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

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).