which the information provided by the Trustee is pretty minimal. All the Trustee has given us is the number of foreign indirects that are challenging his denials of claims. We do not know how much money they invested (their cash-in) nor how much their final statements showed. Nor do we know how many foreign indirects are not challenging the denial of claims, nor how much money is involved in those claims by way of cash-in or final statements. But there are some informed speculations that can be made. Unless Harry Markopolos is all wrong, big money and lots of it came from foreign sources. Much was from royalty, and part of it was hot money of one kind and another. Frankly, it wouldn’t surprise me a bit if half or more of the money invested in Madoff came from foreign sources as indirects.

The amount that was indirect money from foreigners is relevant because, once again, if it is a high percentage of the whole, then it would be easier for SIPC to pay domestic directs if it or the courts were to choose to follow the law. It might also be easier for Congress to provide for domestic indirects if, as could well be true, they are relatively small potatoes next to the foreign indirects. But, again, we cannot know the numbers actually involved because Picard is not releasing the information.

There are two other points arising from the fact that a goodly percentage of the money invested in Madoff came from foreign sources. One is that foreigners will resist clawbacks by simply ignoring Picard and the American courts. Something very analogous to this happened in the Stanford case, and here, as there, it will cause Americans to unfairly be the only nationality widely subject to clawbacks.

Indeed, one would bet it likely that lots of the wealthy foreign indirects and their funds and banks -- like domestic ones too -- pulled out their money in 2007 and 2008 because of losses elsewhere, and yet Picard has given no sign I know of that he will go after any of these groups for clawbacks, despite their failure, before investing in the first place, to exercise the due diligence of which they were financially and professionally capable but which they ignored. So both groups -- both the large domestic and foreign indirects (and their funds, asset managers and banks) who did not do the due diligence they were capable of and which would have exploded Madoff years and years ago, and who pulled out their monies in 2007 and 2008 -- are the real net winners, not the middle class Americans who have lost everything but whom Picard and SIPC almost slanderously term net winners. And the foreign net winners will also be armored by nationality against clawbacks, which Picard has shown no sign of seeking from them in any event.

In addition, it is virtually a sure thing that powerful foreign interests will make it clear to our State Department, Treasury Department and White House that recompense for Madoff’s fraud is demanded by foreign nationals, and that there will at minimum be lawsuits in international tribunals if the foreign demands are not met. Unless I miss my guess, it would appear that representatives of foreign interests have already had some conversations with relevant American officials about this (e.g., conversations with Geithner and/or his staff, I believe (but cannot know for certain).) The end result could well be that wealthy foreigners -- royalty and foreign Mafiosi from various countries, for example -- will obtain recompense through international arrangements or tribunals for Madoff’s fraud while middle class Americans who lack political clout are left to twist in the wind.*

*This posting represents the personal views of Lawrence R. Velvel. If you wish to comment on the post, on the general topic of the post, you can, if you wish, email me at Velvel@VelvelOnNationalAffairs.com.

VelvelOnNationalAffairs is now available as a podcast. To subscribe please visit VelvelOnNationalAffairs.com, and click on the link on the top left corner of the page. The podcasts can also be found on iTunes or at www.lrvelvel.libsyn.com

In addition, one hour long television book shows, shown on Comcast, on which Dean Velvel, interviews an author, one hour long television panel shows, also shown on Comcast, on which other MSL personnel interview experts about important subjects, conferences on historical and other important subjects held at MSL, and an MSL journal of important issues called The Long Term View, can all be accessed on the internet, including by video and audio. For TV shows go to: www.mslaw.edu/about_tv.htm or www.youtube.com/user/mslawdotedu; for conferences go to: www.mslawevents.com; for The Long Term View go to: www.mslaw.edu/about¬_LTV.htm.

Judge Lifland's Opinion On Net Equity.

2010-03-15T11:31:00.001-04:00

March 15, 2010

Judge Lifland’s Opinion On Net Equity.

Having spent time assessing Judge Lifland’s opinion of March 1st, I shall set forth some impressions of it. I shall not deal with the entire opinion, especially since so much of it is taken from the briefs of the Trustee and SIPC. Such points have thus been discussed here before. For the most part. I shall focus on points of especial import or importance (there can be a difference), on points I think should be given far more emphasis in our side’s appellate briefs than was given them in our briefs before Lifland, and on the question of whether it would be wiser to have taken an ordinary appeal to the District Court rather than have sought an appeal directly to the Court of Appeals for the Second Circuit, as the trustee and several of the victims’ lawyers have now done at the suggestion of Judge Lifland. (One knows that, because so many people are hurting badly, it seems to have always been assumed that our side will seek an immediate appeal to the Second Circuit. But the wisdom of that automatically assumed course is subject to debate; one thinks it at least possible that, for reasons I shall discuss, it might be better for our side if an appeal went first to the District Court.)

* * * * *

Judge Lifland paid very little attention to the legislative history of SIPA (while claiming -- wrongly, to be polite about it -- that he was considering the legislative history). His opinion -- in reality one could rightly say his brief supporting all relevant positions of SIPC and the Trustee while denying all relevant positions of the victims -- contains only a few widely scattered lines regarding the legislative history. Instead, his opinion, or brief, extensively parrots the non-legislative-history arguments of SIPC and the Trustee.

Laymen may not understand that it is hardly rare for judges to simply crib the arguments of the side they choose, as Lifland did. (He even admits explicitly that much of his description of the facts is taken from the Trustee. Humorously, even if perversely, he also admits to cribbing from the allocations of Madoff and DiPascali, two notorious liars.)

When cribbing from and deciding entirely for one side, as Lifland did here, it also is not unheard of for judges to simultaneously claim, quite disingenuously, that they think both sides have done an excellent job and both have advanced “compelling arguments” (Op. p. 6), both of which are exactly what Lifland said here while accepting no argument made by the victims. And it has been known for decades that the opinions of most judges, except rare ones like Richard Posner (who has himself written on the subject) (as have I), are written not by the judges but by their young clerks who usually come straight out of law school. For various reasons, this would seem to be the case here -- although one of course cannot be certain -- so that an opinion sealing the fate of thousands of oft-elderly victims of fraud has likely been written -- unless and until this is specifically denied -- by people who are probably barely into adulthood, albeit they wrote it at Lifland’s order.

Here the Trustee and SIPC rarely mentioned the legislative history because it is very adverse to them. They focused instead on other arguments they had made up, or cribbed, which support them. Parroting the Trustee and SIPC, Lifland did the same. He basically ignored the legislative history, though under our form of government the Congressional intent reflected in the legislative history is supposed to govern (except in the eyes of a few outliers like Antonin Scalia).

There is a sense in which one could perhaps argue that this ignoring of legislative history is not all Lifland’s fault. It is a matter on which my own feelings are engaged. Because of the press of work which I had to do later in November 2009, I submitted my brief on November 6, 2009, seven days before the due date of November 13th . My brief was thus the first major one submitted on our side. It began with points that fifty years in the legal profession have taught me are of the essence in this society, even if not in others: it began with the intent of Congress and the results for Congressional intent of the other side’s position:

“The Securities Investor Protection Act of 1970 (SIPA) was enacted to provide to customers of securities broker-dealers protection against losses which might occur as a result of the financial failure of broker-dealers.” This is the very first substantive statement in the Senate Report on the 1978 amendments to SIPA. S. Rep. No. 95-763, at 1 (1978), reprinted in 1978 U.S.C.C.A.N. 764, 764. The House Report on the 1978 amendments says, “The bill would make SIPA more responsive to the reasonable expectations of public investors and would provide investors with greater protection against the financial failure of stockbrokers, thereby enhancing investor confidence in the securities markets.” H. Rep. No. 95-746, at 21 (1977).

These Congressional purposes are not much focused on, if focused on at all, by the briefs of SIPC and the Trustee. This is in a way “understandable,” since the purposes of Congress are deeply thwarted, perhaps even destroyed, by the position on net equity of SIPC and the Trustee. This destruction is not only true in the Madoff case itself, but far more widely. For, as occurred in Madoff itself, no investor with a broker-dealer can be certain that his investment is not part of a Ponzi scheme. After all, one cannot know that one has invested in a Ponzi scheme until after it is revealed. So no investor will be able to withdraw earnings from his investment with confidence that he will not later be told that the withdrawn monies never existed, that the withdrawals diminish his net equity, possibly making it a negative number, that he will lose SIPC protection if it is a negative number, that he will also lose claims against customer property and the estate, and that he is subject to clawbacks.

* * * * *

Thus every investor with a broker-dealer will be at risk, will be threatened with potential economic disaster, if he takes out income from an investment, although taking out income to live, to pay expenses and taxes, and to make other investments is one of the main purposes people have when making an investment in the first place. Investors will have no guaranty of protection -- contrary to the purposes of Congress. They will know they have no protection and that their reasonable expectations, which Congress intended to protect, are irrelevant. Confidence in the securities markets -- another purpose of Congress -- will be vastly diminished. People will quickly realize that they might be much better off simply putting their money in a bank or splitting it among several or many banks, at lower rates of return but with assurance that the FDIC will pay them up to $250,000 for each separate account if a bank should prove fraudulent and bankrupt so that the money the depositors thought was in their accounts was not there in fact.

In my opinion, under our system of government the quotations from Congress should be the beginning and the end of the case. Congress wanted to protect investors and honor their reasonable expectations. The final statement method does. The cash-in/cash-out method does not. Therefore the final statement must prevail. End of story. End of case. Everything else is superfluous under our system.

My own view obviously made little impact on colleagues. For, I think without exception, the other briefs on our side (if I remember correctly) -- just like the briefs of SIPC and the Trustee -- pretty much ignored Congressional intent. Though in other ways a truly outstanding collection of papers, on whose quality even Lifland commented at oral argument, they focused on, and on overcoming, the plethora of arguments made by our opponents, while basically ignoring a dispositive point for our side: the intent of Congress as reflected in the legislative history. Our side, in my opinion, pretty much got sucked into fighting the battle on the grounds chosen by our opponent, rather than on the ground which is our strongest, dispositive suit. The briefs on our side were akin, in a way, to a brilliant execution of Pickett’s charge. Or looked at from the other side, our briefs were akin to what the situation would have been had the Union defended against Pickett’s charge without using its most potent weapon, its artillery, to decimate the Confederate formations as they marched to the attack on Union lines.

I cannot overemphasize the importance of this point. It was only the more important because briefs were submitted by major Wall Street firms and, from everything I have seen in this case, Lifland seems to specially consider the work of such firms while paying far less attention to the work of small fry like myself, or the brilliant writer David Bernfeld, or the highly competent Lax & Neville. Lifland said in his opinion that he read every brief, but this does not change the impression I’ve received time and again in this case that he focuses on the work of the big boys. When the major firms’ briefs didn’t focus extensively on legislative history -- and, maybe they’ll prove me wrong, but I certainly don’t remember other briefs focusing on it -- the game was pretty much up.

I must say that, having been deeply involved in several huge antitrust cases during my career, never before do I recollect one side pretty much ignoring the argument which likely is the strongest one it had -- and here the legislative history was exactly that for our side, as evidenced by the fact that SIPC and the Trustee stayed as far away as they could from the legislative history. (They exemplified Tevye in “Fiddler On The Roof” singing “God bless and keep the Czar -- far away from us.”) I concede to having been very surprised, when reading our side’s briefs, that large firms, which have scores and hundreds of lawyers, gave no indication of having read the hearings or the floor speeches when SIPA was before Congress in 1970 and then again in the late 1970s. They barely gave much indication, if memory serves, of having read the legislative reports. The small fry -- the lawyers who were going it alone or who were in very small firms, had no time to read through this large amount of material -- not to mention that some of us, having never before worked with SIPA or even heard of it prior to Madoff -- were spending enormous amounts of time struggling just to learn the basics of it and doing one or two other day jobs.

What seems the failure of major firms with extensive manpower to go through the legislative history certainly should be corrected on appeal. I already know, because non lawyers have apparently found them, that there are powerful statements by Muskie when opening the floor debate on, and by Nixon when signing, the SIPA bill -- statements which should be quoted by our side. God knows what other powerful statements there may be on our side in the legislative history. Unless we find and use the statements in the history, we are the Union troops defending without firing their artillery; we are Pickett’s Confederates attacking over ground that our opponents want us to attack over because it is infinitely more favorable to them than ground of our own choice would be.

* * * * *

I have recently been in discussions with a number of people regarding our position on net equity. (I prefer not to identify the people.) It is fair to say, I think, that some people, even many people, have trouble accepting our position. To them it seems natural that people who took out more than they put in should get nothing back, so that other people can get money back. As I believe I made clear to such discussants, I myself might even agree with them but for two points.

One is the legislative history, which is controlling. Congress desired to protect investors and build their confidence, and nobody -- and I mean nobody, not even Picard and Sheehan -- claims this can be done by changing after the fact of the fraud from the final statement method to the cash-in/cash-out method, which as far as I know has not been used in something like 319 of 321 prior SIPC cases. (It was used in Old Naples and in part of New Times.) As repeatedly said above, under our system, the will of Congress must govern, not what SIPC or Picard or Lifland think might be more fair.

The second point is the human reality of the situation. In his opinion cum brief, Lifland parrots a hypothetical example, given by the Trustee, of the difference between the results of the cash-in/cash-out method and the results of the final statement method when two investors each invested $15 million, albeit at different times and with large differences in the amounts taken out. Though complicated, the example, as you would expect, was deliberately structured to make the situation as horrible as possible under the final statement method. We all know that, by structuring examples for one’s own purposes -- by rigging the example in favor of one’s own position -- one can make numerical examples support almost anything. There is a reason for the expression that there are three kinds of lies: lies, damn lies, and statistics. If those on our side wished to, we could, and sometimes in fact have, created examples showing that the final statement method is infinitely more fair than the cash-in/cash-out method. For example, suppose someone put one million dollars into Madoff, over the course of fifteen or twenty years took out $1.2 million dollars to live, had a final statement showing $2 million, and had no other money so that he is now wiped out and has to live on welfare. Under the final statement method he will get an advance of $500,000 (because the net equity reflected in his final statement is $2 million) and will thus have at least some money on which to live. Under the cash-in/cash-out method, he will get nothing because he has a negative net equity of $200,000 (he put in $1 million but took out 1.2 million), will have to continue living on welfare or dumpster diving, and is even subject to clawback if you can get blood from a stone. So now which method is more fair, more just?

I repeat: there are lies, damn lies and statistics; and you can rig numerical examples to prove anything you want. That the judge -- or his young clerks, or both -- adopted lock, stock and barrel an abstract example given by the Trustee and rigged in his favor exemplifies the extent to which the judge’s supposed opinion was in reality just a brief in behalf of the other side and ignored the human reality of the situation.

The human reality is that while there were lots of very wealthy people who had money in Madoff and have tens or scores or hundreds of millions of dollars left, there also were many more people of modest means who have been wiped out, have no money left, and do not know where their next dollar will come from because under the Trustee’s cash-in/cash-out method they will get nothing. And -- and mark this because it is the crucial point here -- the Trustee, who has the information needed to make judgments on whether the cash-in/cash-out method or the last statement method would be more helpful to more people, has kept that information secret and will not provide it. The Trustee and SIPC know the information, or can find it out at the touch of a computer button. Thus, the Trustee and SIPC could readily tell the victims, and the courts, the crucial data with regard to determining the relative fairness of the two different methods of determining net equity, crucial data such as:

1. How many claims would be eligible for advances of up to $500,000 under the final statement method, and how many would be eligible for such advances under the cash-in/cash-out method.

2. How much would the total advances be under the final statement method, and how much would total advances be under the cash-in/cash-out method.

3. How much would potential clawbacks be under the final statement method and how much would potential clawbacks be under the cash-in/cash-out method.

4. Information such as how many victims whose final statements showed one million dollars or less will be eligible for advances under the final statement method, how many will be eligible under the cash-in/cash-out method, and what will be the average potential clawback from these persons under the final statement method and under the cash-in/cash-out method.

The same information for people whose final statements showed between one and three million dollars. Ditto between three and five million dollars. Ditto between five and ten million dollars. Ditto between ten and twenty million dollars. And ditto over 20 million dollars.

These kinds of figures, which SIPC and the Trustee have not disclosed, will give us the reality of people’s economic situations and will reveal what is fair in reality -- what is fair when you take account of the economic situations of real people, as opposed to what might be argued to be fair under the abstract economic examples used by the Trustee and adopted by Lifland.

No doubt SIPC and the Trustee will object to providing these figures, claiming it will be too much work. Well, with modern computers, the figures can likely be compiled with literally the touch of a button. (And for obvious reasons it wouldn’t surprise me if SIPC and the Trustee already have compiled the figures.) Moreover, acquiring these figures is the only way in which the courts, or we, can measure whether cash-in/cash-out provides fairness -- in the context of the economic situations of real people -- especially when you consider that some people have had to engage in dumpster diving while others still have tens, scores, or hundreds of millions of dollars left.

Of course, the real reason SIPC and the Trustee don’t want to give courts, or us, the foregoing information is very likely that the actual information about the economic situations of real people will undermine SIPC’s and the Trustee’s completely abstract argument about fairness.

There are, then, two major reasons why our position is correct, notwithstanding the reflexive view of some people that cash-in/cash-out should be used so that people who have not taken out more than they put in will obtain more than they otherwise would. One reason is the Congressional intent and the other is the human reality of the situation, a reality reflected in data which SIPC and the Trustee keep locked away lest the actual facts of the possible unfairness of the cash-in/cash-out method be exposed in concrete terms.
* * * * *

That SIPC and the Trustee have kept the facts of the situation locked away is par for the course here.

Throughout the case SIPC and the Trustee have kept important matters close to the vest. When this writer sought discovery of the reasons why SIPC and the Trustee used the cash-in/cash-out method instead of the final statement method, SIPC and the Trustee vigorously resisted all such discovery. Almost surely the discovery would have proven that cash-in/cash-out was used because early in the case, when its use was decided upon, SIPC and the Trustee were terrified that potential advances to victims would exceed the amounts of money available to SIPC by billions of dollars if the normal final statement method were used. Discovery would thus have shown that fear for SIPC’s finances, with concomitant disregard of Congress’ desire to protect investors and instill confidence in the market, was the driving force. So SIPC and the Trustee vigorously resisted discovery, and Judge Lifland, as always, did what they wanted. He also made clear more broadly, in my view, that he was not going to countenance discovery of any kind lest this delay Picard; his language was telling.

Subsequently, many of us think, SIPC and the Trustee found out that SIPC would not go broke if the final statement method was used to determine net equity. But if this is true, as several of us believe, SIPC again did not reveal the facts, this time perhaps because it did not want to disclose a serious mistake that caused havoc and/or it wanted to save money by using cash-in/cash-out.

It also turns out apparently -- at least it has been said by someone who should know -- that back around 2003, when the GAO and Congress were warning SIPC that its fund was too small to withstand the bankruptcy of a major brokerage house, SIPC somehow got some kind of approbationary actuarial assessment from some alleged experts. But who these people were, and what they said, is, as Churchill said of the Soviet Union, a mystery wrapped in an enigma. Having been kept secret all these years, nobody can yet know or question what the alleged experts actually said, what their reasons were, whether the reasons held water, etc.

I said above that “as always” Lifland did what Picard and SIPC wanted when he denied discovery of the reasons why they chose cash-in/cash-out. There were, you see, many other times when Lifland did whatever they wanted, often with many of us getting no advance notice. Much of this has been discussed here previously. When Helen Chaitman sought an earlier hearing and decision on how to calculate net equity, but Picard and SIPC objected to this, Lifland did as they wanted. When Picard and SIPC later sought a decision on net equity, Lifland did as they asked. When the question then was what should be considered a part of the net equity issue, Lifland eliminated what they wanted eliminated. When their briefs nonetheless brought up matters that had been eliminated, Lifland allowed this to be done. When a prominent victim’s lawyer then asked for extra time to file a brief because of the need to do research on the complex, previously eliminated points that Lifland nonetheless allowed to be emplaced in the briefs of SIPC and Picard, the request for more time was denied.

So, unless one insists on remaining resolutely naïve, it seems to go without saying that the victims’ chances of success in the Bankruptcy Court died with the appointment of Lifland to handle the case. Without getting into the whys and wherefores, and without mentioning how I may know their view, I believe there were people who knew we were dead under Lifland because they were familiar with the shall-we-say-odd reputation he had built up in the late 1980s and the 1990s. Be that as it may, however, it seems to me to be quite factual and quite right to say that the victims had no chance under Lifland. And, in his March 1st opinion, while maintaining a pretense of open-mindedness with regard to preference issues -- clawback issues -- that will arise in the future, he announced the dubiety of one argument made on this question by the victims, and I believe it is dollars to doughnuts he will ultimately deny all the arguments of the victims. My prognostication is that as long as Lifland is the judge, the victims are dead meat.

* * * * *

I want to turn now to a point which constitutes an incredible irony, but which goes beyond irony to illustrate a fundamental weakness in what Lifland has done by simply parroting the points of the Trustee and SIPC. The point is this: despite all the resources available at Baker, Hostetler, other law firms Picard has hired, and Alix Partners, and despite the expenditure (if memory serves) of about a million dollars a week, the Trustee has made serious mistakes regarding facts -- even though the actual facts are readily available. Several of the mistakes are not crucial to the outcome of the case, though at least one is, but they are factual mistakes made although the truth is readily ascertainable. Lifland parroted the mistakes.

There is irony here, as said. The Trustee and Lifland could easily have learned the truth regarding the relevant facts yet suffer nothing for the mistakes they made despite the huge resources at the Trustee’s disposal. Yet ordinary investors, who had no way of learning the truth about Madoff, are being savaged for their mistakes through use of cash-in/cash-out, and thereby the controlling intent of Congress to protect investors and honor their legitimate expectations is being destroyed. Briefly put, Picard is free to make errors of readily checkable fact without penalty despite possessing huge resources, but investors who had no way of ascertaining the truth and few resources are punished for their mistakes.

Let me provide a remarkable example of the phenomenon. As many or most readers will know, our opponents, and Lifland, said we must lose because Madoff’s trades were fictitious. His trades being fictitious, it was said, the case is governed by the portion of New Times dealing with securities that never existed -- that were fictitious -- rather than the portion dealing with securities that existed in the real world but whose purchase was fictitious. (That is to say, the New Times analysis regarding securities which existed and were never bought, but whose performance in the real world could be tracked, was inapplicable here where real world securities also were not bought and also could be tracked, because here the unbought securities were also supposedly sold, with profits thus coming from the fictitious sale of the securities here whereas they came from the fictitious holding of the securities in New Times -- a strange dichotomy in law unless you are looking for a rationalization to use cash-in/cash-out).

Now, none of us denied that, as was the case in New Times, everything the fraudster did here was fictitious, although the real world securities both here and in New Times could be tracked. But, obviously pulling out every stop to try to deny that the securities here could be tracked, our opponents -- parroted by Lifland, quoting a sworn “declaration” submitted by a hireling of Picard -- said that one security appearing on statements did not even exist, “Fidelity Spartan U.S. Treasury Money Market Fund.” As Lifland (or his clerks) put it when parroting Picard’s hireling, “Fidelity . . . has acknowledged that it did not even offer opportunities in any such money market fund from 2005 onward.” (P. 14.) But by any realistic assessment, this parroting statement is flatly wrong.

In 2005, the name “Spartan U.S. Treasury Money Market Fund was changed to Fidelity U.S. Treasury Money Market Fund. As was said in a June 29, 2005 Supplement, “Effective August 15, 2005, Spartan U.S. Treasury Money Market Fund . . . will be renamed Fidelity U.S. Treasury Money market Fund.” That was the only change; the fund continued to exist.

Moreover, while at some point the fund became closed to new investors, Fidelity has confirmed to our library over the phone that the fund remained open for the addition of money by existing investors. So, as long as he had some money in the fund, Madoff could put in more.

Thus, the fund continued to exist, it underwent only a slight change of name, and it remained open for the addition of money by existing investors, yet I guess victims were supposed to know that everything Madoff did was fictitious because their statements used a minimally wrong name for the fund, calling it Fidelity Spartan U.S. Treasury Money Market Fund instead of just Fidelity U.S. Treasury Money Market Fund. Moreover, with all their resources and supposed smarts, the Trustee and FTI Consultants -- one of whose Senior Management Directors swore that the fund no longer existed (“from 2005 onwards, Fidelity did not offer participation in any such money market fund for investment” (Looby Decl. ¶ 57, emphasis added), when in fact it did exist, offered further investment opportunities to existing investors, and had merely undergone a slight name change; with all their resources they still could not get it right and instead claimed that the existing fund did not exist. (It gives one great confidence in the work of FTI, does it not?)

There was a similar point -- made by Picard and FTI and parroted by Lifland -- which may be dubious and for which evidence was not offered as far as I know. Again to prove the fictitiousness of Madoff’s actions -- fictitiousness that no one disputes -- Lifland (or his young clerks) copied Picard’s hireling by saying “the Trustee’s investigation revealed many occurrences where purported trades were outside the exchanges’ price range for the trade date.” (Op. pp. 14-15, emphasis added.) Except for omission of the words “low/high” before the words “price range,” this was a direct crib without quotation marks from the hireling’s Declaration. It was followed by a footnote which cribbed without quotation marks but which at least cited the Declaration: “”For example, in one instance, a monthly account statement for December 2006 reported a sale of Merck (“MRK”) with a settlement date of December 28, 2006. BLMIS records reflect a trade date of December 22, 2006 at a price of $44.61 for this transaction. However, the daily price range for MRK stock on December 22, 2006 was a low of $42.78 and a high of $43.42. See Looby Decl. at ¶ 106.” (Op. p. 15, fn. 20.)

Now, the point here is that, claiming that there were “many” occurrences of prices outside the exchange’s trading data, the Declaration and then Lifland give only one example. Is it really true that there were many? Or was use of the word “many” simply the kind of exaggeration one gets in litigation? There was no evidence given of “many.” As well, could the claimed price or prices have been obtained on days in question on a different exchange or over the counter? On these points there is nothing said, yet we apparently are supposed to simply accept that there were many instances. And, beyond that, is there conceivably an implicit indication that victims should have known something was wrong because of the Merck price gaffe, or other unidentified ones, on documents which we had no reason to disbelieve and which over the years gave information on what? -- thousands of trades? Tens of thousands of trades? Scores of thousands?

There were other claims made by Lifland (or, perhaps more likely, his young clerks) that puzzle me because, perhaps in my ignorance, I do not know where they came from, much less whether they’re true. For example, Lifland’s opinion says “Based on the Trustee’s investigation, it appears that BLMIS began to offer investment advisory services as early as the 1960s . . . .” (Op. p. 9.) Really? Probably I’m missing something, but I have no idea where the Trustee says that. Did Lifland or his clerks ferret this out by talking privately to the Trustee or his people, which would seem to me a serious no no but which also seems to have happened not infrequently shall we say?

Relying on the Trustee, Lifland says (or his young clerks say) that investors did not even invest enough capital to pay for his initial fake purchases, supposedly because prices were “backdated and orchestrated.” (Op. p. 10, n. 15.) The investors didn’t even pay enough for their initial purchases? Really? The Trustee says this, even though such a discrepancy would almost certainly have shown up on customers’ initial statements and been a tipoff to every investor that something is wrong? This is pretty hard to believe, and perhaps I am once again missing something, but where did the Trustee say it? Or was it possibly said to Lifland in private?

Then there is Lifland’s claim that the so called “Net Winners,” persons who took out more than they put in, and who Lifland feels should not get money, in general “will be concentrated among early investors, while a critical mass of Net Losers [who took out less than they put in] will be found among later investors.” (Op. p. 18.) This claim is a critical one because the Trustee, SIPC, and Lifland all say a fundamental point here -- even the fundamental point here -- is (i) the final statement method unfairly benefits long term investors who over the years took out more than they put in (“net winners”), and harms later investors who did not (“net losers”), and the associated claim that “net winners” will be concentrated among the early investors and “net losers” among the later ones. This idea no doubt sounds intuitive to Lifland and his clerks, since there has been a focus on small people who invested early and over the years took out money to live and to pay taxes. Nor are Picard or SIPC, who have the pertinent data, giving out any information to disabuse judges of this idea.

But is this intuitive idea really true? In his new book, Harry Markopolos has a chart -- in the pictures section between pages 178 and 179 -- of the number of funds that invested with Madoff and that had “at least two years worth of returns data through March 2008.” According to Markopolos, over “339 funds of funds, and 59 asset management companies were invested with Madoff.” (See also p. 78.) Now, it is well known that Madoff’s Ponzi scheme collapsed because the big hitters, the huge hedge funds and funds of funds, for example, began pulling monies out of Madoff by the billions of dollars in the 2007-2008 time period to cover huge losses they were suffering elsewhere due to the economic debacle. It has been estimated, in fact, that $12 billion was pulled out of Madoff in the last six months before his collapse, leaving him with only about $17 or $18 million. I myself suspect the amount pulled out of Madoff in the last 18 months before his collapse could be as much as $17 billion or so.

It is a mathematical certainty that all the big hitters who emptied their Madoff accounts by pulling out billions upon billions of dollars were net winners, as the Trustee and Lifland call them. For, since Madoff had nearly no down months, and big hitters’ accounts were credited with profits each month, it is mathematically inevitable that the big hitters had more in their accounts, and pulled out more, than, at least over time, they put in. As well, it is generally thought that many of the big hitters, many of the hedge funds and funds of funds, came to the party relatively late, in the 2000s, many even in the mid and late 2000s, (whereas long term small fry who are so-called net winners often had invested with Madoff for 15, 20 or 30 years or more).

If all of this is true, then, at least on the basis of dollars invested as opposed to mere numbers of investors, it probably is seriously untrue for Lifland to have claimed that “Net Winners will be concentrated among early investors, while a critical mass of Net Losers will be found among later investors,” which is one of the major excuses given by Picard, the Trustee and Lifland to justify using the cash-in/cash-out method that is so harmful to so many average middle class investors in Madoff. The real “net winners,” rather, are the extremely wealthy funds who got all their money out in the last year or two, and often may have invested for only a relatively short time, and the real net losers are the average Joes who left money in and over the years had to take out more than they put in in order to live and pay taxes.

Only Picard and SIPC know the actual facts about all of this, however, and they certainly are not talking lest the truth harm their argument for cash-in/cash-out.

There is, finally, the question of what previously has been called here the bubbe meisse, the question of whether there is both a separate SIPC fund and a fund of customer property, so that if X gets money from the SIPC fund this will not cause Y to get less from that fund, or whether, as in the bubbe meisse peddled by Picard and SIPC, there is only one fund -- there is only customer property -- so that if X gets something, this will automatically mean Y gets less. Lifland, or his young clerks, appear to shift, opaquely, between the truth and the bubbe meisse. The opinion claims that “any dollar” paid to X to reimburse phony lost profit is a dollar less for reimbursement of Y’s loss of principal (so that there “is a zero-sum game”). (Op. 31.) But this claim is absolutely untrue with regard to advances from the SIPC fund, because advances to X and to Y from that fund are totally independent of each other, and if SIPC doesn’t have enough in its fund to cover all advances, it is supposed to tap lines of credit.

The opinion also claims correctly, however, that payments to X from recovered customer property will reduce the money available to pay Y from that property. This claim is accurate, as is Lifland’s statement that the determination of one’s net equity – which governs whether he gets an advance from SIPIC -- will also determine whether he shares in the fund of customer property. (Op. 20.) What Lifland did is that he adopted the position of SIPC and Picard that, to prevent people who took out more than they put in from getting any customer property, one should define net equity in a way that also denies them money from the SIPC fund, and, as part of this, he claimed wrongly that there is only one pot of money, one fund, even while explicitly recognizing elsewhere in his opinion (on p. 19) that there are two separate funds. (“SIPC is charged with establishing and administering a SIPC fund . . . . (Op. 19 (emphasis added).)

Also as part of this confusion, Lifland (or his clerks) denied that the SIPC fund constitutes insurance available apart from customer property, since net equity controls both receipt of money from SIPC’s fund and receipt of customer property. Well, technically speaking, monies from the SIPC fund may or may not be insurance, as one ordinarily conceives of insurance. The Trustee, SIPC and Lifland claim it is not insurance because of the net equity matter -- and, one might add, perhaps it is not insurance because for decades SIPC and its Trustees have made every argument imaginable, including ones denounced as frivolous by federal courts and lawyers, to deny SIPC payments to victims. (Or does this make it more like insurance?) To me, however, the point is not whether the SIPC fund is or is not insurance in the technical sense. Rather, the point is that the SIPC fund has been paraded as insurance; one might say it has been in a sense peddled to investors as insurance. The internet traffic on Madoff websites has often carried disclosures by victims that one and/or another document or statement from SIPC itself or from brokers whom SIPC covers called the SIPC fund insurance. Thus SIPC, and the brokerage community, have worked a fraud upon innocent investors, by claiming to them time and again that they are covered by insurance, when SIPC’s conduct in this and prior cases shows that it doesn’t think there is insurance here at all. This, to reiterate, is fraud upon investors, and SIPC and the Trustee should not be allowed to get away with this fraud by defining net equity here in a way that denies SIPC payments to innocent persons.

(In preparing an appellate brief, I shall have my assistant go through our files to find the emails identifying the places where SIPC or brokers claimed there is insurance. But if those of you who have uncovered or know of these claims that SIPC provides insurance would email me now to say where the claims can be found, this would lessen our workload, and I would be grateful. Naturally, since Lifland claims there is no insurance, his opinion contained no discussion of all the places where the SIPC fund was called insurance, though Helen Chaitman presented him with a list of judicial cases that called it insurance. Nor, of course, was there any discovery regarding statements by SIPC and brokers that the SIPC fund is insurance.)

* * * * *

Normally the question of appeal would be discussed at the very end of this posting. But, because of matters just presented, I shall discuss the question at this point, for reasons that will become clear.

It has more or less been assumed since the beginning that, no matter which way Lifland ruled, there would be an effort to take an immediate appeal to the Second Circuit Court of Appeals. This would bypass the normal first appeal to the District Court -- more particularly, to the District Court judge “supervising” Lifland, Denny Chin (who sentenced Madoff). An immediate appeal to the Second Circuit was desired because many victims who have been denied SIPC payments under cash-in/cash-out, and therefore had little or no money, were suffering and, on the other side, many clawbacks depend on cash-in/cash-out being upheld. So on both sides there has been a desire to have the question of net equity decided with finality by means of an immediate appeal to the Second Circuit.

I also think that hubris had something to do with the matter on both sides. Each side thought it would win, especially at the Court of Appeals level. Lifland himself thought there should be an appeal to the Second Circuit because he believes the case depends on which part of the Circuit’s New Times decision is applicable, the part dealing with fictitious and thus unbought securities, or the part dealing with real but unbought securities.

And on both sides -- the victims’ side and the Trustee/SIPC side -- each side hubristically thought it would win in the Circuit Court, so let’s get on with it and get there as fast as possible. Speed was desired, and not much attention was given to the fact that, regardless of which side wins in the Second Circuit, the losing side will petition the Supreme Court, which will not even decide whether to take the case until probably, at best, about four to six months or so after the Second Circuit rules (which can itself require at least many months for briefing, oral argument, and opinion writing if the Circuit does a careful job of opinion writing (unlike Lifland, with his desire to turn out an opinion quickly and his consequent parroting of the Trustee and SICP and his ignoring of many important points (see below), such as the crucial legislative history).) And if the Supreme Court does take the case, another year or so will likely be consumed in briefing, oral argument, and opinion writing.

Most of this was ignored in a desire on all sides to rush to judgment. This desire had disastrous repercussions for the victims. Especially as a prior participant in major antitrust litigations in which there was extensive discovery in order to try to establish the actual pertinent facts, antitrust cases which had each taken many years, it seemed to me relatively early in the game that discovery of documents and depositions were needed here to determine the truth about crucial matters. As readers may know, my focus initially was on discovery of the reasons why Picard and SIPC adopted cash-in/cash-out. But when it was suggested to other lawyers on our side that a request for such discovery should be made, they demurred, basically for two reasons if I remember correctly. One was that Lifland wouldn’t grant the request, which turned out to be correct and was a measure of Lifland’s lack of concern to uncover the real truth of the situation. The other was that discovery would delay the case, thus further harming now-impecunious clients. Avoiding delay by avoiding discovery also seemed very important to Lifland when he denied my request for discovery on something as crucial as the reasons why SIPC and the Trustee turned -- most unusually -- to cash-in/cash-out, and when, in so doing, he implicitly made clear by strident language he would not welcome any discovery on anything by victims since discovery can delay resolution of a case (even if it helps insure truth). (Is it possible, as well, that discovery by victims, as opposed to discovery by Trustees, may be unusual in the Bankruptcy Court, though the rules plainly allow it?)

Seeking a relatively quick victory to aid victims, and foregoing even requests for discovery in search of a quick victory, our side has now, in the absence of crucial facts which discovery could have unearthed, suffered an initial defeat, one based in part on the absence of evidence on crucial facts and on Lifland’s desire, in the absence of the evidence, to accept claims made by SIPC and the Trustee that may very well be untrue. Of course, perhaps none of this would have been changed had requests for discovery been made, since Lifland might have denied them. But it would have been harder for him to do so if discovery requests had been made not just by some small fry, to-Lifland-unknown lawyer from northern Massachusetts/Southern New Hampshire, but by a large number of New York City firms including several prominent Wall Street outfits.

And consider the crucial facts which could be very helpful to our side but which we don’t know because of the absence of discovery -- crucial facts, moreover, as to which Lifland, when he dealt with the matters at all, could and readily did accept the other side’s unproven, unsupported word for things. There is, as said, no factual proof, developed through discovery, that cash-in/cash-out has almost never been used by SIPC, and was used here, despite its destruction of Congressional intent, solely because SIPC (i) was terrified early-on about the potential amount of money it might owe under the final statement method, (ii) feared bankruptcy if the normal final statement method were used (as it has been in a currently unknown number of other Ponzi cases, such as part of New Times and who knows how many other Ponzi cases or other cases where brokers went bust because of theft and securities were missing), and (iii) feared management would lose its very lucrative jobs.

There is also no factual proof, obtained through discovery or otherwise, that now, having eliminated a host of claims, SIPC and the Trustee know, as many of us believe, that SIPC’s fund, and the lines of credit to which it has access or can readily gain access, are sufficient (or nearly so) to cover SIPC advances to all direct investors who have a positive net equity under the final statement method.

There is here no evidence on what SIPC was told by alleged actuarial experts around 2003 about the sufficiency of its fund, or about why it did not seek to build up the fund to more appropriate amounts instead of giving Wall Street a pass by charging only $150 per year in premiums to gigantic houses that were doing tens, scores, or even hundreds(?) of billions of dollars worth of business each year.

There is here no evidence of what the monetary effect on victims would be of the SEC’s suggestion that the time value of money be considered when determining net equity.

There is here no evidence of what the numerical monetary effects of clawback will be if the final statement method is used or if the cash-in/cash-out method is used.

There is here no evidence of record giving the lie -- as the lie should have been given -- to the claim that the Fidelity U.S. Treasury Money Market Fund did not exist.

There is here no evidence that statements showed other trades than the December 2006 Merck trade were made at erroneous prices.

There is here no evidence obtained through discovery of all the places in which SIPC and its brokers explicitly referred to the SIPC fund as insurance, thereby defrauding investors.

There is here no evidence put into the record via discovery that the responsible agency of government, the SEC, encouraged victims to invest in Madoff via its completely erroneous public statement of December 1992 and also by its contemporaneously well known, repeated failures to catch Madoff thereafter, while now the SEC and a quasi governmental agency over which it has supervisory authority, SIPC, are trying to screw over the innocent victims, whom the SEC itself sucked into Madoff, by use of cash-in/cash-out.

There is here no evidence, which could have been developed in depositions of experts and submission of materials by them, that it was and remains possible to obtain in an orderly way, and to give to victims, the securities which appeared on their final statements.

I must say that, as a lawyer who has participated in huge antitrust litigations involving hundreds of millions of dollars back in the day when that still was real money, I am somewhat astounded at this “non discovery” method of litigating a huge case involving billions of collars. Such method of litigating is almost a sure fire way of insuring that crucial facts do not come out and that false facts obtain -- of insuring, that is, that no facts or false facts obtain with regard to how one should define net equity if one does not focus on the only important question in this regard, the question of Congressional intent. In other words, once one ignores the only matter that should count, Congressional intent, which was ignored by SIPC and the Trustee, by most of the lawyers on our side, and by Lifland, then victims need a host of facts to best combat the Trustee and SIPC on the grounds they have chosen, but the absence of discovery, for whatever reason it was absent, insured that those facts were not introduced into the record and did not have to be taken account of by Lifland, who instead accepted everything the Trustee said in a rush to judgment in favor of the Trustee and SIPC.

Now, what does all of this have to do with an appeal? What does it have to do with the question whether it would be better to appeal to the District Court or to take an immediate appeal to the Second Circuit? Well, as you can see from the foregoing that right now we are missing many of the facts that would be very helpful to the victims’ side if the Courts continue, as they may, to not focus on what should be the sole dispositive point of the case, the legislative history. It would therefore be very desirable to obtain discovery to plumb these facts. One cannot obtain such discovery in the Second Circuit Court of Appeals, however. So a case there has to be fought with one and a half hands tied behind our backs, and our chances of a loss there are vastly greater than otherwise if the Court does not focus on the one thing it should focus on, the legislative history. A loss in the Second Circuit will not help the victims just because the case will be over quicker than otherwise, quicker than if the initial appeal went to the District Court.

Could one get discovery in the District Court if the appeal is initially heard there? Well, I really don’t know. Ordinarily, discovery is obtained in District Courts, but ordinarily a District Court is functioning as a trial court rather than as a court hearing an appeal (except in cases involving initial decisions by magistrate judges, bankruptcy judges and others who hear cases subject to the supervision of District Court). Could discovery be obtained in the District Court if one asked for it? As said, I don’t know, although I suspect that if a party asked for it, and the District Judge agreed it was necessary, he would at minimum remand it to the Bankruptcy Court (Lifland) for the taking of the discovery.

Of course, one could also argue to the Second Circuit that it should order the case remanded to the District Court and then to the Bankruptcy Court for the taking of the needed discovery. But somehow I think this would not be as effective, because once a Court of Appeals has a case there can be a sort of hydraulic pressure on the court to decide it. Moreover, here Lifland’s opinion may be one strike against us in the Court of Appeals, where we will lack a record of facts obtained through discovery to combat it. So, even though Judge Chin, the District Judge to whom the case is currently assigned (and who will keep it unless his nomination to the Second Circuit Court of Appeals is soon confirmed), has written an opinion that may be unfavorable to us (but which may also be distinguishable), it is possible that we would be better off appealing to him than to the Second Circuit. As the judge who sentenced Madoff, he at least is fully aware, from letters and statements made in Court, how much suffering has been undergone by impecunious victims to whom SIPC has denied advances under cash-in/cash-out. As well, even if Judge Chin is soon confirmed to the Court of Appeals, it should be possible if we wish, to at least ask him to sit by special designation on the SIPC matter in the District Court. Sitting on a case as a District Court Judge by special designation is not at all unusual for appellate judges -- even Supreme Court Justices do it.

* * * * *

Allow me to clear up a few minor odds and ends before closing:

1. That Lifland chose to parrot Picard and SIPC was not because he was unaware of our side’s arguments, but because he chose not to accept them though he knew of them. That he (or his clerks) knew of them was illustrated by a special appendix attached to his opinion in which he set forth a list of the arguments on both sides (a list obviously compiled by his clerks). Our arguments were pretty much there, except that the part on legislative intent was skimpy and, while giving some quotes from the legislative history, nonetheless ignored what I consider the most important legislative statements from the Congressional reports set forth above which show that the Congressional intent was to give investors protection against losses arising from the financial failure of broker-dealers. The omission of these statements was perhaps indicative of a dearth of understanding.

2. As partly mentioned above, and as discussed in prior postings and in the brief I filed, SIPC owes the victims the securities shown in their final statements, not mere cash, and those securities can be purchased in a fair and orderly market by buying them in reasonable sized blocs over time rather than trying to purchase them all at once. In discovery, experts would have been brought in to prove this by explaining how traders in huge blocs acquire millions upon millions of shares of particular stocks over time, in an orderly way, and how it could be done here. Such discovery should certainly be requested if we ever get a chance.

3. In the New Times case, the Second Circuit gave deference to the SEC when deciding how to treat the differing classes of victims. That the Second Circuit, if intelligent, as one hopes, would again give deference to what the SEC says, strikes me as dubious. For the SEC has now been revealed as a horribly, horribly incompetent, and even stupid, regulatory body. Nor can it even begin to compete with firms like Baker Hostetler in the quality of its thinking and lawyering.

So were the SEC to continue insisting that the time value of money should be taken account of, and should the Trustee and Baker oppose this as they certainly will, I would not bet all my marbles that the SEC will prevail. Who knows if it would even prevail on the question of the retroactive rightness of using the final statement method in New Times for investors who had real but unbought securities? I do not regard that, either, as a sure thing, although both sides have argued the case before Lifland on the assumption that it is a sure thing that the dichotomy of New Times will continue to prevail.

It seems to me possible, therefore, that on appeal SIPC may try to roll back that part of New Times. It will at minimum of course continue to claim, and the Court will obviously be very interested in whether, the other aspect of New Times is correct, whether the dichotomy of New Times should continue to exist, and which aspect of the dichotomy is applicable here. One major issue will thus be whether, because the final statement method was not used in New Times where the securities were fictitious, it also should not be used here, where the trades were fictitious.

Given these various issues, relating to New Times, that will be involved in an appeal to the Second Circuit, my view is that our position should be, first, that the Madoff victims come under the part of New Times dealing with real but unbought securities, and that it is proper to use the final statement method in such instance because that is the only way to protect investors, to honor their legitimate expectations and to build confidence in markets, i.e, to fulfill the intent of Congress. Nor can it be appropriately argued, ala Picard, SIPC and Lifland, that more fulsome books and records should prevail over the final statement, because the investors have no access to the books and records, therefore cannot know they are facing a fraud, have no protection, depending on their circumstances, if the final statement method is not used, and inherently and legitimately believe and expect that they have the assets shown in their statements.

As well, if the existence of real securities in Madoff is ignored because the trading was fictitious, and the part of New Times dealing with fictitious securities is therefore applicable, we should argue -- and it is true -- that that part of New Times was decided incorrectly, with deference being given to two agencies -- SEC and SIPC, one of which is incompetent and the other of which is venal -- even though their arguments were contrary to longstanding, continuous practice in both finance and litigation. In both finance and litigation, long established techniques are used to estimate what would have occurred in the past had given events or illegality not occurred, and what will happen in the future. Financial experts and economists make the relevant calculations and do the relevant studies literally every day. They have been done in cases I personally have participated in, and are done widely.

Thus in New Times the profits that would have been realized by persons who bought the nonexistent securities could have been measured by the gains of the securities which existed, or by some reasonable surrogate such as the performance of the S&P 500, the S&P 100, the Dow Jones, a bond index, or whatever was close to those securities in style and purpose. That kind of measurement by surrogates is common. Here the profits that would have been made by the Madoff investor could be measured by the performance over time of the S&P 100, from which Madoff took the securities he allegedly was using. Or the profits could be measured by an index of hedge funds that, as Madoff claimed to do, sought reasonable growth with stability through buying and selling securities just as Madoff claimed to do. Or the profits could be measured by a comparison with the profits made from use of the split strike conversion strategy by other funds that actually used that strategy, as some did.

In every case where something is fictitious, there are appropriate surrogates that can be used to measure what would have occurred, as occurs daily in finance and litigation. The unwillingness of SIPC and the SEC to use them reflects pure greed on SIPC’s part, and on the part of the SEC reflects the incompetence, stupidity and complete lack of financial sophistication that Harry Markopolos has regularly said are hallmarks of the SEC, and that he has been dining out on. The failure to use these surrogates is also just a method of cheating defrauded investors out of monies they legitimately believe they should get from SIPC, failing to give them the protection Congress intended them to have, and screwing over their legitimate expectations. Frankly, I am quite surprised that a smart, sophisticated Circuit like the Second did not realize in New Times that surrogates could and should be used, and instead accepted a bunch of hooey from the SEC and SIPC.

* * * * *

I shall close by very briefly restating, and adding just a bit to, some of the points made above that I consider the most important. I wish they would have an impact on my fellow lawyers, but doubt that they will for reasons having to do with decades of experience.

One of the points is that the legislative history is far and away the most important aspect of the case from our standpoint. It should be dispositive for us and everything else should be irrelevant. The trustee and SIPC understandably ignored it because it is so favorable to us, and, being sucked into fighting on grounds of their choosing, our side pretty much ignored it also. This was a mistake and contributed to an opinion which represents something which is wholly improper in our system: a decision implementing what one side and the Court think fair instead of carrying out the will of Congress -- what Congress deemed fair. Let us hope that our side proves and extensively presents the legislative intent in the next go round, whether in the District Court or the Court of Appeals.

Second, in the absence of focus on the intent of Congress, and with focus instead on points of our opponents’ choosing, the lack of discovery was an absolute killer for us. In the absence of discovery, the other side got away with hiding its motivation and with various crucial claims that might very well be wrong and would have been disproven by discovery. As an antitrust lawyer, I simply fail to grasp how one can litigate big cases without significant discovery. Is this how it’s done in the Bankruptcy Court?

Discovery should be demanded. It should be demanded if the appeal goes to the District Court, and, if the appeal goes to the Second Circuit, that Court should be warned that the absence of all discovery renders conclusions uncertain and highly disputable.

Third protecting Congress’ intent is at stake here, not just in this case, but in any number of potential cases. For years SIPC always used the final statement method and issued publications saying that the final statement is used. Now, however, there are three cases where it has not used this method, Old Naples, part of New Times, and Madoff. Given the greed, hard-guy conduct, and decades of efforts by SIPC to thwart victims who simply seek to obtain monies they legitimately thought they had a right to, if SIPC succeeds here, if it is not slammed hard here, it likely will be only a question of time -- and not much time at that -- until SIPC extends, to other cases and other situations and other victims, its efforts to illicitly avoid payments that Congress intended it should make to victims.*

*This posting represents the personal views of Lawrence R. Velvel. If you wish to comment on the post, on the general topic of the post, you can, if you wish, email me at Velvel@VelvelOnNationalAffairs.com.

VelvelOnNationalAffairs is now available as a podcast. To subscribe please visit VelvelOnNationalAffairs.com, and click on the link on the top left corner of the page. The podcasts can also be found on iTunes or at www.lrvelvel.libsyn.com

In addition, one hour long television book shows, shown on Comcast, on which Dean Velvel, interviews an author, one hour long television panel shows, also shown on Comcast, on which other MSL personnel interview experts about important subjects, conferences on historical and other important subjects held at MSL, and an MSL journal of important issues called The Long Term View, can all be accessed on the internet, including by video and audio. For TV shows go to: www.mslaw.edu/about_tv.htm or www.youtube.com/user/mslawdotedu; for conferences go to: www.mslawevents.com; for The Long Term View go to: www.mslaw.edu/about¬_LTV.htm.

More On SIPC’S And The Trustee’s Bubbe Meisse. Plus: Can The Fact That SIPC And The Trustee Have Created A Bubbe Meisse Be Put Before Judge Lifland.

2010-02-19T14:07:00.001-05:00

February 19, 2010

More On SIPC’S And The Trustee’s Bubbe Meisse.
Plus: Can The Fact That SIPC And The Trustee Have Created A Bubbe Meisse
Be Put Before Judge Lifland At This Time?

On Wednesday, February 17th, I wrote of the underlying theory invented from whole cloth by SIPC and Trustee -- on Wednesday I wrote of their bubbe meisse. Yesterday, Thursday, February 18th, I posted an analogy that made it easier, even easy, to understand their bubbe meisse. Today I would like to add to that analogy a point that somehow escaped my mind but now has been pointed out to me by a Madoff victim.

The analogy previously given is this. Sam Smith has one million dollars in the bank and knows he may or may not receive ten million dollars from Jack Jones in somewhere between one and ten years. Smith gives you $10,000. Does the $10,000 come from the one million dollars Smith has in the bank, or from the ten million dollars he may or may not receive from Jack Jones in somewhere between one and ten years? In the Madoff victims’ view, the ten thousand dollars, which is the analogical counterpart of payments to victims by SIPC of up to $500,000, comes from the one million dollars Smith has in the bank -- money which is the counterpart of the fund already held by SIPC. Under the bubbe meisse invented by SIPC and the Trustee, it comes from the ten million dollars that Smith may or may not receive from Jack Jones in somewhere between one and ten years, which is the counterpart of “customer property.”

Now, here is the additional fact that had slipped my mind. SIPC’s fund largely or exclusively comes from payments by the brokerage industry. Thus, to the analogy should be added the following fact. Sam Smith’s one million dollars in the bank comes from payments to him by his family -- these payments are the analogy’s counterparts to payments for SIPC’s fund that are made by brokers.

So now the question raised by the bubbe meisse is this: Does Sam Smith’s $10,000 payment to you come from Smith’s money in the bank that was amassed by payments from his family, or does it come from the one to ten million dollars that Smith may or may not get in somewhere between one and ten years from Jack Jones? In the analogy, the payment of $10,000 to you is, as said, the counterpart of SIPC advances of up to $500,000, the one million dollars Smith has in the bank because of payments to him by his family is the counterpart of the SIPC fund, and the ten million dollars that Smith may or may not receive from Jack Jones is the equivalent of the “customer property” that the Trustee may or may not obtain after years of searching and litigation.

To me, at least, the answer in the analogy is crystal clear and makes clear the truth of the real situation under discussion: the ten thousand dollars Smith gives to you obviously comes from his one million dollars in the bank that was amassed by payments from his family, not from the ten million dollars that the may or may not receive from Jack Jones in somewhere between one and ten years. Likewise, payments to victims by SIPC of up to $500,000 come from SIPC’s fund (amassed by payments from brokers), not from the entirely separate, so-called “customer property” that the Trustee may or may not recover from Madoff hiding places and from Madoff confederates after years of searching and litigation.

Let me add one other point. The idea of the analogy -- in fact, the whole idea that the underlying theory propounded by SIPC and the Trustee is an invention, a bubbe meisse -- largely came to me after reading, in mid February, the transcript of the February 2nd hearing and pondering what Sheehan was saying. Before that, apparently, SIPC and the Trustee kept the relevant underlying theory sufficiently opaque that I cannot remember anyone on our side speaking of it or writing of it in a brief (except, perhaps, for comments by Helen Chaitman which covered part of it by explicitly pointing out (if memory serves) that the payments of up to $500,000 come from a SIPC fund. That there is here an invention by SIPC and the Trustee, a bubbe meisse invented and now made clear by them, seems to me (and I know it seems to a few others) a relatively important idea. As far as I know, this idea of a bubbe meisse has never been put before Judge Lifland (because SIPC and the Trustee kept their theory opaque), and the Judge could conceivably be unaware that SIPC’s and the Trustee’s underlying theory is merely an invention. Could the bubbe meisse aspect of their supposed theory be put before Judge Lifland now? Could it be submitted in a letter responding to Sheehan’s letter of February 9th replying to Helen Chaitman’s letter. (Sheehan’s letter is mentioned in the posting of Wednesday, February 17th and makes the underlying (bubbe meisse) theory of SIPC and the Trustee crystal clear, as did the transcript.) Because the matter is sure to be argued on appeal no matter who wins before Judge Lifland, might it even be only fair to present it to Judge Lifland before he rules? Or is there no way to put the idea before Judge Lifland at this date?

I wonder what the victims think, and what the lawyers who argued on February 2nd think about now putting the idea before Lifland, and what is thought by other lawyers who filed briefs but did not argue on February 2nd. I especially wonder because it has seemed to me in the past that the Trustee, SIPC and the SEC have filed papers before Judge Lifland whenever they please. Perhaps some of the victims who read this might want to ask their lawyers what they think about the propriety and possibility of telling Judge Lifland of a point that arose because of what the other side said at oral argument and in a subsequent letter of February 9th. Or, if any of the lawyers read this, perhaps they would let me know their view on the propriety and possibility of now informing Judge Lifland of an idea that crystallized because of the transcript of argument and a subsequent letter from Sheehan of February 9th. I would greatly appreciate hearing the views of both lawyers and non lawyers in this regard.*

*This posting represents the personal views of Lawrence R. Velvel. If you wish to comment on the post, on the general topic of the post, you can, if you wish, email me at Velvel@VelvelOnNationalAffairs.com.

VelvelOnNationalAffairs is now available as a podcast. To subscribe please visit VelvelOnNationalAffairs.com, and click on the link on the top left corner of the page. The podcasts can also be found on iTunes or at www.lrvelvel.libsyn.com

In addition, one hour long television book shows, shown on Comcast, on which Dean Velvel, interviews an author, one hour long television panel shows, also shown on Comcast, on which other MSL personnel interview experts about important subjects, conferences on historical and other important subjects held at MSL, and an MSL journal of important issues called The Long Term View, can all be accessed on the internet, including by video and audio. For TV shows go to: www.mslaw.edu/about_tv.htm or www.youtube.com/user/mslawdotedu; for conferences go to: www.mslawevents.com; for The Long Term View go to: www.mslaw.edu/about¬_LTV.htm.

More On The Bubbe Meisse of SIPC and The Trustee

2010-02-18T12:04:00.000-05:00

February 18, 2010

More On The Bubbe Meisse of SIPC and The Trustee
by
Lawrence R. Velvel

Yesterday I posted quite a long set of comments on the hearing of February 2nd. It subsequently seemed to me that some of the most important points are in the last third or so of the essay, which discusses the basic underlying theory of SIPC and Picard and some of the major flaws in their theory. (I called the underlying theory a bubbe meisse (with hopes that my very limited understanding of Yiddish is correct).)
The reasons these matters strike me as especially important is that, when the fallaciousness of the underlying theory is exposed, the Trustee and SIPC are fundamentally left with only their claim that what they wish to do is fair (and must therefore be done regardless of what Congress intended), and what the victims desire is supposedly unfair and therefore must not be done regardless of what Congress intended.
Additionally, the underlying theory and its flaws are important because they are likely to be major subjects on appeal regardless of who wins before Judge Lifland, and because they could well prove to be very important in the lobbying of Congress, which to some extent has already taken place and which is about to be stepped up considerably. (I regard the lobbying of Congress to be so crucial that, without getting into dollar figures, I will say that I have pledged all that I can reasonably afford if necessary to support the lobbying through NIAP. I would urge and hope that others too contribute what they can, because it has long been my opinion that Congressional action is the best hope, and certainly by many years the quickest hope, for fairness and decency toward Madoff victims.)
Though the last part of yesterday’s post discussed truly crucial matters, I recognize that the post was long and complex, and I therefore think it entirely possible, perhaps even likely, that even some or many of those who read it did not read the entirety of it, and therefore may never have gotten to the crucial discussion of and exposure of the flaws in the basic underlying theory of Picard and SIPC. This is my fault for putting such crucial matters at the end (for reasons I won’t get into here), but it could nevertheless be the fact. I have therefore decided to repost below the last third or so of yesterday’s post, and to put into this brief essay an analogy that may help make it simpler to understand the basic ideas elaborated in the reposting.
Here is the analogy: Suppose Sam Smith has one million dollars in the bank and knows that, in somewhere between one and ten years, Jack Jones may or may not give him ten million dollars more. Smith decides to give you ten thousand dollars. Does that ten thousand dollars come from the one million dollars Smith has in the bank, or does it come from the ten million dollars that Smith may or may not receive from Jones in somewhere between one and ten years? Under the victims’ theory, the ten thousand dollars comes from the one million dollars Smith has in his bank account. Under the theory of SIPC and the Trustee, the ten thousand dollars comes from the ten million dollars that Smith may or may not receive from Jones in somewhere between one and ten years (and the $10,000 you receive is merely an advance from that possible ten million dollars).
This example, though simplified, is, I believe, a pretty exact representation of what is involved in the theory of SIPC and the Trustee, with the $10,000 playing the role of the SIPC advance of up to $500,000 from SIPC’s fund, and the ten million dollars that may or may not be received in somewhere between one and ten years playing the role of “customer property.” The only thing that needs be added in terms of the analogy is that, to insure that you will not get anything later from the ten million dollars that Jones may or may not give Smith if SIPC and Picard feel you don’t deserve to get anything from it, SIPC and the Trustee are defining net equity in a way that ensures you receive neither the ten thousand dollars now nor anything later from the possible ten million dollars.
With the foregoing analogy set forth to try to make it simpler to understand things, here is a reprint of the relevant parts of yesterday’s posting:

REPRINT FROM POSTING OF
FEBRUARY 17, 2010

I will conclude with two matters that are major: the interesting questions of (i) the relationship between net equity and customer property, and (ii) insurance. Sheehan’s argument at the hearing on net equity and customer property, strike me as confusing, even deeply confusing. But I think I’ve got it right. The Trustee and SIPC are saying that all distributions to victims come out of so-called customer property, which the Trustee is looking for all over the world and is suing Madoff confederates to recover. (The question of estate property is irrelevant here). Therefore the $500,000 that a victim may get comes out of customer property; it is an advance on a victim’s (ratable) share of customer property. It is therefore not insurance. Rather, it is, as said, an advance on one’s share of customer property.

To determine one’s share of customer property - - to determine what one should get from customer property - - you must determine one’s net equity. So, if a person’s net equity were one one thousandth of total net equity, one would get one one thousandth of the customer property.

Because your share of customer property is based on your net equity, it is unfair to use the amount shown in your final statement as your net equity, because this would result in a portion of the customer property being allocated to people who previously took out from Madoff more than they put in, while lessening the amount of customer property going to people who have never taken out a dime. (The amount going to the latter will necessarily be lessened because there will not be sufficient recovered customer property to pay off everyone in full on the basis of their final statements.)

Since it would be unfair for people who have taken out more than they put in to get a share of customer property, and to thereby lessen the share going to people who have never taken anything out, which would be the result if the final statements were used to calculate net equity, we must instead use cash-in, cash-out to calculate net equity, because that insures that the amount you receive in customer property will only be proportional to the amount of real money you had in Madoff - - and remember, the advance of money up to $500,000 that you get from SIPC comes from, and is a part of, customer property. And coming from customer property it is not insurance. Rather, it is an advance on, and from, customer property. True, Senators sometimes said in the legislative history (e.g., in the Senate Report) that it is insurance, but they are wrong.

The foregoing is how I, at least, understand the argument made by SIPC and the Trustee at the oral argument, and made by them before that for about a year. My understanding is given credence by such statements as Sheehan’s at the oral argument that:

Your Honor, … let’s not get confused over what we are dealing with here because we are in this case, because we are in Madoff, the world just doesn’t go upside down. It stays right and steady. We stay with the fact that we are dealing with a fund, a fund of customer property, and it is out of that which distributions take place.…

I submit to your Honor if you look at the legislative history one could be beguiled by some of the statements made erroneously by the senators there to the effect, yes there is insurance. They are wrong….Because the $500,000 is an advance. That word is key. (Pp. 16-17.)

And in a letter to the court dated February 9th, Sheehan said the position of SIPC and the Trustee “with respect to net equity, recognize[s] the fundamental unfairness to permit ‘net winners’ to share in the fund of customer property with the customers who have not yet been made whole.”

So, it looks to me like my understanding of the position of SIPC and the Trustee is correct: the money one gets from SIPC - - up to $500,000, based on one’s net equity- - is simply an advance on what one gets from customer property; net equity must therefore be defined in a way that prevents those who have taken out more than they put in from sharing in customer property and must therefore prevent them from getting an advance up to $500,000; an advance from customer property is not insurance; and Senators who said otherwise and (I will now add) who said the bill they were enacting provided insurance, did not know what they were talking about.

Now, there is a whole hell-hole of errors in the logic of SIPA and the Trustee. I will deal only with the most egregious of them. Our system, as said before, does not run on the basis that Senators and Congressmen who enact a bill don’t know what they are talking about, and therefore governmental, quasi governmental or private bodies can do whatever they want whenever they think their desires are fair and that what Congress wanted is undesirable. It just doesn’t work that way in this country. Yet that is what Sheehan has explicitly admitted his side is doing here. I would think condign punishment to be deserved. The more so because, as has been discussed often in this post, and as was at least implicit in previous quotes or comments made at the oral argument by Brian Neville, many believe that the position taken by SIPC and the Trustee, far from being fair, is disastrously unfair to thousands of people. The more so yet again because the Senators were right, as will be discussed below. There is insurance here.

Then too, it is obviously and completely wrong to say that the advance one receives from SIPC is merely an advance from customer property. The advance comes from a fund that Congress ordered SIPC to set up for this purpose (and which SIPC neglected to keep at a sufficient level). Indeed, the statute even explicitly says the Trustee shall pay net equity claims out of monies SIPC provides even though the debtor does not have sufficient funds to pay the claim. In SIPC cases there may never be enough customer property to cover the advances or even more than a very small part of them, yet victims still get the advances, thus showing that most or all of an advance will always remain just a payment from the Congressionally – ordered fund, and not even conceivably, or in theory, a part of customer property. This happens all the time as far as I know - - or it would happen all the time but for SIPC’s miscreant denials of money to (most) victims in most cases. And, because the $500,000 has to be paid from the SIPC fund regardless of whether there is enough customer property to cover any part of it, the advances are insurance, just as the Senators said. What SIPC and the Trustee are doing, in order to suit SIPC’s selfish purposes, are that they are creating an intellectual invention, are making up a bubba meisse if my Yiddish is right, that an advance supposedly is customer property. It is not.

True, in setting forth the order of allocation of customer property, the statute says some of it will go first to SIPC for certain things, including certain repayments of monies that SIPC put out for customers, some will go to customers for certain things, SIPC will be subrogated to some of it, etc. But that SIPC can get some of the customer property money to cover what it previously gave to victims, or that the amount of money customers later get from customer property is reduced by advances on net equity that they previously received, does not mean the advances came from customer property, either in theory or in reality. On the contrary, both in theory and reality, the advances come from the SIPC fund set up for the purpose; later SIPC can recoup some of the advance in the (normally unusual, I believe) event that there is enough customer property for such recoupment; and victims have their payments reduced by the amount of net equity they already were given via an advance.

Additionally, the concept of net equity serves as a measurement. It measures whether a person can initially get up to $500,000, and it measures a victim’s share of (usually-later-recovered) customer property. But that the same measure is used in both instances does not mean - - and it does not logically follow - - that the measure should be defined in a way that harms people who seek advances in order to help people who later will receive customer property - - which is precisely what SIPC and the Trustee are trying to do. Rather, the measure is what Congress said it is, and what SIPC therefore used for decades until it felt threatened with bankruptcy due to the size of the Madoff fiasco. The irony, of course, is that the people whom SIPC and the Trustee claim they wish to help by cash-in/cash-out (many or most of whom may be pretty well off anyway) may not see a nickel of recovered customer property for years on end - - for seven to ten years - - because of lengthy litigation over efforts to recover the property from Madoff confederates and similar types, that people in penury due to the actions of SIPC and the Trustee are hurt immediately and on into the foreseeable future, and that in many cases such people will not see better days because of Stengel’s theorem; while people who will be helped, because the method adopted by SIPC and the Trustee will provide them with an enlarged share of customer property, will not receive that customer property for many years and in lots of cases are still pretty rich anyway. To put some of this briefly, claiming a desire to help victims, SIPC and the Trustee have adopted a calculation of net equity that will desperately hurt thousands now and into the foreseeable future, while not helping others for years and years.

As many will know, one day after the oral argument, Helen Chaitman wrote Judge Lifland a letter urging him to reach a compromise verdict that would, she said, accomplish Lifland’s aim of not having customer property go to persons who had taken out of Madoff more than they put in. Let me quote her relevant two paragraphs.

I write on behalf of a very large group of investors in Bernard L. Madoff Investment Securities, LLC (“Madoff”) to suggest a partial resolution of the “net equity” issue. Mr. Sheehan’s rebuttal ended yesterday with the passionate argument that it is unfair to investors with a positive net investment that investors with a negative net investment should share in the fund of customer property. There is a large group of investors who have a negative net investment, and many who have a positive net investment, who would forego any distribution from the fund of customer property if they were promptly paid their $500,000 in SIPC insurance. Hence, we ask the Court to consider incorporating this proposal into Your Honor’s decision on the “net equity” issue.

That is, if you are persuaded that SIPC is correct and that Ponzi scheme cases arising in non-SIPA liquidations are applicable here, before relieving SIPC of its entirely independent insurance obligation, you give investors the choice of foregoing any distribution from the fund based upon each customer’s November 30, 2008 statement. This would provide incalculable relief to approximately 3,000 elderly Madoff investors whose lives have been decimated more by SIPC’s denial of their insurance coverage than by Madoff’s crimes. Neither SIPC nor the Trustee has provided the Court with a single authority for the proposition that a third party insurance entity like SIPC should be relieved of its insurance obligations to innocent third parties solely because the broker operated a Ponzi scheme.

Chaitman also set forth a long list of cases that had referred to the advances of up to $500,000 as insurance. Chaitman’s proposal was joined on the same day by Brian Neville. Then on February 9th, Sheehan wrote a letter claiming that, by her proposal, Chaitman has “essentially conceded the propriety of the Trustee’s and SIPC’s position with regard to net equity, recognizing the fundamental unfairness to permit ‘net winners’ to share in the fund of customer property with those customers who have not yet been made whole.”

That Chaitman conceded the legal correctness of the Trustee’s and SIPC’s position is so patently false on its face that one can only wonder that it was set forth. (Although it is all too symptomatic of SIPC’s and the Trustee’s method of litigating.) In fact, I for one suspect that Chaitman’s letter could have been in part a ruse designed to enable her to get before the court a long list of cases describing the SIPA fund as insurance, the point Sheehan vigorously denied the day before. Be that as it may, Chaitman obviously understands that it will be years before any victim gets any customer property, and, conceivably pushed by desperate clients, she is asking the court to show what in Yiddish would, I think, be called rachmonis. (Do I have the word and the meaning right?) Of course, if I am correct, she probably should not have confined the offer to the situation of the court deciding for the Trustee, but also against the Trustee, since appeals would still take years, so would litigation to recover customer property, and her clients still will not see dime one for many years. In any event, the problem I see is that at one point she asked the court to incorporate her proposal into its legal decision. I find it hard or impossible to understand how this could be done, since the definition of net equity is what it is, and the definition controls both the advances from the fund and participation in customer property. (In my brief I said it would be nice if such advances and such participation could be determined separately but it seemed to me that the definition of net equity controlled both.) True, it is not unknown in law for the very same word or phrase to mean different things for different purposes. But I find it hard to think that that would be the ruling here. But maybe I’m wrong.

Of course, it is one thing to say that the judge will find it difficult or impossible to rule as a legal matter that the definition of net equity changes as between advances and later recovery of customer property, and it is quite another thing for the judge, before issuing any ruling, and at a time when he therefore holds a club over the heads of both sides, to call them in for a settlement conference and say, “This is what I want you to do. I want you to reach an out of court settlement under which people can elect to receive $500,000 (and not be subject to clawbacks) while agreeing to give up any future right to customer property. If you reach that settlement, great. If you don’t, one of you is going to be hammered in the opinion I write.” There are judges who do force those kinds of split-the-baby settlements on people. But whether Lifland would is something about which I have no idea.