More On The Bubbe Meisse of SIPC and The Trustee
February 18, 2010
More On The Bubbe Meisse of SIPC and The Trustee
Lawrence R. Velvel
Yesterday I posted quite a long set of comments on the hearing of February 2nd. It subsequently seemed to me that some of the most important points are in the last third or so of the essay, which discusses the basic underlying theory of SIPC and Picard and some of the major flaws in their theory. (I called the underlying theory a bubbe meisse (with hopes that my very limited understanding of Yiddish is correct).)
The reasons these matters strike me as especially important is that, when the fallaciousness of the underlying theory is exposed, the Trustee and SIPC are fundamentally left with only their claim that what they wish to do is fair (and must therefore be done regardless of what Congress intended), and what the victims desire is supposedly unfair and therefore must not be done regardless of what Congress intended.
Additionally, the underlying theory and its flaws are important because they are likely to be major subjects on appeal regardless of who wins before Judge Lifland, and because they could well prove to be very important in the lobbying of Congress, which to some extent has already taken place and which is about to be stepped up considerably. (I regard the lobbying of Congress to be so crucial that, without getting into dollar figures, I will say that I have pledged all that I can reasonably afford if necessary to support the lobbying through NIAP. I would urge and hope that others too contribute what they can, because it has long been my opinion that Congressional action is the best hope, and certainly by many years the quickest hope, for fairness and decency toward Madoff victims.)
Though the last part of yesterday’s post discussed truly crucial matters, I recognize that the post was long and complex, and I therefore think it entirely possible, perhaps even likely, that even some or many of those who read it did not read the entirety of it, and therefore may never have gotten to the crucial discussion of and exposure of the flaws in the basic underlying theory of Picard and SIPC. This is my fault for putting such crucial matters at the end (for reasons I won’t get into here), but it could nevertheless be the fact. I have therefore decided to repost below the last third or so of yesterday’s post, and to put into this brief essay an analogy that may help make it simpler to understand the basic ideas elaborated in the reposting.
Here is the analogy: Suppose Sam Smith has one million dollars in the bank and knows that, in somewhere between one and ten years, Jack Jones may or may not give him ten million dollars more. Smith decides to give you ten thousand dollars. Does that ten thousand dollars come from the one million dollars Smith has in the bank, or does it come from the ten million dollars that Smith may or may not receive from Jones in somewhere between one and ten years? Under the victims’ theory, the ten thousand dollars comes from the one million dollars Smith has in his bank account. Under the theory of SIPC and the Trustee, the ten thousand dollars comes from the ten million dollars that Smith may or may not receive from Jones in somewhere between one and ten years (and the $10,000 you receive is merely an advance from that possible ten million dollars).
This example, though simplified, is, I believe, a pretty exact representation of what is involved in the theory of SIPC and the Trustee, with the $10,000 playing the role of the SIPC advance of up to $500,000 from SIPC’s fund, and the ten million dollars that may or may not be received in somewhere between one and ten years playing the role of “customer property.” The only thing that needs be added in terms of the analogy is that, to insure that you will not get anything later from the ten million dollars that Jones may or may not give Smith if SIPC and Picard feel you don’t deserve to get anything from it, SIPC and the Trustee are defining net equity in a way that ensures you receive neither the ten thousand dollars now nor anything later from the possible ten million dollars.
With the foregoing analogy set forth to try to make it simpler to understand things, here is a reprint of the relevant parts of yesterday’s posting:
REPRINT FROM POSTING OF
FEBRUARY 17, 2010
I will conclude with two matters that are major: the interesting questions of (i) the relationship between net equity and customer property, and (ii) insurance. Sheehan’s argument at the hearing on net equity and customer property, strike me as confusing, even deeply confusing. But I think I’ve got it right. The Trustee and SIPC are saying that all distributions to victims come out of so-called customer property, which the Trustee is looking for all over the world and is suing Madoff confederates to recover. (The question of estate property is irrelevant here). Therefore the $500,000 that a victim may get comes out of customer property; it is an advance on a victim’s (ratable) share of customer property. It is therefore not insurance. Rather, it is, as said, an advance on one’s share of customer property.
To determine one’s share of customer property - - to determine what one should get from customer property - - you must determine one’s net equity. So, if a person’s net equity were one one thousandth of total net equity, one would get one one thousandth of the customer property.
Because your share of customer property is based on your net equity, it is unfair to use the amount shown in your final statement as your net equity, because this would result in a portion of the customer property being allocated to people who previously took out from Madoff more than they put in, while lessening the amount of customer property going to people who have never taken out a dime. (The amount going to the latter will necessarily be lessened because there will not be sufficient recovered customer property to pay off everyone in full on the basis of their final statements.)
Since it would be unfair for people who have taken out more than they put in to get a share of customer property, and to thereby lessen the share going to people who have never taken anything out, which would be the result if the final statements were used to calculate net equity, we must instead use cash-in, cash-out to calculate net equity, because that insures that the amount you receive in customer property will only be proportional to the amount of real money you had in Madoff - - and remember, the advance of money up to $500,000 that you get from SIPC comes from, and is a part of, customer property. And coming from customer property it is not insurance. Rather, it is an advance on, and from, customer property. True, Senators sometimes said in the legislative history (e.g., in the Senate Report) that it is insurance, but they are wrong.
The foregoing is how I, at least, understand the argument made by SIPC and the Trustee at the oral argument, and made by them before that for about a year. My understanding is given credence by such statements as Sheehan’s at the oral argument that:
Your Honor, … let’s not get confused over what we are dealing with here because we are in this case, because we are in Madoff, the world just doesn’t go upside down. It stays right and steady. We stay with the fact that we are dealing with a fund, a fund of customer property, and it is out of that which distributions take place.…
I submit to your Honor if you look at the legislative history one could be beguiled by some of the statements made erroneously by the senators there to the effect, yes there is insurance. They are wrong….Because the $500,000 is an advance. That word is key. (Pp. 16-17.)
And in a letter to the court dated February 9th, Sheehan said the position of SIPC and the Trustee “with respect to net equity, recognize[s] the fundamental unfairness to permit ‘net winners’ to share in the fund of customer property with the customers who have not yet been made whole.”
So, it looks to me like my understanding of the position of SIPC and the Trustee is correct: the money one gets from SIPC - - up to $500,000, based on one’s net equity- - is simply an advance on what one gets from customer property; net equity must therefore be defined in a way that prevents those who have taken out more than they put in from sharing in customer property and must therefore prevent them from getting an advance up to $500,000; an advance from customer property is not insurance; and Senators who said otherwise and (I will now add) who said the bill they were enacting provided insurance, did not know what they were talking about.
Now, there is a whole hell-hole of errors in the logic of SIPA and the Trustee. I will deal only with the most egregious of them. Our system, as said before, does not run on the basis that Senators and Congressmen who enact a bill don’t know what they are talking about, and therefore governmental, quasi governmental or private bodies can do whatever they want whenever they think their desires are fair and that what Congress wanted is undesirable. It just doesn’t work that way in this country. Yet that is what Sheehan has explicitly admitted his side is doing here. I would think condign punishment to be deserved. The more so because, as has been discussed often in this post, and as was at least implicit in previous quotes or comments made at the oral argument by Brian Neville, many believe that the position taken by SIPC and the Trustee, far from being fair, is disastrously unfair to thousands of people. The more so yet again because the Senators were right, as will be discussed below. There is insurance here.
Then too, it is obviously and completely wrong to say that the advance one receives from SIPC is merely an advance from customer property. The advance comes from a fund that Congress ordered SIPC to set up for this purpose (and which SIPC neglected to keep at a sufficient level). Indeed, the statute even explicitly says the Trustee shall pay net equity claims out of monies SIPC provides even though the debtor does not have sufficient funds to pay the claim. In SIPC cases there may never be enough customer property to cover the advances or even more than a very small part of them, yet victims still get the advances, thus showing that most or all of an advance will always remain just a payment from the Congressionally – ordered fund, and not even conceivably, or in theory, a part of customer property. This happens all the time as far as I know - - or it would happen all the time but for SIPC’s miscreant denials of money to (most) victims in most cases. And, because the $500,000 has to be paid from the SIPC fund regardless of whether there is enough customer property to cover any part of it, the advances are insurance, just as the Senators said. What SIPC and the Trustee are doing, in order to suit SIPC’s selfish purposes, are that they are creating an intellectual invention, are making up a bubba meisse if my Yiddish is right, that an advance supposedly is customer property. It is not.
True, in setting forth the order of allocation of customer property, the statute says some of it will go first to SIPC for certain things, including certain repayments of monies that SIPC put out for customers, some will go to customers for certain things, SIPC will be subrogated to some of it, etc. But that SIPC can get some of the customer property money to cover what it previously gave to victims, or that the amount of money customers later get from customer property is reduced by advances on net equity that they previously received, does not mean the advances came from customer property, either in theory or in reality. On the contrary, both in theory and reality, the advances come from the SIPC fund set up for the purpose; later SIPC can recoup some of the advance in the (normally unusual, I believe) event that there is enough customer property for such recoupment; and victims have their payments reduced by the amount of net equity they already were given via an advance.
Additionally, the concept of net equity serves as a measurement. It measures whether a person can initially get up to $500,000, and it measures a victim’s share of (usually-later-recovered) customer property. But that the same measure is used in both instances does not mean - - and it does not logically follow - - that the measure should be defined in a way that harms people who seek advances in order to help people who later will receive customer property - - which is precisely what SIPC and the Trustee are trying to do. Rather, the measure is what Congress said it is, and what SIPC therefore used for decades until it felt threatened with bankruptcy due to the size of the Madoff fiasco. The irony, of course, is that the people whom SIPC and the Trustee claim they wish to help by cash-in/cash-out (many or most of whom may be pretty well off anyway) may not see a nickel of recovered customer property for years on end - - for seven to ten years - - because of lengthy litigation over efforts to recover the property from Madoff confederates and similar types, that people in penury due to the actions of SIPC and the Trustee are hurt immediately and on into the foreseeable future, and that in many cases such people will not see better days because of Stengel’s theorem; while people who will be helped, because the method adopted by SIPC and the Trustee will provide them with an enlarged share of customer property, will not receive that customer property for many years and in lots of cases are still pretty rich anyway. To put some of this briefly, claiming a desire to help victims, SIPC and the Trustee have adopted a calculation of net equity that will desperately hurt thousands now and into the foreseeable future, while not helping others for years and years.
As many will know, one day after the oral argument, Helen Chaitman wrote Judge Lifland a letter urging him to reach a compromise verdict that would, she said, accomplish Lifland’s aim of not having customer property go to persons who had taken out of Madoff more than they put in. Let me quote her relevant two paragraphs.
I write on behalf of a very large group of investors in Bernard L. Madoff Investment Securities, LLC (“Madoff”) to suggest a partial resolution of the “net equity” issue. Mr. Sheehan’s rebuttal ended yesterday with the passionate argument that it is unfair to investors with a positive net investment that investors with a negative net investment should share in the fund of customer property. There is a large group of investors who have a negative net investment, and many who have a positive net investment, who would forego any distribution from the fund of customer property if they were promptly paid their $500,000 in SIPC insurance. Hence, we ask the Court to consider incorporating this proposal into Your Honor’s decision on the “net equity” issue.
That is, if you are persuaded that SIPC is correct and that Ponzi scheme cases arising in non-SIPA liquidations are applicable here, before relieving SIPC of its entirely independent insurance obligation, you give investors the choice of foregoing any distribution from the fund based upon each customer’s November 30, 2008 statement. This would provide incalculable relief to approximately 3,000 elderly Madoff investors whose lives have been decimated more by SIPC’s denial of their insurance coverage than by Madoff’s crimes. Neither SIPC nor the Trustee has provided the Court with a single authority for the proposition that a third party insurance entity like SIPC should be relieved of its insurance obligations to innocent third parties solely because the broker operated a Ponzi scheme.
Chaitman also set forth a long list of cases that had referred to the advances of up to $500,000 as insurance. Chaitman’s proposal was joined on the same day by Brian Neville. Then on February 9th, Sheehan wrote a letter claiming that, by her proposal, Chaitman has “essentially conceded the propriety of the Trustee’s and SIPC’s position with regard to net equity, recognizing the fundamental unfairness to permit ‘net winners’ to share in the fund of customer property with those customers who have not yet been made whole.”
That Chaitman conceded the legal correctness of the Trustee’s and SIPC’s position is so patently false on its face that one can only wonder that it was set forth. (Although it is all too symptomatic of SIPC’s and the Trustee’s method of litigating.) In fact, I for one suspect that Chaitman’s letter could have been in part a ruse designed to enable her to get before the court a long list of cases describing the SIPA fund as insurance, the point Sheehan vigorously denied the day before. Be that as it may, Chaitman obviously understands that it will be years before any victim gets any customer property, and, conceivably pushed by desperate clients, she is asking the court to show what in Yiddish would, I think, be called rachmonis. (Do I have the word and the meaning right?) Of course, if I am correct, she probably should not have confined the offer to the situation of the court deciding for the Trustee, but also against the Trustee, since appeals would still take years, so would litigation to recover customer property, and her clients still will not see dime one for many years. In any event, the problem I see is that at one point she asked the court to incorporate her proposal into its legal decision. I find it hard or impossible to understand how this could be done, since the definition of net equity is what it is, and the definition controls both the advances from the fund and participation in customer property. (In my brief I said it would be nice if such advances and such participation could be determined separately but it seemed to me that the definition of net equity controlled both.) True, it is not unknown in law for the very same word or phrase to mean different things for different purposes. But I find it hard to think that that would be the ruling here. But maybe I’m wrong.
Of course, it is one thing to say that the judge will find it difficult or impossible to rule as a legal matter that the definition of net equity changes as between advances and later recovery of customer property, and it is quite another thing for the judge, before issuing any ruling, and at a time when he therefore holds a club over the heads of both sides, to call them in for a settlement conference and say, “This is what I want you to do. I want you to reach an out of court settlement under which people can elect to receive $500,000 (and not be subject to clawbacks) while agreeing to give up any future right to customer property. If you reach that settlement, great. If you don’t, one of you is going to be hammered in the opinion I write.” There are judges who do force those kinds of split-the-baby settlements on people. But whether Lifland would is something about which I have no idea.