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.