Wednesday, February 17, 2010

Comments On The Hearing Of February 2nd Before Judge Lifland

February 17, 2010

Comments On The Hearing Of February 2nd Before Judge Lifland
Lawrence R. Velvel

I did not attend the hearing before Judge Lifland, but have read the transcript and obtained some impressions, a few of which I have not seen alluded to elsewhere. Let me begin with a few matters heavily involving personalia (a Frankfurterian word, if memory serves), before moving on to substance alone.

As others have said, both on the net and orally, David Sheehan appears to have conducted himself badly, to have been condescending towards the victims and their lawyers. There really is no excuse for such comments as “No one in their right mind would say you have to use the last statement.” (P.23.) That evoked both (bitter) laughter, as I’ve been told and as the transcript shows, and the subsequent justifiably sarcastic response from Daniel Glosband that “Notwithstanding Mr. Sheehan’s opening remarks I tend to harbor the illusion that I am in my right mind.” (P.83.) Glosband spoke for many of us, whom Sheehan gratuitously insulted.

There is equally no excuse for Sheehan’s arrogant comment with regard to the victims’ claim that Congress intended the final statement to be used even if there was a fraudulent scheme, that “If I could talk to 535 Congressmen, I couldn’t find one that subscribed to that view.” (P.22.) There are plenty of Congressmen and Congresswomen who subscribe right now, today, to the view ridiculed by Sheehan; and the Congresses which enacted SIPA in 1970, and amended it in 1978, were motivated by a desire to protect investors and certainly knew that Ponzi schemes existed, yet did not say that in such cases innocent victims should not receive the full benefit of the protection Congress was providing or that a Trustee in such cases should use cash-in/cash-out instead of the ordinary method of determining net equity.

The foregoing were comments in Sheehan’s opening argument - - what he said on rebuttal was even more insulting, or even was libelous. To support his claim that Madoff’s returns could not have occurred in the real world (where many mutual friends, incidentally, had higher overall returns than Madoff albeit not as consistent returns), Sheehan asked whether, if Madoff had actually been trading in the real world, “Do you think anyone in the room believes they would have gotten the returns they got? They got fraudulent returns.” (p. 136.)

Having thereby defacto called everyone in the room a knowing beneficiary of a fraudulent scheme, Sheen further drove in the knife thusly: “Why was everyone going to Madoff when people ten years ago forgot about the SEC. When everyone said it was a Ponzi scheme and it was a fraud, they didn’t go to the SEC because they were getting results.” (P. 136.) So again, we were all knowing beneficiaries of a Ponzi scheme and didn’t complain until it collapsed.

Well, pace Sheehan, but you and your exaggerations are way, way beyond the pale. Most of the victims honestly thought Madoff could obtain the results he was obtaining - - the returns were smaller overall than those of many mutual funds and were both much smaller than and no more consistent than those of Warren Buffett, and Madoff claimed to be swinging only for singles, which seemed consistent with avoiding losses. And most of the victims had not a clue that anything at all was wrong, that there was a Ponzi scheme, and that monies they obtained from Madoff were not legitimate earnings. Having read, reread and on February 12th done a tv show with Erin Arvedlund on the SEC Inspector General’s Report, I know that on Wall Street there were quite a few who suspected something might be wrong with Madoff. But they didn’t tell us plain folk of their suspicions, most of them (all but a handful) didn’t tell the SEC either, and the SEC was worse than useless because Madoff used its continuous awards to him of clean bills of health as an argument for raising money from big money people and institutions - - a point you would never know from listening to Mr. Sheehan.

Comments like Sheehan’s - - insults about people’s sanity, their level of knowledge of evil, their willingness to benefit from a scheme they supposedly knew was illegal, and distortions of Congress’ views - - say a lot more about Sheehan, and about Picard as one who uses him and is “his long-time partner and friend” (they were in a different firm together), than they say about victims or Congress. And what they say about Sheehan and Picard is not good. They bespeak disdain for the victims and their lawyers, arrogance, serious exaggerations, plain meanness, and a willingness to say or do anything to win, qualities that, due to politeness, one would not ordinarily wish to point out but which have now been displayed so many times that it seems inappropriate to continue to ignore them. As one whose practice, for decades, revolved around Supreme Court cases, court of appeals cases and trial court cases involving major antitrust matters, I do not ever remember hearing or reading of remarks like Sheehan’s being made in open court. Have he and Picard had their way so often, and suffered so little defeat, that they feel free to speak of opponents so disdainfully, even so libelously?

Then, too, in arguing that opponents wish to ignore the reality of the situation with regard to Madoff’s lack of securities, Sheehan said, as “an anecdote” (p. 25), that “When we went into the premises that first day we were advised that, for example, the 11/30 [08] statement relied upon by the attorneys if we were to give all the statements out from Microsoft’s position we would have had to have 220 million shares of Microsoft stock. When we call DTC we had under 700. It doesn't take a genius to find out we didn't have any stock, certainly not enough stock to cover 220 [million] shares.” Well you know, as far as our librarians at MSL have been able to determine, 220 million shares of Microsoft is considerably less than a mere four days trading of that stock. As was said in the brief filed before Lifland by this writer, the shares could easily have been acquired for victims by SIPC, especially by acquiring them over time as is done by traders in large blocs, had SIPC desired to do so and had it possessed or been willing to obtain the necessary money. But obviously it didn’t want to, yet now Sheehan presents the matter as indicative of why Picard and SIPC supposedly had to use cash-in/cash-out.

This brings me to comments by Josephine Wang. (Thank goodness, because I’m tired of Sheehan’s). Wang insults the victims just like Sheehan did, but she does it by parroting the briefs of SIPC and the Trustee. The victims, she says, by relying on their final statements, which present the results of purported trades by Madoff, have become the principals on whose behalf Madoff committed a fraud acting as their agent. So we, the victims, are responsible for what he did. If one were to believe Wang, we are not relying on our statements because Congress said this is the usual method of determining net equity and it is the method that has been almost uniformly used to make the determination of net equity in the past. We are not relying on our statements because for years - - for decades - - we thought the statements represented the truth. We are not relying on them because, since the advent and now nearly uniform practice of holding securities in street name rather than delivering them to their buyers, statements are the only thing we can rely on (as will be discussed below). No, we are relying on them solely for greedy advantage, and since the victims thereby “choose to rely upon the bad acts of Madoff they have to accept the consequences” (p. 133), which is that we are the principals who employed Madoff as our agent to commit fraud and SIPC can therefore (for some reason) use cash-in/cash-out. The argument is disgusting.

But Ms. Wang is herself disgusted. For victims and their lawyers have questioned the motives of SIPC and the Trustee in adopting cash-in/cash-out, and this “is not only absolutely false but truly it goes beyond the pale.” (P. 133.) How do we know it is false and beyond the pale? Well, Ms. Wang says so. Plus SIPC has advanced 629 million dollars, “more than SIPC has advanced in all its 320 liquidations to date.” (P. 133.) And SIPC cannot sanitize a Ponzi Scheme by “bless[ing]….fake profits” and hurting people who did not take out their principal. (Id.) No talk from Wang, however, of a SIPC concern that it would be bankrupt if it didn’t use cash-in/cash-out instead of the final statements. No talk from Wang of the possibility that SIPC’s management might lose their jobs, including Wang’s $400,000 annual salary, if SIPC went bust. No talk from Wang of the possibility that the reason SIPC has given out more here than in all prior liquidations combined is that, as many say, SIPC and its captive Trustees have been amazingly successful in bashing claims of victims on the head in prior liquidations, so successful that it has paid more in lawyers fees than it has to victims. No indeed, what we have in this case - - and we should take Ms. Wang’s word for it - - is pure generosity on the part of SIPC, so that it is beyond the pale to question SIPC’s motives.

Of course, when discovery was sought to obtain the documents which would actually show SIPC’s and the Trustee’s motives - - and which would prove the correctness of Wang’s claim if it is correct (but which equally would show its falsity if it is false) - - Ms. Wang, SIPC and the Trustee fought vigorously against such discovery, and got the judge - - on the basis of their say-so alone with regard to the alleged purity of their motive, and with no proof whatsoever for what they were saying - - to deny the discovery (in a two paragraph opinion which was a farce, was against the vast weight of precedent, and cannot in good conscience even be considered an opinion). SIPC, Ms. Wang and the Trustee were horrified at the possibility that there could be discovery that would uncover their motives in switching to cash-in/cash-out (and from his statements one suspects that the judge, in what might have been a fit of exceptional naiveté in one so experienced, felt that matters might be cleaned up properly and with dispatch if SIPC, Wang, Harbeck and the Trustee did not have to bother themselves with such impudence as questions about their motives). So now, according to Wang, it is beyond the pale to question their motives, and we must accept their word for the purity of the motives.

Needless to say, if their motives were really so pure, the quickest, easiest way to prove it would be to permit discovery on it, discovery which would prove to us benighted cynics that we are wrong. But permit discovery which would show the truth? Not on your tintype.

During the argument the judge himself interjected a few comments here and there, but their import, if any, is difficult to fathom, except to say that he seems to know more about the case than some feared. (Which is not to say he necessarily knows enough about it - - that remains to be seen.)

When Sheehan was in the midst of what appears to be his argument that Congress did not want the final statement to be used because it gave fictitious results, the judge interjected that “That is not uncommon in Ponzi scheme cases where no stock is ever purchased.” (P.21.) Was Judge Lifland just making a statement of fact? Did he have in mind that Congress did not say “don’t use the final statement in Ponzi cases, where securities are missing by definition”? Did he have something else in mind? One cannot know.

When Sheehan was beginning his argument that the Second Circuit’s discussion in New Times regarding the treatment of fictitious securities should control here (because there was fictitious trading here), Judge Lifland interjected, “In that instance, aren’t they talking about the class of claimants who received information on securities that never existed?” (P.35.) So the judge is well aware of the two different kinds of securities in New Times - - ones that existed in the real world and ones that did not. But it remains to be seen whether the Judge will nonetheless accept the argument of SIPC and the trustee that this case should be treated as the fictitious securities were in New Times because here the trading was fictitious although the securities were real. (Which, as I’ve said in previous posts, amounts to an argument that a fraudster’s claim of buying and holding real securities, as in New Times, should be treated vastly different from a fraudster’s claim of buying and selling real securities, as in Madoff.)

When Wang said a “customer” for SIPC purposes is one who gave a broker cash for the purpose of buying securities, the judge said, “Isn’t that the position of most of claimants here that they deposited cash for that purpose?” (P. 45.) The purpose of the Judge’s question, and what if anything it tells about Judge Lifland’s thinking, is perfectly opaque to me. Was it merely to establish a fact? Does it implicitly indicate a sort of sotto voce skepticism about where the other side may be going with its arguments? Does it indicate something else? It beats me.

When the SEC’s lawyer was arguing that not the final statement, but all of Madoff’s books and records must be looked at to find out what was owed to victims, or that Madoff’s obligation must be “otherwise established to the satisfaction of the Trustee” (P. 51), the judge interjected, “You mean the Trustee has a subjective position to interpret.” The SEC’s lawyer then denied - - very weakly - - that there was subjectivity, and Lifland responded “It’s the satisfaction of the Trustee though it is a very subjective term.” (P. 51.) Then when the SEC lawyer again responded - - weakly - - and further said “if the trustee were way off base on it, then perhaps you could say” - - the judge cut her off by saying, “Well the argument on the other side is that it is a deeper issue.” (P. 52.)

Now, I find it impossible to know with any assurance what Lifland’s comments mean. My best guess is that he is not enamored of an argument that gives vast subjective power to the Trustee - - judges often don’t like such subjectivity because it opens the door to arbitrariness. Plus, he seems to be aware that the victims’ side is making some important arguments that would defeat the SIPC/Trustee argument based on subjectivity. But in the end I don’t pretend to know the import if any of his comments.

One last comment by Judge Lifland. When rebuttal began, the SEC’s lawyer led off by saying that victims’ lawyers had spoken of customer confidence having been shaken, by the belief that if they leave securities with brokers and if “there is a problem, that SIPC protection wouldn’t be there.” (P. 128.) But the SEC, she said, “has taken important steps to ensure it never happens again. I assure you we have taken this extremely seriously. It is devastating to us as well, although not in the same way.” (P. 128.) At that point Judge Lifland interjected, “And Toyota is now saying the same thing.” (P. 128.)

What is the import of this comment by the Judge? Was it just a wisecrack engendered by the similarity in the situations? - - by the ignoring in both cases of a problem known to the party (by the SEC and Toyota respectively) but ignored by it until the roof fell in? Does it mean more than that - - could it mean that the judge does not think the other side should be allowed to have ignored the problem and then, when the roof falls in, to change rules (at least in this case) in a way that injures the victims (and may thereby encourage additional reprehensible acts by malefactors in the future)? One really doesn’t know, although it is obvious that the Judge’s comment is unlikely to augur for the position of SIPC and the SEC.

Let me now leave personalia behind, in favor of matters more purely substantive, both doctrinally as well as substantively in the realm of professional competence. It is, I think, a professional judgment, not one born of favoritism, that causes me to say, in company with others, that the lawyers for the other side were not very good, while the lawyers for the victims were generally excellent. (At least I hope my judgment is professional rather than mere favoritism - - one might note in this connection that the Judge’s sarcastic or questioning comments were directed mainly or wholly to lawyers for the other side.) But given the nature of the format of the argument - - which had to be split up among seven lawyers for our side, with a minimum of, or no, overlap or repetition - - it was inevitable that certain points did not receive as great an emphasis as might conceivably be desired. One thinks in particular of four arguments.

One is that the Second Circuit explicitly said in New Times that the critical distinction was between investors who intended to buy securities that existed in the real world and those who intended to buy ones that did not. This was mentioned once, but one wishes it had been mentioned again and again. Of course, Lifland seems to be well aware that two kinds of investors were involved in the New Times scam, as evidenced by his aforementioned comment to Sheehan, and one may therefore hope and believe it is likely he is also well aware that the difference in investors was said to be the critical factor.

There is also the question of Congressional intent. My own view, and the view focused on at the very beginning of the brief I filed, is that this case should begin and end with Congress’ desire to protect investors. Nothing else needs to be considered or discussed. Yet because the lawyers - - beginning with the desperate gambits of those on the other side to whose arguments our lawyers understandably felt the need to respond - - have thrown in the kitchen sink (as is typical of lawyers), there was discussion of a huge list of matters, and Congress’ intent, though mentioned, did not get the repeated, repeated, repeated emphasis which I think it should have received from our side. This is the more unfortunate because, as will be discussed later in connection with insurance, it was the position of the other side, explicitly stated by Sheehan, that Congress did not know what it was talking about, and therefore its explicitly stated views should be ignored. Which I may say, is not the way our system works. When it comes to statutes, our system is not to say that Congress was ignorant in the premises, so ignore what it wanted and do what I say. Our system is to do what Congress desired. And hammering home Congress’ desire, as explicitly expressed several times in the legislative history, should have been the order of the day, although the format the judge demanded for the argument tended to militate against this.

A third point I would have wished to receive continual repetition is that, if the view of SIPC and the Trustee were to prevail, then no investor through brokerage houses will ever be safe, with a comitant reduced willingness to invest in the first place. (I admittedly gave this argument pride of place in my own brief, so could be considered biased. Yet I believe the argument both right and powerful.) Nobody will be safe because one cannot know in advance that she has invested in a Ponzi scheme - - by definition one would not have made the investment had one known the deal was a Ponzi scheme, and one will not know the investment was a Ponzi until the fecal matter hits the fan. Unable to know until afterwards that the investment is a Ponzi, people will necessarily be reluctant to invest, and to take out earnings on which to live - - as is often the purpose of investments - - lest they later find they are victims of a fraud, will not receive the $500,000 they thought they would get from SIPC, and may be subjected to clawbacks. Nothing could be more calculated to destroy, instead of instilling, the confidence in markets desired by Congress.

Moreover, the unhappy outcome goes beyond Ponzi schemes because, were SIPC and the Trustee to prevail here, all will know that the rules of the game can be successfully changed after the fact by SIPC and the Trustee, a vastly destructive, all encompassing principle that need not and will not be confined to Ponzi schemes, but may instead be implemented wherever and in any way that it suits SIPC’s purposes.

This point seems to have been excluded from the argument on our side, although a point quite similar in import was argued. It was said by Brian Neville that, now that securities are held in street name instead of being delivered to the purchasing investor, as is the nearly uniform case today, the confirmations received from the broker (and tax documents based on them) are the investor’s only proof of what she owns, what her net worth is, what financial decisions are prudent, etc. The confirmations are the only thing the investor receives that she can rely on, and SIPC and the Trustee have not said what else the investor could rely on - - and of course cannot say what else the investor could rely on because there is nothing else. Let me quote part of what Neville said:

But what they cannot deny when a security is held by a broker firm for an investor in its street name, and virtually all are today, there is no tangible item, no ….certificate, no bond certificate to show ownership. . . .

So it is these confirmations, account statements and 1090s that let the investors know what they are, what they earn and what their net worth is, they make life altering decisions and many, many clients and customers in that instance chose to retire, to fund children’s education, made large gifts to charity. They paid 30 years plus of income taxes based upon fees and documents from an SEC registered broker-dealer.

The most important financial decisions that thousands of Madoff victims made were based on these documents and their legitimate expectation. Yet the Trustee, SIPA and the SEC now argued with the full benefit of hindsight, …. [that] these confirmations... cannot be relied upon.

What the SIPA Trustee and the SEC have not said is what could a customer have relied upon.… So the cash in and cash out supporters failed to identify a single document, item or thing that would allow customers to make rational decisions on their lives. (Pp. 105-106.)

* * * *
So even if you did everything right and you tracked it, there was at no time any customer in the United States can ever be safe from a revisionist’s point of view, their accounts are safe, you never knew if you had SIPC coverage.

From the cash-in/cash-out approach, all securities investors from this point on would have a whole new problem. (P.107.)

So Neville too is saying that, if an investor cannot rely on the confirmation statements, if the rules of the game can be changed by SIPC after the fact whenever this suits its purpose, no investor can ever be safe, and SIPA, contrary to “Congress intention” would not “increase the investor’s confidence.” Rather, we would be “back to ‘Let The Buyer Beware.’” (Pp. 107-108.)

One final matter that unfortunately received no discussion is that nobody on our side argued that SIPC owes the victims securities, not cash. That is too bad, because I think it is true, and because the same securities are worth an awful lot more today than on December 11, 2008.

Before concluding this essay with a discussion of the question of insurance, which received considerable attention both at the hearing and in subsequent letters to the court, let me clear away a few odds and ends. There was dispute over the question of Madoff’s obligation to investors. (The statutory definition of net equity incorporates “the sum which would have been owed” by the debtor to the customer (minus and plus certain figures), i.e., the definition incorporates the debtor’s obligation (what is owed) to the customer (§78lll(11)), and the statute provides for payment to a customer of all “obligations” to her and her net equity claims (§78fff-2(b)). Karen Wagner, arguing for the victims, said the final account statement shows Madoff’s obligation to a customer shows “what the broker owes the customer” (p.66)), and said that, had the customer sued Madoff before December 2008, the customer would have received the amount of the obligation shown on the statement. (Pp 66-67.) The SEC and Sheehan, arguing to the contrary, said the account statements cannot show Madoff’s obligation to the customer because the statements were based on fiction and Madoff didn’t have the money to pay off a suit. (Pp. 61, 137). Well, even wholly aside from all the other reasons why the final statement is the embodiment of one’s net equity, including Brian Neville’s point that the statement is the only piece of paper the customer has that shows what is owed him now that securities are held in street name, it is a fact that up until the end Madoff had enough money to pay off and did pay off all who actually asked for their money back. He recognized the account statement as the measure of what was owed to them and he paid it. To be sure, he did so to escape detection. Nonetheless he did it, and, as discussed here in prior posts, one need not and does not pay the money in order to escape detection if the money is not owed.

Another matter is that, as should be of some consequence, the SEC itself said it is improper, in a SIPA case, to use the analysis used in non SIPA Ponzi scheme cases. So far so good. But the SEC’s lawyer also said things which, if correctly reported in the transcript, I admit to not understanding, to not understanding in themselves, to not understanding in regard to their consequences, or both. For example, the SEC’s lawyer said “The Trustee is correct that in Ponzi schemes generally equity favors satisfying claims for investors who have recovered their principal.” (P. 53.) This is what the Trustee is saying? To me it seems as if he is saying the opposite. The SEC lawyer also said that because New Times arose under SIPA, so that “the net equity of the customers who invested in the real mutual fund was the value of the mutual fund on the filing date, not the amount of money those customers initially invested.” (P. 53.) “This means that the prorated distributions of profit from these customers would have been partly the principal they had left and partly the earnings. This simply is not the rule in the Ponzi scheme cases, but it is under SIPA.” (Pp.53-54.) Well, we should be grateful that the SEC disagrees with SIPC and the Trustee, as it damn well should, but why “prorated distributions of profit were partly [of] the principal they had left” is a matter of which I am not au courant. Doubtless it is my ignorance, but I would bet that many of us who took out money from Madoff - - I would even bet most of us who did so - - believed we were withdrawing earnings, not principal, and were leaving in the principal, and were even leaving in part of the profits, so that the principal and such portion of the profits would earn more money. My idea does not apply to people who deliberately redeemed the entire sum shown on their statements, or an amount which they knew had to come partly from invested principal, but it would certainly apply to lots of us I would hazard.

There is also the question of the length of time the litigation will occupy. Karen Wagner said, as have so many, that SIPA explicitly requires prompt payment of monies owed to customers, but the Trustee has vitiated this requirement by undertaking “an amazing lengthy process in investigation of every customer’s account to figure out how much cash in and cash out, it will take a very long time.” (P. 69.) Helen Chaitman augmented the point by correctly saying that, given the complexities of the Trustee’s cases against the big hitter Madoff confederates whom Picard has sued in order to recover monies they took out, “it could easily be seven to ten years before the Trustee is in a position to make a distribution” to victims of such recovered monies, so that “the only money hundreds” (or more) clients can “count on is SIPC insurance.” (P. 119.) And Milberg’s lawyer, Mathew Gluck, said that under cash-in/cash-out there could be an enormously long trial (with subsequent time consuming appeals, I would add), to determine exactly when Madoff’s real investments of his early days were converted into a Ponzi scheme. (All seem to assume Madoff’s early days involved real investments - - or at least might have - - rather than Madoff having run a Ponzi scheme since he founded his firm in 1960.) A trial for this purpose is needed because, under cash-in/cash-out, people who have been with Madoff for three and four decades must receive credit, as cash-in, for real profits made before the Ponzi scheme began.

So, one thing very clear is that, if the final statements are not used as the measure of net equity, lots of people will never see a dime from SIPC for years, directly contrary to Congress’ desire for promptness, a desire stated both in the legislative history and in the statute. And those who are older may, prior to receiving any distribution, and accordingly after years of penury, suffer the fate remarked by Casey Stengel when he said “Most people my age are dead at the present time.” Such will be the fate visited on people by SIPC and the Trustee though they and their representatives continuously tell us - - including at the oral argument - - how sympathetic they are to the victims and how much they regret what happened to them. Well, as someone once said (I think), or as is close to what someone once said, “By your deeds are ye known.”

Then there was the argument on behalf of Carl Shapiro. Shapiro, it is clear, was one of those who floated Madoff, to the tune of hundreds of million of dollars and literally from the very beginning in the early 1960s until the very end in 2008. Shapiro’s lawyer, Stanley Fishbein, has no problem with the victims’ argument that the final statement controls because there were real securities here, as in the relevant part of New Times. But if the judge should adopt the Trustee’s argument that the final statement does not control because the trading was fictitious, well then, says his lawyer, Shapiro still should get credit for vast amounts he had in Madoff because his account was not a participant in the split strike conversion strategy, but instead had real securities bought and sold for it, made huge profits on Microsoft when the trading supposedly was real, and should continue to be credited with huge profits over the years because, as in the relevant part of New Times, Shapiro’s account set forth profits from the appreciation of real securities, not from phony trades. (Though, of course, the alleged purchase of real securities for Shapiro’s account was just as phony as was the split strike conversion activity.) So, what Fishbein is saying in essence is that, even if cash-in/cash-out governs and limits us ordinary mortals, who had to use split strike conversion, it does not govern and limit the fabulously wealthy man who floated Madoff for fifty years, because his account is predicated on appreciation of real securities, not on trading profits from split strike conversion. (Pp. 122-125.) Isn’t that position a fine how-do-you-do? Shapiro, who floated Madoff, wins. The innocent victims lose.

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.