Velvel on National Affairs

It Appears That The Madoff Scam Was Not, Repeat Not, A Ponzi Scheme.

2012-07-18T14:01:00.001-04:00

July 18, 2012

It Appears That The Madoff Scam

Was Not, Repeat Not, A Ponzi Scheme.

From the time Bernie Madoff’s fraud was uncovered in December 2008 until today, a period of over 3½ years, his scam has been regarded as a Ponzi scheme. I know of only one person, a brilliant lawyer named David Bernfeld, who did not concede it was a Ponzi scheme, but nobody accepted his view. Victims, (very importantly) the media, and courts all thought and said Madoff was a Ponzi scheme. Of enormous importance the Trustee in the Madoff case, Irving Picard, and his chief lawyer, David Sheehan, regularly insisted it was a Ponzi scheme because, they said, there were no securities transactions, and accordingly there were no securities, and no earnings (and could not have been any earnings). Crucial legal and factual consequences, some of which are mentioned below, flowed from the fact that the scam was regarded as a Ponzi scheme.

But now it is beginning to look as if Madoff was not a Ponzi scheme. It was a huge fraud to be sure, but not the species of fraud called a Ponzi scheme, with the consequences attendant upon that species of fraud.

As I have always understood matters (I think and hope correctly), in a Ponzi scheme the crook tells people that he will be investing their money in particular stocks or particular goods or what have you, and then fails to do so. Instead he blows the money, uses it for other purposes, etc. The key point, the central point, is that he does not purchase or acquire the investments that he told victims he would acquire in order to induce them to give him their money. Along this line, in the Madoff case the Trustee has always insisted -- in court filings, in remarks, whenever and wherever -- that none of the securities that were shown in victims’ monthly account statements -- none of the securities that Madoff inducingly told victims he would buy and sell for them -- were ever bought or sold. There were, the Trustee and his lawyer have told victims, the courts and the world, no transactions in these securities. Ergo, a Ponzi scheme.

But apparently there were purchases and sales of these securities -- untold and currently unknown billions of dollars of these purchases and sales. On his books, however, Bernie Madoff did not, as he should have, credit the investor-victims with ownership of the billions of dollars in securities he was buying (and selling). Instead, on his books he unlawfully kept ownership for himself. There was a fraud alright, but the fraud was not the Ponzi fraud of failing to buy the very items the crook said he would buy. The fraud, rather, was in failing to credit his investors with the ownership of the securities on Madoff’s books, as should have been done, and instead keeping the securities for Madoff himself. The securities, that is to say, were bought and sold for what was called the proprietary trading arm of Bernie Madoff’s company, the arm which bought and sold securities, and attempted to thereby make a profit, for Bernie’s company. They may also have been bought for the market making arm of his business. The monies given to Madoff by his investor victims was used not to purchase the promised securities for them, but instead to purchase those securities for Madoff himself -- for his own account, as it is said, and, when necessary, to support another arm of his business, the market making arm. (The monies were also used to fund the Madoff family’s extravagant life style.) The account statements received every month by victims, and showing that they owned the securities, were a lie, a fraud.

It would be fair for the reader to ask at this point, “How do you know all this? Can you be sure of it?” Let me answer this way: For reasons discussed below, and for other reasons too, we already know enough to be virtually positive that the foregoing is what occurred. But we do not know enough to know certain of the details, e.g., what was the total value at any given time of the securities that Madoff purchased for his own account, and how closely did the value of these securities match up with the amounts of monies victims invested with him; how much of the money invested with him was used to support the market making arm of Madoff’s business or the family’s life style instead of being used to buy the securities for Madoff’s own account that he fraudulently told victims were being bought for them; what amounts of profit or loss did Madoff make or suffer on the purchases and sales of securities for his own account.

Well, then, why do we not know these details over 3½ years after the Madoff scam was uncovered? The answer (or answers) to that, I’m afraid, is (or are) pretty simple. The only persons or organizations that have the information needed to flesh out the details are the Securities Investor Protection Corporation (SIPC) and its Trustee, Irving Picard (and his army of lawyers, workers, and acolytes). In order for the rest of us to flesh out the details, we have to obtain what lawyers call “discovery” from SIPC and the Trustee. That is, we have to obtain from SIPC and the Trustee, in law cases, the documents and information that will enable us to figure out the details. I am assuming, of course, that SIPC and the Trustee will not give the information to us voluntarily, outside the four corners of law cases, because they benefit, and for years have benefitted, from us not knowing the details, as discussed later, and to date they have vigorously resisted any discovery of anything in law cases.

Also to this day, however, the lawyers arrayed against SIPC and the Trustee in law cases have basically not pushed for, or even sought, the needed discovery or any discovery. There has been only one exception. (Guess who that was?) This writer, acting as his own lawyer, sought discovery on a number of issues in the Bankruptcy Court, sought to have the Second Circuit require requested discovery, and then told the Supreme Court that the absence of discovery was an important reason to hear the Second Circuit’s ruling on net equity. In the Second Circuit and the Supreme Court a small number of other lawyers at least mentioned the absence of discovery, after totally ignoring it in the Bankruptcy Court, but there has been only one person really pushing for it. That person -- me -- lost in every court, with SIPC and the Trustee vigorously, even stridently, and on one or two occasions even falsely, resisting discovery and telling the courts, ultimately with the support of the SEC and the sainted Solicitor General’s Office of the Department of Justice, that discovery was unnecessary or unneeded or what have you.

So . . . . when you get right down to the truth, the reason we cannot yet know all the details we would like to know about what Madoff did, the reason we cannot know the full truth of what happened, is that the Trustee and SIPC, supported by the courts and by the Solicitor General, have not provided, and have strongly resisted providing, the information needed to determine the full truth. We know enough anyway to be pretty certain of the broad outline of what happened, but not enough to know certain relevant details.

But we do know that Madoff Securities was a single corporation that was internally divided into an investment advisory arm, a market making arm, and a proprietary trading arm. We also know that Bernie Madoff ran and had sole control over the whole shooting match -- over the entire business and all of its operations, including all three of its arms. Also, persons who traded for Madoff apparently have said that the securities in which Madoff traded for his own account were generally the same securities that appeared in investors' monthly statements as the securities he allegedly was buying and selling for them. And we know that every year Bernie Madoff transferred scores of millions of dollars from the so-called 703 Account at Chase Bank, the account in which he put monies received from investors, into the so-called Madoff 621 account at The Bank of New York, the primary bank account for the proprietary trading and market making arms of Madoff’s business.

This last point was told to us by SIPC itself at page 20, and in a table on page 20, of a January 24, 2011 letter SIPC sent to a Congressman in answer to questions he asked SIPC. The letter thus said: “The table below includes amounts transferred directly or indirectly from the Madoff 703 Account at Chase Bank, the primary bank account used by House 17 (the investment advisory business), to the Madoff 621 Account at The Bank of New York, the primary bank account used by House 5 (the proprietary trading and market making business).” The table referred to shows almost $734 million being transferred from 2000 to 2008 from the investment advisory bank account (Chase 703) to the proprietary trading and market making bank account (Bank of New York 621).

SIPC further said, on the next page of its letter (page 21), that “the funds transferred from House 17 [the investment advisory business] were recorded by House 5 [the proprietary trading and market making businesses] as revenue” for the latter and “represented a substantial part of House 5’s liquidity. Without these funds from the IA [investment advisory] business, House 5 would have incurred annual net losses . . . .” In other words, SIPC itself has told us that the monies Madoff took in from victims/investors in his IA business were used to prop up and support his market making and proprietary trading businesses, the latter of which deals in the purchase of securities for his own account. As indicated, we do not know the total amount of such securities he owned at any given time, though the collective amount of securities and associated cash he had in any given year must have usually been hundreds of millions or billions of dollars more than the amount of monies transferred from Chase 703 to Bank of New York 621 during that year, since the collective securities and cash included stocks and cash from all prior years. But, as previously indicated, we do know that Madoff was taking money from the investment advisory business account (Chase 703) to support the proprietary trading arm of the business which bought and sold securities for Madoff himself and to support his market making.

To deliberately repeat myself, even if we do not know all the details, we know for certain that Madoff was using investors’ money not to purchase securities for them, but for himself. And these were -- in some proportion currently unknown to us because SIPC and the Trustee will not disclose the information necessary to calculate it -- the same securities as he told investors he would buy for them and, on their monthly statements told them that he had bought for them. Because he used investors’ monies to buy the very things he said he was going to buy - - to buy the very securities he told the investors he would buy -- Madoff was not running the kind of fraud called a Ponzi scheme, which exists when the crook does not buy what he says he will buy, and simply blows the money in one way or another. He was nonetheless, of course, running a fraud, with his fraud, as said, being that he was not buying the securities for the investors, but for himself (and for market making). (In law, I gather, the securities and any profits, dividends or interest on them belonged to the investors even though Madoff bought the securities himself and thereby stole the investors’ money.)

So . . . we know enough to be pretty certain of the broad outline of what happened, but not enough to know certain relevant details.

I suspect, in this connection, that good old Bernie is sitting in his cell laughing at us. For in various statements that we need not get into or parse here, he practically told us what he had been doing. But with only one guy as an exception, for over 3 ½ years nobody seems to have caught on to what he was saying -- he had hidden the truth in plain sight, if you ask me -- and instead everyone was talking about a Ponzi scheme in which there were no transactions and no profits or earnings.

Calling Madoff’s scam a Ponzi scheme has certain huge advantages for SIPC and the trustee, of course, some of which I will discuss below. Because they will wish to retain these huge advantages, they are quite likely to reply that I am wrong -- that Madoff was running a Ponzi scheme because there were no purchases or sales of securities for the investment advisory arm of the business, the arm that investor victims were “associated with.” The purchases and sales, they will say, were rather for the proprietary trading arm (and the market making arm) of the business, arms the investor victims were not associated with. But this excuse does not wash. Consider, if you will, a big law firm which is a partnership and has many different sections, a tax section, a securities section, an antitrust section, a banking section, a bankruptcy section, and so on. The work in each section is significantly different and separate, the clients are different, the lawyers are different, may be in separate cities and may not even know each other. But if the tax section does something illegal or unethical, the whole firm, including every section, will be hammered -- every lawyer, no matter his or her section, will have to pay. Or take a huge company which, in a single corporation, makes a variety of drug products, with manufacture of different products being in different plants, with different scientists for different products, etc. If one of those drugs culpably causes injury, the whole company will be liable, not just the people or plants associated with the culpable product.

Or look at it somewhat in reverse. Suppose a parent corporation which manufactures products X and Y creates a subsidiary corporation to manufacture product Z, which causes injury. If the injured party sues the parent corporation, the latter will say that he can’t sue it, because Z was made by a different corporation, its subsidiary. Will this defense work? It depends. Courts will look at who sets policy for the subsidiary. Who are its directors, executives and employees? Do the two corporations use the same plants and sales force? And so forth. The more that the two corporations use the same policies, offices, officers, plants and so on, the more likely it is that the parent will be held responsible for the misconduct of the subsidiary. The corporate veil will be pierced, as they say.

Now let’s look at the Madoff situation. Madoff did not even have separate corporations for his three business arms. It was all just one entity, so there is not even any corporate veil to be pierced. Bernie Madoff owned everything. He controlled everything. He set all policies. The three arms were run in tandem, with Bernie’s investment advisory arm being used to finance the other arms. The whole business was Bernie Madoff, plain and simple. As he used to tell people, it was his name on the door. So there is no way that it is legally proper to say that one can ignore the fact that the very securities Madoff told people he would buy were in fact bought, or can correspondingly say that there was a Ponzi scheme because the securities weren’t bought by the investment advisory section of the integrated business but by the proprietary trading arm to which investors gave the money that Madoff transferred over to the proprietary arm’s bank account.

Let me turn now to the question you’ve all been waiting for. What difference does it make whether Madoff was a Ponzi scheme or was, rather, a different kind of fraud, a fraud in which he simply bought for himself the securities that he falsely told investors he was buying for them? I believe that for SIPC, the Trustee, his lawyers and victims, it makes a huge difference whether Madoff was or was not a Ponzi scheme.

To begin with, take the concept of net equity. Without refighting the battle in which courts have found for the Trustee and SIPC and have, if I may be so crude, screwed innocent investors, SIPC and the Trustee have argued from day one, and have gotten the courts’ agreement, that investors’ so called net equity is not measured by the amounts shown owing to them on their last monthly account statement (the final statement method), but is instead the far smaller amount calculated by subtracting the amounts an investor physically put into Madoff from amounts he physically took out of Madoff. Investors got no credit for the amount of earnings shown on these account statements. This method is called the cash-in/cash-out method (CICO), has been used in only two or three percent of SIPC’s cases -- the rest all measured an investor’s net equity by what is shown on his account statement -- and has been used, as I understand it, only where there have been Ponzi schemes. The CICO method, by greatly reducing an investor’s net equity, results in investors, especially small ones whom Congress enacted the Securities Investor Protection Act specifically to protect, getting greatly reduced or no recompense from the SIPC insurance fund.

The fund allows an investor to get up to $500,000, if his net equity is that high. But many investors -- even thousands perhaps, especially small ones who are suffering great hardship -- have ended up with tremendously reduced net equity or no net equity, and accordingly with greatly reduced or no payments from the SIPC fund, because SIPC and the Trustee have measured net equity by the CICO method rather than by the standard final statement method used 97 or 98 percent of the time. SIPC and the Trustee say it is proper to use the CICO method because Madoff was a Ponzi scheme in which there were no purchases or sales of securities, no transactions in securities. But there were purchases or sales of promised securities, there were transactions in promised securities, apparently in the many, many billions of dollars. It’s just that, instead of giving the victims ownership of the securities, as he was legally obligated to do, Madoff kept the ownership for himself. To reemphasize the obvious, the fact that Madoff illegally kept for himself the ownership of securities in which he was conducting billions and billions of dollars worth of transactions does not mean that there were no transactions. (Nor, of course, did keeping the ownership for himself relieve him of any duty, as the holder of discretionary customer accounts, to allocate trades to the customers before trading for his own account.)

Make no mistake about it: the vast reduction or elimination of payments to victims from the SIPC fund, and the consequent savings to the fund, were matters of enormous consequence not just to thousands of small, often elderly victims in their 60s, 70s and 80s who found their savings depleted and often had to scramble to live, but also to SIPC and its managers (who make up to or more than $750,000 per year). One estimates that the savings to the SIPC fund were between one billion and 2.5 billion dollars per year. (Once again the precisely accurate information is in the hands of SIPC, although the numbers may be calculable (I really don’t know) from complicated information released by SIPC in answer to a Congressman’s questions.) There was deep concern in SIPC that, had the final statement method of determining net equity been used, with consequent far greater payments to victims from the SIPC fund, the fund would have gone broke. In order to save the fund, SIPC -- which had refused to increase the size of its fund when leading federal legislators urged it to do so in the early-mid 2000s lest the fund prove incapable of handling a major disaster -- would have had to levy assessments upon members of the financial services industry (who for years had been paying only $150 per year even if they were Goldman Sachs or Morgan Stanley), or drawn down upon a huge private line of credit that SIPC then had (but soon ceased renewing), or ask Congress for more money. SIPC did not want to do any of these things, especially, one assumes, because it would have looked very bad if it had been necessary to do them in order to save the fund: the necessity would have cast great doubt on the competency of management (which had, as said, refused a few years earlier to increase the size of the fund upon congressional urging, lest the fund prove inadequate if there were a major financial disaster -- as occurred with Madoff). Very likely, heads would have rolled at SIPC: managers making half a million or 750,000 dollars per year -- which is still good money even in the profligate Washington, D.C. area -- would have lost their jobs. The way to save the fund without assessing and aggravating the financial services industry which supports SIPC and its fund, without drawing down the then existing line of credit, and without asking Congress for more money, was to use the CICO method of determining net equity -- the method which arguably could be used if there were a Ponzi scheme but not if there weren’t -- and to thereby vastly reduce or eliminate payments from the fund. So CICO was used on the theory that there was a Ponzi scheme even though Madoff was buying and selling billions upon billions of dollars of the very securities he told investors he would buy, payments from the fund thereby were dramatically reduced, and the fund and management’s lucrative jobs were saved.

So, as said, calling Madoff a Ponzi scheme, in which there were no transactions and no profits, was of tremendous importance to, and had tremendous consequences for, not just newly impoverished, scrabbling victims, but also SIPC and its management.

There also were tremendous consequences for the Trustee, Irving Picard, and his law firm. Picard reached a deal with and joined his law firm (he left another one) in mid December 2008, just a few days after SIPC asked him to be the Trustee. We know, because of statements made in open court and from a GAO Report, that under his deal with his new firm he receives a portion of the firm’s fees attributable to the Madoff case. We do not know the percentage, because neither Picard nor his firm will disclose that information. But the legal and associated fees thus far are around 500 million dollars, and estimates are that ultimately the total such fees will be around one billion dollars. I would guess that about 300 or 400 million dollars of the already incurred 500 million dollars has gone to the law firm, and, based on what (little) I know of the kinds of deals in which lawyers receive a percentage of what they bring into the firm, I would estimate (or guesstimate) that Picard himself already has personally made somewhere between 50 and 75 million dollars and that his firm’s take and Picard’s personal take will double before the case is over if the relevant fees mount to around a billion dollars, as Picard says they will. If any of my guesstimates are remarkably wrong, there is an easy remedy to correct them: Picard and his firm could disclose how much he is making under his deal with his firm: could disclose what percentage of the fees go to him personally, how much he thus has personally made so far, and how much it is expected he personally will make in future. Why do I think that neither Picard nor his firm will voluntarily disclose the specific relevant information to correct my mistaken estimates if those estimates are mistaken?

Of key importance here is the question of what legal and associated work is it that produces the huge fees. As I understand it, and I believe I am almost surely correct, it is work that arises because SIPC and the Trustee are using not the standard final statement method of determining net equity, but instead the CICO method which they can employ if there is a Ponzi scheme. Under the final statement method, the question of the amount of a person’s net equity is usually pretty straightforward and simple: his net equity is what his brokerage account statement shows to be owing to him. Oh, there can sometimes be some complications, I assume, such as when a person has two accounts, one with a positive net equity and one with a negative net equity (because of loans from the broker, for example), and the question is whether you should combine the two accounts, so that the investor’s overall net equity will be less and he will receive less from the SIPC fund (and from so-called customer property, if any) because his positive net equity in one account will be reduced by the negative net equity in the other, or whether you should instead keep the accounts separate so that he will receive more from the SIPC fund (and from customer property) because his net equity in the positive account will not be reduced by the negative net equity in the other account. But though there can occasionally be complications, usually the amount of one’s net equity is straightforward: it is what the account statement shows it to be, and no elaborate legal or accounting work is needed to calculate it.

The situation is completely different, however, when CICO is used to determine net equity for SIPA purposes because there is a Ponzi scheme. Now the legal and accounting work can be, and in the Madoff case often (even usually?) is complicated and difficult. To determine what was put into an account (and taken out of it) might require reconstruction of records going back 40 or 50 years, as in the Madoff case. It might require assessment of what was put into and what was taken out of the accounts of grandparents, parents, uncles, aunts, brothers or sisters whose accounts were, by inheritance, gift or in other ways merged into the victim’s account over the decades. Needed records may be missing and/or very hard to find. The whole process is something of a mess requiring extensive forensic work by the Trustee and his people, and the numbers and ideas they came up with, which almost inevitably will favor SIPC, which has billions at stake collectively, will almost surely be contested by the victims (as is regularly occurring), who individually have large sums at stake, think the Trustee’s numbers and notions about what happened over decades -- over scores of years -- are quite wrong, and who bring long-lasting, expensive lawsuits to contest the Trustee. It is little wonder that, when CICO is used, the work of the Trustee and his minions mounts into untold numbers of hours, hundreds of millions of dollars in fees for the Trustee’s law firm, and gigantic fees for the Trustee himself.

So, once again, enormous consequences attach to the claim that Madoff was a Ponzi scheme. The work and fees of the Trustee, his law firm, and his other minions are increased almost beyond belief (as are the costs to victims of contesting the determinations of the Trustee and SIPC). The work and fees of the Trustee and his minions, which would be far less, perhaps almost incalculably less, under the simple, standard final statement method, are increased under the CICO method of Ponzi cases to the point where fees now total around 500 million dollars in the Madoff case and are estimated to ultimately reach about a billion dollars. (I personally think it possible that, conceivably, one billion dollars ultimately could prove to be a low ball estimate.)

Calling Madoff a Ponzi scheme also has major consequences for so-called “clawbacks.” “Clawbacks” mean that the Trustee can recover, from victims, amounts of money that they completely innocently took out of their Madoff accounts, thinking that the money was theirs because it was shown on their account statements as being theirs, either as principal or as earnings on invested principal. Often such monies were elderly victims’ dominant, even almost sole, source of income (along with Social Security) on which to live. Now victims, often elderly ones, find themselves without this source of income, and, horrifyingly, being subjected by the Trustee to clawbacks of the money they took out of Madoff. Large numbers of victims are truly terrified by the possibility of these clawbacks.

Now, I am the first to say that the subject of clawbacks is, legally speaking, a very complex topic about which I don’t know a whole lot. True, I am a member of a committee of about 20 victims’ lawyers who are submitting consolidated briefs on subjects relating to clawbacks, but I desired to be on this committee only because I have 50 years of brief writing experience and feel qualified to comment on such things as logic, persuasiveness, style, etc., not because I pretend to have significant substantive knowledge on the subject of clawbacks. Fortunately, the committee has many other lawyers, excellent ones, some from Wall Street firms and some from smaller firms, who do know a lot about clawbacks.

But though my knowledge of clawbacks is limited, I do think it true that sometimes -- perhaps even often, or possibly always -- a clawback of monies taken out by a victim cannot be obtained by the Trustee unless the fraudster gave the money to the victim with the actual or constructive intent of thereby hiding the fact that there was a fraud. To prove this intent can be difficult for reasons we need not canvass here.

If there is a Ponzi scheme, however, the situation is altered to the Trustee’s benefit in a crucial way. It is automatically assumed that the broker -- Madoff -- gave money to the victims in order to hide the existence of a fraud. (This is the so-called Ponzi presumption.) The Trustee is then relieved of the oft-difficult task of proving that the fraudster -- here Madoff -- gave money to the victims for the specific purpose of hiding the fraud. This is presumed.

So . . . to call Madoff a Ponzi scheme has important ramifications benefitting the Trustee in his clawback work for SIPC (and benefitting SIPC too in various ways). For to claw back, the Trustee does not have to prove the fraudster was acting with the purpose of hiding his Ponzi scheme when he gave the investor the money requested by the investor. The Trustee is relieved of bearing this oft difficult burden of proof -- a burden he might not be able to meet -- and the illicit purpose is instead presumed in his favor.

(I note that, in the absence of the Ponzi presumption, one of the many factors that can be looked at to determine if hiding the existence of a fraud was the fraudster’s purpose in transferring money to the victim is whether the fraudster was insolvent when he gave the victim the money. Was Madoff insolvent when he honored requested withdrawals, or did he instead own enough in securities and associated cash to pay back the monies he had taken in (about $17 billion at the end) or to pay back the vastly greater amounts that victims’ account statements showed he owed them (about $64 billion at the end)? And which of these was the true measure of insolvency in this particular case? (Or is neither the measure of insolvency here because, I have been told (I presume correctly but don’t really know), that by law a broker need not have on hand enough securities and cash to cover the full value of customers’ accounts (like, I suppose, a bank’s reserves are only a fraction of the deposits owing to bank customers)? Also, in a related vein, when did Madoff’s indebtedness to investors become so much greater than his assets that it became clear he could never repay his entire debt, so that at that point his scam conceivably could be thought to have become a partial Ponzi scheme (if there can be a partial Ponzi scheme)? These are all questions to which we do not know the answer (at least I do not), and it is hard to believe that Madoff ever had $64 billion in securities and associated cash, though it is not so hard to believe he had $17 billion (or at least around $10 billion). But who knows what the situation was or what all the factors are that could bear on it? All that one knows for sure is that, by labeling Madoff a Ponzi scheme, and by getting courts to agree to this (mistaken) view, the Trustee was relieved of any possible need to prove that Madoff had the requisite illicit intent when he transferred to an investor the money that the Trustee now wants to claw back.)

Also, to reiterate, by calling Madoff a Ponzi scheme, the Trustee is enabled to claw back any monies an investor took out over and above the amounts he put in. For, according to the Trustee, such monies cannot be earnings accruing to the investor, since there were no transactions and thus no earnings. The Trustee thus need not prove that the monies taken out over and above principal were not earnings -- they are presumed not to be earnings.

But what is the truth about earnings? Were there earnings, because of appreciation in, and dividends and interest paid on, the securities Madoff bought and sold for his own account with the monies provided by investors, instead of buying and selling the securities for his investors’ accounts as he should have -- securities which in law, although not on Madoff’s internal books, apparently belong to the investors? Only the Trustee and SIPC know if there were such earnings, and they are not saying, but instead are simply benefitting from the fact that, in a Ponzi scheme, it is assumed there were no earnings and the Trustee therefore need not show there were not sufficient earnings so that monies taken out by investors, over and above the principal they put in, were not earnings but simply other people’s money as the Trustee claims.

Let me now turn to the unintentionally somewhat humorous story of how I came to realizations discussed above, and to a question that has been put to me by laymen with whom I have discussed them, to wit, what is the responsibility before the law, if any, of the Trustee (and his minions, and SIPC) for the long prevalent belief that Madoff was a Ponzi scheme, a belief which they continuously propounded and, I think, caused to be the accepted wisdom.

Like everyone else I know, except the lawyer named David Bernfeld, I myself long accepted and thought that Madoff was a Ponzi scheme. Even though I had read and noted the statements quoted above from the SIPC report relating to the two computers called House 17 and House 5, the statements, and their full meaning, had not penetrated my thick skull any more than they had penetrated others. About three weeks ago, however, I was again discussing aspects of Madoff with Bernfeld and another individual. Bernfeld made some comments that struck me -- they must have had to do with the fact that Madoff used the monies he took in to float the rest of his business, and later that day I mentioned Bernfeld’s comments to my wife. Her response stopped me cold, absolutely cold, and got me to thinking. Her response was something like this: “Of course, she said, “Madoff is a smart guy. He wasn’t going to do something that would necessarily fail.” The implicit assumption underlying her remark, she confirmed, is that a Ponzi scheme always fails in the end. None of us have heard of one that succeeded -- although if there is one that succeeded, of course we’ve never heard of it, since one hears of Ponzi schemes only when they are uncovered, usually after failure. To put her underlying assumption a different way, Madoff probably did not initially intend to start a Ponzi scheme, because such a scheme is inevitably destined to fail one day, with disastrous consequences for its perpetrator. (If I remember correctly, after Madoff was caught, the telly showed a video of him at some meeting or conference, telling the attendees something to the effect that he thought Ponzi schemes resulted from persons starting some financial arrangement that ultimately got away from them and became a Ponzi scheme.)

Well, if Madoff, as my wife said, is a smart guy who would not have intentionally started something destined to fail -- a Ponzi scheme -- what had he intended to do? The answer was obvious. Initially expecting his business to be profitable, he was using investors’ money to float his proprietary trading in the very securities he told the investors he was buying for them and, to some extent, to float his market making operation, too. Indeed the fact that he was dealing for his own account in the securities he told investors he was buying for them was probably one of the reasons he knew so much about the securities that he apparently could judge whether the prices for the securities shown on the account statements sent to customers made sense. It was also, probably, one of the reasons -- although only one of them -- why nobody in his firm thought boo about what he was doing. For the most part, all that they could see was that, as expected, the proprietary trading (and market making) arms of his firm were buying and selling Fortune 100 securities. And it enabled Madoff to parade himself before the world as what one suspects his ambition and psyche demanded that he be: a brilliant and enormously successful Wall Street investor.

So the scales fell from my eyes because of the perspicacious comment of a lay person -- my wife -- who is not a lawyer, knows quite a bit about the Madoff case for a layman but not nearly so much as all the experts I deal with or myself, and simply made a perspicacious comment about Madoff as a person.

In the few weeks since I began to understand what Madoff had been doing, I discussed my views with a few people, some being Madoff experts and some being lay people. The initial reactions, I think it fair to say, were some degree of disbelief. After all, Madoff’s scam had been portrayed for 3½ years as a Ponzi scheme in which there were no trades and no profits, everyone had accepted that Madoff ran a Ponzi scheme, and now, after 3½ years, I was saying that his scam wasn’t a Ponzi scheme? Get real. After listeners came to understand what I was saying and why, however, people asked whether the Trustee had known all of this; asked why, if he did know it, he and SIPC had continued to propound that Madoff was a Ponzi scheme; asked whether the Trustee is culpable for doing so; asked whether his doing so was a second fraud on investor victims; and, shockingly to me (but upon reflection perhaps not so entirely shocking -- I don’t know), asked whether the Trustee could go to jail because he (and SIPC) perpetrated this second fraud on victims.

My initial response to questions was that, even if they knew the facts, I didn’t know whether, and even doubted that, the Trustee, his lawyers and SIPC actually understood what the facts meant: actually understood what Madoff was doing and that he was using the monies he took in from victims to run the other arms of his business, especially the proprietary trading arm. My response received the equivalent of hoots and catcalls. Nobody else had the doubts I had (and I have to admit that, for all my world-induced cynicism, I am pretty naïve when it comes to whether people are good, though I do draw the line at Hitler and Stalin). Everyone else seemed to think that the Trustee and SIPC knew exactly what Madoff had been doing and exactly what they were doing themselves for their own benefit. Thus, the question from laymen of whether what the Trustee was doing, which they considered a second fraud upon (oft-impoverished) victims for the benefit of the Trustee and SIPC, could result in jail time -- a question which absolutely knocked me off my feet when I heard it. Lawyers, I guess, are not used to the idea, are staggered by and disbelieving of the idea, that a Trustee could end up in the slammer. To laymen, I guess, there would be no surprise in the possibility that a Trustee -- a lawyer -- might do illegal things for the benefit of himself and his law firm.

I have to say that I still give Picard and his lawyers -- and maybe even SIPC -- the benefit of the doubt. I just can’t believe that they set out to screw victims via a second fraud so that they themselves could benefit greatly. I do believe that they set out to screw victims in order to benefit SIPC, but this is not the same as them realizing that they were fraudulently screwing victims -- even possibly criminally screwing them -- by saying Madoff was a Ponzi scheme when in reality it wasn’t. I’m even willing, personally, to believe it possible that, notwithstanding the statements quoted above from the letter of January 24, 2011, SIPC and the Trustee didn’t realize that the overall effect of the operations that were combined in one corporate entity, run and controlled entirely by Bernie Madoff, was that he was not running a Ponzi scheme, and I’m also willing to believe that they thought -- very wrongly, I think, but honestly -- that it was proper to separate out the investment arm of the business as if it stood alone without regard to the rest of the business. I do fear, however, that others will think my willingness to give these benefits of the doubt are simply more examples of my endless naiveté about people.

In any event, I am sure about one thing, about something I have been sure about since early days in the case and that courts have inflexibly resisted. We will never know the truth about what Madoff did, about what SIPC has done, or about what the Trustee has done unless and until lawyers are granted discovery into these matters in law cases, unless and until lawyers are given access to all pertinent documents and information and are allowed to depose witnesses -- the Trustee, his lawyers and minions, and SIPC’s personnel, about the relevant events. Discovery in legal proceedings is one of the greatest engines for obtaining truth ever invented, is perhaps the best engine for determining it. And unless we get discovery regarding the Madoff case, an awful lot of truth will remain hidden as a factual matter even if we rightly believe that various things happened.

How The Current Situation In Legal Education Came To Pass. Part III

2012-06-21T09:17:00.001-04:00

June 21, 2012

How The Current Situation In Legal Education Came To Pass

Part III

In the mid 1990s the Department of Justice’s Antitrust Division threatened to bring a case against the ABA (after our school complained to the DOJ about the accreditors’ anticompetitive activities). The ABA, which of course had high level contacts in the government, persuaded the Antitrust Division to enter a weak consent decree which solved very little, but which prevented the extensive damning evidence collected by the Government from being disclosed at a trial, and thereby enabled the ABA to keep that evidence -- thousands of pages of it -- secret. After entering the weak consent decree, the ABA proceeded to violate even that weak decree, and, where the decree called for non faculty to fill committee positions, it appointed judges and lawyers who in previous lives had been faculty members, were imbued with the ABA orientation, and sometimes had even been ABA accreditors.

Perhaps the only thing really accomplished by the Antitrust Division’s case was that, under the consent decree, the accreditors had to stop demanding that law schools pay ever higher salaries. Yet even this supposed accomplishment proved a failure because, ever increasing salaries having been baked into the cake indelibly, law schools just went right on increasing them. This was furthered by the fact that the schools, being among the most elitist parts of a very elitist profession -- Brian Tamanaha, author of the new book entitled Failing Law Schools, calls the schools an “elite-drenched environment” and says “Law is an obsessively credential-focused profession -- have competed obsessively for well known researchers and writers, competition which has driven up salaries across the board even though most law professors -- being lazy? -- don’t write.

After the Antitrust Division fizzled, our law school began submitting papers to and appearing at meetings in Washington of the so-called National Advisory Committee of the Department of Education. The NAC advises the Secretary as to which accrediting bodies should be federally recognized and with what conditions. Our point was that the NAC should require the ABA’s Section of Legal Education to begin enforcing proper and legitimate accrediting standards instead of being the front man for standards designed to advance the economic and professional perquisites of the law professoriate. Our effort went on for perhaps five or six years, but finally we quit the lists because it proved impossible to get DOE to do what should be done. There were a few very good people on the NAC -- ultimately we even asked one, former Governor Salmon of Vermont (who also had been President of the University of Vermont), to join our Board of Trustees, which he did -- but there were also bureaucratic hacks on the NAC. Even far more importantly, the DOE staff, which ran the show, was thoroughly incompetent -- this was Washington, you know -- and in the hip pocket of the ABA. (Once the staff even claimed, with truly astonishing incompetence, that accrediting standards cannot be considered in light of student achievement. Yet student achievement, I would venture, is the very touchstone of accreditation.)

There was also one other reform effort that failed. In the mid 1990s, many deans were already disgusted with ABA accreditation. The deans of 14 schools, often highly prominent ones such as Harvard, Chicago, Stanford, Pennsylvania, Virginia, Cornell and others wrote a letter highly critical of accreditation, formed the American Law Deans Association, which quickly rose to almost 110 members, and regularly criticized ABA accreditation. To no avail. They had no effect and, as was publicly conceded, were basically ignored by the accreditors.

But none of the ALDA schools ever opted out of ABA accreditation; none ever quit it. I have long thought that the only thing that could cause change would be if some leading schools like the ones just mentioned or others (e.g., Yale, Columbia, Michigan, Texas, Berkeley, UCLA, NYU, etc.) were to say to the accreditors, “We are not going to play your game anymore. We disagree with what you are doing, and we quit.” (Edward Levi, later the Attorney General after being Dean of the University of Chicago Law School and President of the University, once told the ABA to go fly a kite when it threatened to disaccredit Chicago because of a dispute over a particular important library standard. The ABA backed down.) Such action by leading schools would have an effect because nobody in his right mind would say that Harvard, Yale, Chicago, Stanford, Michigan, etc. are not competent law schools, which is the threatened statement, with associated loss of accreditation, which insures that the vast majority of law schools stay in line. But (pace Ed Levi) the leading schools don’t generally care enough (notwithstanding that some of them helped create ALDA), don’t participate much in the workings of ABA accreditation, probably receive some benefits from it, and generally are frying other fish. (I note that quitting ABA accreditation would not cause these schools’ students to lose federal loans because the universities of which the law schools are a part are themselves accredited by regional accrediting bodies recognized by DOE.)

The foregoing then, as said at inception, is a brief overview of how the current situation in legal education came to be. The situation did not just happen. It is the result of intended actions of men and women -- self interested men and women. They persuaded most state supreme courts to go along with them, although a small number -- preeminently the courts in Massachusetts and California -- did not go along with the accreditors’ desire that ABA accreditation be the sole means for a law school’s graduates to be eligible to take the bar exam. (Thus the graduates of our school, which is located in Massachusetts, can take the bar there and, after passing it, can take the exam in a number of other states.) Attempts at change have fizzled and failed, including attempts by the Antitrust Division, by ALDA, before DOE and, though previously unmentioned here, occasionally before state courts. If history is a guide, future attempts would also be pregnant with possible failure.

The key to everything, of course, lies with the state supreme courts. If they were to change their rules so that (as in Massachusetts and California) accreditation by the ABA were no longer the sole means for a school’s graduates to be eligible to take the bar exam, if they were to change their rules so that, for example, accreditation by one of the regional accrediting bodies which accredit such a wide variety of schools would also enable a law school’s graduates to take the bar exam, then the situation of legal education likely would change dramatically. For schools, as is true of ours in Massachusetts, would no longer have to follow the ABA accreditors’ high cost, tuition increasing, heavily-research-oriented rules. Rather, schools would be able, if they wished, to follow a competent, low cost, more practice-oriented model.

Years of experience have made me pessimistic about the possibility of obtaining change. Yet, on the other hand, it has become more and more obvious, to more and more people, that, as Brian Tamanaha extensively argues in Failing Law Schools, the current model of law school enforced by the ABA accreditors is not working and room should be made for schools that (like MSL) wish to use a different model. Perhaps this realization may have dawned on some state courts, or could dawn on them if competently called to their attention. Perhaps this is worth a try and, despite my own personal pessimism, will become even more worth a try as a result of Tamanaha’s book and the discussions it may well spawn. At this point, who can say? But we shall see.[1]

[1] Much of the overview posted here comes from a small book, entitled The Gathering Peasants’ Revolt In American Legal Education, written by Professor Kurt Olson and me in 2008. Anyone who would like more details, or to obtain any of the extensive books, reports, and memos on which we relied, can consult Peasants’ Revolt.

How The Current Situation In Legal Education Came To Pass. Part II

2012-06-20T08:19:00.001-04:00

June 20, 2012

How The Current Situation In Legal Education Came To Pass

Part II

The period 1923-1973 was preparation for developments of truly enormous importance in 1973 itself. In that year leading legal educators were deeply concerned over the economic and professional status of law professors. There accordingly was a meeting of eighteen prominent leaders to discuss the problem. (Later they incorrectly (in two senses) became called the “Ten Wise Ones.”) Their proceedings and conclusions were published in the Journal of Legal Education -- this was a few years before the Supreme Court ruled the professions subject to antitrust, so that one assumes the publication was not thought the danger it would have been after that ruling. The report of the Ten Wise Ones said “many of us envision a more active role for the [AALS], both in defending the fiscal entitlements of legal education generally and in advancing the economic standards of law professors directly.” (Emphasis added.) They discussed using collective bargaining to do this, an idea which ultimately went nowhere, and, more to the point, “Some thought a possible goal might be to develop enforceable standards in support of entitlements of law faculty members as an alternative to trying to utilize the dynamics of labor-management bargaining.” (Emphasis added.)

In pursuit of the goal of promoting the “fiscal entitlements” and “economic standards” of law professors, in 1973 a committee drafted ABA accreditation standards to achieve this. These standards were approved by the ABA’s House of Delegates. One negative comment was expressed by William Spann (not to be confused with Warren Spahn), who would soon become President of the ABA. Spann said that if the ABA adopted the proposed accreditation standards, “we have sort of set ourselves up as a collective bargaining agent for law professors against the various Boards of Regents and other educational bodies of the state.” The ABA should not, he said, “become a collective bargaining agent for the law professors and this [set of standards] looks very much like a labor contract drawn by a law professor to me.” There was obviously little doubt as to the economic purposes of the new standards.

The other major development of 1973 was the appointment of a professor named James White to the position of ABA Consultant on legal education. White ruled with an iron hand for the next 25 years, for the purpose of promoting the economic goals and professional perquisites of the law professoriate. In 1992 an article in the National Law Journal said that he was “arguably the most powerful person in the field.” (In truth there was no “arguably” about it: he was the most powerful figure.) The article also said that “[a]s the person in charge of accreditation of law schools for the ABA,” he could “decide almost single-handedly on the very existence of a law school, and the terms of that existence.”

In advancing the economic and professional perquisites of the professoriate, White employed a group of insiders -- mainly professors but also some practitioners who did his bidding. Members of the group did not change much over time. They enforced rules and practices that dramatically increased professors’ salaries, dramatically lowered their hours of teaching, vastly increased the size of full-time faculties, largely barred (comparatively inexpensive) part-time teachers (who were expert judges and lawyers), required highly expensive libraries to be vastly increased in size and personnel, demanded facilities costing scores of millions of dollars, promulgated and enforced rules whose effect was to keep minorities and the poor out of law school and the legal profession, required large and expensive administrative staffs in law schools, required heavy use of (and reliance upon) the LSAT (whose owner, the LSAC, was one of the Big 3 and was financing, from its receipts, many of the activities of legal education), and, withal, made it necessary for tuitions to be pushed ever upwards.

ABA inspection teams pushed this agenda on law schools, which had to meet it under pain of being called incompetent and being disaccredited -- a threat that was meaningful to law schools not named Harvard or Yale or Stanford or Chicago or perhaps 20 others of a total that ultimately exceeded 200. No school was allowed to use a different model of legal education than the high cost research model that was desired and demanded by the academics, led by the powerful James White, who ran the enterprise. Inspection reports were rigged to accomplish the White group’s purposes, and were kept secret so that the vox populi, the general press, and all non insiders could not know what was happening. Inconsistent treatments of law schools abounded, inconsistencies made possible because secrecy covered them up until much later when, for example, a person who had been at one law school saw something different perpetrated on his new school. New schools that desired accreditation, or existing schools that were having difficulties with accreditation, had to hire as dean, at a high salary, a member of White’s inside group in order to succeed, so that White had this too to dispense as patronage as well as the trips to fabulous vacation spots.

TO BE CONTINUED TOMORROW, JUNE 21^ST

How The Current Situation In Legal Education Came To Pass. Part I

2012-06-19T08:54:00.001-04:00

June 19, 2012

How The Current Situation In Legal Education Came To Pass

Part I

A prior post discussed the unhappy state of legal education today. So I have thought to now set forth a brief historical overview of how this situation came to pass. It is, perhaps, a classic story of the seizure of power and authority -- for the purpose of self interest, of course. It is also, perhaps, one of only a few cases in America where power and authority were seized by persons who lacked and did not use big money to achieve their goal. The seizure occurred, rather, through lawyerly verbalness and influence.

The beginning of the story can be placed at approximately the turn of the 20^th Century. The legal profession was in bad odor. Night law schools serving the immigrant poor were proliferating. Nativist and racial attitudes were, shall we say, not uncommon. Wanting to rid themselves and the profession of the competition from the night schools and the immigrant poor, academics who were in the ABA’s Section of Legal Education (begun in 1893) created the Association of American Law Schools in 1900. More stringent standards and practices for legal education were likewise created. The men and the schools which led the cavalcade were academic in orientation, not practice oriented. And ultimately, in the first 50 or 60 years of the 20^th Century, many or most of the schools which were serving the poor were driven out of business. A few -- I think it fair to say only a very few -- survived, in large part by adopting an academic orientation.

In 1923 there were two major developments. The position now known as the “Consultant” to the ABA on legal education was created. And the ABA’s Section of Legal Education -- whose leading personnel were interchangeable with AALS personnel (they were usually one and the same), began to accredit law schools. The Consultant’s position grew into the most powerful one in legal education by the 1980s, when his word, as veritable dictator, determined which law schools would live and which would die.

ABA accreditation, run by the Consultant with the extensive assistance of the ABA Section/AALS academics, began to be used to run out of business the schools that did not do as the academics desired. This exclusion of the nonconforming was achieved by persuading most state supreme courts not to allow law graduates to take the bar exam unless their law schools were accredited by the ABA. If a school’s graduates could not take the bar exam, the school would be unable to continue in existence because its graduates would be unable to practice law.

The process of running the nonconforming schools out of business went from strength to strength one might say, until it achieved the apogee of near (but never complete) success in roughly the 1970s. State supreme courts acceded to the ABA because, they have claimed, the ABA Section of Legal Education was supposedly a good accreditor; they could not themselves judge schools (and apparently did not want general accrediting bodies to judge law schools); the Section lobbied state judges extensively; and it made sure to honor state supreme court justices, especially chief justices, by putting them in high positions in its structure (and, of course, by paying their way to the fancier watering spots of the U.S. and the western world (e.g., Jackson Hole, Sarasota, London) where conferences and conventions were held.

Between 1923 and 1973 there were two other major developments. In 1952 the ABA persuaded HEW to approve it as the nationally recognized accrediting body for law schools. This imprimatur aided state court acceptance of ABA accreditation. And, of truly enormous importance when the federal government began guaranteeing and/or making student loans, HEW’s imprimatur meant such loans would be available for legal education (even if a law school was “free standing” and thus not part of a university that was itself approved by an accrediting body recognized by the federal government). Loans ultimately became the method of financing law school tuition and, thus, law schools. So, much of what occurred that caused tuitions to be raised to today’s astronomical levels is attributable to HEW’s recognition of the ABA in 1952. As the Consultant wrote as far back as 1989, “The single most important factor in financing legal education has been, and continues to be, the availability of student loans.”

The other major development in the period 1923-1973 was the rise of the Law School Admissions Council. The LSAC sponsors and has made scores of millions of dollars from the LSAT (which was created in the late 1940s). It also has run a crucially important loan program. The LSAC became the third controlling organization in legal education, along with the ABA Section of Legal Education and the AALS. They were called the Big Three of legal education. The LSAC’s leaders were people who also were leaders of the other two organizations (the whole crowd played collective musical chairs) and it financed conferences and conventions at major and expensive vacation spots which legal educators (and judges) were delighted to visit.

TO BE CONTINUED TOMORROW, JUNE 20^TH

Law School Should Remain Accessible to All

2012-06-13T09:05:00.000-04:00

June 7, 2012

Law School Should Remain Accessible to All

The legal profession and, in roughly the last 110 years or so, law schools have always been a route to advancement in America. At the presidential level, lawyers include, among others, Jefferson, Madison, Monroe, Lincoln, Cleveland, Franklin D. Roosevelt, Nixon, Clinton and Obama. The numbers of state and federal legislators who have been lawyers are legion. The same for governors. Many high corporate officials have been lawyers. And none of this is even to mention that lawyers are prominent at professional and civic levels ranging from Wall Street to small firms.

So it is important that law schools and the law remain open to, remain a rite of advancement for, the middle and lower economic classes. But such access is increasingly difficult to come by. The reasons have to do with elitism, failure to teach students what they need to know in order to practice, and costs. The elitism has been with us for scores of years. The failure to teach the skills of practice have been with us almost as long. The staggering costs (tuitions) are a more recent phenomenon. All of this, and much more, is discussed in a new book by Brian Tamanaha, formerly a dean of the St. John’s Law School and now a law professor at Washington University of St. Louis. Many of Tamanaha’s criticism and suggestions mirror the views and practices of the Massachusetts School of Law since its inception in 1988.

The criticisms made of law schools include the following: law professors’ salaries are very high (sometimes ranging into the mid three hundred thousand dollar range or averaging over $250,000). They are far higher than any other academic fields except medicine. In part due to very high salaries, law school tuitions are very high -- often being between $35,000 and more than $50,000 per year. Law professors teach few hours of class, making it necessary to have more professors in each school, which again pushes up tuitions. Law professors are entirely research oriented (although their research is of little or no benefit to students); they have very little experience in practice, lack knowledge of the arts and skills of practice, and cannot teach such skills to students though most students wish to become practicing lawyers. In pursuit of higher US News rankings, law schools seek students with, and give available financial assistance to, students with high LSAT scores. This forces other, “lower ranked” students, who pay full tuitions, to in effect pay the way of the students with high LSATs. Again in pursuit of high US News rankings, some law schools have told falsehoods about their students’ LSAT scores, undergraduate grade point averages, or starting salaries after graduation. Law schools have failed to prepare students for bar examinations. By increasing tuitions to astronomical levels, law schools have made it necessary for students to take on very high amounts of debt, often ranging between $100,000 and $135,000. These amounts of debt play hob with students’ lives after they graduate.

A way to cure these problems, and to make legal education and its associated social and economic mobility available to middle class and lower class students, is to reverse the current practices (as our school has done). Professors should have extensive, and often continuing, experience in practice, teach the arts and skills of practice to students. Professors teach reasonable numbers of hours, not low amounts of hours. They should focus on good teaching, rather than on research of little or no value to students. They should earn good but not astonishingly huge salaries. Schools should eschew the inevitably elitist LSAT. They should prepare students for the bar examination. And, by use of these and similar techniques, tuition should and can be kept low – it can be kept to between 15 and 20 thousand dollars per year, instead of not 35 or 40 or 45 or 50 thousand dollars per year.

THE COMMITTEE ON FINANCIAL SERVICES THE SECURITIES INVESTOR PROTECTION CORPORATION: PAST, PRESENT, AND FUTURE

2012-03-14T12:10:00.003-04:00

THE COMMITTEE ON FINANCIAL SERVICES

THE SECURITIES INVESTOR PROTECTION CORPORATION: PAST, PRESENT, AND FUTURE
(PDF of transcript)

WEDNESDAY, MARCH 7, 2012

9:30 A.M.
INDEX

EVENT PAGE

PANEL I 20
THE HONORABLE DAVID VITTER 20

PANEL II 28
MR. STEPHEN HARBECK 28
MS. SHARON BOWEN 35

PANEL III 110
MR. JOE BORG 110
MR. STEVEN CARUSO 119
MR. IRA HAMMERMAN 121
MR. RON STEIN 126

[BEGINNING OF RECORDING]
Mr. Garrett: This hearing is entitled “The Securities Investor Protection Corporation: the Past, the Present, and the Future”. This hearing will now come to order and I recognize myself for four minutes to give the opening statement.
So, with regard to today’s hearing, today’s hearing is fashioned, as I just mentioned, in a broader oversight hearing of the, of Securities Investor Protection Corporation, SIPC. And it’s not meant entirely to be focused solely on a particular aspect of SIPC’s work.

But, to me, the failure of SIPC in regards to the Madoff liquidation are so fundamental, relative to the protections that SIPC is supposed to provide to investors. And so, antithetical to the goals that SIPC and Congress set out to achieve at their beginning, that I would like to focus much of my time, and my thoughts, and my energy, and my comments on the circumstances surrounding that particular case.

I also think that it’s worthwhile to hear today about SIPC’s work in regard to the Lehman bankruptcy. And also, what we -- examining the long-awaited and recently-released report of SIPC’s Modernization Task Force as well. And going through that task force and looking at it, unfortunately, is that it’s somewhat of a missed opportunity, if you will, and it seriously studies some of the shortcomings of SIPC exposed by the recent failures of the broker-dealer.

So, let’s return now to the failure of the Madoff firm and let’s examine the facts of that case. As we’re all probably too familiar.

The Madoff firm was regulated by both FINRA and the SEC. And they repeated received government stamps of approval that it was operating basically legally. The firm proudly displayed the SIPC logo, which again implies government backing since SIPC is backed by the US Treasury. Madoff investors paid taxes to the IRS, US Government, for years. Again, another government agency saying that its investors and profits were, well, real.

Just around the same time SIPC was enacted, investors no longer held stock certificates. So, the only proof of ownership they have, or had, was the statement that they received from a government-regulated broker-dealer.
So, what does it mean? So, the Federal Government both provided a stamp of approval and relied upon that stamp of approval and yet, innocent private citizens now, as investors, are being held to a higher standard than them. So, instead of being provided protection by SIPC, as Congress did intend in order to increase confidence in investment in our markets, innocent investors in this case are being sued by the very same Trustee chosen by SIPC.

Now, am I the only one when you go down that whole litany of facts that are here to say that, “Well, something is simply not right here”? Now, an additional irony is that if the Trustee is successful in suing individual investors, who will go to, who will the money go to? It will largely go to pay off institutional investors. Now, this is the same class of investors that the Trustee has repeatedly tried to sue because he believes, well, that they should have known better. But they’ll be paid.
It’s because of my concerns over these issues I’ve introduced H.R. 757, the Equitable Treatment of Investors Act. This legislation would reaffirm and clarify key protections for ordinary investors that were put in place when Congress passed and amended the SIPC.

In particular, the bill aims to shield innocent individual investors, who have already been defrauded and financially devastated by the Madoff situation, from further clawbacks by the SIPC Trustee. In addition, the bill clarifies that for purpose of SIPC protection, customers of registered brokers are legally entitled to rely on their broker statements as evidence of what their broker owes them. Indeed, in a world where customers do not any longer hold the physical stock certificates, how can it be done any other way? Finally, H.R. 757 would end an ongoing conflict of interest by having the SEC, rather than SIPC, select Trustees for the SIPC liquidation.

Now, several of my colleagues already joined me in cosponsoring this legislation and I encourage my other colleagues to look at it and consider it as well. So, I look forward to today’s testimony of our witness, and all the panels that we have, and a hearty discussion on SIPC activities and roles, those of the past, and the present, and the future as well.
And, with that, I yield back and I yield to the gentlelady from New York for three minutes.

Ms. Maloney: Okay. Thank you. Thank you, Mister Chairman. I thank you for your deep concern on this issue, which is a major concern for many of us on this committee. And, I welcome Senator Vitter. You honor us with your presence. We look forward to your testimony.

As a representative of New York City, the financial industry is a very important part of our economy. The massive fraud that was put forth by Bernard Madoff is very personal to me and it hurt many of my constituents and certainly violated the trust of the public for the industry. So, it was a tremendous blow to many people on an individual basis and to the industry at large.

My constituents, many of whom are victims of this fraud, from union workers who lost their pensions, to charities that lost their operating funds, to investors large and small who lost their life savings, literally lost their homes, lost absolutely everything, the experience has been absolutely devastating and they are devastated.

Even worse, the confidence of investors around the world in the system of regulation and law enforcement of our financial markets was visibly shaken by this scandal. Just yesterday, Mister Stanford, another perpetrator of a Ponzi scheme who cheated his investors out of over $7 billion was convicted on 13 out 14 counts that he faced. This should be some comfort for the people he defrauded, but we want to make sure that if this ever happens again, there are tools in place so that victims can be made whole and SIPC can do its job.

I believe that markets run as much on confidence as they do on capital. And this is a serious blow to investors’ confidence at a critical time. We still see that many people are holding their money back from investing and going forward with our financial system.

The reason we are here today is to look at the Securities Investor Protection Corporation, SIPC, and to shed light on the reform proposals that are out there, including several pieces of legislation that are pending before the House. I know this committee is looking closely at the SIPC Modernization Task Force Report, which was released at the end of last month. So, this hearing is very timely.

I know that my colleague, Mister Ackerman, and the Chairman have put forth thoughtful bills. I’m interested in seeing how their bills coincide or reflect, go further, or not as far as the SIPC Modernization Task Force Report’s recommendations. And I look forward to working with them on these bills. I hope we can explore both of these legislative proposals and hear from the witnesses, what they believe is the right, is the better approach, or the right approach we should be taking.

I look forward to the hearing. It’s one that’s very important to our country. And I thank the Chairman for calling this important hearing and his work on his legislation. And also, I compliment Mister Ackerman for his hard work.
I reserve the balance of my time and turn it back to the Chairman.

Mr. Garrett: Okay. Gentlelady yields back. The gentleman from New York is recognized now for three minutes.

Mr. King: Thank you, Mister Chairman. Thank you for calling today’s hearing. It’s very timely for the representative from SIPC to come before the subcommittee. After several years, they’ve finally produced the recommendations of their Modernization Task Force and this hearing and report come against the backdrop of the Madoff liquidation, which you have referenced and which Miss Maloney has referenced.
This was unearthed three years ago and for the past three years that process run by SIPC has gone profoundly amuck. This is tragic, this is wrong. From my perspective, at least four takeaways from this liquidation.

One, the Trustee, Irving Picard, is out of control. He interprets SIPA as he desires, not as intended by the courts. And on several occasions, has been slapped down by the courts. He intimidates innocent victims, brings spurious clawback suits against them, maligning their reputations in the process, and leaking spuriously to the media. Even Chairman, Chairwoman Mary Schapiro expressed surprise as the initiation of the baseless lawsuit.

Just the other day, in an order dated March 5th in the Southern District of New York, Judge Rakoff in the case Irving Picard versus Saul Katz made a finding, “The Court remains skeptical that the Trustee can ultimately rebut the Defendants’ showing of good faith, let alone impute bad faith to the Defendants. More generally, the Court is concerned that much of ‘the evidence’ that the parties proffered on summary judgment did not comport with the Federal Rules of Evidence. Conclusions are no substitute for facts, and too much of what the parties characterized as bombshells proved to be nothing but bombast.” And that’s what that lawsuit has been from beginning to end, bombast.

Two, the victims are being treated unfairly. A very few victims have received the statutory mandated SIPC advances. The Trustee has hatched an accounting mechanism that disregards real-world, cuts reputations on broker-dealer protocol, it’s lawyer intensive, and it has run up the fees of $300 Million, paid to Mister Picard. $300 Million. He has an open piggybank here for himself.
It’s not an exaggeration to say the victims have been victimized twice, once by Bernie Madoff and now by Irving Picard.

Three, the Trustee is not being properly supervised. Where were the regulatory bodies tasked with oversight over this Trustee, SIPC directly and the SEC indirectly? Moreover, where was the Statutory Mandate Report on the liquidation required of the Trustee? The Trustee of the Lehman liquidation has completed and filed such a report. The broker-dealer failure is arguably much more complex and complicated than the Madoff debacle.

Lastly, this miscarriage of justice endured by the Madoff victims could happen to any investor if a broker-dealer fails for any reason.

We need to restore some reason and some rationality to the unwinding of failed brokerage firms, and that’s why I am proud to sponsor with Chairman Garrett H.R. 757, a proposal enjoying bipartisan support.

Chairman, thank you for your leadership on 757. Thank you for holding this hearing. I look forward to hearing from the witnesses.

I yield back.

Mr. Garrett: And again, I thank the gentleman from New York. Thank you for your work in this legislation as well and for this issue, leadership.

Mister Green is recognized for two minutes.

Mr. Green: Thank you, Mister Chairman. I’d like to thank my colleague and friend from Louisiana, my home state. While I represent Texas, I was born in Louisiana. So, I’m honored to have you with us today.

Mister Chairman, I, too, am concerned about investor confidence. I think it’s exceedingly important that investors understand that we desire to impose proper protection for their investments. As I weigh this issue of whether we are going to base our payments on account statements or actual net cash investments, my concern is the actual statements. Because as you know, in the Madoff case, his statements were misrepresentations and they were actually fraudulent in and of themselves. That causes a degree of concern. I’m eager to look at the legislation and make some decisions. My thoughts are rather ambivalent right now.

I do want the investors to be protected and I stand for investor protection. I would like to peruse legislation to ascertain how we manage these statements that are fraudulent, that themselves are misrepresentations. And, we are talking about tax dollars to a limited extent.

So, for this reason, I thank you and I look forward to hearing more so that I can come to a final conclusion.

Mr. Garrett: And thank you. The gentleman yields back.
Mister Dold for two minutes.

Mr. Dold: Thank you, Mister Chairman. Certainly appreciate you holding this hearing and for your leadership. I want to thank Senator Vitter for being here as well and our other witnesses.

We all have tremendous sympathy for all of the direct and indirect Madoff victims, and all other Ponzi scheme victims as well, which is why we’re all here, to see how we can improve available protections in a balanced way, without creating unsustainable, unfair, and otherwise negative, unintended consequences.

The fundamental reality of the Madoff Ponzi scheme, and every other Ponzi scheme, is that money is stolen from many innocent people and there isn't enough money to make everyone whole. That’s a difficult and complicated situation. And there aren’t any perfect answers or perfect solutions. People suffer in those circumstances and we need to find the most balanced way to minimize the losses and the suffering among a large group of innocent victims.

But all innocent victims aren’t in the same position. Many innocent victims have great conflicts of interest with many other innocent victims. Some victims ended up getting more money than they put in. In some cases, much more money than they put in. Their profits were, I would argue, all fake, were fraudulent, stolen by the Ponzi schemer from other innocent victims. Those other innocent victims received absolutely nothing and instead lose everything. And their stolen money has gone to pay for those fraudulent profits to others.

What do we do in that situation? There’s no perfect, or even good answer. But, historically, we’d recover the fake profits from the innocent victims who received them to partially repay the actual losses of other innocent victims. In that way, nobody gets to profit from the Ponzi scheme. There might be a better way, or more fair way, or a less unfair way to handle this difficult situation and I hope that we hear one today.

And if no investor should profit from a Ponzi scheme, the Federal Government should also never profit from the Ponzi scheme. For decades, innocent people paid very real taxes on totally fake profits. When the fraud is exposed, the IRS says that the innocent victims can only get refunds for the taxes paid during the last five years. So, ironically, the Federal Government benefits more and more from a long-term Ponzi scheme the longer it continues. Why shouldn’t the innocent investors be able to recover all taxes that were wrongly paid on totally fake or fraudulent profits?

I have a number of other questions and I see my time has expired, but I do hope we have an opportunity to ask them during the question and answer period.
I certainly want to thank those that are coming here today testifying. And again, Mister Chairman, I thank you for your work.

Mr. Garrett: Thank you. Thank you for your comments.
The gentlelady from California for the remaining time on her side at least.

Ms. Waters: Thank you very much, Mister Chairman. And thank you for holding this hearing on the Securities Investor Protection Corporation.

The past few years have been very challenging for SIPC. During the height of the financial crisis, the Corporation was forced to liquidate Lehman Brothers, one the world’s largest brokerage firms. Shortly thereafter, the Madoff Ponzi scheme was uncovered. In the years since Madoff, we’ve also seen the case of the Stanford Group Company and the failure of MF Global.

Following the liquidation of Lehman Brothers and the discovery of the Madoff Ponzi scheme in 2008, SIPC’s board of directors created the SIPC Modernization Task Force to review whether any changes to the law of the SIPC’s operations were needed.

Today, we’re considering the report published by this task force. Their recommendations include items that is requiring acts of Congress and items that can be pursued administratively. I’m interested to hear from the Corporation on the rationale behind these recommendations, as well as any areas where certain task force members may have alternatives to what was presented in the consensus report.

It’s also important to know how we can increase investor understanding of SIPC and make certain that investors realize that it does not offer the same protection as FDIC insurance.

I’m also interested in exploring how we can ensure the most equitable outcome for investors who put their savings into Madoff, Stanford, and MF Global.
I understand that Chairman Garrett and Representative Ackerman have legislation that would attempt to provide additional assistance to certain victims of the Madoff fraud. I’m very curious to hear more about this bill, but I’m also very mindful that Congress should be very careful in this area since any changes to how customers’ claims are calculated will inevitably make certain investors winners and others losers.

Finally, I’m very curious to hear more about SIPC’s rationale for not paying out claims under the Stanford Group Company fraud and this issue that the SEC has contested. The timing of this hearing is all the more apt in light of Allan Stanford’s conviction yesterday on 13 counts related to his $7 billion Ponzi scheme.
Thank you, Mister Chairman. I yield back the balance of my time.

Mr. Garrett: Thank you, gentlelady. And that’s an interesting point on the last one you raised there.

And we have one other member who, Doctor Cassidy, who would, without objection, would like to serve, or sit on the panel later on today once we get into the panels, without objection.

PANEL I
Mr. Garrett: So, we will now go to our, to our first panel. And we welcome the gentleman from the other side of the Capital. Welcome back to a former House Member, Senator Vitter. I know you serve on the Senate Banking Committee and I know also that coming from where you do, down south, that you have a number of your constituents who were more than adversely affected, not by the, well, some may by the Madoff case, but more often by the Stanford case, and that you have been a leader in trying to bring a equitable solution to that situation. So, we thank you to coming and joining us in this committee. Senator.

Mr. Vitter: Well, thank you very much, Chairman Garrett and Ranking Member Waters, and all of you for the invitation. I really appreciate it. And even more importantly, thank you for your important work and partnership on all sorts of issues, this, as well as a lot of challenges that have confronted Louisiana. Hurricane Katrina and Rita, the BP Oil Disaster, all of you have been wonderful and generous in terms of our working partnership. Thank you for that.

And it is great to be back on the House side. I remain a House Member in spirit. I brought a healthy House skepticism to the Senate, which I still don’t drink from the water fountains over there and that’s not going to change any time soon. So, it’s great to be here.

I am here, of course, because this is a very important issue and I have been particularly involved in the case that you mentioned, the Stanford case. I’ll submit my full comments for the record and I’ll summarize here. And because of that focus, of course, my comments are going to be very informed by the Stanford case in particular, although I certainly acknowledge the importance of many other cases and share all of your concerns, including, in particular, about the Madoff case.

I’m very involved in the Stanford case because, unfortunately, there are thousands of victims nationwide, and many of them, many retired oil and gas workers and executives are in Louisiana. So, I’m talking personally to dozens and dozens of them. Like in the Madoff situation, many lost their entire life savings. Many have literally had to sell their homes, go back to work well after normal retirement, things like that. They are real victims that have been taken advantage of.

In the Stanford case, as you know, SIPC has denied coverage completely. And that’s the fundamental problem. SIPC is basically taking the position, “While these were valid CDs, that were lowered in value, lost value, and we don’t cover market losses.” Well, I think that position’s just flat-out wrong. And through the Stanford experience, I’ve come to the conclusion that there is a need for major SIPC reform.
It isn't to change their coverage. It isn't to change the parameters of the statute. I’m not here to argue that that should be broadened. Again, I think there is clearly coverage in the Stanford case under the present statute. And I don’t propose that SIPC should cover market losses or every evil or bad situation under the sun. Rather, I think reform is needed in a different way, and in some ways a much more fundamental one.

I reached the conclusion that SIPC, if it were a true regulator, would, in the [inaud.], is the, a situation of complete regulatory capture. I do not think SIPC is focused enough on following the law and executing the law. I think it’s far too focused on serving the industry and its member companies and looking after their interests. And my experience in the Stanford case in particular, has led me to that unfortunate conclusion.

First of all, let me talk briefly about why there is coverage. As was mentioned, Allen Stanford was found guilty just yesterday of 13 criminal counts. He was found guilty of basically fraud, stealing customer funds. Instead of purchasing Stanford International Bank CDs, the Stanford Group Company, which was a SIPC member, acquired control of its customer funds and the funds were stolen by Allen Stanford. The SEC and courts have taken the position in litigation that the Stanford companies operated a Ponzi scheme and “a Ponzi scheme is, as a matter of law, insolvent from its inception.” So, it’s not a matter of real CDs losing value, it’s a matter of a Ponzi scheme, a fraud, and Allen Stanford stealing those funds.

There are several other precedents in law and other cases that back up this point of coverage that are in my written testimony. I won’t go into it exhaustively.
But, my first point is that there is coverage. Now, people can disagree about legal points, but what I’ve really been [inaud.] about isn’t simply that SIPC has disagreed, but the way they have acted again has led me to conclude that they’re not primarily focused in the right spirit on executing the law and protecting people properly covered under the law, but they’re really focused on protecting their fund and their member companies.

Let me give you some examples. The very first meeting I ever had with SIPC, the Chairman was there, top staff were there, the first concern mentioned about the Stanford case was the amount of money it would drain from the fund and the reaction of member companies to the need to replenish the fund through other assessments. That was the first thing that came out of their mouths, quite frankly, before we talked about, what’s the right thing to do, what the law says. Later, after they had dug in their heels for months and months denying all coverage, after the SEC finally acted and did the right thing, they entered into settlement negotiations and were willing to settle, albeit for far less than a hundred cents on the dollar. So, apparently, their view of the law changed if it was going to preserve more of their fund. When they couldn’t reach a settlement, they went back to court and are presently, in my opinion, dragging their feet and prolonging court action as much as possible. This includes spending $200,000 of what is there for ultimate recovery by the victims on certain discovery. This includes presently asking for more prolonged discovery, rather than getting to the heart of the issue in the legal proceeding.

You put all of that together, Mister Chairman, in my opinion, that is not a picture of an agency or an entity trying to meet its responsibility to covered victims under the law. It’s more of a picture of what would be akin to an industry trade group, or association, an active party litigant, if you will, just trying to preserve as much as they can of their resources and their fund. And I believe that’s the fundamental problem and that’s the most fundamental need for reform.

So, Mister Chairman, again, thank you for this hearing and calling attention to this important matter, including the Madoff case, including the Stanford case. I think this discussion will promote important reform. I hope, in the meantime, that SIPC still does the right thing in the Stanford case and that it doesn’t prolong the court activity and the litigation and we get to that bottom line as quickly as possible for the good of all of the victims. And I really appreciate the invitation to be here and all of your partnership on this important issue and other important issues. Thank you very much.

Mr. Garrett: Senator, I thank you for coming to join us today and speak on the first panel. I thank you also for your concern for your constituents and other constituents around the country as well for this matter. I appreciate also and thank you for your work and leadership in the Senate on this matter. As you see from the questions and by the opening statements, I think we, it is a bipartisan concern on this issue in general. And as you can see with the legislation that is here partly to be considered, you can also see that it is a bipartisan initiative as well. Still open questions as to the finality of some of these things, but I think we’re going to try to do it in a bipartisan manner.

I understand that we’re already at the top of the hour and I was told by staff that you have, as always for Senators, a commitment back on the other side of the House. So, I appreciate your coming over and appreciate accepting our invitation and look forward to working with you and the other side of the House as well on this issue.
Mr. Vitter: Thank you very much and appreciate it.

PANEL II

Mr. Garrett: With that, then we will move on to Panel II. And they can come to the table.

At the table, we will have President and CEO of what we’ve just been talking about, the Securities Investor Protection Corporation, Mister Harbeck. And also, we have Miss Bowen, the Acting Chairman of the Board, Securities Investor Protection Corporation as well.

I’ll let you get situated there.

And welcome, again, to the committee hearing today. I appreciate both of you coming, joining us to talk about this very important topic. Your completed, written testimony, of course, as always, will be made part of the full record. We will recognize each of you on the stand for opening statements for five minutes each.
Mister Harbeck? Usually, we start from left to right.

Mr. Harbeck: If you wish, I’ll begin. Chairman Garrett, Ranking Member Waters, and members of the subcommittee, thank you this opportunity today. My name is Steve Harbeck, and I am the President and CEO of SIPC.

Since the collapse of Lehmen Brothers’ entities, mentioned by Ranking Member Waters, in 2008, SIPC has been at the center of the financial crisis. I’d like to give you an overview of what SIPC has done between 2008 and the present day.

First, the guiding principle SIPC has used in this period is the greatest good for the greatest number consistent with the law. I’d like to briefly highlight some of the matters in both Madoff, Lehman, MF Global, and Stanford.

The Madoff case is the largest Ponzi scheme in history. The people who have not received funds from SIPC are those people who have either received a hundred percent of their investment back or people who must repay a portion of what they received before receiving funds. The courts have uniformly confirmed that SIPC’s method of computing what is owed to customers is, in fact, correct and in accordance with previous precedent.

I’m pleased to note that the GAO Report on Page 31 that was just issued within the last day indicates that the driver of administrative expenses in the Madoff case is asset collection for those people who have not received a hundred percent of their investment back. The Trustee has used the so-called “avoiding powers” wisely, judiciously, and effectively. The avoiding powers are precisely what makes the Trustee’s distribution in that case among innocent investors truly an equitable one. The Task Force on SIPC Modernization agreed and Exhibit B to my written statement demonstrates that SIPC doesn’t benefit from the avoiding powers, but those people who are most damaged are the people who benefit.

The Trustee has also adopted a hardship program to discontinue any avoidance suit that should be dropped given the nature of a defendant’s circumstances. It’s very important to note that no customer money is used for administrative expenses. And there has been an incredible benefit to investors.

I first appeared before this body in January of 2009. And if I had told you then that the Trustee would recover $9-$10 billion for the Madoff investors, you would not have believed me. But that is already what’s been what has accomplished to date. And the driver of the $300 million of administrative expenses is the recovery of that $9 billion.
Those who would expand the distributions to net winners in the Madoff game should recall that the distribution in a Ponzi scheme is a zero sum game. And the Trustee’s plan distributes benefits to those who have been most damaged by Mister Madoff’s theft. If other victims, and they are victims, but people who are net winners, who have received a hundred percent of their assets back, share in that fund, it is mathematically ineluctable that the people who are most damaged will suffer on a dollar-for-dollar basis.

Turning to Lehman. Lehman is the largest bankruptcy in history. And in the early days of Lehman, or under SIPC’s initiation of the liquidation proceeding, 110,000 customers received $92 billion in ten days. Second, the Trustee in that case has been extremely successful in lawsuits. He’s won $2.3 billion from Barclays Bank, settled a suit for over $700 million with JP Morgan Chase, and lastly, the Trustee scored a major victory in the Supreme Court of the United Kingdom that will benefit American investors directly.

The impartial observer closest to the case, the bankruptcy judge, states that the case has been an extraordinary success and it is coming to a successful conclusion.
In the MF Global case, SIPC acted to protect investors and did so demonstrating that we can act quickly and decisively. SIPC placed a fiduciary in charge of the firm less than 12 hours after being notified that customer protection was warranted. As I outline in my written statement, significant distributions to both commodity investors and security investors have been made.

And that brings us to the most difficult subject. And that is the Stanford case. SIPC protects the “custody” function that brokerage firms perform. Let me say that again. SIPC protects the “custody” function that brokerage firms perform. The investors in the Stanford case, unlike the investors in the Madoff case, knowingly sent their money away from the brokerage firm to an offshore bank. They were specifically told, in writing, that SIPC does not protect their investments. They each opened a bank account in a bank of Antigua. And they now seek rescission of that investment and have SIPC pay the original purchase price of their investment using SIPC and, if necessary, taxpayer funds.

Simply put, Congress never intended, and the statute has never been held, to refund the purchase price of a bad investment. That is absolutely not what the law mandates. And while there are other legal reasons as well, that is why SIPC has not initiated the customer protection proceeding for the firm.
SIPC has acted to protect and benefit investors in those three cases, but SIPC’s protections are not available to restore the purchase price of a bad investment on a CD issued in an overseas bank.

Mister Chairman, if I could mention, or if I could respond to one of your comments at the beginning of this case, you mentioned that institutional investors would receive most of the money in the Madoff case. This is a point made by Mister Stein in his written communiqué. And I think we’re failing to connect some dots here that very, very much need to be connected. Mister Stein mentions that a number of investors received zero in the Madoff case and that is quite true. So, there are thousands of investors who did not receive money. But then, when you say 75 to 90 percent of the assets in Madoff are going to institutional investors, you must connect the dots by saying the thousands of people who did not receive anything are the people who own those institutions, and they will be satisfied by distribution to the institution.

So, I wanted to make that clear so that we realize that when the indirect claimants are not paid, they will receive their proportionate share of the distribution when the funds they own receive the distribution from the Trustee.

And another point made in the written comments concerning SIPC’s actions in this case, is that the distribution was not prompt. The Trustee stands ready to make a $9 billion distribution as soon as he can, but the people who have initiated litigation to allow net winners to share in that money, have delayed that distribution. And if you don’t connect those dots, you don’t get the complete picture.

SIPC’s done a great deal, we’ve advanced $800 million for the investors in Madoff. And we think, in that sense, the process is coming to a sound conclusion.

I’d be pleased to take any other questions you have. Thank you very much.

Mr. Garrett: And I thank you for your statement. Miss Bowen is recognized for five minutes and welcome to the panel.

Ms. Bowen: Thank you. Chairman Garrett, Ranking Member Waters, and members of the subcommittee, thank you for the opportunity to appear before you today to discuss the important work of the Securities Investor Protection Corporation. My name is Sharon Bowen, and I am the Acting Chair of SIPC. Because I also served as the Vice Chair of the SIPC Modernization Task Force, I will focus on the forward-looking issues raised by that report.

SIPC was created in 1970. With some narrow exceptions, every registered broker or dealer is a member of SIPC. Membership in SIPC is automatic upon registration as a broker or dealer. SIPC is not a government agency. Its policies are set by its seven-member Board of Directors, five of whom are appointed by the President and confirmed by the Senate.

SIPC administers a fund, which is comprised of assessments paid by its members. The fund is used to support SIPC’s mission of customer protection and to finance SIPC’s operations. Should the fund become inadequate for any purpose, SIPC may borrow against a $2.5 billion line of credit from the Treasury. In its nearly 40-year history, SIPC has never drawn on that line of credit.

Every customer at SIPC is protected up to $500,000 against lost or missing cash or securities deposited with the broker or dealer for that customer’s account. Of the $500,000, up to $250,000 may be used to satisfy claims for cash only.

To date, SIPC has overseen the administration of 324 customer protection proceedings, which have involved a distribution, through 2010, of roughly $109 billion of assets for those customers. Of that sum, $108 billion has come from the debtors’ estates and $1.1 billion has come from the SIPC Fund.

Former SIPC Chairman, Orlan Johnson, promised Congress at his confirmation hearing that he would form a task force to conduct the first comprehensive review of the Securities Investor Protection Act and SIPC’s operations, since the amendments of 1978. The SIPC Modernization Task Force has completed its work, and the Report and Recommendations of the task force are attached.

The task force reached out to obtain a broad input. It conducted a live forum in New York City to receive the personal views of individual investors. It held an internet question and answer forum with investors as well. A website was also established to advise the public of the issues being considered and to solicit input from investors.
In particular, the task force reviewed issues raised by recent complex litigation. In some instances, the task force recommendations will require legislation. And others will require rule changes. And some of the recommendations can be implemented directly by SIPC. We also considered areas where we decided there should be no change.

Let me quickly cover some of the key recommendations. First, the task force concluded that SIPA should be amended to allow for inflation since 1980. In that year, the maximum SIPC advance was set at $500,000. In inflation-adjustment dollars today, that level of protection would be $1.3 million and the task force has concluded that sum should be used and should be adjusted for inflation periodically.

Second, the task force was presented with numerous cases where cash was being “caught” at a moment just before a security is purchased, or subsequent to a security’s sale, and thus was subject to a lower protection. Because these results are somewhat arbitrary, the task force has recommended that we eliminated the treatment of cash for securities.

Third, since smaller investors often have so much of their wealth in pension plans, the task force has recommended that we extend “pass-through” protection for pension plan participants that currently does not exist today.
Fourth, and what we believe was an unintentional consequence of an amendment to SIPA, some SIPC members actually had their assessments reduced. We recommend correcting this oversight.

Fifth, the task force recommended that SIPC assist in creating an international association of investor protection entities. While SIPC has memorandum of understanding with a number of these organizations, the Lehman and MF Global cases show that international issues will only increase in the future.
Finally, the task force allocated that SIPC continue to develop programs to fully educate investors about SIPC protections and limitations on those protections.
These are a few of the recommendations. I would like to take the opportunity to thank the members of the task force for their work. And I’d be happy to take any questions.

Mr. Garrett: And I thank you for your testimony. And so, I’ll recognize myself to begin with just a couple questions.

And maybe, I’ll throw it out to Mister Harbeck, but it certainly goes with the last comment that Miss Bowen was making as far as educating the investors and the like. So, Mister Harbeck, you made a comment, which was an interesting one, with regard, and I’ll bring this all around, with the Stanford case that, in that case that there was actually written notice -- well, your first comment was to the effect that the coverage and insurance, if you will, as protection is for the securities that are held by the broker. And you, in that particular case, I think you made comments just now saying the fact that actually written notice was made to the investors that they were investing and their money was going, as you put it, offshore. Correct?

Mr. Harbeck: In the Stanford case, as a part of the investor package that each investor received from the Stanford International Bank in Antigua, the investors, most of whom never gave money to the SIPC member firm at all, but some did, but all when they gave their money to the brokerage firm, the money went to the Stanford International Bank in Antigua, and that bank issued a statement saying that the brokerage firm is not liable and that SIPC does not protect the investment.
Mr. Garrett: Right. Okay. So that’s good to know on that particular case. In all other cases, or the average situation is when the investor goes into the broker’s office, there’s the SIPC logo there and the implication and whatever that comes with that as well. And I remember when we met for the first time, I guess, the comment was made is that there’s a perception that you are covered and insured, if you will, up to $500,000. I remember you saying at that time, “No, not in all cases.” So, and I think that’s the message that you’re delivering today as well from your testimony.

No, you’re not covered in, for $500,000, in all cases.

So, I guess a very seminal question here is, should we go back to the days of allowing, or requiring that people actually have the stock certificate in their hand so that they can be guaranteed that this is actually what they have, if, and if without that, you’re not really sure what you have?

Mr. Harbeck: Congressman, that would solve the problem, but that’s just not going to happen. It’s not the way the world works. Transactions are done instantaneously at this juncture and in order to physical, take physical possession of securities, I think is an impractical --

Mr. Garrett: Right. So, if -- and I would agree with you. But, if that’s the case that we can’t really be sure of what I have in my hand, as I used to in the old days, then I have to be guaranteed of something, assured of something. And, in this case, the IRS was, or in certain of these cases, the IRS is ensured of something because they see the statement, I guess it’s a 1099 or what have you, that goes to them saying this is what the dividends or payments out, so they’re assured of it. I, as an investor, hypothetically, or an investor would say, “I have the certificate” or “I have the statement saying this.” If you can’t rely on, if the investor can’t rely on the statement, what should he rely upon then?

Mr. Harbeck: The, one of the problems here, of course, is that the investors in Madoff gave discretion as to what to buy to Mister Madoff.

Mr. Garrett: Well, in any case, in any case --

Mr. Harbeck: Yeah, but it --

Mr. Garrett: -- what can I rely -- if I can’t rely on the statement, what should I be able to rely on?
Mr. Harbeck: In the overwhelming majority of instances, you can. But what you cannot rely on is that when you give discretion to someone to buy securities and he backdates statement and generates fictitious profits again and again, month after month after month, it is --

Mr. Garrett: But the investor wouldn’t know about the backdating.
I only have a minute left already. As far as discretion, I mean, we can get right to the point on this one, the discretion right now as far as in this situation, when you have a situation like this and the appointing of a trustee, is the selection, the nomination of that process is by SIPC, correct?

Mr. Harbeck: Correct.

Mr. Garrett: Would it be a better process to take that step away from SIPC and have it to a so-called neutral party, which would be the SEC, let that, let them make at least the nomination of it, so you would avert any idea whatsoever, real or otherwise, of any conflict that SIPC would have? If not, why would that be bad?

Mr. Harbeck: Well, I think SIPC has an extended body of knowledge concerning who has expertise on this, number one. And number two, that knowledge and expertise has to be applied on about an hour’s notice. The MF Global case is a perfect example of that. I --

Mr. Garrett: So, if we could set up something within SEC that they would, A, get the knowledge, and, B, have a mechanism to be able to make these things quickly, could that address most of the situations?

Mr. Harbeck: I’m not sure it could, but there’s a further reason. And the further reason is that the people who are saying that these trustees are not comporting with the law are being unsuccessful in that position in courts. It would be different if these trustees were advancing positions in courts and the courts were saying, “No, you are incorrect.” But, in Lehman, and in Madoff consistently, the trustee has upheld the law as Congress has written it. And the courts have said that that is the case. So, I don’t think there is anything broken about the process. Experts are being put in place and they are doing a good job.
Mr. Garrett: Well I -- my time has expired. I’m always mindful of my colleagues. I guess the question not necessarily is whether they are breaking the law, but whether they are, whether the intention of Congress is being fulfilled as far as how the trustee is managing the case. With that --
Mr. Harbeck: In 1978, Congressman, the Congress investigated that precise point and chose to strengthen SIPC’s ability to designate trustees.

Mr. Garrett: Thank you.
Gentlelady from California’s recognized.

Ms. Waters: Thank you very much, Mister Chairman. And let me thank our witnesses who have appeared here today to help us better understand some of the discussions about SIPC and these cases that have been mentioned here today that have played out in the press.

I want to understand -- can I get a summary of the areas where SIPC and the SEC disagree about how to resolve first the Robert Allan Stanford case?

Mr. Harbeck: Certainly. The essential dispute is that the SEC’s position is a change in the 40-year interpretation of the statute. For the first time, the SEC is saying that SIPC should pay rescission damages to people who are in physical possession of the security that they purchased. That’s never been the law, and it is not the law. And the reason that SIPC has not been involved for two years is because the SEC staff looked for instances where individuals left assets at the SIPC member brokerage firm and did not receive those assets. There is no such investor.
The investors who lost money knowingly and willingly sent their money to an offshore bank. And, saying that there is some vague connection between -- well, it’s not a vague connection. To say that there is, you can just sort of smush everything together and say therefore the brokerage firm must have had custody of the investors’ assets is factually incorrect.

The fact is, the investors got what they paid for and they were defrauded. But, SIPC does not pay that as a damage claim. These are victims, but they are not covered by the statutory program.

Ms. Waters: Well, I must say, Mister Harbeck, you make a very good case. What is the current status of SEC’s effort to force SIPC to initiate a claims procedure for Stanford’s victims?

Mr. Harbeck: The SEC delivered a letter to SIPC on June 15th of last year. Our board examined the issue very, very carefully. The board did not take the staff’s recommendation without hiring outside counsel to make sure that the staff recommendation not to start a liquidation proceeding, under these circumstances, comported with law. We did attempt to resolve the problem. We were unsuccessful in resolving the problem with the SEC. And, as a result, the SEC filed suit to compel SIPC to take action.

But we have yet to have been presented with someone who left custody of their assets with the SIPC member brokerage firm, and that’s why we feel we must go forward with the lawsuit.

Ms. Waters: Thank you very much. Let me just ask about the Madoff case. How -- can you discuss how clawbacks have been treated by SIPC as it relates to Madoff’s scam?

Mr. Harbeck: Yes, I’d be happy to.

Ms. Waters: Fraud, I’m sorry.

Mr. Harbeck: Ever since Charles Ponzi enacted his own Ponzi scheme, there have been avoidance powers that allow a trustee to reach back to people who have already received assets out of the fraudulent scheme and bring them back into a common pool. That is exactly what the Trustee has done and that’s exactly what the task force has looked at with respect to whether that should continue under the Securities Investor Protection Act. And the task force concluded that if any bankruptcy trustee has that authority and right, then a SIPA trustee, under the Securities Investor Protection Act, should have that right. And the reason is, the common pool is expanded and it, we don’t let the luck of the draw, by getting out the day before, or withdrawing profits and even your principal just before the collapse of the scheme, gives you an advantage over people who are stuck.
And so, the trustee has used those avoiding powers and by starting one particular lawsuit, he’s brought back billions and billions of dollars into this estate for distribution to the people who need it the most.

Ms. Waters: Mister Chairman, I yield back.

Mr. Garrett: The gentlelady yields back.

Mister Dold, start please.

Mr. Dold: Thank you, Mister Chairman.
Miss Bowen, even though almost 11,000 indirect investors lost their money in the Madoff fraud, not one single indirect investor was invited to be on the Modernization Task Force. Why is that?

Ms. Bowen: The task force actually was comprised of a broad group of people with expertise including two lawyers who represent investors, such as the ones you’ve mentioned. So, we felt that their voice was being heard at the table. In addition, we created a website and we had the internet forum as well. And we had a live presentation where we had an open forum in New York City. I was there at that forum. Investors showed up and they did speak to the task force. And we heard their words and we took their comments to heart.

Mr. Dold: Mister Harbeck, do you believe that President Nixon, and Senator Muskie, and the other supporters that led the 1970 passage of SIPA to provide financial relief for all investors?

Mr. Harbeck: That’s a statement of extraordinary breadth. It -- the fact is the statute as originally drafted in 1970 was intended to protect the custody function performed by brokerage firms. And that is -- we’ve been following that mission for 40 years.
Mr. Dold: Do you believe that it’s fair and equitable to differentiate between direct and indirect investors?

Mr. Harbeck: The indirect investors that you’re referring to are people who I was referring to with respect to comments to Chairman Garrett. The Trustee did not pay them, but they -- the reason he did not pay them is he will pay the institution that they owned, the feeder funds that they owned. So, if five people own a feeder fund, they will each get whatever portion they get in terms of their ownership.
Mr. Dold: And that, will that be considered a single entity? Because I know we’re talking about each individual entity has certain abilities to receive resources back. Will that fund that has five individuals be counted as one or will that be counted as five?

Mr. Harbeck: It would be counted as one. And two points --

Mr. Dold: And you think that’s fair and equitable?

Mr. Harbeck: Yes, I do and here’s why. There’s two points on that. First of all, the task force considered that and considered the fact that small investors in pension funds might well be considered your small investors that are supposed to be protected by this statute. But moreover, the big protection is not the advance from SIPC. The big protection is the share of customer property. And in the Madoff case, this is precisely what Trustee Picard is trying to expand using the avoiding powers and those funds will, if numbers hold, will receive 50 cents on the dollar, which is, was an unthinkable result, an unthinkably positive result in 2008.

Mr. Dold: I just -- I understand what you’re talking about, but I think my concern is that the assumption is that these are going to be smaller investor. Could you not see a situation where actually a group actually with a large investor is coming in and will all be now be treated as one?

Mr. Harbeck: The size of the individual investor --

Mr. Dold: Obviously there is.

Mr. Harbeck: -- is not relevant. What is relevant is whether they had a direct relationship with the brokerage firm.

Mr. Dold: Are you saying --

Mr. Harbeck: And many of the indirect people had no direct investment.

Mr. Dold: Well, are you then trying to pick winners and losers in terms of who, in determining the direct or indirect?

Mr. Harbeck: Absolutely not.

Mr. Dold: You don’t believe that there’s any difference there?

Mr. Harbeck: No, if a large investor owns a share of a feeder fund, he will get a proportionate share.

Mr. Dold: Capped at what, $500,000, is that correct?

Mr. Harbeck: No, sir. The fund itself will get $500,000 plus a share of its prorated share of the fund. And the prorated share of the fund is the lion’s share of what any investor will receive.

Mr. Dold: Mister Harbeck, let me just move on then a little bit. How does the net equity of, or the cash in minus cash out computation protect all customers of a failed broker-dealer?

Mr. Harbeck: This is the methodology that’s been used in every single case under the Securities Investor Protection Act dating back to the ’70’s where fictional statements have been involved. S.J. Salmon in 1973, Adler Coleman in the ’90’s, many cases in between. These -- the money in, money out methodology is not new to Madoff. It is historically what has always been used when brokers enter fictional transactions to benefit customers.

Mr. Dold: Thank you. I realize my time has expired, Mister Chairman, but I do -- hopefully, we’ll have another round to talk about some clawbacks, which I think is important when you talk about some of these Ponzi schemes. I yield back.

Mr. Garrett: Gentlelady from New York is recognized for five minutes.

Ms. Maloney: First, I’d like to thank you for your testimony and voice my support for the task force’s recommendation that the 500 be raised to, with inflation, to $1.3 million and to provide pass-through protection to some indirect investors. I think that was a thoughtful recommendation and I support it.

I would like to ask a question on H.R. 757. It is one of the bills that we are debating and is before this committee. And, in that bill, the last statement would be used when determining a customer’s eligible claim. As was stated, the courts have recently ruled that this standard in a Ponzi scheme is not appropriate. And that the standard that SIPC is using, net investment money in, money out, is more appropriate. And I do think that there could be some problems with this and I ask you to comment on it. And one example that came into me was investors that most use in this case -- basically, the claim could be based on fraudulent information to begin with, so if you’re using, you know, the last statement, it could be based on fraudulent information and it could be a fraud in the first place. And, for example, if you invested $1 million ten years ago and your statement says you now have a fictitious earning and that you now have $10 million, you would be treated the same as someone who invested $10 million yesterday. So, the former has $9 million in fictitious earnings, the latter had no fictitious earnings, however both are treated the same. So, if the pot of money actually in a Ponzi scheme was $5 million, each would get $2.5 million and that doesn’t seem fair because it doesn’t reflect the reality of what is behind that. I ask you to comment on that and other ideas of why you think your recommendation of money in, money out is better and that that, of course, is what the courts are saying.

But, I also would like to ask, how do you and Trustee Picard determine when it would be a hardship to clawback funds?

Mr. Harbeck: I’d like to speak to your first issue first, if I may, Congresswoman. Exhibit D to my written testimony goes through the examples of why the avoidance powers resolve the problems and actually do equity. And that H.R. 757, while well intentioned, creates actually inequitable results.

Ms. Maloney: Thank you. And though we will read that, but now could you answer how do you and Trustee, or how does Trustee Picard determine when it would be a hardship to clawback funds?

Mr. Harbeck: The hardship program is one where anyone who has been sued, under the avoiding powers, can demonstrate financial hardship and there, those are as unique as the number of individuals involved. And I think the Trustee, first of all, made a decision not to sue certain of these, of the people who received relatively small amounts, although they’re, in absolute terms to me, they’re somewhat sizeable. But he didn’t sue everyone who received more than they put in.

But when he did, he was more than willing to listen and apply a rule of reason. That’s the only way you can really describe it to a situation. It makes no sense to sue someone when they have no assets or they’re extremely elderly.
Ms. Maloney: And my time is almost up. Can you discuss the task force’s recommendation to provide pass-through protection to indirect investors and certain ERISA qualified plans, but not investors in other funds?

Ms. Bowen: Making that determination, we start at least with the ERISA plans that those trustees have a fiduciary obligation. Those were retirement funds.
We also thought that, you know, the whole purpose of SIPC is to protect the small retail investor. And, given how people invest money today, most people’s savings are tied up, frankly, into their retirement accounts. And so, we were attempting to, to address that by really limiting it to that short list of people, frankly. And not to extend it to large institutional investors.

Ms. Maloney: Thank you. My time has expired.

Mr. Garrett: Thank you. The gentlelady yields back.
Mister Hurt is recognized for five minutes.

Mr. Hurt: Thank you, Mister Chairman. I want to thank you all for being here today as we try to understand and deal with these important issues.
I had three things I wanted to cover and maybe each of you could address it as appropriate. The first is, can you give us some concrete idea of what the financial solvency of the fund is, especially with the pressures that you face in wanting to raise the maximum reimbursement or the maximum claim amount, and, I hope, also considering the fact that you want to keep these assessments as low as possible?
The second question deals with the assessments themselves. How are you dealing with the fact that, you know, a lot of these broker-dealers are part of a small, smaller outfits, smaller firms? And how do you account for the pressures that they face as small business people?

And then finally, just a general question, is, are these reforms things that will require Congressional action or are these things that you all, from your standpoint, would prefer to be able to do from within?

Mr. Harbeck: Well, let me take a attempt to answer that. First of all, in terms of SIPC’s financial solvency, prior to the start of the Lehman Brothers case, SIPC had $1.7 billion. Even after paying $800 million to Madoff investors and paying administrative expenses of $300-$400 million that have brought in $9 billion for the Madoff estate. Because we, in effect, turned the spigot back on off assessments, we now have a fund of $1.5 billion. And that is adequate to perform the statutory functions that Congress has assigned to --

Mr. Hurt: Has anything been drawn down from the Treasury?

Mr. Harbeck: No, we have never used Treasury funds. But I hasten to add that if SIPC is to be tasked with some new and radically different level of protection or rescinding bad investments as in the Stanford case, I would anticipate that the Treasury line of credit may or may not be sufficient. And we would have to assess the industry.

To your second point about assessing the smaller, independent members, I have met and other SIPC staff members have met with the National Association of Independent Broker/Dealers to brief them on these issues. And we understand the nature of the problem. They are currently being assessed at one quarter of one percent of their net operating revenue.

Mr. Hurt: Well, and if I could just interrupt. Before, it was at $150 per member. $150 annually for each member, is that right?

Mr. Harbeck: We assessed on net operating revenues through the 1990’s when we reached a target of $1 billion, we cut back to a very nominal sum. But, with the onset of the Lehman and Madoff cases, we reestablished a higher target of $2.5 billion that we would like to have on hand.

Mr. Hurt: So, what does that mean? Is there a way to characterize that as it relates to the smaller firms?

Mr. Harbeck: Yes, if we were to continue --

Mr. Hurt: In a cash number?

Mr. Harbeck: On a cash number, it’s very difficult because the, frankly, the large brokers --

Mr. Hurt: Is it 500 bucks? $1000?

Mr. Harbeck: It varies dramatically and as Miss Bowen has said, some of the very smallest brokers have now actually, inadvertently, had their assessments reduced to zero.

Mr. Hurt: Okay.

Mr. Harbeck: But, and the basic point is that we will be assessing if we continued at the current rate of one quarter of one percent of net operating revenues, we would reach our target of $2.5 billion between the years 2015 and 2016.

Mr. Hurt: And then, the last question -- well, are -- well, the last question deals with Congressional action. Is it -- are these things -- is -- are these things that you all are inviting Congressional action or are these things that you feel like you can handle with in-house?

Mr. Harbeck: I think the task -- well, some of the things can be done in-house, but the most -- changes concerning the limits of protection require Congressional action and when Former Chairman Johnson issued the task force, he requested that, and raised at the board meetings, that we do some empirical studies as to the effect on the industry and on investors before we go to Congress and ask for those changes.

Mr. Hurt: Thank you. I don’t -- my time’s about to expire. Miss Bowen, do you have anything to add to that?
Ms. Bowen: The only other thing I would add with respect to the assessments is that obviously that number’s determined based on litigation when and if it happens in time. And so, we can’t predict necessarily if there’s going to be another big failure tomorrow. But so, the concept of assessments really depends on, you know, the likelihood of litigation, the outcome. Stanford obviously would definitely be a huge problem.

Mr. Hurt: Thank you.

Mr. Garrett: The gentleman yields back?

Mr. Hurt: Gentleman yields back. Thank you.

Mr. Garrett: Mister Green, is recognized. I think you’re next.

Mr. Green: Thank you, Mister Chairman. I thank these witnesses for appearing as well. And, I do concur and believe that we should raise the amounts that investors can assume that they may acquire if there is some scheme that’s uncovered. Now, let’s focus specifically on Mister Madoff and I’d like to speak to you if I may, Mister Harbeck. Sir, is it true that Mister Madoff had with malice aforethought statements issued that were misrepresentations?

Mr. Harbeck: Absolutely.

Mr. Green: And, is it true that these statements, and I’m not sure that you’ve added them, but if you did add them, that they would total probably billions and billions more than you’re capable of paying if you pay based upon statements?

Mr. Harbeck: The -- on a money in, money out basis, the customers of the Madoff brokerage firm deposited between $17 billion and $20 billion. The final statements totaled about $63 billion. He had on-hand virtually nothing.

Mr. Green: Before going on, let me make it very clear that I’m, I really am in sympathy with people who’ve been defrauded. This is a dastardly deed, perpetrated by a criminal mind, without question. The question, however, becomes how do you
compensate these victims? And this is why I said my thoughts are somewhat ambivalent because I’m trying to do equity. I want to make sure that people can have some confidence in capital markets and confidence in, that when they go to these brokers that they’re going to get some degree of equity.

Just address it, please, given that the wide chasm between the statements and the money in, money out methodology.

Mr. Harbeck: The difficult answer, but the correct answer, which the courts came to, is that the to base the payments on the last statement is to allow the fraudulent actor, the dastardly criminal who you correctly characterized, the final say as to who wins and who loses. If you, and further, if you go by the last statement, the unintended consequence of that is you make Ponzi scheme participation a good thing. You make it a -- you make it profitable.

So, in one of the comments that I made to one of the bills, it was to create a dialogue between a fraudulent salesman and someone who, who is questioning, “Well, if this is a fraud, will I get money back?” And the answer is, “Don’t worry about that, SIPC will pay for it. Even if it goes down, even if it’s fraudulent.” So, it’s a difficult question.

But, the courts that considered it, the Trial Court, the Bankruptcy Court, and the Second Circuit Court of Appeals, came to the conclusion that, and this is not my words, this is the words of the four judges who have considered this, that it would be absurd to let the thief determine who wins and who loses, and consequently, you can’t use the last statement.

Mr. Green: Now, I concur with the Chairman with reference to the statement and to this extent, I want the person receiving the statement, the investor, to have some belief in that statement and to rely on that statement. Is there any means by which we can use technology, or somehow cross-reference, or give that person receiving the statement the opportunity to -- as an aside, are all or most of these person sophisticated investors?

Mr. Harbeck: We make the assumption that they are not.

Mr. Green: Okay. Now, they’re not sophisticated investors, how can we, perhaps with technology or some other means, give them a greater degree of confidence in that statement? Because the Chairman makes a good point. I have my statement. I’ve --

I’m relying on my statement. To a certain extent, there are other entities that rely on the statement. How can we strengthen the statement?

Mr. Harbeck: I think you’ve put your finger on it. I think technology is the answer. In this case, Bernard Madoff, acting as an investment advisor, used his own firm as the custodian of the securities supposedly held for his clients. If you divorce the custody function from the investment advisor function, as is done by most investment advisors, then the problem solves itself. Then the brokerage firm with custody has the securities. It’s a check on the system. And I think the SEC is, has located that as one of the problems in the Madoff case.

Mr. Green: Thank you. Mister Chairman, I yield back.

Mr. Garrett: And I thank you. The gentleman from New Mexico is recognized for five minutes.

Mr. Pearce: Thank you, Mister Chairman. Miss Bowen, the -- as I’m reading through Senator Vitter’s testimony, he alleges that SIPC is dragging its feet on solving the cases. Do you have a rebuttal to his testimony?

Ms. Bowen: Yeah, obviously, I think you're referring to the Stanford case.

Mr. Pearce: He’s talking also, saying he says you’re dragging your feet on the Madoff case also.

Ms. Bowen: I would say just given the outcome with the Madoff case that we haven’t been dragging our feet and we’ve been maximizing on the returns to the investing public.
With respect to Stanford, it’s a very complicated issue. We decided that we did not have the authority to change the law or to change the statute. And our reading of the statute is such that we felt we had to go to court. I believe that court has decided to be as expeditious as possible in reaching a resolution. And we’ll follow the law.

Mr. Pearce: Does the SEC agree with your position? Or SEC oppose your position?

Ms. Bowen: It opposes our position as to whether or not --

Mr. Pearce: So, they feel like it -- you -- it -- they feel like it is not required to change any law?

Ms. Bowen: I believe, again I haven’t really read their filings, but I believe they think that there is, there may be a customer who is entitled to recovery. We don’t see a customer of a broker-dealer.

Mr. Pearce: Do you all get involved at all in the nullifications up front that investors are worried about, about their investment? Do you all -- are you all notified at all? Or you just come in later as the insurers?

Mr. Harbeck: The -- well, first of all, we are not a regulator in any way, shape, or form. And, unlike the FDIC, one of the questions earlier was, you know, concerning the FDIC. We are not an insurer. And that’s in our name. We do come in, and you are correct, only after the firm has failed.

Mr. Pearce: So, are you involved in the MF Global case at all?

Mr. Harbeck: Yes, sir. We -- I was notified at 5:20 a.m. on Halloween Day that MF Global’s customers were in need of protection and one of the gentlemen in this room, who was on the legal staff of SIPC, was in court and had a trustee appointed that afternoon.

Mr. Pearce: Who notified you at 5:20 a.m.?

Mr. Harbeck: A member of the trustee -- pardon me. A member of the trading and market staff of the Securities and Exchange Commission.

Mr. Pearce: You remember the name?

Mr. Harbeck: Yes, his name was Mike Macchiaroli.

Mr. Pearce: The -- you received the SEC’s email at 7:29 on October 31st and that email set forth the basis that they thought that a settlement was going to be reached. Is that correct?

Mr. Harbeck: I think you’re conflating two cases, sir. The old -- oh, a settlement in the MF Global case?

Mr. Pearce: Okay.

Mr. Harbeck: Yeah, at 7:29 on October 31st of last year, that was a written confirmation that MF Global had failed and was in need of protection.

Mr. Pearce: Okay.

Mr. Harbeck: Subsequent to my, the 5:20 call from the Securities Exchange Commission, Mister Macchiaroli in New York. We put an attorney on a plane that day. And that day, we took over the firm or, and placed a trustee in position.
I think that demonstrates that we don’t drag our feet. We had no idea whether we had billions of dollars worth of exposure in that situation, and we did it because that was the right thing to do.

Mr. Pearce: The -- you were discussing in another circumstance about the professionals that you all contacted. Who are the professionals that you all contacted? Can you give us the list of that? And, what were their positions?
M
r. Harbeck: We contacted attorneys from Weil, Gotshal, and Manges. We contacted attorneys from several other law firms, the names of which escapes me. Several of them had conflicts of interest. And we felt that, as it turned out, that MF Global was the eighth largest bankruptcy of any kind in history, that that would be a poor time to put in someone who had no previous experience in this case.

Mr. Pearce: Do you -- let me get one question before my time is out. I’m sorry to interrupt. But, you talked about going and getting settlements from -- say people had received a payment, they had cashed in their account, and you go back and you, you’re not going to let them succeed just because they got paid out the day before the bankruptcy. Do you ever go after the personal assets of the people, the principals involved in these decisions? In other words, Mister Corzine?

Mr. Harbeck: Well, since no lawsuit’s been started against Mister Corzine, I’d rather speak to either past cases or theoretically.

Mr. Pearce: I was just using that as an example. You do go after person- --

Mr. Harbeck: We go -- the SIPC trustees are financed by SIPC to take every -- we think it’s a good lesson for people who steal money to be held accountable for it and we will finance litigation to do that and take those people down to their last cent.

Mr. Pearce: All right. Thank you, Mister Chairman. Appreciate it.

Mr. Garrett: Thank you. Mister Royce, you’re recognized.

Mr. Royce: Thank you, Mister Chairman. I guess what’s caught all our attention is, among other things, is the report of the Office of the Inspector General Office of Audits where they have some very pointed things to say about the oversight. They say, “We found that significant criticism and concern have been expressed about the amount of trustee fees awarded in the two largest liquidations in SIPC’s history, Lehman and Madoff.” Here’s what they say about that. And I’ll ask -- we’ll have a comparison up on the board in terms of the way Lehman in the UK has been handled versus the US up there, but here’s the observation from the report. “To the Lehman liquidation, SIPC’s trustee fee chart combined both the trustees and the counsel’s time, and the hourly rate ranged from $437 to $527 an hour. Moreover, the fees paid to date for both the Lehman and Madoff liquidations are a mere fraction of the amounts that will be eventually sought.” Well the fees paid to date, I think, are in the order of $600 million. And, I guess, my question is the same question that the Office of Inspector General is getting to, and that is, do you believe the $600 million-plus in legal fees is reasonable?

Mr. Harbeck: Yes, sir, I do.

Mr. Royce: And then, let me ask you, if this is reasonable, what would you deem reasonable for a completed Lehman liquidation? Because, as they point out again, again “it’s a mere fraction of the amounts that will eventually be sought…significant work relating to customer claims with pending litigation remains to be done.” Now, this is after three-plus years. And, of course, they point out that they would like additional oversight, that they would like SIPC to negotiate with outside court-appointed trustees more vigorously to obtain a reduction in these fees.

So, they’ve got a little different take than this, on this than you do. What do you think the final cost will be?

Mr. Harbeck: The cost estimation for Madoff case in administrative expenses is $1 billion. To date, I believe somewhere in the vicinity of $400 million has been expended in legal fees.

Two important things to note. One, not one penny of that came from customers or diminished customer assets. SIPC paid for it all. So, SIPC paid for the litigation, which drove, which the GAO Report, which was issued yesterday or today, indicates brought in billions and billions of dollars in the Madoff case. Customers haven’t been diminished in any way, shape, or form by that.

Mr. Royce: I understand that.

Mr. Harbeck: As to the Lehman Brothers case, there is, this is the largest bankruptcy of any kind in history. And what I would refer you to in terms of the person closest to the facts on the legal fees is Bankruptcy Judge Peck in New York. And I’ve included in my written statement his comments at the Chapter 11 Confirmation Hearings where he says the case is coming to an unbelievably successful conclusion and that he congratulates all of the professionals involved.

So, I -- my God, the hourly rates these people charge are staggering. Everybody knows that. But, in that one instance, with, and I’m familiar with that, the SIPA trustee did an outstanding job and I think the fees are reasonable.
Mr. Royce: Well, one of the unique situations here is that we can compare and contrast with a situation in the UK. And, in terms of return of customer assets, you’ve got a situation in the UK, where of the $21.8 billion of client assets, $20 billion was returned. In terms of settlements with foreign affiliates, in terms of the UK, you have a situation where they have settled with US affiliates, with Lehman Hong Kong, with affiliates around the world, that process hasn’t gotten underway here.

In terms of general unsecured estate, in the UK they’ve resolved the majority of its unsecured claims, whereas in the US, they’ve yet to review unsecured claims.
B
ut, most importantly is the fees. And you look at the difference, and you look at the timeframe, three-plus years versus what’s occurred in the UK, and it truly grabs one’s attention in terms of the cost, but also the criticism of the Office of Inspector General brought to process about the oversight and the way in which we’re conducting this, and especially the way in which, you know, you’re down to two firms doing some pretty major work. Or one firm is handling MF Global and Lehman simultaneously, reportedly in the financial press, that is causing some backlog in terms of the ability to push this through. I’d like to get your response.

Mr. Harbeck: If I could respond.

Mr. Royce: Yes.

Mr. Harbeck: Actually, the fact that the Trustee in the Lehman Brothers case and the MF Global case has leveraged their work incredibly well. The Lehman Brothers Trustee just won a case for American investors over Lehman Brothers, Inc. Europe before the Supreme Court of the United Kingdom last week. And the exact same issue arises in the MF Global case. This is an example of picking a veteran staff and a veteran trustee who knows what they’re doing and does it well.

Mr. Royce: I’ll close with this. Reportedly, part of the problem in terms of making progress is that you’ve got people pulled off of one case to work on the other case because you’ve got one firm.
But my time’s expired.

Mr. Harbeck: I can speak to that. I asked that exact same question on the morning of October 31st to make sure that the Trustee’s staff would not affect either case. I was assured that it would not and our supervision of the case indicates that it has not.

Mr. Garrett: Thank you. Gentleman from Colorado. And then you’ll -- you’d like to come back to you? Sure.
What’s then -- gentlelady from New York then.

Ms. Hayworth: Thank you, Chairman. If we could just leave that slide up for a moment. And, Mister Harbeck or Miss Bowen, I am intrigued by the difference in the, in the differences between the two columns. To what do you attribute -- is there a matter of the laws being different in the UK? Or, how does --

Mr. Harbeck: It’s apples and artichokes. They’re just not comparable. The size and scope of the operations are incomparable, the laws are different, the administration of bankruptcies are different. The fact that they both have the name “Lehman Brothers” is the reason they’re both in the same chart.

Ms. Hayworth: Understood. Now, is there something that we can use from the UK -- I mean, it, although two different entities, it’s obviously the Lehman Brothers applies to two different entities, but is there something we can take home from that as legislators in terms of our approach to these kinds of problems.

Mr. Harbeck: Well, let’s think about Lehman Brothers and MF Global, and the Dodd-Frank Act. I think the eighth largest bankruptcy in history was not a Dodd-Frank event. And that’s a good thing. So, the fact is I think the system works, it is an expensive system. Bankruptcy is an expensive process in financial institutions. But by and large, the system is working in the United States.
The, again, the Lehman Brothers Holding bankruptcy judge comments on this case really strike home for those of us who have been living with that situation for several years.

Ms. Hayworth: In terms of Madoff, I’ve met a couple of folks who’ve been directly affected by the Madoff situation. Is there any shred of hope we can offer people who --

Mr. Harbeck: Well, that’s --

Ms. Hayworth: -- trusted their Madoff accounts and --

Mr. Harbeck: Well, one thing that the Trustee has run across when he has sued financial institutions saying that those financial institutions knew or should have known of

Madoff’s problems, he has been running into a defense that he does not stand in the shoes of all of the individual customers. I think he does under the law. Some courts have held to the contrary. If we get some clarity on that, then SIPC could use its funds to set, to prosecute lawsuits against entities that should be held financially responsible and that would benefit customers at no expense to them.

So, if the courts do not see it our way, perhaps legislation to give the Trustee an overruling of old, old case called Kaplan versus Marine Midland would be a tool in the Trustee’s [inaud.] that he could use to benefit investors.

Ms. Hayworth: Miss Bowen, any --

Ms. Bowen: Nothing to add to that, no.

Ms. Hayworth: Thank you. Mister Chairman, I yield back.

Mr. Garrett: Well, the gentlelady will yield to me.

Right. Just a couple quick points. On the point that Mister Royce was raising, or, and Nan was raising as far as the two entities, UK and US, if you convert these to dollars, are they the size of the assets, are the bulk of these companies apples and artichokes? What are the --

Mr. Harbeck: No, I think -- I think the answer to your question is the overwhelming majority of assets were in the United States. For example, SIPC, the Trustee, transferred $92 billion in the first week. And the wind-down of the other assets, the non-liquid assets, is being conducted in the Chapter 11 proceeding of Lehman Brothers Holding.

Mr. Garrett: I understand that.

Mr. Harbeck: Not the liquidation of the SIPC member firm.

Mr. Garrett: Yeah.

Mr. Harbeck: But it’s much, I think the American entity is larger by a factor, I don’t know the factor sitting here, no.

Mr. Garrett: All right. And as long as there’s time. So, part of your position is as well the, that SIPC has done such a tremendous job, your point of saying, well, $9 trillion (sic) at, now, I guess, at a cost of a billion dollars in fees in this particular case, ballpark figure.

Mr. Harbeck: But that’s projected out into the future, sir.

Mr. Garrett: Right. But, I mean, out of that $9 billion, isn't the bulk of that just through one case? I mean, the very great case. The Jeff Picower matter. There was net equity in that case of my understanding on Madoff’s books, basically saying, “Hey, you really owed this money back to us,” meaning Madoff from Picower. So, that’s 99% of that net equity, in the bulk, was from the Picower case. And that was around a little over $7 billion, is that right?

Mr. Harbeck: The overwhelming majority of it was, absolutely.

Mr. Garrett: So it --

Mr. Harbeck: But the Trustee is not done yet, sir.

Mr. Garrett: Right. So, but when you -- yeah, you have $200 million on top of that, I guess from the kids of the Picower family, which is all good. But, I mean, but to come and say, “Well, we spent a billion bucks,” which, as you agree, is amazing fees, $500 or so an hour. That’s good work if you can get it. I used to be an attorney. I billed at, I guess, a tenth of that or so, or a little more than that. But, yeah, so out of the $9 billion when you came here, I thought, at first I thought, “That’s great,” but, you know, seven-plus billion dollars of that is one case and the other -- so, a little over a billion dollars comes from all the rest. So, I guess, you would have to put that in perspective as to exactly what the trustee has accomplished. But for that case, you’d be spending a billion dollars to get about $2 billion.

Mr. Harbeck: And the answer to your, the answer to your point is we’re not done yet.

Mr. Garrett: Well, I think --

Mr. Harbeck: The Trustee hopes to get back, he hopes to get back 100 cents on the dollar. Will he do that? I don’t know.

Mr. Garrett: And I guess -- and that’s -- that’s the concern.

Mr. Harbeck: But, if you say, I think if you said to anyone from any source that you were going to get back $9 billion --

Mr. Garrett: Right. We keep going back to that, yeah. But we never knew the Picowers were out there and there was a negative equity that there, out there that one individual had. But, and we -- and this is when you say, “They’re not done yet,” and there is the rub, there is the concern is that they’re not done yet. There’s probably not that many more Picowers, if I’m saying the names correctly, out there anymore, so the rest are going to be the smaller ones, the rest are the other people that we’re concerned about in this panel, and that is, or some of us are concerned on this in this panel, are going back to those people who, as Mister Green was saying and shares with me the concern, all they did was rely upon what was sent to them. And, to your comments that that makes power, makes Ponzi schemes a good thing, only if there’s the intention of, or knowing that that’s a Ponzi scheme.

But I’m going over my time. If the gentleman is not ready from Colorado yet, then Mister Stivers is recognized for five minutes.
Mr. Stivers: Thank you, Mister Chairman. My first question is for, I think it’s probably Mister Harbeck, although probably both, maybe both of you could answer this one. What would the impact on the SIPC Fund be if every indirect investor expected to receive SIPA coverage?

Mr. Harbeck: At the start of the case, at the start of the Madoff case, we made an effort to tell every person who thought they even remotely was damaged by the Madoff case to file a claim. Thousands of people did so, who had, who didn’t even know that they were invested in Madoff. Some of the people who have testified in front of this body bought a feeder fund that bought a feeder fund that bought a feeder fund that bought Madoff and said that they were an indirect investor. So, that’s like throwing a ping-pong ball into a bunch of mousetraps loaded with ping-pong balls. I couldn’t possibly tell you what the cost would be because the cost would be capped at the net equity of $17 billion, assuming that they were all owed by feeder funds.

But, the relationship between broker and customer is really, it’s -- that’s not -- that’s the one part about this that isn't rocket science. “Did you open an account? Yes?
Okay. If you didn’t open an account, you’re not going to be a customer.”

Mr. Stivers: Miss Bowen, do you have anything to add to that?

Ms. Bowen: No, I don’t.

Mr. Stivers: Well, do you say -- do either of you think that SIPC has a responsibility to warn customers about possible signs of fraud or conduct that might indicate fraud?

Mr. Harbeck: Whether we have an obligation to do so or not, it’s a good thing to do and Miss Bowen has recommended and championed on the task force an investor education program. I’ve been doing what I would call “dog and pony shows” with members of the North American Securities Administration Association on fraud. And I have in the back of my mind a program that I want to use at Walter Reed Hospital because you’d be surprised at the fact that people will steal money from entities. And the, you know -- I, I’ve seen enough different kinds of these schemes. I’ve been doing this for 35 years. And I’ve seen enough of these things to put together a program where we could say these are some red flags that you should have. And, actually, I enjoy doing that.

Ms. Bowen: So, I would add to that to that with the task force we did have some securities regulators who were part of our task force. And we’d talk about --

Mr. Stivers: Was it the SEC or FINRA, or who was that?

Ms. Bowen: Well, Mister Borg is here from Alabama.

Mr. Stivers: Oh, so state regulators. Sorry. Thank you.

Ms. Bowen: Yes, state regulators. And so, we talked about having forums, maybe throughout the country, you know, to get the word out. And also, to, frankly, if there’s a way for us to work with the SEC and FINRA to maybe change the language that’s in the broker statement, although we know, frankly, that’s, that may not solve the problem in terms of education.

And then, part of what the task force did recommend that we have a person dedicated to investor education who would work with us to figure out a way to get the word out much more effectively.

Mr. Stivers: Right. Do either of you think that SIPC should be empowered to conduct spot audits to ensure that cash and securities are really in the custody of broker-dealers?

Mr. Harbeck: The an-, the one-word answer is no, but I’d really like to explain why.

Mr. Stivers: You got a minute and six seconds.

Mr. Harbeck: There are five levels of review of that issue. The internal auditor at the brokerage firm, let’s assume he’s corrupt. The outside auditor, let’s assume that that auditor is either corrupt or incompetent. A state audit, a self-regulatory organization audit, and the SEC. If you added SIPC as a sixth, SIPC would have to hire the experts who are already doing it. And I’m not sure that we --

Mr. Stivers: Can I do a quick follow-up on that?

Mr. Harbeck: Sure.

Mr. Stivers: Like, in Madoff’s case, he was not covered by FINRA, so he wouldn’t have had an SRO, he would have only had an SEC, and they actually do it once every 10 years for firms of his size?

Mr. Harbeck: I don’t believe you’re correct, sir. I believe he was -- every brokerage firm is a member of a self-regulatory organization. It’s required.

Mr. Stivers: Okay.

Mr. Harbeck: So, yeah, FINRA did not find this, nor did the SEC.

Mr. Stivers: I yield back the balance of my time, Mister Chairman. Thank you.

Mr. Garrett: The gentleman yields back. Gentleman from Colorado is ready and recognized.

Mr. Perlmutter: Thanks, Mister Chair. And thanks to the panel. I guess, let’s just sort of -- and I know you have broken it down into two categories. You got the situation where it’s a fraud from the outset or more or less a fraud, insolvent as a result of it being a fraud, and then it’s insolvent as a result of things falling apart, it wasn’t a sham to begin with.

Well, let’s deal with the fraud one first, the Madoff, the Stanford, the Peters or Petters, whatever they’re called. In Colorado, we had a number of investors who invested in, you know, Company A that invested in Company B that then invested in Madoff, or Stanford, or some other Ponzi artist. As I’m looking at the recommendations of the task force, those in-, you know, everybody calls them “indirect investors” are sort of out of luck based on the law today, the SIPC law today or the task force recommendations, except for those that might be pension plan. Am I right? Wrong?

Ms. Bowen: That --

Mr. Perlmutter: And I’m asking both of you, so.

Ms. Bowen: Yeah, that’s correct. That is the recommendation.

Mr. Harbeck: Sir, if I could elaborate, though. The indirect investors will share, and I believe in my written comments I speak to this specifically because I know this is of particular concern to you, if you take a look at Exhibit B to my written comments, it is a letter that I wrote to you and to Congressman Ackerman to make sure that when we settle with one of those feeder funds on a preference of fraudulent transfer, that the money flows directly through to the indirect holders.

Mr. Perlmutter: Okay. But, I guess, I’m just trying, from a policy standpoint, to understand why the pensioners -- and, you know, and they’re a sympathetic, obviously a sympathetic group. I think the firefighters lost some money or their pension initially was in the Madoff mess. So, why the pensioners? I mean, I, I guess I’m happy if they get it, but I’d like to see others, indirect investors, be entitled to some recovery directly from the fund. What’s the policy distinction you all make?

Ms. Bowen: I can -- one of the things we considered is the fact that, with the pension plans that we suggested was the pass-through, there is already a level of fiduciary obligation under ERISA. You know, so we spoke to that level of protection, that they will -- gave us some comfort. If you’re talking about people who may invest in a hedge fund, for example, we wouldn’t be privy to what the, you know, what their arrangement is in terms of, you know, they may have been invested in a huge hedge fund in Connecticut.
Mr. Perlmutter: And I guess what I’m saying -- and Mister Harbeck, I understand you’re sort of black and white position that you know who’s opened an account with Madoff. You can go back, you know, so and so, so and so, and so and so. But, the reality of how the system works these days is that you’re going to have -- or, at least in that instance, and I think in many, you’ve got a number of different investors who invest in Company A, who then conglomerate into Company B, who then Company B invests with the Madoff, with the broker-dealer. So, I understand your wanting to have a black and white line there, but that’s not how it works. And the guys who are really getting clobbered are these, the little investors back here and the indirect investors.

Mr. Harbeck: Again, if you focus on the common pool of assets known statutorily as customer property, that’s where the lion’s share of any customer’s assets is typically restored. Not the advances from SIPC. So, typically, the person who is an indirect holder will not be clobbered because the entity that has the account will get, typically, not in Madoff granted, but typically, that entity will get a large share of its assets because, typically, and here I find myself reluctantly, very reluctantly, defending the SEC, they usually find these things at a point where the amount of missing assets is small. And that means that the common pool of assets is in the 95, 98 percent range.
In Madoff, there was an egregious failure that proves that rule. So, ordinarily, the entity would receive a substantial portion. There have only been, prior to Madoff, somewhere in the vicinity of 350 customers, entities or any kind, whose claims were not 100 percent satisfied. Individuals, entities, whatever. And the total amount that those claimants did not receive, again this is prior to Madoff, was somewhere in the vicinity of only $47 million.

So, I am not sure that, you know, pounding the Madoff issue is the reality for most people who get caught in one of these unfortunate situations.

Mr. Perlmutter: Thank you. And, Mister Chair, if I could introduce, if it hasn’t been already, the letter dated March 2nd, 2012 from the Agile Fund’s Investor Committee.
Mr. Garrett: Without objection.

Mr. Perlmutter: Thank you.

Mr. Garrett: And the gentleman yields back. [inaud.] Cassidy?

Dr. Cassidy: I just want to first thank the Chairman and the Ranking Member for allowing me to ask questions.

Mr. Harbeck, I am not a securities attorney, I am a doctor. So, your knowledge greatly exceeds mine and if I say something stupid, it won’t be the first time, it won’t be the last, and please forgive me. That said, let me first ask, was there a settlement offered by SIPC to SEC on behalf of the Stanford victims?

Mr. Harbeck: There were settlement discussions, yes, Doctor.

Dr. Cassidy: And was one offered?

Mr. Harbeck: We made an offer, but I would hasten to add that I won’t go into the details on that.

Dr. Cassidy: That’s fine. That’s fine. But the fact that you offered, even though you categorically deny the rationale for your testimony, gives me a little bit of a pause regarding your testimony. Secondly, let me ask you this. There -- it seems as if you have two objections to SIPC extending coverage. One, that SIPC does not cover losses of an investment. And two, the custody issue.

So, let me take the first. You quoted a court case earlier in your reply to Mister Green, clearly you’re an attorney, you defer to court. Do you disagree with the Fifth Circuit Court, which found that a Ponzi scheme is, as of a matter of law, insolvent from the inception, that the value is fictitious, there is no value to lose because the value is not there at its inception? Do you disagree with the Fifth Circuit?

Mr. Harbeck: The fact that it is insolvent from the initial moment does not detract from the fact that the instrument received by the Stanford people was a real Certificate of Deposit issued by --

Dr. Cassidy: It was a --

Mr. Harbeck: -- issued by a real bank in a real country that is in a real --

Dr. Cassidy: Let me finish. It is a piece of paper, all agree with that, but whether or not the value is real or fictitious seems to be the point. And the fact that it’s insolvent at inception suggests that the value is fictitious. And I would just make that point and we, you can hash that out in court. But I --

Mr. Harbeck: The other thing I’d like to say, Doctor, is this matter is in litigation.

Dr. Cassidy: I understand that. But one other --

Mr. Harbeck: And, and I --

Dr. Cassidy: And I think --

Mr. Harbeck: -- I’m constrained by that.

Dr. Cassidy: Your testimony written and spoken really went after this case as if it were in case, and I think it’s important on behalf of the victims, to make the counter-argument, if you will. So, if the first point is that indeed the value is fictitious and there may not have been value to lose, let’s move to the second regarding custody. Again, knowing that you’re an attorney and that you’ve previously quoted court cases in reply to Mister Green, you spoke earlier about how you would have to fold in these different entities in the Stanford Financial Group to, if you will, give the Stanford victims standing. And yet, there is a US District Court for North Texas that said that the Stanford International Bank and Stanford Financial should be collapsed together. That, indeed, that they should be folded. And it is, again, a fiction to pretend that they are different. Now, that affects, and my understanding -- again I’m a gastroenterologist, what do I know? Although, I feel like I’m kind of in the sweet right now.

What, what -- that would not give them standing as a customer?

Mr. Harbeck: For a wide variety of legal reasons, the answer is no. Among other things, the independence of the entity in Aruba has been recognized in several other countries, separate, who have not turned over assets to the receiver in Texas.

Dr. Cassidy: Now, let me just point out, though, that the Stanford Group Company was broker-dealer registered with Commission and a SIPC member, that both that and the Stanford International Bank, Limited were wholly owned and directed by Stanford, that the Stanford Financial Group was a brand name under which STC, SIBL, and others operated to give credibility to SIBL, and that domestic clients purchasing Stanford International Bank, Limited CDs dealt substantially, if not exclusively with Stanford Group Company brokers. And that some SGC’s, if you will, accountholders received consolidated statements from SGC regarding their Stanford International Bank loan investment.
I can go on, but I think I’m making the point. It does seem as if there is a case for them to be folded together. As the North Texas District Court suggests, this would be the one to do so. Then I just kind of go on for a couple other things because I’m almost out of time, I apologize. I have to admit, you give the hypothetical of well, you have a salesman that says, “Go ahead, invest in the Ponzi scheme and you will be covered,” and I have to say that there isn't a victim yet who I have learned would have invested in this Ponzi scheme should they have known it was a Ponzi scheme.

Now, I will just frankly dispute that and the idea that somehow, “Don’t worry, you give your $500k to us and we’ll cover it on the backside,” forget the fact that you’ve lost the investment value of the period of time it’s with them. I will just make that point.
But, one last thing, since there was a settlement offer, and since there has been discussion as to the amount of money it would cost for such a settlement, can you give us the cash figure that SIPC thought would be involved in such a settlement?

Mr. Harbeck: No, sir, I will not. That is a matter in litigation.

Dr. Cassidy: But I will presume because you are a fiduciary agent, it would not have been one that would have broken the bank and I think that point needs to be made.
You’ve been generous with your time. I yield back. Thank you.

Mr. Garrett: I thank the gentleman. All questions have been asked. No, strike that. All members have been, had the opportunity to ask questions, but a couple members have asked just for follow-ups. So, what we thought we would do is just put five minutes on either side to split however the members want to on either side. And -- oops. I reclaim that false statement. And we’ll start with the gentleman from California for his five minutes.

Mr. Sherman: Last and, probably in this case, least, what is the financial position of SIPC and how is that affected by how you determine whether the Madoff investor is, when pooled, is eligible for one $500,000 limit or several?

Mr. Harbeck: We didn’t take SIPC’s financial situation into consideration in the slightest in making those determinations. Those determinations are made by the law. The laws --

Mr. Sherman: Yeah. No, not that -- I’m asking a financial question, I’m not asking for legal defense. What’s your financial position assuming your position on the Madoff claims is upheld by the courts as I’m sure you think it will be.

Mr. Harbeck: Our financial position would be that we’ve already paid all of the customers who are entitled to protection. We've paid every --
Mr. Sherman: So, what’s the net worth of SIPC right now?

Mr. Harbeck: $1.5 billion.

Mr. Sherman: And that’s after paying all of the Madoff claims?

Mr. Harbeck: Correct.

Mr. Sherman: And if you were to lose on the arguments that have been raised for Madoff, how far under water would you be?

Mr. Harbeck: Which arguments, sir? There are several.

Mr. Sherman: The argument that each participant in a pool is a separate investor.

Mr. Harbeck: I’ll preface this by saying we’ve never lost that issue.

Mr. Sherman: Right.

Mr. Harbeck: And I believe it -- the outside is $17 billion because that would, you know, I assume --

Mr. Sherman: That would be the pool of -- yeah.

Mr. Harbeck: -- that all, everybody would get paid 100 cents on the dollar.

Mr. Sherman: Okay. And do you have different rates for, in effect, what is insurance based upon whether the securities are being held in one of the generally accepted depository houses or whether they, the member of SIPC just says, “Hey, I got a safe in the back room”?

Mr. Harbeck: First of all, since it’s almost all done electronically now, almost all securities positions are held at a common facility, such as the Depository Trust Corporation or something like that. But, we have tried, and many members have proffered the fact that our kind of brokerage firm poses less risk. And every time a group of brokers says that, I can come up with an example of -- well, large firms --

Mr. Sherman: So, you charge the same amount for --

Mr. Harbeck: We charge the same amount for everybody. It doesn’t work --

Mr. Sherman: What portion of your members do the, “we've got our own safe” approach rather than using one of the established depository --

Mr. Harbeck: I don’t think it’s possible to go back to the days of the 1960’s where --

Mr. Sherman: Well, I mean, Madoff did it.

Mr. Harbeck: Well, no, Ma- -- oh, I see your point.

Mr. Sherman: Yeah.

Mr. Harbeck: I --

Mr. Sherman: If Madoff had had all his securities --

Mr. Harbeck: Many brokerage firms, you know, self-custody positions, but, in turn, the positions should be reflected at the Depository Trust Company, DTCC, and, in Madoff’s case, if any examiner had bothered to check between the positions shown on Madoff’s records and what was in DTTC (sic), they would have dropped dead on the spot.

Mr. Sherman: If anybody had bothered to notice that he had an audit letter from a one-person CPA firm on a $17 billion balance sheet, that would have been caught, too.
But I yield back.

Mr. Garrett: The gentleman yields back. And seeing no one else coming in at the last moment, we will then go, just close with five minutes, if there is five minutes of questions on either side to be split up. I’ll begin with gentlelady from New York and then Mister Pearce and then Mister Stivers.

Mr. Pearce: Thank you, Mister Chairman. The -- you’ve brought almost a thousand clawback suits. How many of those were against institutional investors?

Mr. Harbeck: I don’t know the answer to your question or the percentage. They -- it was done specific --

Mr. Pearce: Do you ever bring clawbacks against hedge funds or the big guys?

Mr. Harbeck: Oh, absolutely. And, in fact, if I could speak to your question and simultaneously to a point made by the Chairman, many of the clawback suits are in sums that, in the hundreds of millions of dollars that have been settled.

Mr. Pearce: The one speculation is that -- well, the Trustee has said that 75 percent of the property that’s going to be distributed to institutional investors in the Madoff case. What happens to all the little guys?

Mr. Harbeck: That statement was made by, I believe, Mister Stein in his written statement. The Trustee is going to distribute the money pro rata in the --
Mr. Pearce: No, I understand, but what happens to the little guys?

Mr. Harbeck: If there’s a claimant who is owed, regardless of the nature --

Mr. Pearce: So, the big guys get protected and the lawyers get 500 bucks an hour and make about a billion bucks.

Mr. Harbeck: No, sir, everyone gets the same pro rata share.

Mr. Pearce: And you give 75 percent to the big guys, it looks like the little guys are going to get left out, but I suspect I’ve used my minutes there, Mister Chairman.

Mr. Harbeck: No, sir, I’d like to respond.
Mr. Pearce: Let me --

Mr. Harbeck: If I may.

Mr. Pearce: Let me --

Mr. Harbeck: Every customer gets --

Mr. Pearce: The Chairman owns the time, sir.

Mr. Garrett: Yeah, let me go to the gentlelady from New York first. Do you have any other questions for them Mister Stivers since --

Mr. Stivers: Thank you. I have one quick follow-up because when I was talking to Mister Harbeck about the Madoff portion, I believe Mister Madoff had two sides of his business. He had a broker-dealer side and an investment advisor side. And most of the problems were in the investment advisor side, but that’s the side that’s not regulated by FINRA and you indicated that his entire business was regulated by FINRA, or at least gave that impression, and I just want to make sure everybody in the room, and everybody that might see this, understands that the investment advisor side was not regulated by FINRA and that’s where most of the losses were. Is that correct?

Mr. Harbeck: No, sir, because the custody of the assets would have been at the brokerage firm and that should have been discovered.
Mr. Stivers: The brokerage firm had the custody of the assets, but it may or may not have had the custody of the assets.

Mr. Harbeck: It did not, that’s the entire problem.

Mr. Stivers: But that’s the point, it may or may not have in the first place.

Mr. Harbeck: But FINRA --

Mr. Stivers: There was no requirement that the investment advisor firm keep all of its assets at that broker-dealer firm, was there?

Mr. Harbeck: No, but they did.

Mr. Stivers: Okay. Well, if it’s -- well, but there was no requirement, so therefore they could say, “Well, they’re, we got them somewhere else.” And FINRA doesn’t -- you have to -- there’s too much coordination required and FINRA, you know, doesn’t have the ability to look at everything, so they’re looking at the broker-dealer side of the business and, you know, maybe they missed some stuff, but the whole point is there’s not really an SRO on all of the Madoff business, is there?

Mr. Harbeck: No.
Mr. Stivers: Thank you.

Mr. Harbeck: Okay.

Mr. Stivers: I yield back my time.
Mr. Garrett: Mister Green?

Mr. Green: Thank you, Mister Chairman. When the individual investor makes an investment through an institution and that institution benefits from the common pool of assets, does the institution that benefits from the common pool of assets receive instructions as to how it is to distribute the funds to the individual investor?

Mr. Harbeck: That’s done by contract between the individual investor and the fund. But, in response to Congressman Perlmutter’s concerns, when we have settled, when the Trustee, rather, has settled with a fund, perhaps on a fraudulent transfer or preference, thus allowing the fund to share in the pool, one of the things that we, the Trustee has done is as part of the settlement get an agreement from the fund that the money flows straight through to the individual investors.

Mr. Green: Thank you. I yield back to the Chair.

Mr. Perlmutter: Thank you. And, you know, I think the, sort of going back to the preference fraudulent transfer piece of all this is, question is, let’s say I put $100 in, I get, to a fraud, I get 50 bucks back, so I’ve still lost 50 bucks. Somebody else puts $100, they get nothing back because they were the last guys in the game. Question is, I’ve, I’m out 50, but I got 50 more than the other guy who got robbed. So, the question is should we all get robbed equally? And I think that’s where this clawback stuff comes in and the policy behind the clawback. As we do these preferences, let’s say Tremont settled with the Trustee, recovers all sorts of money, goes to Tremont -- and when I’m looking at your letter, and I thank you for your letter of September 11th actually, or September 30th, how will my, all these investors from Colorado know that if they’re going to get treated proportionally as to Tremont’s share?

Mr. Harbeck: We don’t.

Mr. Perlmutter: In terms of the preferential or fraudulently transfer recovery.

Mr. Harbeck: Oh, well, once -- the way it works is Tremont would have returned a preference or fraudulent transfer to the Trustee, thus enabling them, freeing up, if you will, the entire amount of their valid claim. To -- in the settlement of that preference, the Trustee said that he would only enter into this settlement if the, if Tremont or the other entities similarly situated would agree that regardless of any contractual commitments between the individual investors and the fund, that they would pass the money straight through. There are -- you’ve demonstrated one of the harsh, hard problems of, you know, what happens when somebody pulls out of the fund itself, not out of the Madoff case? And all of that has to be done at the level where the books and records are for that particular fund.

Mr. Perlmutter: Thank you.

Mr. Garrett: The gentlelady from California.

Ms. Waters: Thank you very much. Miss Bowen, I see that you have described to us your work with the task force and I’m looking at Recommendation Number 3, “Protect Participants in Pension Funds on a Tax-Free Basis”. And I happen to have a communication here from Colorado, from one of your constituents, was to -- and, let me just read it to you. “My name is Peter J. Leveton. I live in Lakewood, Colorado, a Denver suburb, in Congressman Perlmutter’s Seventh District and I’m a direct investor victim of the Bernard Madoff investment securities Ponzi scheme and a Co-Chairman of the Agile Funds Investor Committee of the Agile” -- is it Agile? “Agile Group, LLC, Boulder, Colorado.

In December, 2008, Agile had 205 investors and managed three primary hedge funds. The group and its fund are currently in liquidation.” Now, listen to this. “A large portion of Agile’s funds under management were invested by Agile into wide, select broad market prime funds, prime funds, managed by Tremont Holdings, Incorporated, or Tremont Group and invested by Tremont with Madoff BLMIS. Tremont is a subsidiary of Oppenheimer Funds, it’s separate subsidiary of Massachusetts Mutual Life Insurance Company.” I’m trying to read this so I can get it all in very fast. Is this what you’re referring to when you’re rejecting the idea of pass-through to all who would claim that they should be considered for protection?

Ms. Bowen: Yes. You mean outside of a pension, we would say other indirects would not be entitled, would not be using direct customer relationship in that case.

Ms. Waters: What moves me about this is, he goes on to say, “Many of us placed a lifetime of savings in what we believed were safe investments, but were ultimately invested with BLMIS often without our knowledge. Many of us are now devastated financially and psychologically. So many of us have sold or are trying to sell our homes just to obtain money to live on without becoming wards of the state. Many of us in our sixties, seventies, and eighties and have been retired but have had to or are attempting to go back to work.” On and on and on. The pension funds that, where you have a protection, they’re more sophisticated and, of course, they should have a lot more knowledge about investment. But, these people who appeared to have invested in some small entities who were managed by other entities, that were managed by other entities, had no idea this was going on. So, do you feel that they have no right to some kind of protection?

Ms. Bowen: I do empathize with them. They obviously have recourse against, you know, the [inaud.] in this instance. But, SIPC is not, was not really created to reimburse victims such as that, you know, who unfortunately suffer because they put money into the wrong place. It’s really unfortunate, but that’s not what we’re entitled to do.

Ms. Waters: All right. Given that, I understand exactly what you’re saying, but, for those who are members of SIPC --

Ms. Bowen: Mmm-hmm.

Ms. Waters: -- are they advised or told, or any regulation, or rule about who they represent and how many they represent and who these people are? I mean, what’s the responsibility of SIPC to the, their members who are covered?

Mr. Harbeck: I’m not certain I know what you mean unless you’re talking about the Agile to Rye, the Tremont situation, something like that?

Ms. Waters: Yeah. I am talking about this situation.

Mr. Harbeck: Well, you know, the fact of the matter is, there would be no way for SIPC to know what those relationships --

Ms. Waters: I know and that’s my question. In your task force review, did you consider this aspect of it that you have your members who don’t -- I mean SIPC would not know the relationship of the members that are protected to all of these other entities that are involved with them.

Ms. Bowen: Yeah.

Ms. Waters: Was that considered?

Ms. Bowen: It was considered by the task force and we did hear from investors, such as the one that you mention. We also, with some of our participants on the task force, particularly the state securities regulator, rightly pointed out, you know, there are Ponzi schemes and frauds that occurred throughout their state all the time and those folks are not entitled to SIPC protection because it’s not a broker-dealer. So, unfortunately we do have, you know, really bad people who are taking money from other people, but that’s not the role that SIPC is supposed to be protecting.

Ms. Waters: So SIPC has no responsibility in this, whatsoever, in terms of educating the kinds of --

Ms. Bowen: Yes.

Ms. Waters: -- forums that you are talking about --

Ms. Bowen: Yes. Yes. You know, that’s -- yes. That, and that’s something we did spend a lot of time talking about because there is a misperception as to what SIPC is and what SIPC is not. And, so, one of the recommendations is that we work with the SEC, with federal, with the state regulatory agencies to try to, you know, broaden the educational pool to, in fact, to hire someone whose job is to work with these entities to better get the word out to the investing public as to what it is that SIPC does protect as well as what it does not protect.

Ms. Waters: Does the broker dealer have any responsibility to tell them that?

Mr. Harbeck: The only responsibility is to display the symbol. We, at one point, many, many years ago tried to expand the investor education levels by the SEC and we were not met with very enthusiastic results.

Ms. Waters: Well you need some congressional help.

Mr. Harbeck: Well, let’s see what we can do on our own first, and then we’ll try.

Ms. Waters: Thank you.

Mr. Garrett: Thank to the gentlelady. And thanks to the panel for your testimony and fielding questions today. Thank you.

Ms. Bowen: Thank you.

Mr. Harbeck: Thank you, sir.

Mr. Garrett: And then we, following that, move on to our third and final panel for the day.

PANEL III

Mr. Garrett: Welcome. And as you’re getting ready, we have four members of the panel, Joe Borg, Director, Alabama Securities Commission; Steven Caruso, Partner, Maddox, Hargett & Caruso; Ira Hammerman, Senior Managing Director and General Counsel, Securities Industry and Financial Markets Association; and Ron Stein, President, Network for Investor Action and Protection.

I assume that gave all of you enough time as I read that to get your papers oriented.

I thank the members of the panel for coming forward today and we look forward to your statements. As you know, your complete record, your complete statement is put into the record and you’ll be recognized for five minutes.
Mister Borg.

Mr. Borg: Good morning, Mister Chairman and Ranking Member Waters, and members of the subcommittee. Thank you for the invitation. I’m honored to be back before the committee in these hearings. I am Joe Borg, the State Securities Regulator at the State of Alabama. Our office has administrative civil and criminal authority under the Securities Act and in addition to the examinations of the audits of broker-dealers and investment advisors. We do quite a bit of investigation on Ponzis, pyramids, illegal blind pools, off-shore and tax scams, fraudulent private placements under Reg. D, oil and gas, and everything.
I have filed my written testimony with the committee and I will briefly go over some of the points in that and I’ll try to skip over some of the points that were discussed in the earlier panel.

Direct equity investments, retirement plans, mutual funds, and similar investment vehicles have become the primary method by which Americans save for their future, accumulate wealth, and plan for a secure retirement. Financial fraud in and form threatens the future security and wellbeing of our citizens, destroys the hopes and dreams of families, and destroys what should be the golden years of our life-experienced seniors.
As I previously testified back in September, the committee was charged to -- the task force was charged to look at 12 particular areas and out of that, we have a report covering 15 specific recommendations. The task force was split into two working groups. My particular subgroup covered recommendations 1 through 4, 14 and 15. So I will briefly talk about those particular points.

The $1.3 million reflects my original opinion of an increase to $1 millions plus an adjustment for indexing to inflation. Americans are looking to markets and investments to secure their long-term future goals. The days of realizing the America dream of a secure future by saving only in a bank account or a Certificate of Deposit are long gone, especially with current rates generally below 40 basis points. Interestingly enough, in meeting with the Federal Banking Authorities, they had concerns about SIPC diverging from the historical relationship between FDIC and SIPC protection levels. In my opinion, the historical ties between SIPC and FDIC levels have contributed to the lack of understanding of the differences of FDIC and SIPC coverage. The insurance of FDIC to bank accounts and the coverage, non-insurance, of SIPC to securities is fundamentally different both in statutory application and practical application, at least under existing law. The reality is that my future security and retirement is not going to come form my savings and checking account, but from my investment accounts.

Recommendation Number 2 had to do with distinction of -- eliminating the distinction for cash and securities. This is outdated. It’s meaningless in today’s markets. Consider that money market accounts were relatively small in 1978, now they’re $2.7 trillion. Brokerage cash sweeps into money market accounts or bank accounts overnight, and back and forth with substantial investor cash routinely held in brokerage accounts. Those funds deserve the full amount of SIPC protection. This distinction has caused inconsistent court decisions, investor confusion, and in some cases, lost the customer funds. Interestingly enough, the Canadian counterpart to SIPC did away with the distinction back in 1998.

Again, banking authorities expressed concern that SIPC will offer greater protection against cash losses than FDIC. This is an artificial connection. And, again, maintaining parity does not benefit investors. The recommendation allows the realities of today’s markets to determine the actual and appropriate means for the benefit of all investors.
Recommendation 3 had to do with the pensions funds on a pass-through basis. There’s a lot of Americans whose investments are not, right now, covered by SIPC protections, but they should not be discriminated against because they have generally small accounts, they are part of a defined benefit, defined contribution, or a deferred profit sharing plan. The recommendations made comports with the trust and fiduciary provisions under ERISA and we also took into consideration certain pension plans and employee benefit plans have been covered by FDIC and NCUA on a pass-through basis since 1978.

On the minimum assessments, according to the staff at SIPC, 25% of the membership paid a flat $150 based on net operating revenue. After Dodd-Frank, the 0.02% of gross revenues, many of the same members are actually going to pay less than $150. I think this has to do with accounting issues.

If members are utilizing SIPC in marketing materials, and benefiting from the SIPC program, they should pay some minimum amount. I personally thought the $1,000 was a little low, but the general consensus was that $1,000 would be reasonable in the current environment.

The task force also discussed whether mutual fund dealers and assessments on mutual fund reserves should be included. SIPC currently exempts mutual fund revenue representative of the mutual fund industry made a case that there was no significant history of loss to the investment. I did not agree with the majority of the task force not to assess mutual fund revenues because the mutual fund industry utilizes the SIPC logo, touts the SIPC coverage and billions of dollars of mutual fund shares are held in street name. However, the fact is there is a history of minimal losses and that was persuasive to the majority of the task force, and I respect the decision.
Concerning International Relations. It’s a global economy. Geographical boundaries have no meaning. Cross border effects of a failure, like a Lehman or a Global, have local, national, and international implications. The resolution depends on the respective national jurisdiction. That is not, doesn’t work. The task force recommendation encourages SIPC to elevate the program in taking the lead in development of a new international association.

I think investor education has already been covered. I proposed a suggestion with regard to adding information into brokerage accounts. The task force considered that recommendation, but were unable to govern the costs. The issue is left with the SIPC Board.

The invitation also asks for views on pending legislation. I will try and cover that very quickly. The purpose of fraud is simple; deprive honest people of their funds to benefit the crook. Look, in a perfect world we want anyone so injured to get back what they lost. The question is, is it the actual investment that was stolen and distributed as profits to other victims, less the amount taken by the crook, or what was promised? That is, the representations of potential profit. Our office investigates numerous Ponzi, pyramid, and other scams. I currently have 48 defendants awaiting trial for various forms of securities fraud. Right now, mostly Ponzi and pyramids and that type. The past year we’ve convicted 16. The problem is always the same, limited assets to distribute. And while the intent of 757 is noble, I think it is not equitable and confers an unequal benefit to some victims over the other. And unfortunately, early investors may benefit at the expense of later investors and may receive distributions in excess. So, with a limited amount of assets to distribute, we must find a way to treat every investor equitably by first attempting to make everyone whole on their initial investment. That’s the amount invested minus amount received equals actual cash lost. Unless there is an endless supply of funds to pay promised returns it becomes impossible from assets available to cover all promises. The fundamental problem with the last statement approach is that when thievery is involved, the statements will match the fraudulent misrepresentations, historical or otherwise, regardless of reasonableness, market conditions, or reality. And H.R. 757 attempts to fix a terrible problem.

I have a suggestion with part of it. During the September 23, 2010 hearings, Professor Coffee and I, and I will give most credit to Professor Coffee, it was his idea. Here’s a suggestion to consider the creation of a de minimis exemption, exception instructing the SIPC trustee not to bring a suit against persons whose withdrawals exceeded their investment by a set amount, a given amount. This would give peace of mind to many, but would not impede the trustee in his pursuit of the very large net winners.
Another possible exemption is giving early investors credit for the imputed interest on their investments. Such amounts should not be regarded as fictitious profits. Congress can immunize some minimum amount of rate of return from the concept of fictitious profits. I don’t know what that rate would be, 5%, 7%, 2%, or adjusted to some sort of standardized index. But whatever the basis is used, it should maintain equitable balance between the victim of a Ponzi scheme.
H.R. 1987 contains similar concepts as H.R 757. My commentary will be the same. I would say, again, there’s no real profits in a Ponzi scheme. The payments to early investors are proceeds of a crime unbeknownst to both the earlier and later investors.

For a second, let me discuss indirect --

Mr. Garrett: Before we do that second, since you’re four minutes over time, let us allow the other members of the panel to do that and we’ll come back.

Mr. Borg: [inaud.]

Mr. Garrett: Thank you.

Mr. Caruso, welcome.
M
r. Caruso: Thank you, Mister Chairman, Ranking Member Waters. My name is Steven Caruso. I’m with the law firm of Maddox, Hargett, & Caruso in New York City. And as you may recall from our last appearance before this committee, our representation is of investors, people who have been defrauded, whether, it’s through some of the examples that we’ve discussed today, what I’m going to call the “trifecta of criminality”, the Madoffs, the Stanfords, the MF Globals. But we see this every day. And in serving on the SIPC task force, one of the overriding considerations is, what are we going to do the next time one of these blow up? And we’ve already, today, discussed the finances of SIPC. And, if the Stanford case alone goes against the SIPC Fund, that fund is gone. That fund is gone. The Federal Government backup of the SIPC Fund is gone. And I would submit to you, investor confidence in our entire capital market system is going to be gone.

So one of the primary things I think that needs to be looked at is how do we pay for what needs to be done? And clearly, there are victims of Madoff, there are victims of Stanford, but the time I would suggest has come, for this committee to consider requiring brokers and investment advisors to have insurance. It is too easy today to become a stockbroker. It is too easy to become a registered investment advisor. But, none of those folks are required to have insurance. So when we’re entrusting them with millions of dollars, in some cases hundreds of millions of dollars, there is no requirement for any insurance whatsoever. And, I think, as part of any legislation, that is something that needs to be considered. There is no free lunch in this world and asking for insurance when we have to have insurance to drive a car, when we have to have insurance to rent an apartment. I think when we have a fiduciary who is out there as an investment advisor and investment professional, requiring insurance will go a long way towards helping potential victims. I will yield the rest of my time given Commissioner Borg running over. And I thank you for the opportunity to appear here today.
Mr. Garrett: There you go. Thank you Mister Caruso. Mister Hammerman, please.

Mr. Hammerman: -- the subcommittee. Thank you for the opportunity to testify as a member of the SIPC Modernization Task Force. I am appearing here today in my individual capacity and not speaking on behalf of my fellow task force members.

I’d like to highlight some of the important pro-investor changes recommended by the task force, mainly expanding and increasing the protection available to customers in three important ways.

First, when a brokerage is liquidated and the customer property marshaled by the trustee is inadequate to return all customer funds and securities, SIPC makes advances from its own funds to assure the return of the customers’ property. For over 30 years these advances have been capped at $500,000 per customer. The task force recommends increasing the maximum advance to $1.3 million to adjust the limit to reflect inflation since 1980.

Second, SIPA currently distinguishes between claims for cash and securities, setting a lower $250,000 limit on claims for cash entrusted to the broker-dealer. The task force recommends eliminating this distinction, which has been a subject of controversy and unproductive litigation.
And third, the task force recommends a limited pass-through of SIPC protection to make individual pension plan participants eligible for advances with respect to their share of the plan’s account at a failed broker-dealer.

While I support these recommendations, I wish to note that they were made without any real consideration of their cost. This cost will be funded by the members of SIPC and, ultimately, by the investing public. Before implementing these recommendations, I suggest Congress obtain a reasonable estimate of the cost of the expanded protection and consider whether these costs would be justified by the increased investor confidence.

I am disappointed by the task force’s failure to take action with respect to several critical areas previously identified by SIFMA. It is essential to ensure consistency between SIPA and the SEC’s rules that determine the property a broker is required to reserve or segregate for its customers. Inconsistencies between the two may result in an insolvent brokerage holding an inadequate customer property to satisfy all the customer’s claims for the property entrusted to it.

To take just one example, discrepancies in the treatment of the proprietary accounts of broker-dealers may result in a multi-billion dollar short fall in the property available for distributions to customers of Lehman Brothers, as we’ve heard earlier today. The current discrepancies were briefly addressed by the task force’s report, which recommended further study.

The task force missed an opportunity to recommend a solution to a problem that is only going to become more urgent as the SEC promulgates rules for the protection of securities-based swap customers.

Although the Dodd-Frank Act addressed the treatment of these customers in a liquidation under the bankruptcy code, it did not address their status under SIPA, where their status is highly uncertain. If they are not protected as customers under SIPA, securities-based swap customer protection rules may be futile. On the other hand, if they are protected as customers under SIPA, regular securities customers may be exposed to risks arising out of this swap business. The SEC should be authorized to make rules under SIPA so that it can promulgate harmonious rules addressing both the requirements for brokers to set aside property for customers and also the distribution of that property in a liquidation. The SEC should consider tailoring the customer protection and distributive schemes so that customers with simple securities accounts are not unduly exposed to the risk of newer and more complex types of transactions.

Finally, to the question of fraud committed by a broker-dealer, I would like to note, as intended by Congress, SIPC’s funds are available only to replace missing customer property that was in the custody of a failed broker-dealer.

I share in the sympathy with, and outrage on behalf of, the many innocent victims of massive frauds by the likes of Madoff and Stanford. Financial fraud undermines confidence in our markets and our regulatory system. However, SIPA is not intended to protect investors against losses on their investments, only against losses of their investments in the event of a broker-dealer failure. Investors who lose money because of a decline in the value of the securities are not protected by SIPA against such losses, whether the decline is due to market forces or even due to fraud.

In conclusion, SIFMA appreciates the opportunity to participate in the work of the task force and is committed to working constructively to modernize SIPA, to better protect investors and thereby increase confidence in the financial markets. We look forward to continuing to work with the subcommittee on these important investor protection issues.
Thank you.

Mr. Garrett: Thank you, Mister Hammerman. Mister Stein.

Thank you, recognized.

Mr. Stein: Thank you. Chairman Garrett, Ranking Member Waters and Members of the subcommittee, my name is Ron Stein, and I am the President of the Network for Investor Action and Protection, NIAP, a national nonprofit organization comprised of small investors dedicated to improving our nation’s investor protection regime. I’m also a registered investment advisor, certified financial planner, and a member of the Financial Services Community.

NIAP’s primary constituents are individual, non-institutional investors who are often the least equipped to deal with the fallout arising from Madoff-like catastrophes, but include an increasing number of regular investors concerned about protecting their assets.

To supplement my written testimony, which goes into great detail about the Madoff liquidation and the urgent need for H.R. 757, I wish to emphasize the following points.
First, a majority of the Madoff victims have not, and will not receive any of the SIPC advance guaranteed by Congress under SIPA statute due to the misguided and inequitable methodology adopted by SIPC and the Trustee, which minimizes investor protection and the amount that SIPC needs to pay to defrauded investors. Despite assertions to the contrary, the payment of SIPC advances has nothing to do with investor-to-investor fairness, or parity, nor does it reduce the amount of the customer fund available for distribution to customers. SIPC advances come from the SIPC Fund not from the customer property.

Over three years into the fraud, it appears as though the Madoff liquidation has protected SIPC and enriched the Trustee and the Trustee’s law firm at the expense of the customers. The Trustee has acknowledged in court filings that his method for calculating net equity has saved SIPC over a billion dollars. Money that should be paid to the victims. At the same time, the cost of the liquidation has exceeded $450 million and this committee has been told to expect that an additional billion dollars will be spent before the process is complete. Ironically, it would have cost approximately the same amount to pay each Madoff victim the full measure of SIPC advances guaranteed by Congress when it enacted SIPA.

SIPC and it’s Trustee have fashioned a net equity methodology which consciously ignores reasonable customer expectations as reflected in customer account statements, destroys the certainty Congress intended under SIPA law and virtually ensures that no rational investor can have confidence in our capital markets or in the protections that SIPC promises, but fails to deliver.

These core principles of basic investor protections were the fundamental reasons, indeed the stated purpose of enacting SIPA, despite an explicit Congressional prohibition to the contrary. And in the Madoff liquidation, the Trustee has been given carte blanche to create whatever definition he wants of net equity, including the one which favors SIPC over customers. As a result, customers can never be sure, until long after the fact, what protections they have if their brokerage firm fails. Moreover, in light of the clawback cases the Trustee has brought, no investor will be able to safely withdraw funds from their brokerage account for fear that years later some SIPC trustee will sue to recover those monies under the rational that it was other people’s money. Victims who have lost everything are now forced to defend against lawsuits that treat them as thieves and victimizes them yet a second time.

How can investors be asked to rely on a system which leaves, wide open, whether, and to what extent, SIPC will provide coverage and which investors remain subject to clawback in perpetuity even though they withdrew funds from their own accounts in good faith, under the reasonable assumption that it was their own money. Simply put, as of now, no investor can have confidence in the validity of their statements.
Enactment of H.R. 757 is a crucial step in restoring sanity to the SIPA process. It will make clear that account statements, which reflect positions in real securities, will be honored in the event of a brokerage firm failure. It will end the use of clawbacks against innocent victims, and it will end the cozy relationship between SIPC and their shortlist of trustees.

I also commend Congressman Ackerman for his legislation, which, among other things, would aid indirect investors, who are often just as damaged both financially and emotionally from an event like Madoff.

Thank you for allowing me to testify. I would now be pleased to respond to any questions. Thank you.

Mr. Garrett: Thank you. Thanks panel. I’ll recognize myself and I was going to say because -- well, I’ll begin on this point. We’re all in agreement that there’s untold number of victims that are out there. But the, some of the beginning comments from this panel, this leads me to a different set of, I don’t know if I, I don’t use the word lightly, “victims”, that is that the conversations with regard to what happens as far as the fees, if you will, or the cost to the brokers because, the broker-dealers, because of the money that is being paid out now and trying to build up the fund going forward, what have you. Well, it’s interesting to hear, first of all, as far as the previous figure that $150 and that may actually be less in certain circumstances, but we have also heard from certain broker-dealers that the assessment figure could be substantially higher. And these are the, usually still the smaller guys who did absolutely nothing wrong in this situation and did nothing wrong in any other situations. They might say, from their perspective, and ours as well, perhaps, that they are now being penalized for the errors of others. So, I guess I’ll throw that out to Mister Caruso because I believe you were talking about the idea of mandating the idea of insurance. Is this a different, is this another class of “victims” that we have to consider because of the ills and the bad behavior of others?

Mr. Caruso: Chairman Garret, one of the ways I would respond to your question is, I’ve never had a car accident in 35 years of driving and yet, through my insurance coverage I’m certainly paying for the ills of others.

Mr. Garrett: Uh-huh.

Mr. Caruso: Again, looking at our financial system, somebody is going to need to focus on how we finance what we’re discussing in this hearing and in similar hearings, whether we provide restitution, the money is not endless. Although, I guess in this city sometimes people think it is endless. But, if you look at the SIPC Fund, there is not enough money to accomplish, I would submit, what needs to be accomplished. The Madoff investors, they are victims because, quite honestly, the government let them down. They did not, the SEC did not pick up on what was going on. I think they deserve to be treated differently then the Stanford investors or the ML (sic) Global investors. But clearly where the government’s at fault and allowed certain things to go on longer than it clearly should have, those people are, indeed, being victimized twice.

Mr. Garrett: Thank you. On another note, the whole panel is here, obviously all day listening to the previous panel, Mister Stein, you heard Mister Harbeck discuss several reasons why, or three or four reasons why he had concerns with, or problems with 757. Would you like to run down some of those? His positions versus whether he is correct in his opposition?

Mr. Stein: Well, I think Mister Harbeck has a slightly different worldview then we do at NIAP. I think what we’ve all clearly heard from Mister Harbeck today is that the SIPC Fund, instead of perhaps saying, “How can we help?” says, “How can we not help?” I think, in Mister Harbeck’s worldview, there is equitability in denying SIPC protection for 75% of the victims, of the innocent victims, of a fraud. I think in Mister Harbeck’s worldview, suing a thousand innocent victims on a clawback claim is an equitable solution. I think in Mister Harbeck’s world, making sure that close to 90% of the recoveries of customer property go to the highest, most wealthy, institutional, and institutional investors is equitable.

I think what Mister Harbeck is missing is the point that there are basically two pots from which to provide restitution for victims, or benefits to victims. You have the SIPC Fund, which has a responsibility, it has a responsibility to pay victims based upon their final account statements or the reasonable expectations of those final account statements. And I would say that that is a very, very core principle underlying the creation of SIPA and that is step one. Step two is finding and seeking some equitable solution to dealing with the distribution of money from the recovery of customer property. But to focus on customer property, we believe is a red herring.

Second of all, the, Mister Harbeck seems to feel that in some way, by paying SIPC benefits in a Ponzi scheme empowers the fraudster, it legitimizes the fraudster. I would suggest to you that the only thing that legitimizes the fraudster is the failure of the regulatory apparatus to catch the fraudster. And to say that the protection of -- that giving funds to a customer or a victim of a fraud in a situation like this enables the fraudster is akin to saying a fire truck and a fireman putting out a fire that was caused by an arsonist in some way legitimizes the arsonist. It’s an absolute absurd twisting of the concept.

At the core, we are talking about protecting customers. We are protecting small customers, people that are at the core of our financial system. And it doesn’t sound to me that Mister Harbeck has really addressed those core principles because that, in fact, is what’s needed for Madoff victims now.
Mr. Garrett: And I have a few more questions but, Mister Hurt.

Mr. Hurt: Thank you. Just following up with Mister Stein. What I thought I heard Mister Harbeck talking about, though, was that, in his opinion, that SIPC was not designed, financially, in a fiscal way to be able to address all of the inequities that could possible occur and that, with respect to the Stanford case, that if you follow the rules, as he interprets them, that it was not designed to do that. Now, if Congress or SIPC wants to expand that authority, then suddenly you’re going to have to build a different model and there’s going to have to be more capital involved. I think what he said was, you’d end up having to have, have to draw down on the equity line with that, with the Treasury to be able to guarantee that. Can you -- I mean, I think that’s what he was saying. Can you help talk about it in terms of that, because I think that is what he was saying?

Mr. Stein: Yeah, well let me speak to that briefly, Congressman. I think, first of all, we are in great sympathy with a vast majority of the victims of the Stanford fraud. The vast majority of them had no knowledge that they were investing in something that was not going to be protected, that they were investing through a broker-dealer that was not going to properly manage their funds. They are truly victims. And, what I think is important for SIPC to do in a situation like this is to address the situation in a way that says, “What can we do to help?” and “What do we need to do in the future to prevent these sorts of calamities from happening again?” And frankly, that’s something that requires all parts of the regulatory apparatus to work together on. The fact of the matter is, Mister Harbeck was correct. There were major failures of regulatory oversight that allowed the SIPC, I’m sorry, the Stanford fraud to continue and that is something that we have to pay very, very significant attention to. That said, I think we also have to find a way to think about how we can help the Stanford victims rather than do them further damage.

Mr. Hurt: Another question that I would like to address, or have addressed is a question that I asked the previous panel. And that is, when you look at the broker-dealers that are paying for these, for this protection for the public, which I think everybody understands and agrees is appropriate, but at some point it seems to me, you have to be concerned about how much you’re asking those individuals to contribute, because at the end of the day, that comes out of their bottom line. It makes them either more profitable or less profitable, allows them to stay in business, and provide that protection. But it is something that I’m aware of because as I travel across my district, I hear from people in every line of work who say, these little fees, they sound good when you’re talking about them in the committee meeting in Washington, but once they all pile up on us, they have a devastating effect on our ability to be competitive. And I was wondering if you all, if maybe just each of you could speak to that topic. What is the appropriate level of assessment and does that assessment take into account the size and relative risk that perhaps each dealer-broker exposes the fund to.

Mr. Stern: Well I -- I think Mister Caruso has spoken well to that issue. But, the fact that, for the last, for the better part of the last 20 years, that every member of SIPC has been charged a paltry $150 per year, and that ultimately led to the potential trauma that is now being experienced by the SIPC fund is beyond comprehension. And by the way, the SIPC fund, as is presently constituted, has more than sufficient assets to pay off the advances to all the Madoff victims, just as a point to be made. But you get to a very important point, and that is, why were the members of SIPC resistant to increasing SIPC fees for the last 20 years when this committee and other committees recommended an increase to the SIPC assessment over the last 20 years. We would have a SIPC fund that would have multiples of billions of dollars more than capable of paying for the Stanford and the Madoff and potentially even some of the MF Global situation had there been a proper assessment on the SIPC members.

Now, the second part of this that Mister Caruso alluded to is the process of underwriting. If you are going to take on a SIPC member who increases by their very practice the level of risk, it’s important that we find some method to increase the cost for that individual. A high-risk insurance -- a high-risk driver should be charged a higher rate than a low-risk driver. An investment advisor that has custody of their own assets should probably be charged a different rate than one that doesn’t. So I think to end, to get to the ultimate part of it, I think we have to find an assessment level that is consistent with the risk and also begin the process of bringing in the private sector to add and improve the quality, the extend of the --

Mr. Hurt: Well -- thank you, Mister Chairman. My time is expired, but I don’t know if, without objection, if there were others that had, could add to that point?

Mr. Hammerman: Thank you, Congressman. I just wanted to echo the concern raised by your question. There are approximately 5,000 different broker-dealers, many of whom are small business operators, which is why in my oral statement I indicated that while as a task force member I agreed with the notion of the increasing the level of protection to the $1.3 million. One piece that we, as a task force, just did not really analyze is the cost. What will these costs ultimately require for all the broker-dealers from the smallest firms, up to the largest? I just think that’s a relevant question and part of the data analysis that should occur.

Mr. Hurt: Mister Caruso?

Mr. Caruso: Thank you, Congressman. I mean, obviously, we don’t have access to the member assessments from SIPC, as far as who’s paid what over the past number of years.
But looking back just a few years ago realized Citigroup Global Markets, Smith Barney, Merrill Lynch, Morgan Stanley - those firms paid a total of $150 apiece.
So, does the system have to be changed? Certainly. You can’t have a firm of that size with thousands of brokers paying $150. To come down here today, the shuttle cost me $800. Now, at $150 a year, I would have paid my SIPC dues for almost six years. That is insanity. And that is what’s at the core of the problem today and why I would suggest the SIPC Fund with just one more catastrophe will not be viable any longer on its own or with the Treasury backstop.

Mr. Hurt: Mister Borg?

Mr. Borg: Thank you. The question of assessments really depends on what the focus of the fund is to do. If it’s going to be limited to where it is now, at least under the current interpretation, that’s going to be one assessment. If you’re going to expand it to cover potential losses on statements that may be inflated, especially 20 years worth of Bernie Madoff, that’s going to be a completely different assessment. I think the committee, the task force, when looking at this made recommendations not knowing what those costs would be. So, we took what was the current law, the Dodd-Frank .02, quarter of one percent on revenues and said, “That’s what the law is now.” And what we only did was say, “Look, it’s ridiculous to have $150. At least have some minimum.” But, I think it’s incumbent upon congress to decide where the parameters are and I think a lot’s going to depend on this SIPC, SEC versus SIPC lawsuit. Because, quite honestly, if the SIPC, if SIPC is required to pay the Stanford or the accounts stated on accounts statements, then I would submit to you that I’ve got about $4 or $5 billion worth of Reg. D 506’s sold through broker-dealers, on oil and gas deals, and medical facilities that also would be required to pay. What my concern is on the bills is not what you’re trying to accomplish, it’s that they only cover certain Americans, in certain situations.
You’ve got to -- everybody’s entitled to equal protection of the law. If you’re going to cover Stanford, which, in essence, is going to cover an overseas bank, basically turning SIPC into FDIC insurance for an overseas bank, what about one of my cases? Mallory In-, is a now defunct broker-dealer. I put them all in jail. There’s no assets.

But I’ve got probably $600 million worth of account statements and folks invested in U.S. projects that were fraudulent. There is no SIPC coverage for that. I can’t give them their money back.

Let’s cover it for all Americans. But, at that point, you have to look at what that universe is. You cannot partial the universe and say, just Stanford or just Madoff. Cover everybody or decide not to cover anybody. Or, try and find some level of protection that everybody can participate in.

Mr. Hunt: Thank you, Mister Chairman.

Mr. Garrett: Just on that last line, I’m sorry, I wasn’t familiar with that case. That’s -- so this -- so that was not a securities case? It was an --

Mr. Borg: Most of --

Mr. Garrett: Is that my -- they were --

Mr. Borg: Yeah, Mallory was a broker-dealer out of California.

Mr. Garrett: Okay. Yeah.

Mr. Borg: It was FINRA registered, however they sold, they specialized in the private placements under Regulation 506.

Mr. Garrett: Okay.

Mr. Borg: Which is exempt from state security jurisdiction, except for enforcement, there’s no gatekeeper function. And what we discovered was that out of Southern California, they were running a operation where they would do multiple 506’s.

Mr. Garrett: Uh-huh.

Mr. Borg: 75, 72 to 75 percent of all the money went to the company, salaries, bonuses, salesmen. There was never any money for projects. They’d open up a new project and there was no chance it would ever succeed because there was no money to fund it. And this was a primary fraud.
We see the same thing with capital broker-dealers in the oil and gas industry where an oil and gas developer will set up a broker-dealer and sell only oil and gas placements. DBSI out of Idaho was a real estate pool.

Mr. Garrett: And that come, and that doesn’t come under, would not come under, under the SIPC then.

Mr. Borg: No, because it’s all, it’s all fraudulent statements with false profits. It’s identical to the Stanford situation.

Mr. Garrett: Yeah.

Mr. Borg: But, if the case turns out that it’s covered, then I think all those have to be covered as well.

Mr. Garrett: Yeah. I mean, I have a couple of particular questions, but let me -- I guess there goes -- well Miss Bowman actually raised some of that point before as to that there are other, there are other classes, there are other activities of fraud that are out there and we’re trying to address where this fraud is, should be covered. And I, I appreciate that. Part of the problem, in this particular area is, is where you’re, where you were clearly, in Madoff, which is the more infamous one, where you’re looking at that situation, there, there was an expectation -- there, A, was covered, right? And B, there was an expectation of coverage. Now we’re getting to the two issues that we have in that particular case, obviously the one that the gentleman from Colorado takes up the most, which is the, this feeder fund situation. And what was the expectation in that situation as far as the unlearned, that the average investor on that situation? And the other is the situation about the, the various pools of funds that are available for this, for recovery.

And so that’s, to those separate points, Mister Borg, you raised the point, I guess in your opening comment, you took the side line on this is, is to how mutual funds are treated under this and the fact that they have the, you know, the logo there, so to speak. Although, I guess, most people really don’t see that since you’re doing a lot of this over, online and what, nowadays. And you’re position was, and I’ll get to the rest of the panel, as to what the solution is dealing with mutual funds? The exemption is appropriate or is the exemption, or the simply removing of that logo and say since they’re not going --

Mr. Borg: Mister Chairman, I disagree with the rest of the task members on this point. I thought mutual funds because they do, one, use the logo and, two, because money is going back and forth in brokerage accounts and there’s all these mutual funds being held in street names. For that matter, all those shares that back up the mutual funds. I just thought they should not be an exemption. I don’t know what that kind of money would bring in, but that’s a huge industry.

Mr. Garrett: Does anybody else want to, just, since we know where you were on that, just so I understand where the rest of the panel is.

Mr. Caruso: The only thing I would offer, Mister Chairman, is when we explored that issue in part of the task force --

Mr. Garrett: Yeah.

Mr. Caruso: One of the things we looked at were how often did mutual funds fail. Yes, they all use the SIPC logo, but they don’t pay anything for it. And the counter argument from the investment company institute, you know, the trade association for mutual funds, was “None of our members ever fail.” As Commissioner Borg indicated, mutual funds are a huge business in today’s day and age. And they are part of the securities industry. But, you know, historically they have been carved out.

Mr. Garrett: Right.

Mr. Caruso: Revenues from mutual funds, and I think given the current financial position in the environment, it’s something that needs to be re-visited.

Mr. Garrett: Right. Anybody else?
Mr. Hammerman: The only thing I would add, Mister Chairman, is that many mutual fund complexes have broker-dealers as part of the complex. That’s how they sell the mutual funds. So, there would be SIPC coverage and assessment at that level.

Mr. Garrett: To -- okay. The magnitude of those funds would -- well the magnitude, I guess, is still the minimis based upon the current configuration. Mister Stein?
Mr. Stein: I would agree exactly with what Mister Hammerman just said on that.

Mr. Garrett: Yeah, okay. As long as I’m down here and since I gave myself as much time as I want, but I’m mindful of your time. So, SIPC says what with regard to the payment method, cash in, cash out, right? When you’re dealing in net equity calculation. Do you just want to spend a moment on the appropriateness of that? And then, to bifurcate that issue, and the rest of the panel, I’ll throw it out to you as well. To bifurcate that issue to the fact that you can you can bifurcate that as far as to whether you have one pool or two, right? It advances or the other assets clawed back and show -- your answer, your comment would on in general, A, and B, should there be a distinction when you’re dealing with both pools?

Mr. Stein: Sure.

Mr. Garrett: Okay.

Mr. Stein: Sure, Let me get to that.

Mr. Garrett: Okay.

Mr. Stein: All right, so when Congress passed SIPA law in 1970 at the same time that it was moving away from the use of physical securities that you referred to earlier today, it was doing so at the same time it was making an agreement with the American public of offering a degree of assurance that what was going to be replacing that physical security had to be meaningful. It was intended to be modeled on the kinds of assurances that were provided by the Federal Deposit Insurance Corporation, FDIC. In fact, the original legislation was essentially a cut and paste from the original FDIC legislation. At the upshot, it was trying to establish for the small investor, to protect the smaller investor and create a state of certainty, so that an investor knew that when we were dealing with something that was on an account statement, it was a true, and honest, and legitimate reflection of what they owned. Congress made this recommendation amidst the backdrop of failed brokers, of Ponzi schemes, of thefts. The circumstances all existed that we’re talking about today in various forms. And Congress still said, “We are creating a SIPC Fund. This fund is going to protect the net equity based on,” understood to mean, “final account statement,” so that an investor knew when they looked at their statement that they owned something. And it was necessary.

Because, after all, we were looking at protecting the smaller investor. And Richard Nixon’s statement when he signed that legislation is a profoundly powerful one. And what it does tell us, very clearly, is that investors that are in their later years, that are now living on their retirement funds cannot afford to think that their protections are being reduced by the amount of money that they pull out of those funds. That the profits that their hard earned savings had made on those funds in those accounts, whether it’s at a bank or financial institution, has to be protected. And that we’re still, somewhere down the road that no trustee can come in 20 years hence and say, “No, you’ve got to give that money back.” That’s precisely what’s going on now. So the SIPC Fund itself has to be based upon reasonable expectations of final account statements. And frankly, if the statements are outrageous or wrong, then we really have to get to whether or not a person receiving those statements was willfully turning a blind eye, and the courts have the ability to say, “No. You’re getting 40 percent return, maybe you don’t get that protection.” But when we come to the issue of the recovery of customer property, and I think that’s where so much of the time has been spent, maybe there is a different standard. And the Trustee has had the flexibility to apply a standard, and a reasonable standard. And that standard could incorporate the time-value of money. It could find some way to equitably determine what the fair distribution would be of the recoveries of those monies.

But it should not eliminate the use of final account statement and reasonable expectations on the core of this protection, which is the SIPC Fund. So, customer property has an opportunity to have all kinds of equitable, ratable methodologies applied to it to come up with a good solution, based upon what the Trustee sees at that particular time. The fund, however, that belongs to SIPC, the SIPC Fund, is inviolate. It cannot be modified or changed. It is what the customer has to be relying upon for their protection.

Mr. Garrett: Thanks for the comment.

Mr. Caruso: The only thing I would add, Chairman Garrett, is the one thing that’s been clear from today’s hearing is how do you stop this problem? You don’t allow people to prepare their own account statements. If Madoff had not prepared his own account statements on one side of his floor, none of this would have happened. So, a very simple solution, if we want to keep this from happening again, is, “I cannot prepare my own statements.” That solves the problem.

Mr. Garrett: Mister Borg.

Mr. Borg: In my office, investment advisors are looked at once every three years on a rotating cycle. We use a risk assessment. If they have custody and control, they go way to the top of the list and they are looked at a lot sooner and a lot quicker. If they are strictly financial advisors, they just give advice and they have no custody, no control, no physical assets, no physical custody of the property, then they go to the bottom of the list because there’s a clearing firm or someone else out there.
The comment was made, and we try and encourage at least the investment advisors under our jurisdiction, Madoff would have been under the SEC jurisdiction, is that “Get a clearing firm.” And, again, I agree. A lot of these problems with these Ponzi schemes, if they’re going through either a brokerage or using an IA, can be eliminated by actually having a dual or triple control because now you have three entities that have got to conspire, to make it all work.

Mr. Garrett: Unless, of course, you control all three entities as in the Madoff situation where --

Mr. Borg: In that case, I would consider that as a unitary control because Mister Madoff actually had control over both ends of his business. There has to be a Chinese wall between the two. Even where there are clearing firms that self-clear, we look at the controls between the two. Usually it’s an outside auditor or an outside advisor, or some other third party that has to certify that they have looked at those systems, and those systems are intact.

Mr. Garrett: Have you ever had the case where you have a separated, a situation like that where there is collusion that it doesn’t solve the problem as Mister Caruso suggests?

Mr. Borg: I have not seen -- yes, one time that I can think of. In fact, it gets tied up with that Mallory case because they, it was a separate organization called Capital Guardian which handled the trust accounts.

Mr. Garrett: Okay.

Mr. Borg: In other words, if you had an IRA.

Mr. Garrett: Yeah.

Mr. Borg: And there was collusion between the two. There was joint-ownership.

Mr. Garrett: Okay.

Mr. Borg: But, it was so cleverly disguised, it took us a little while to find.

Mr. Garrett: Find it, yeah.

Mr. Borg: But it didn’t last 20 years.

Mr. Garrett: Yeah. Yeah, well, that’s because he has good folks over there digging into it on a regular basis.

Mr. Borg: Thank you, Mister Chairman, I appreciate that.

Mr. Garrett: Sure. Well, if Mister Hurt does not have any other questions, I will, at this time, I will dismiss the panel and thank you all very much for your testimony today. As always, there may be, and there will be, other questions that we’ve thought of, so the record’s always open for another 30 days to submit questions to you. So, I appreciate the opportunity to do that.

And, without objection, I’ll put into the record from, a statement for the record, for today from the Financial Services Institute and also from BDA, Bond Dealers of America. Without objection, that’s so ordered.

And again, I very much appreciate this entire panel for your information and discussion today. Thank you. Meeting is adjourned.

[END OF RECORDING – TOTAL TIME 03:05.10]

C E R T I F I C A T E

I, KATIE JONES, DO HEREBY CERTIFY THAT THE FOREGOING RECORDS, PAGES 2 THROUGH 154, IS A COMPLETE, ACCURATE, AND TRUE TRANSCRIPTION OF THE VIDEO RECORDING TAKEN IN THE AFOREMENTIONED MATTER TO THE BEST OF MY SKILL AND ABILITY.

______________________
KATIE JONES
TRANSCRIBER

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

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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.

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