Thursday, June 11, 2009

Irving Picard's Three Percent Commission In The Madoff Case.

June 11, 2009

Re: Irving Picard’s Three Percent Commission In The Madoff Case.

On May 30th Time Magazine posted an online article about Irving Picard, the SIPC Trustee in the Madoff case. Time said that “Picard is considered the superstar of SIP[C] trustees, having handled the largest cases SIPC has managed”. Time also said that SIPC “Trustees are paid well, receiving personally 3% of anything over $1 million they recover for victims. For example, if $2 billion is ultimately recovered in the Madoff case, Picard stands to make personally $60 million in fees, provided the New York federal judge overseeing the case, the Hon. Louis Stanton agrees to it.”

Later Time said that Picard has sued various large feeder funds for ten billion dollars. Time did not, in this regard, carry out the logic of its prior statement. Were Picard to recover ten billion dollars in these suits and distribute it to Madoff victims, his personal share, at three percent, would be 300 million dollars. Nice work if you can get it.

Time’s article fuels a fire that has existed -- sometimes raging, sometimes damped -- within the Madoff victim community for many months. Picard and SIPC have insisted that the so-called “net equity,” for which each victim can be compensated by SIPC up to $500,000, must be computed in a way that is different from the way net equity has almost always -- or even always? -- been computed previously. If net equity is computed their way, many victims will get either nothing at all from SIPC or much less from it than if net equity is computed in the ordinary way. Also, on a separate but intimately-related point, many victims would also become subject to clawbacks by Picard of monies they took out of Madoff in the last six years, often monies they needed to live and/or to pay taxes on phantom income from Madoff.

These two matters -- getting less or nothing from SIPC and becoming subject to clawbacks by Picard -- have been extensively discussed and explained previously -- by many writers. So I shall not explain here the mechanics of how this works. Suffice to say here that, if the definition of net equity adopted by Picard and SIPC is upheld against the judicial attacks which already have begun, then Picard personally will make more money if Time’s description of how he is compensated was correct. For Picard will be able to claw back and distribute far more than otherwise -- who knows, conceivably even a billion or two more than otherwise -- which would yield Picard personally 30 million or 60 million dollars more at a compensation rate of three percent.

It is this fact -- that Picard will personally make a lot more money if he uses his and SIPC’s novel -- one might even say niggardly and quite possibly illegal -- definition of net equity that has caused outrage in the victim community. The victims feel Picard is denying them money that many of them desperately need to live on (they are often in their late 60s, 70s or 80s and have nothing to live on because they were wiped out) so that he personally can profit to the tune of millions of dollars, even tens of millions of dollars.

On important question, consequently, is this: Is Time right in indicating, as so many believe, that Picard will receive three percent of everything over one million dollars that he recovers and distributes to victims, so that use of his and SIPC’s novel definition of net equity, by enabling him to claw back and then distribute more money, will increase his personal take. This question is not completely the straightforward one it may seem.

I myself am concededly pretty ignorant in the premises. I knew nothing at all on the subject when the Madoff situation began, and of late have been trying to learn at least a little as I go along. Thus, as far as I know, it seems that there are two statutory sections that are relevant. One is Section 330 of the Bankruptcy Code (11 U.S.C. §330). It says that a trustee in bankruptcy can be awarded “reasonable compensation for actual, necessary services rendered,” and that in determining what compensation is reasonable, a court must consider the time spent, (hourly?) rates charged, the necessity of the services, whether they were performed within a reasonable time commensurate with the problem, the trustee’s skill and experience, and whether the amount of compensation is reasonable in comparison with what is charged by comparably skilled people. Section 330 also says that, in determining reasonable compensation, the court should treat it “as a commission, based on section 326.”

Section 326 of the Bankruptcy Code (11 U.S.C. §326) is the other relevant provision here. After stating the amounts or percentages allowable on sums distributed by the trustee that are less than one million dollars, §326 says that the court can award the trustee “reasonable compensation not to exceed 3 percent of such moneys in excess of $1,000,000, upon all monies disbursed or turned over in the case to parties in interest, excluding the debtor [i.e., excluding Madoff].”

So, in sum, under §330 the Trustee is to receive reasonable compensation for actual, needed services and under §326 such reasonable compensation, called a commission, cannot exceed three percent of all monies collected and distributed to the victims in excess of one million dollars.

How does this generally work in practice, and how may it work in the Madoff case? My understanding, after talking to a colleague who serves as a bankruptcy trustee and whom I think I understand correctly, and from what seems implicit in stuff I’ve read, is that the way it generally works in practice is pretty much what one might expect. Trustees in bankruptcy seek awards of the full amount of the commission allowable under §326, and courts sometimes award the full allowable commission. But sometimes courts award less than the full allowable commission because, for example, the trustee was able to accomplish a job in very few hours or the task was simple, etc.

Now, nobody has yet said the Madoff job is a simple one or one that will require but few hours. Distinctly the contrary. And it is always possible that Picard will seek the full three percent commission allowable under §326 on monies he distributes to victims in excess of one million dollars. Would the full commission be reasonable compensation? It does not seem so. If Picard were to distribute only the two billion dollars posited in one part of the TIME piece, the statutorily permitted commission at three percent could be, TIME said, sixty million dollars. If he was to collect and distribute ten or twelve billion dollars or more, which encompasses the amounts he either already has in hand or is seeking, the permitted commission would be 360 million dollars. These kinds of figures are nuts for a trustee in bankruptcy. Neither can be considered “reasonable” for a trustee. And remember, Section 330 says a trustee shall be paid a sum that is reasonable, while Section 326 not only explicitly echoes this but distinctly does not provide that three percent of everything over one million dollars necessarily is reasonable, but only that three percent is the top limit on what could be considered reasonable in appropriate circumstances. I reiterate that three percent for a trustee on two billion or twelve billion dollars -- i.e., $60 million or $360 million dollars for a trustee -- is not reasonable. (For those interested in such things, if Picard himself were to work, for example, 10,000 hours on the Madoff case, which would be four to five years of extensive annual work, his hourly fee at thirty million dollars would be $6,000 dollars per hour and at 360 million dollars would be $36,000 per hour. Such fees are insane.)

So, while one cannot know at this point how much Picard is likely to seek from the bankruptcy court by way of commission, the idea that he will seek the full three percent commission seems to accuse him of both phenomenal greed and lack of sense, although one cannot definitively say at this point that he won’t seek the full three percent.

But does all this necessarily mean that use of the novel and niggardly definition of net equity -- a definition which would enable Picard to pay out less of SIPC’s money and claw back more money to distribute to other victims -- is therefore irrelevant to his personal financial calculations? One doesn’t think so, although I personally believe, unless and until proven wrong by testimony or written evidence if there should ever be any on the question, that other matters (to be discussed below) were the motivation underlying use of the novel and niggardly definition. Yet the reason the novel definition is not necessarily irrelevant to Picard’s personal situation is precisely that the novel definition will result in more being clawed back and then distributed to victims. If such an amount is as “little” as one billion dollars more -- and the grapevine makes me think it could be a multiple of that -- this amounts, at three percent, to an additional permissible commission to Picard of 30 million dollars. That ain’t chicken feed baby. And even if one assumes that the court will not consider 30 million dollars to be reasonable compensation and will cut it down, the fact that Picard clawed back and distributed another billion dollars will almost surely count for a great deal in a court’s decision on what is a reasonable commission in the circumstances; it will cause a court to pick a number that is higher, probably much higher, than otherwise. Maybe -- in particular circumstances -- it won’t count for all that much, because it would be the small change if Picard recovers another ten billion dollars from the malefactors whom he has sued, but it will count for a lot if he does not recover much in the lawsuits. Moreover, he adopted and announced his decision to use a niggardly definition of net equity before he was aware, as far as we know, that various feeder funds could be sued for mucho billions. When he developed and announced his decision, the net equity question likely loomed a lot larger than it may loom today in calculations of what he personally stands to make from the Madoff affair.

What, then, does this writer think is the real reason Picard adopted the novel and niggardly definition of net equity? I have discussed before the ostensible reasons for this decision that were given by Picard and by the President of SIPC, Steven Harbeck. Those ostensible reasons do not hold water and my prior discussion of them will not be repeated here. Here I will deal only with what I think to be the (often recognized) real reasons.

Irving Picard was appointed to be its Trustee (the “SIPC Trustee”) in the Madoff case by SIPC. He is, as I understand matters both from reading articles and a conversation with a lawyer who knows about these things, one of a small coterie of lawyers who regularly get SIPC appointments, which are said to be lucrative. Picard apparently is SIPC’s “go to” guy among the coterie of regular SIPC trustees, “having handled the largest cases SIPC has managed” and also ‘“handling more SIPC liquidations than any other attorney,’ Harbeck said.” In the so-called Park South securities case, “Picard paid [only] 22 of 302 investors who requested recoveries, finding many didn’t have valid claims, according to his report to the U.S. Bankruptcy Court in Manhattan in October,” according to a January 21, 2009 article in Bloomberg. (Emphasis added.) It is my personal recollection -- I believe I am right -- that an experienced lawyer whom I was dealing with in regard to SIPC claims in the Madoff case told me that, when he contacted Picard about the Madoff matter to discuss it with him, Picard told him that, if he wanted to know how Picard was going to run the Madoff matter, he should read the Park South papers.

As someone who for years has been, and is, repeatedly appointed by SIPC to be its Trustee, and who must surely make a fair piece of change as the SIPC Trustee, it is dubious in the extreme that Picard would want to contravene SIPC’s wishes. What, then, would SIPC’s wishes be? As with everything else related to Madoff, I have no prior experience or knowledge of any of this and only know what I read or am told. But what I read and am told about SIPC is not good, as was pretty fully brought out as long ago as September 25, 2000 in a lengthy article by Gretchen Morgenson of the New York Times.

Here are some of the things Morgenson wrote:

Mr. Heebner figured wrong. For more than four years, the corporation [SIPC] maintained he was entitled to nothing -- even though three federal courts ruled that S.I.P.C. should pay him $87,000. Only last week, days after a reporter interviewed the lawyer representing the corporation about Mr. Heebner, did the investor receive a check in the amount of $87,000.
''I never got the sense that S.I.P.C. was in any way trying to help my client,'' said William P. Thornton Jr., a lawyer at Stevens & Lee in Reading Pa., representing Mr. Heebner against the corporation. ''They are very aggressive in attempting to prove that investors' claims do not come within certain legal definitions within the S.I.P.C. statute. And the loser is the investor.''
* * * *
But convincing the corporation [SIPC] to pay can be extremely difficult. The organization, requires investors to run a gantlet of legal technicalities that would challenge even those knowledgeable about securities law.
Some securities lawyers say this is because trustees overseeing the cases are chosen by, and paid by, the corporation. This differs from the independent trustees who are appointed by the court to handle corporate bankruptcy cases, and who are working for the people owed money.
Indeed, the trustees working for the investor protection corporation -- many of them from a coterie of lawyers who have made a lucrative specialty of such cases -- have received far more from representing the corporation than the corporation itself has paid to investors. Their critics say that trustees wanting repeat business from the corporation have an incentive to minimize payouts to investors. One trustee is the former president of the corporation. (Emphasis added.)
* * * *
''Although these legal arguments [by SPIC] may follow the letter of the investor protection act, S.I.P.C.'s reliance on them is reminiscent of a private insurance company trying to use every conceivable esoteric legal stratagem to avoid customer claims,'' said Lewis D. Lowenfels, a lawyer at Tolins & Lowenfels in New York and a leading authority in securities law.
* * * *
The investor protection corporation and the F.D.I.C. are vastly different. While the F.D.I.C. is an agency of the federal government and its insurance fund is backed by the full faith and credit of the government, the corporation is financed by the securities industry and can borrow from the government, with special approval, only in emergencies. It also maintains a $1 billion line of credit with a consortium of banks.
* * * *
Not long ago, brokerage firms paid much more to be members of the corporation. Between 1991 and 1995, firms were levied an amount based on their net operating revenues. In 1995, for instance, members were required to pay 0.095 percent of such revenues and the organization received $43.9 million. But when the S.I.P.C. fund reached $1 billion, the corporation cut the levy to $150 a member [including giant members like Goldman Sachs, Merrill Lynch, etc.].
* * * *

The corporation itself has paid investors $233 million over almost 30 years. But that amount is far less than the money received by the lawyers that act as trustees and the firms that help them shepherd the cases through the bankruptcy courts, trying to recover additional assets from the failed brokerage firms and assessing customer claims for validity. Since 1971, trustees have received $320 million, 37 percent more than has been paid to wronged investors. (Emphases added.)
The money the trustee receives comes from two sources: the assets of the failed brokerage firm and the corporation itself. As is typical in most bankruptcy cases, the corporation's trustees are paid first, customers second.
* * * *

Nevertheless, of the 3,368 customers who submitted claims for S.I.P.C. coverage in the failure [of the Stratton Oakmont brokerage house], as of last May only 34 had been deemed entitled, to a total of $2.1 million, according to the trustee overseeing the case. The corporation's executives and Weil Gotshal & Manges, the law firm representing the trustee in the case, argue that only 1 percent of the Stratton customers seeking remuneration from the corporation are entitled to payments. (Emphasis added.)
* * * *

A key problem with S.I.P.C. liquidations, some securities lawyers say, is that trustees overseeing the cases have allegiance to the corporation that appointed them [SIPC], rather than to wronged investors. To be truly in the corner of investors, these people say, trustees in brokerage firm liquidations should be completely independent of the corporation, which naturally wants to protect its assets. Trustees are indeed independent in corporate or personal bankruptcy cases because they are appointed by the bankruptcy court. (Emphases added)
* * * *

A coterie of bankruptcy lawyers does get repeat business from the corporation. Irving H. Picard, a partner at Gibbons, Del Deo, Dolan, Griffinger & Vecchione in New York, has been appointed trustee in four brokerage firm failures the last nine years, and J. William Holland of Holland & Holland in Chicago has overseen three liquidations since 1990. Five other lawyers have overseen two or more liquidations for the corporation the last decade. (Emphasis added.) [Picard recently moved from the Gibbons firm to Baker Hostetler.]
* * * *

Some securities lawyers and regulators say that the arguments used by the corporation to justify the denial of Mr. Heebner's claim for more than four years are characteristic of the corporation's approach to investor protection. ''It's part of the gantlet to make it as difficult as possible for an investor to make a recovery,'' said Mark Maddox, a former Indiana securities commissioner who is now a lawyer representing victims in the Stratton Oakmont case. (Emphasis added.)
Indeed, one argument used to deny many investors' claims in the Stratton Oakmont case, if applied to all brokerage firm failures, would disqualify millions of investors from S.I.P.C. coverage even though their brokerage firms are members of the organization.
Mr. Miller, the trustee at Weil Gotshal, has argued successfully to the bankruptcy court that Stratton customers do not qualify for S.I.P.C. coverage because their assets were not held physically at Stratton, they were held at the firm that cleared Stratton's trades. The act of Congress that created the corporation states that the coverage extends only to customers of firms that hold their assets. Customers of a failed broker that used another firm to clear its trades and conduct administrative duties do not qualify.
This delineation may have made sense in 1970, when most brokerage firms cleared their own trades. But today, most of the nation's brokerage houses use clearing firms to carry out their customers' transactions and administer accounts. Using Mr. Miller's argument, customers of these firms, were they to fail, could get no satisfaction from the corporation.
* * * *

Robert M. Morgenthau, the Manhattan district attorney, who has aggressively pursued fraudulent brokerage firms to help wronged investors recoup some of their losses, said: ''The investor protection act has to be revisited for two reasons. It doesn't cover a majority of investors' losses, such as those incurred by fraud or malfeasance, and the red tape that is involved for investors trying to recover is incredible.''
As I say, the news from Morgenson, as far back as September of 2000, was not good. And, as far as I can see, nothing has changed. So, if one is right in thinking nothing much has changed, in precisely what way would this have relevance today, by what mechanics, so to speak, would it have relevance today?

Well, today SIPC has something like 1.6 billion in its coffers. But the amount claimed to be owing the Madoff investors at $500,000 per claim is said to be in excess of four billion dollars (and one suspects could be a lot higher even than that). Therefore SIPC does not have enough to cover the amounts that are owing on the basis of the final, November 30th statements from Madoff. To cover those amounts, it would either have to tap and then repay a line of credit, borrow from and then repay the government, and/or increase the annual charges to the securities industry (which to some extent it already has, I believe). None of these possibilities does it consider desirable, one gathers.

How then, to avoid these undesirable alternatives? Well, one obvious way is to lessen the payout to victims so that SIPC will not have to pay out the full $1.6 billion in its coffers, and will only have to pay out far less. Avoiding payouts does seem to be its modus operandi historically, after all (even to the point of making ridiculous arguments). And since SIPC must pay out $500,000 (or lesser amounts) to people whose positive net equity reaches $500,000 (or the lesser amounts), an easy way to avoid paying out money is to define net equity in a way that is different from usual and (i) that results in negative net equity for many people so that they will get nothing from SIPC, or (ii) that results in a net equity that is positive but is nonetheless far below $500,000 so that victims will get only this lesser amount. This is an especially easy way to accomplish SIPC’s goal of non payment to victims because smart lawyers like SIPC’s, and like Picard, who works for SIPC, can come up with rationalization after rationalization for doing this. Even if, in the end, their numerous rationalizations are insupportable, and destructive of what Congress intended to accomplish when it passed the Securities Investor Protection Act to help protect investors, still they may persuade courts to rule as they request. Courts are not overly famous for doing the right thing, you know. They are often persuaded, or fooled, by rationalizations to rule quite differently.

Now, one would not expect Irving Picard to resist SIPC’s desire to greatly lessen its payout. As said, Picard has, after all, made what looks to be a lucrative career as SIPC’s go-to guy, and he cannot be expected to bite the hand that feeds him. And, if you ask me, it probably is even likely, or at minimum there is a good chance, that not Picard, but SIPC itself, developed the idea of using the novel and niggardly definition of net equity that is injuring Madoff’s victims and is being used to lessen SIPC’s payout, and that Picard “merely” went along with this. I know that, if I were a lawyer for Madoff victims in regard to SIPC, I surely would press actively for discovery on the question of how the niggardly definition came into being, a matter which I think is not subject to privilege as between SIPC and Picard.

So to sum up this part of the story, it seems to me that a desire on the part of SIPC to greatly lessen what it must pay to Madoff victims is almost surely the motivating force behind the novel and stingy definition of net equity currently being used by Picard and SIPC.

But just what, you should ask, does all this have to do with the three percent commission that could be paid to Picard under the bankruptcy code, not the law establishing SIPC. Well, the relationship is this: For reasons about which I know absolutely nothing (but which I wonder about, and wonder as well what their relationship to the niggardly definition might conceivably be), when SIPC gets involved in a bankruptcy case -- as when a broker-dealer such as Madoff goes bust -- the Trustee appointed by SIPC to be the SIPC Trustee also becomes the bankruptcy trustee. This is exactly what happened here, of course, when the originally appointed bankruptcy trustee, Lee Richards, was replaced as bankruptcy trustee just a few days later by Irving Picard, as soon as Picard became the SIPC Trustee. Picard began to immediately wear both hats, as is customary.

When Picard began to wear the customary two hats, he began, as the SIPC Trustee, to participate in decisions, in particular the decision on how net equity would be defined for SIPC purposes, that would affect his commission as bankruptcy trustee. Which is to say that, as discussed earlier, the niggardly definition of net equity, which will result in victims getting less or nothing from SIPC, will also result in more being clawed back from some victims to be distributed to other victims. And by resulting in more being clawed back and distributed, the niggardly definition of net equity will result in the permissible three percent commission under the bankruptcy act being a higher number than otherwise. As said, an extra billion being clawed back from some victims for distribution to other victims will result, at three percent, in an extra 30 million dollars in commission being permissible for Picard’s commission, and, even if a court thinks $30 million in commission is outrageous, will result in Picard’s fee award being higher than it otherwise would be. So, as the SIPC Trustee, Picard is affecting -- perhaps dramatically -- what he may be paid as the bankruptcy trustee.

There seems to me to be a good deal wrong with this as a systemic matter. SIPC is a quasi governmental entity in my opinion (it is set up under a complex statute, for example), although some, maybe many, would claim -- only the worse for Picard’s position here -- that it is a private company. So, as trustee for SIPC, Picard must be acting as a private, or, at best, quasi governmental officer, not a government official. The bankruptcy court, on the other hand, is a governmental body, and therefore the trustee in bankruptcy must be acting in a governmental capacity. So what you have here is a self-interested private or at best quasi governmental body and trustee (SIPC and Picard as SIPC’s trustee) making a crucial decision (the definition of net equity) that will play a major role in establishing the compensation of a governmental officer (Picard as bankruptcy trustee). That does not seem proper to me. Is there any other example of where it is done?

Even worse, conceivably, it is systemically the case that Picard is unavoidably, even if unintentionally, involved in self dealing. For as SIPC trustee he is involved in establishing and enforcing a rule that will affect his compensation as bankruptcy trustee. Maybe this could be thought bearable if all that was happening was that he was enforcing a standard definition of net equity, a definition that is commonly used. But this is not what is happening. What is happening, rather, is that Picard -- whether at SIPC’s direction or not -- has created and enforced a novel rule, a rule that is, to boot, greatly injuring the very people that Congress established SIPC to help: investors who have lost huge sums of money and in many cases have lost everything. How self dealing can possibly be allowed in such cases -- even if it results from a systemic problem rather than a perhaps unlikely Picardian venality regarding the three percent commission -- simply escapes me.

There is even a line of cases in this country which bears on the problem. They are the cases usually referred to as the Tumey v. Ohio line of cases. They began in the Supreme Court with Tumey in 1927, and the latest opinion in the Supreme Court was delivered just a few days ago, on June 8th, in what I will refer to, with total lack of reverence for the supposed niceties, as the West Virginia three million dollar judicial bribery case. (Caperton v. A.T. Massey Coal Co. Inc., No. 08-22 O.T. 2008, decided June 8, 2009.) The underlying idea is that, where a judge or administrator has a pecuniary interest in the outcome of a case, whether that interest be personal or on behalf of an institution he heads (e.g., a village of which he is mayor), he must not sit on the case as a judge. In the June 8th case, a three million dollar campaign contribution from a party meant that a West Virginia Supreme Court Justice should not have sat on the party’s case.

To be sure, Picard, as Trustee, is not a judge. And there will later be judges who rule on the matter, although it is equally true that there are (often already ruined) people who are so frightened of possible clawbacks arising from Picard’s novel and niggardly definition of net equity that they have not yet and may never file a claim, but instead will waive a SIPC claim and thus would not benefit from a later ruling against Picard by judges (assuming judges would have the courage to rule against SIPC, Picard, and their rationalizations). Also, one could argue on Picard’s behalf that something analogous to his situation has been permitted to exist, despite extensive criticism, in so-called forfeiture cases, where police forces can decide whether to seize property and then are permitted to keep (and sell) what they seize in order to help fund themselves this way. Yet one still thinks the Tumey rule should apply here. For the idea that an official can make a decision which can benefit him personally to the tune of tens or scores of millions of dollars, while injuring victims in the face of a statute whose passage was an expression of congressional solicitude for the victims and of a congressional desire to help them, is just too much. The West Virginia judge was forbidden to do this because of a campaign contribution of “only” three million dollars. Picard, even if only because of the system rather than personal venality, has done it in a matter that could mean tens or scores of millions of dollars in income for him personally. I really don’t think this should be allowed, whether systemically caused or caused by other reasons.*

* 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, or on the comments of others, you can, if you wish, post your comment on my website, All comments, of course, represent the views of their writers, not the views of Lawrence R. Velvel or of the Massachusetts School of Law. If you wish your comment to remain private, you can email me at

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