03-03-11 net equity ct of appeals

8/7/2019 03-03-11 Net Equity Ct of Appeals

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3 UNCERTIFIED TRANSCRIPT DISCLAIMER

4IN RE: BERNARD L. MADOFF

5 INVESTMENT SECURITIES, LLC

6 March 3, 2011

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UNCERTIFIED ROUGH DRAFT

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1 ROUGH DRAFT

2This ROUGH DRAFT file is an

3 uncertified, unedited rough draft of theproceedings, and is not to be used in any way as a

4 final transcript. The rough draft may be used inplace of or in addition to or only to enhance notes

5 taken during the proceeding. Anyone choosing tocross-examine or prepare a witness using a rough

6 draft is doing so with full knowledge the roughdraft is uncertified, and that they are doing so at

7 their own risk.Rough drafts are to be replaced with

8 the final certified copy upon its completion. Thisis an unofficial transcript, which should NOT be

9 relied upon for purposes of verbatim citation oftestimony.

10 This transcript has not been checked,proofread, or corrected. Corrections will be made

11 in the preparation of the certified transcript,resulting in differences in content, page and line

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1 JUDGE JACOBS: At this time we'll

2 hear In Re Bernard L. Madoff Investment Securities,

3 LLC.

4 MR. LAX: If it may please the Court,

5 my name is Barry Lax of Lax & Neville. I'll be

6 arguing on behalf of the appellants, six minutes,

7 and then Karen Wagner of Davis Polk will argue eight

8 minutes, and we're going to reserve six minutes for

9 rebuttal.


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10 JUDGE JACOBS: Are you going to divvy

11 up issues in any way?

12 MR. LAX: We're not really, Your

13 Honor.

14 JUDGE JACOBS: All right.

15 MR. LAX: Thank you very much.

16 This case can be decided by simple

17 statutory application. The issue before this Court

18 is how net equity should be determined under the

19 Securities Investor Protection Act, period. The

20 Bankruptcy Court misinterpreted the law and the

21 issue before it by significantly relying on the

22 size, nature and effects of an SEC-regulated

23 broker-dealer's fraud that caused its failure.

24 However, those factors are irrelevant under the

25 statute for the determination of net equity. Net


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1 equity is determined by valuing the dollar amount of

2 the customer's account by calculating what would

3 have been owed by the broker had the customers'


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4 securities positions been liquidated on the filing

5 date.

6 JUDGE JACOBS: Of course if the

7 positions had actually been liquidated on the filing

8 date, there would have been nothing there.

9 MR. LAX: I understand that, Your

10 Honor, but whether or not there are security

11 positions in a customer's account is irrelevant.

12 And that's what the statute says. The statute says

13 when there's no securities positions in a customer's

14 account the Trustee is obligated to go into the

15 market to try to purchase those securities. And

16 that's what makes sense, to use a customer's account

17 statements. The customer account statements is the

18 beginning and the end of the inquiry.

19 JUDGE JACOBS: Let me give you a

20 hypothetical. Let's say that a customer invests

21 with /SPH*G fiduciary of $10,000. Within a month,

22 wonderfully, it doubles. The broker takes half the

23 gains, $5,000, and spends it on wine and cigars.

24 And then the company goes bust. The account

25 statement would list only 15,000 and not 20,000.



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1 Are you saying that under those circumstances the

2 customer would only be entitled to 15,000 because

3 that's what's on the account statement fraudulently

4 worked up by the broker, or would the customer be

5 entitled to the full 20,000?

6 MR. LAX: The customer would be

7 entitled to the full 20,000 in that scenario.

8 JUDGE JACOBS: But that's what's on

9 the account statement. You just said the account

10 statement was the beginning and the end of it.

11 MR. LAX: Well, the account statement

12 controls, Your Honor. But what you would have to do

13 is value what the broker owes the customer on the

14 filing date, so in your scenario that's what the

15 broker would owe the customer on the filing date.

16 JUDGE JACOBS: So but that wouldn't

17 be determined by reference only to the account

18 statement.

19 MR. LAX: Well, when you can work

20 ^ within the statutory framework.

21 JUDGE JACOBS: Well, wouldn't you

22 have to look then at books and records and at the


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23 market price?

24 MR. LAX: Well, the account

25 statements and confirms are books and records.


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1 They're actually the only books and records that

2 customers have access to and the only ones that are

3 delivered to customers.

4 JUDGE JACOBS: Yes, but in my

5 hypothetical you wouldn't rely on the account

6 statement, you would look behind them.

7 MR. LAX: There are certain

8 circumstances where you could look behind account

9 statements and confirms and that's what the statute

10 provides. But that's when the statutory framework

11 doesn't work, but the statutory framework works for

12 Madoff victims. Madoff victims received account

13 statements and confirms for the purchase of real

14 securities. And I'd like the Court to notice when

15 they do their -- when they render their decision if

16 they look at volume 3, page 792 to 799 you'll


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17 recognize all of the securities that are contained

18 on those customer account statements. It goes from

19 Wells Fargo to Wal-Mart to Merck to Microsoft to

20 Apple, all of these securities are going to be

21 complete and known by the Court.

22 JUDGE RAGGI: None of these were

23 orders placed by the customers, if I understand it,

24 right? There was complete discretion as to what

25 would be purchased.


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1 MR. LAX: But there is no difference,

2 Your Honor --

3 JUDGE RAGGI: Am I right in that

4 assumption?

5 MR. LAX: Correct, but broker-dealers

6 get discretion either when the accounts are opened

7 or --

8 JUDGE RAGGI: One of the bases for

9 the bankruptcy judge's decision was the

10 determination that net equity has to be -- doesn't


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11 bear a particular statutory definition, rather that

12 it's to be determined by looking to the totality of

13 the circumstances of the conduct that brings

14 everyone before the Court. AUD and it was that

15 assumption that informed this choice. Is that a

16 flawed assumption or is it just that it was applied

17 incorrectly? I want to know where you think the

18 error originates.

19 MR. LAX: That's a flawed assumption,

20 Your Honor.

21 JUDGE RAGGI: Tell me why you think

22 so.

23 MR. LAX: Because there is no

24 exception for Ponzi schemes in the statute, there is

25 no exception for the size or the nature or the


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1 effect.

2 JUDGE RAGGI: ^ for the bankruptcy

3 judge cited to portions of the statute to support

4 his conclusion that it was appropriately viewed in


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5 the context of the particular conduct at issue in

6 the case.

7 MR. LAX: Well, I saw and that was

8 error, Your Honor.

9 JUDGE RAGGI: Why?

10 MR. LAX: Because the statute doesn't

11 provide for any exceptions to those kinds of

12 consideration. Those factors are completely

13 irrelevant. The loan issue is can you follow the

14 definition of net equity, which this SIPC Trustee

15 could have. All he had to do was go into the market

16 and purchase those real securities, which he could

17 have.

18 JUDGE RAGGI: But the bankruptcy

19 judge cites to different hypotheticals that I assume

20 was applied by the parties, but no matter. In which

21 what you're urging could deal with absurd results,

22 namely the individuals who had withdrawn some money

23 but whose account statements AUD indicated a certain

24 holding, might be recovering more under this

25 valuation method than counterparts who had never



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1 withdrawn any money.


3 Honor.

4 JUDGE RAGGI: Same investment. And,

5 you know, the law abhors an absurd result.


7 Honor. But in this statute there is no absurd

8 result test. What I believe is absurd is that half

9 of the Madoff victims of the worst SIPC liquidation

10 in history didn't receive SIPC protection.

11 JUDGE RAGGI: You know, you suggest

12 that the law does not tolerate any exceptions, and

13 yet our decision in New Times did treat two

14 different forms of investments differently. So that

15 seems to me to run counter to your argument that the

16 law admits no flexibility. The only question is

17 whether these facts warrant one treatment or the

18 other, but I'm not sure your argument that the law

19 does not permit different treatments can be

20 maintained after our New Times decision.

21 MR. LAX: But it can, Your Honor,

22 because these customers, the Madoff customers are in


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23 the exact same situation as those New Times

24 customers that received account statements and

25 confirms --


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1 JUDGE RAGGI: That was just if they

2 fall on one side. But it doesn't suggest that there

3 isn't another side to how net equity can be

4 calculated.

5 MR. LAX: Right. But in that very,

6 in that example which was a departure from the

7 statutory framework, the SIPC Trustee could not go

8 out and purchase the New Age Fund securities. There

9 was no legitimate expectation on behalf of the

10 customers that they actually own those securities.

11 No one had any idea what the New Age mutual fund was

12 invested in. And the Trustee couldn't go out and

13 buy those securities.

14 But in this case the SIPC Trustee

15 could go out and buy IBM, Google, Microsoft, all

16 those types of securities.


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17 JUDGE RAGGI: What I understand to

18 be, I believe, one of the differences here is that

19 those purchases are not necessarily reflective of

20 what your clients may have invested because their

21 total portfolio is a function of all these

22 fraudulent trades usually done in hindsight that

23 were brought to create that figure. So it's not

24 like purchasing as occurred in New Times, what the

25 client had basically invested.


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1 MR. LAX: But that's really a

2 distinction without a difference because when you

3 give a broker-dealer discretion or when you get on

4 the phone with your broker and say, okay, I want to

5 buy that security, there is no difference. The only

6 thing that establishes more by giving the

7 broker-dealer discretion is you give the

8 broker-dealer a fiduciary responsibility to increase

9 the burden.

10 JUDGE RAGGI: Use small numbers so as


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11 not to get complicated. If one invests $1,000 and

12 the broker, in order to keep that money in the

13 scheme, keeps sending you reports that now you have

14 $1500, now you have 2,000, now you have 2500, and

15 here's what it's being invested in, well, you've

16 never put in that extra money AUD and nothing ever,

17 no security ever yielded that result, the market

18 could not have yielded it. I don't know how you

19 have a claim that you're entitled to the 2500

20 afterward. AUD

21 MR. LAX: Well, if you can go and

22 look and see if your security increased in value,

23 then you would have legitimate expectations in that

24 increase in value. But if you went and checked the

25 market and you looked and your security is not


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1 increasing in value, but yet on your account

2 statements it is increasing in value, that might be

3 an exception to the statutory framework, where a

4 legitimate customer's expectations are not met.


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5 JUDGE JACOBS: Thank you.

6 MR. LAX: Thank you very much.

7 MS. WAGNER: Good morning, Your

8 Honors. May it please the Court, my name is Karen

9 Wagner, I'm a member of the firm of Davis Polk &

10 Wardwell, representing Sterling Equities and

11 associated entities in this matter.

12 Your Honors, it is our position that

13 the customers' account statements should control in

14 this case. Now obviously there are situations

15 where --

16 JUDGE LEVAL: You're relying on the

17 provision of the SIPA which requires the Trustee to

18 discharge obligations insofar as such obligations

19 are ascertainable from the books and records of the

20 debtor? That's the language that you rely on?

21 MS. WAGNER: Your Honor, I'm relying

22 on the net equity definition, which I think is

23 completely consistent with the language that Your

24 Honor has just recited. The way that we understand

25 the statute to work is this:


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1 Outside of SIPA, before SIPA ever

2 comes into play, you engage in a transaction with

3 your broker. Your broker issues you a statement

4 saying you own ten shares of IBM. Under all the law

5 that's applicable prior to the SIPA filing, if you

6 go to your broker and you say I want my ten shares

7 now and the broker says, sorry, I don't have it, you

8 can sue him and get a judgment and you will be

9 entitled to your ten shares of IBM. When SIPA comes

10 into play does something change? Does the broker

11 now have a defense? Especially a defense based on,

12 sorry, I didn't buy your securities and I'm engaging

13 in a fraud, so actually I don't owe this to you

14 anymore? Obviously that doesn't make much sense.

15 AUD

16 JUDGE LEVAL: So if the broker took

17 your money, if the money comes in and the broker,

18 instead of investing it, pockets a large percent of

19 it and sends you a statement saying that you

20 invested, a fictitious investment, he selects an

21 investment that went plunging down, sorry, I

22 invested for you in this at 100 and it's now worth

23 40, sorry, you're saying that the appropriate debt


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24 is the 40 because that's the statement that you

25 received? AUD


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1 MS. WAGNER: No, Your Honor. What

2 I'm saying actually is normally your statements

3 control and in this case we believe they control.

4 Now, it certainly is the case in the language Your

5 Honor read, permits the customer, when it's clear

6 that the broker has defrauded the customer and has

7 issued a statement that is inconsistent with what

8 the customer thought he was investing in, the

9 customer can go to the broker and to the SIPC

10 Trustee and say, look, I actually invested $10,000,

11 not $5,000, so my claim is bigger. In section 8B,

12 the provision that Your Honor is reflecting on,

13 permits the customer's claim to be enlarged if the

14 Trustee considers that whatever records the customer

15 has reflects that transfer of funds.

16 JUDGE LEVAL: Let me give you another

17 hypothetical. Supposing that it happens to be a


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18 week before the whole thing, the Ponzi scheme is

19 exposed, that a week before, a month before, two

20 people come in on the same day and one of them says,

21 he's an old friend of Mr. Madoff and he says,

22 Bernie, I'm in a terrible situation, I'm in

23 desperate need for money for this, that and the

24 other thing, I hope you can do good by my account.

25 And the other one Mr. Madoff decides he doesn't like


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1 at all, he's always hated him, and for his friend,

2 they both come in with a million dollars on the same

3 day, and for his friend, he received statements of

4 spectacularly successful trades and the million

5 becomes two million, 2-1/2 million in the space of

6 that week. And the other one, who Mr. Madoff didn't

7 like, his equity that he engaged in distinctly

8 unspectacular trades and his investment drops and

9 it's practically all lost. So you're saying to me

10 that when the whole thing comes apart a week later,

11 the proper way to measure what is owed to the two of


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12 them is that the one who received notice of entirely

13 fictitious spectacularly successful trades is 2-1/2

14 million where the other only gets $50,000?

15 MS. WAGNER: Your Honor, two

16 responses to that. First of all, that is not the

17 situation that is presented to you today. The

18 record is clear that --

19 JUDGE LEVAL: The situation that's

20 presented to us today is whether peoples' accounts

21 should be valued on the basis of fictitious trades

22 that never occurred, on the basis of statements that

23 were simply figments of the imagination and never

24 involved any real securities whatsoever.

25 MS. WAGNER: Your Honor, the


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1 securities on people's statements, and this is

2 what's in the record before you today, they were

3 securities that do exist in the market.

4 JUDGE LEVAL: Oh, I know the

5 securities exist, but the ownership of those


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6 securities by those persons was entirely fictitious.

7 MS. WAGNER: Absolutely correct.

8 JUDGE LEVAL: As in my example that I

9 gave you.

10 MS. WAGNER: Mr. Madoff breached his

11 obligations to the customer to buy securities. But

12 the customers received statements that show

13 ownership of these securities, under all

14 nonbankruptcy law those statements give them

15 ownership rights and I think SIPA also gives them

16 ownership rights.

17 Now, your question I think goes to

18 the question of whether somebody is a customer. If

19 somebody knowingly invests in -- gives money to

20 Mr. Madoff, knowing Mr. Madoff is engaged in a Ponzi

21 scheme --

22 JUDGE LEVAL: No, I didn't say they

23 knowingly knew.

24 MS. WAGNER: I'm getting there. If

25 you know it, if they know it, then I think they may


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1 not be a customer and then maybe none of this

2 protection works for them. But if they don't know

3 it and if they get a statement that appears

4 consistent with the market, which is what happened

5 here, I would suggest to you all the law says they

6 are entitled to rely on that statement.

7 JUDGE LEVAL: That was my

8 hypothetical to you. These people gave money to

9 Madoff in good faith and they received statements

10 which they believed to be accurate. One of them was

11 disappointed and one of them was very, very happy.

12 MS. WAGNER: I think the statement

13 controls, Your Honor, when the customer believes

14 rationally that the statements that they're getting

15 are consistent with what they own. And the reason,

16 Your Honor, is because you never know when your

17 broker is engaged in a Ponzi scheme or some other

18 nontrading of securities. You don't have any

19 physical securities anymore in your possession. You

20 have no idea what's going on behind the scenes. You

21 must rely on your statements.

22 JUDGE JACOBS: What I think you're

23 arguing is that the fund should pay out in respect


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24 of each investor whatever amount Madoff made up

25 chewing on his pencil and looking at the ceiling.


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1 MS. WAGNER: Your Honor, customers

2 are entitled to rely on their statements and I

3 believe the funds are obliged to honor their

4 expectations unless it can be shown that they are

5 not customers because they actually knew something

6 was going on. I do believe that. I also believe

7 that it's consistent with the New Times decision.

8 JUDGE JACOBS: Well, your reference

9 as to expectations, which of course are legitimate

10 expectations is the reference to the wording in New

11 Times which deals with whether the account will be

12 classified as one of cash or as an investment in

13 securities. Every one of the claimants here has

14 already gotten the benefit of that classification,

15 that means that they have, as it were coverage, a

16 half a million instead of 100,000. But I'm not sure

17 legitimate expectations governs what the precise


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18 amount of money that they get, within that limit.

19 MS. WAGNER: Your Honor, I'm not sure

20 it's legitimate expectations exactly, either. I'm

21 saying that outside of SIPA the statement controls

22 unless you can conclude that there is some reason

23 why it would not. Inside of SIPA the statement also

24 controls subject to, you know, if the broker

25 doesn't --


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1 JUDGE JACOBS: What I don't

2 understand is you're saying controls unless there's

3 some reason why not.

4 MS. WAGNER: The reason why not is

5 the customer is complicit. Otherwise it controls.

6 JUDGE JACOBS: So that you're saying

7 that's the only reason?

8 MS. WAGNER: Yes, I am, Your Honor.

9 The customers are entitled to this protection, and

10 the reason is they have no other way -- the whole

11 system is dependent upon the customers' statement,


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12 the statement issued by the broker saying this is

13 what you own.

14 JUDGE LEVAL: In New Times was there

15 a challenge in this Court to the valuation by the

16 customers who had fictitious nonexisting securities

17 on their statements? I'm sorry. With respect to

18 the customers who had actual securities, true

19 securities?

20 MS. WAGNER: No.

21 JUDGE LEVAL: There was no challenge.

22 MS. WAGNER: That's right. The only

23 issue before the Court in that case when you cannot

24 value the securities because they never existed,

25 that's when you come into a situation where SIPA is


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1 exposed to an unreasonable result because there is

2 no way of knowing --

3 JUDGE LEVAL: So our court decision

4 in that case does not represent a precedent for

5 using the account statement on the other securities


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6 because it was challenged, it was the subject of

7 dispute.

8 MS. WAGNER: I think that's correct,

9 Your Honor, but I think the analysis in that

10 decision is if the statute can be followed it must

11 be followed, but if it cannot be followed then some

12 other approach is needed, is directly applicable to

13 this case because in this case --

14 JUDGE JACOBS: In that case the

15 requisite analysis was frustrated. It was

16 impossible to figure out what the real value is of

17 securities issues that never existed of companies

18 that were just figments of the imagination and

19 therefore people were limited to what they had paid

20 in, less what they took out. Why is this not an

21 analogous situation in the sense that the securities

22 may have real names, but the transactions that

23 generated the upside were just as fictitious as the

24 stock issues in New Times?

25 MS. WAGNER: Your Honor, the whole


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1 system is set up to protect the customer, so I think

2 you need to look at it from the customer's

3 perspective and from the customer's perspective the

4 transaction is not fictitious. The customer

5 provided funds to a broker and said, please invest

6 this, at your discretion. The broker kept issuing

7 statements that looked like they were consistent

8 with the market, that told the customer this is what

9 you own. This went on for 30 years, it seemed to

10 work pretty well for a pretty long time.

11 The customer had every reason to

12 assume that the protection of the securities law of

13 Article 8 and finally of SIPA would govern in this

14 case.

15 JUDGE JACOBS: It does seem awfully

16 unfair to the people who were credited with having

17 fake securities in New Times that they shouldn't get

18 the benefit of exactly the same expectations. After

19 all, ordinary investors don't really have the

20 ability to go out and find out whether, you know,

21 Blue Sky Corporation actually exists or has a

22 certain capitalization or traded here or there. I

23 mean, your argument, it seems to prove too much that

24 New Times is wrong. All of those people were

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25 unfairly treated, according to you. And they may


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1 indeed have been unfairly treated in the overall

2 scheme of things. The question is were they

3 unfairly treated under the statute?

4 MS. WAGNER: Your Honor, I think

5 those customers were entitled to what was on their

6 statements and I think that's the statute that

7 controls. The problem is no one could give them

8 what was on their statements, it didn't exist. So

9 in that circumstance --

10 JUDGE RAGGI: Well, no one is going

11 to give your clients 20 shares of AT&T. All of this

12 is money. So the question is why does this money,

13 which reflects thousands, if not millions of

14 transactions that are entirely fictitious, yield a

15 dollar figure that is more worthy of SIPA protection

16 than the dollar figure that was reached by purported

17 purchases of nonexisting companies in New Times.

18 MS. WAGNER: Your Honor, I think the


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19 issue is simply that the fictitious securities in

20 New Times could not be valued. They certainly

21 couldn't be bought but they also for the same reason

22 could not be valued and, therefore, SIPC would be

23 exposed to risk which there was no way to tether in

24 any way to the market.

25 Here, what is before you today, the


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1 statements customers received all reflect real

2 securities that were traded, according to the

3 statements, at prices you would expect in the

4 market. Here you can determine --

5 JUDGE RAGGI: Means that the customer

6 took risks in the market. And these customers, as I

7 understand it, were never at risk because they were

8 never in the market, but more to the point, even

9 their statements were concocted after the fact,

10 always to show gains. So there was never the risk.

11 And that suggests to me that the distinction you're

12 drawing isn't one that's particularly persuasive.


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13 What have I missed, perhaps?

14 MS. WAGNER: Your Honor, I think the

15 point again is this has to be regarded from the

16 perspective of the customer. The customer has no

17 information about what the broker is doing except

18 what the broker tells the customer. The customer is

19 relying on that information and month after month

20 after month when the customers received the

21 statements, they relied on that information and they

22 acted --

23 JUDGE RAGGI: That's the same in both

24 the circumstance of the fraudulent stock and the

25 fraudulent transactions. I need to know how we


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1 distinguish those.

2 MS. WAGNER: The distinction is

3 simply can the statute be applied or can it not. If

4 it can be applied because, I agree that SIPC is not

5 going to go out and buy the AT&T but SIPC can tell

6 you how much the AT&T was worth on the filing date.


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7 You could not tell in the New Times case how much

8 the securities were worth because they never

9 existed, they were never traded, as the decision

10 says, there were no prospectuses, there were no

11 financials, you had no idea what the securities were

12 worth, so there was just no way to do what the

13 statute told you to do.

14 JUDGE LEVAL: Can you clarify for my

15 something, which to what extent are we talking about

16 an issue of dividing up a pie of predetermined size?

17 In other words, how large is each of the former

18 customers' size of participation, slice of a pie of

19 a predetermined set of assets what remained after

20 the debacle. And to what extent are we talking

21 about a distinction that would change the size of

22 the overall pie as a result of bringing in new funds

23 from SIPC?

24 MS. WAGNER: Your Honor, there are,

25 as you note, conceptually two pies. One is the SIPC


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1 advance, which is there for every customer, whether

2 or not another customer gets it, every customer is

3 entitled to it. So in that sense, whatever the

4 customer's claim is, it's not going to reduce the

5 next customer's claim. Ultimately there are also

6 the estate, the Madoff estate once the Trustee has

7 done all his litigation, and in that case the

8 relative recovery on claims will be affected by how

9 many claims there are. But not in the first

10 instance.

11 JUDGE LEVAL: And so you're saying

12 there are two different pies, one of which is of a

13 predetermined size, and that's the estate, and the

14 other is the pie that is created by the SIPC

15 contributions, and that's, the size of that pie will

16 vary according to how this question is determined?

17 MS. WAGNER: That's correct, Your

18 Honor. One customer's recovery from the fund will

19 not affect another customer's recovery from the

20 fund.

21 JUDGE LEVAL: And how do the size of

22 those two pies compare to one another? Which is the

23 bigger pie and by how much?

24 MS. WAGNER: I can't answer that


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25 question, Your Honor. The SIPC fund, to the best of


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1 my knowledge, although you can certainly ask SIPC,

2 is enough to cover everybody who's involved here

3 today. The Madoff estate --

4 JUDGE LEVAL: Enough to cover them?

5 You mean to make them whole?

6 MS. WAGNER: No. The only thing SIPC

7 is liable for is $500,000 per claim. So there is

8 enough for that.

9 The Madoff estate I don't think we

10 know yet what exactly the size of that estate is.

11 The Trustee is still engaged in litigation. I think

12 right now it's seven or eight billion or something

13 like that.

14 JUDGE LEVAL: It seems to me that the

15 argument that you're making makes better sense in

16 the SIPC application than it does in the division of

17 the pie, as to the division of the estate pie, who

18 gets more and who gets less would be entirely a


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19 function of, as Judge Jacobs was saying, of

20 Mr. Madoff's imagination.

21 MS. WAGNER: Your Honor, the question

22 of who gets more and who gets less, and that is I

23 think the motivating factor here in what the Trustee

24 is doing, you have to go and figure out, well, what

25 body of law is going to govern that question. Who


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1 decides -- where is it coming from that who gets

2 more and who gets less is the controlling issue in

3 this case. And I would suggest to you that is not

4 something that appears in SIPA, except to the extent

5 that SIPA does give the Trustee the authority to

6 avoid preferences. Preference is the concept that

7 you use when you want to equalize recoveries across

8 all creditors. And that is an important bankruptcy

9 principal, but it's a 90-day principal. It is not

10 one that goes across 35 years. It's a 90-day

11 principal. That I think is completely consistent

12 with the net equity recovery.


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7 statements were invalid, just like this one, so

8 we're going to deduct from what the broker should

9 owe you, we're going to deduct those valid payments

10 that you got in the past and, therefore, your claim

11 is going to be lower. So, for example, if you had a

12 claim for -- if your customer statement says you are

13 owed a million dollars and the Trustee goes through

14 his analysis and finds out that you're owed

15 $200,000, then the SIPC recovery is $200,000 rather

16 than $500,000. And that is how people are being

17 harmed by this even as to the SIPC fund.

18 JUDGE RAGGI: May I be certain I

19 understand why you think that the Trustee did not

20 have the discretion to proceed as he did under 78

21 triple F 2D. That's the section that says that he's

22 obliged to discharge net equity claims only insofar

23 as such obligations are ascertainable from the books

24 and records of the debtor or are otherwise

25 established to the satisfaction of the Trustee. I


29


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1 just want to be sure I understand your position.

2 MS. WAGNER: Surely, Your Honor. The

3 statutory context is that you have a net equity

4 claim and once the Trustee understands what that is,

5 then he has to discharge it, 8B the statutory

6 framework here, you have to then discharge it.

7 ^ ???

8 The customer statement is a record

9 which brokers are required to maintain and to give

10 their customers.

11 JUDGE RAGGI: That's not talked about

12 in the statute as the document that the Trustee has

13 to rely on.

14 MS. WAGNER: None of them are talked

15 about specifically.

16 JUDGE RAGGI: So, what it says is

17 he's obliged to discharge them insofar as such

18 obligations are ascertainable from the books and

19 records of the debtor or are otherwise established

20 to the satisfaction of the Trustee. That's the

21 statutory language. Do you agree that that controls

22 his determination here, that that is the relevant

23 section, or not?

24 MS. WAGNER: No, I do not agree, but

25 I don't think it's inconsistent with what I think is


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30

1 the governing provision. The governing provision is

2 the net equity definition. I believe the net equity

3 definition says that you must give the customer what

4 the broker owes the customer on the date of filing.

5 I think you determine that by looking at the

6 statements, generally speaking. There may be times

7 when you have to see if there has been some

8 intervening event, but generally speaking you look

9 at the statement. Once you look at the statement

10 then 8B says to the Trustee, now you've got to go

11 and deliver securities or cash consistent with that.

12 If the customer, for example, doesn't have a

13 statement because the customer just isn't too good

14 at keeping records, the customer can go to the

15 Trustee and say, you know, he owed me ten shares of

16 AT&T and the Trustee says prove it and if there is

17 some way to prove it the Trustee is enabled by that

18 provision to take other information in order to

19 prove the Trustee's claim. But I don't think that


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20 provision governs in the first instance and

21 certainly nothing in that provision that says do not

22 look at the statements. The statements on their

23 face would have to --

24 JUDGE RAGGI: It says you pay

25 obligations only insofar as they are ascertainable


31

1 from the books and records of the debtor. My

2 understanding is that the Trustee's position is that

3 when you look at the books and records of the

4 debtor, the purchases on particular days that were

5 ascribed to the particular accounts never occurred.

6 And, indeed, were not identified for anyone until

7 after the fact, when it was clear that they had been

8 profitable. And given that that was the scheme, the

9 Trustee concluded that you couldn't ascertain that

10 these profitable transactions had taken place from

11 the books and records and, therefore, that that

12 would not be a reliable way to calculate the net

13 equity that was appropriately discharged. And I


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14 just need to understand why you don't think that

15 that is a decision that that statutory section

16 affords the Trustee the discretion to make.

17 MS. WAGNER: Your Honor, again, to go

18 back to my first principal here, this should protect

19 customers. That's the name of the statute and the

20 customer should be the focus.

21 JUDGE RAGGI: I understand that we're

22 all interested in statutory purpose, but we are

23 limited by statutory language.

24 MS. WAGNER: Absolutely, absolutely.

25 JUDGE RAGGI: So I'm asking you again


32

1 why that statutory language did not afford the

2 Trustee the discretion he exercised here.

3 MS. WAGNER: Because he's not

4 permitted under that section to ignore the

5 statements. The statements are mandatory records of

6 the broker and if you look at it from the customer's

7 perspective and if you analyze it from the day


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8 before the filing, before SIPA comes into play under

9 Article 8 of the UCC and under the federal

10 securities law, the customer can sue the broker on

11 the day before the filing --

12 JUDGE RAGGI: Maybe I'm not making

13 myself clear, but the totality of the books and

14 records show why those statements are totally

15 fraudulent. Namely, there is no book or record that

16 even shows a false transaction on the day it's

17 supposed to have happened. Rather, the transaction

18 is identified sometime down the road when it's clear

19 it was profitable.

20 So, to that extent, the Trustee

21 didn't think there ever was a transaction. It's not

22 like Mr. Madoff's told someone today that he

23 purchased AT&T for him. Rather he tells him next

24 week that today he purchased AT&T for him, when he

25 can assure him that it was a profitable transaction,


33

1 and that the Trustee was not prepared to accept as a


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34

1 Protection Act continues the protection that was

2 available to the customer prior to the filing. AUD

3 in which manner it is entirely consistent with other

4 forms of insolvency law where the customer's claim

5 remains the same inside or outside of bankruptcy.

6 The recovery of course is different, but there is no

7 reason why the Securities Investor Protection Act

8 would suddenly reduce the customer's claim against

9 the broker, just because the broker breached his

10 obligation to the customer. That doesn't make

11 sense. It makes sense that the Securities Investor

12 Protection Act should be read consistently with the

13 whole framework of the securities laws. That would

14 be my argument.

15 JUDGE JACOBS: Let me make one

16 clarification. All of the claimants in this suit

17 are split strike customers? None of them are in the

18 nonsplit strike customer category?

19 MS. WAGNER: Your Honor, that is


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20 my -- yes. That's the case.

21 JUDGE JACOBS: Thank you very much.

22 MS. WAGNER: Thank you, Your Honor.

23 JUDGE JACOBS: There will be

24 rebuttal.

25 MS. WANG: May it please the Court,


35

1 my name is Josephine Wang, I represent the

2 Securities Investor Protection Corporation or SIPC,

3 S-I-P-C. The Court in these appeals is being asked

4 to decide what customers are owed in the Madoff

5 liquidation proceeding. The appellants contend that

6 the Court must be guided by the last account

7 statements that were issued to them by the

8 broker-dealer. However, those statements are

9 fictitious.

10 JUDGE RAGGI: If they were to sue

11 Mr. Madoff, that wouldn't be a defense for him. He

12 would be obligated to pay them what the statements

13 he sent them, wouldn't he?


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14 MS. WANG: That's absolutely correct

15 if the firm had remained in business, Your Honor.

16 JUDGE JACOBS:

17 JUDGE RAGGI: Why should SIPC's

18 calculation be different?

19 MS. WANG: Because we're bound by a

20 federal statute and that statute does not authorize

21 a Trustee to benefit certain customers at the

22 expense of other customers; because the prices on

23 the statements were back-dated; because the profits

24 or so-called profits were fictitious.

25 JUDGE LEVAL: How is it at the


36

1 expense of other customers when you're talking about

2 the SIPC, the funds coming from SIPC that measure

3 for each customer independently how much that

4 customer is entitled to?

5 MS. WANG: Well, first of all, we're

6 not only talking about the funds that come from

7 SIPC. We're talking about customers who are all


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2 customers. It's property that belonged to customers

3 that the Trustee finds when it takes possession of a

4 broker-dealer but it's also customer property that

5 the Trustee recovers during the liquidation perhaps

6 by bringing third-party actions.

7 JUDGE RAGGI: So any monies in

8 Mr. Madoff's possession and then clawbacks?

9 MS. WANG: It could be. It could be.

10 But returning to Your Honor's

11 question, all customers' property is shared pro rata

12 among customers. So if you rely on the last account

13 statements, that means that people who are owed

14 ^ ??? simply estate property will be sharing with

15 other customers who are actually owed their

16 principal. And once again, those profits will be

17 paid out of other customers' money and that is

18 simply unfair.

19 JUDGE LEVAL: That part is very

20 clear. But it's the part that relates to the money

21 coming from SIPC.

22 MS. WANG: It also indicates the SIPC

23 fund because obviously the exposure will be much

24 much greater. We believe there to be an actual

25 exposure of approximately 17 to 20 billion. If you


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38

1 rely on the last account statement, obviously the

2 exposure becomes much greater, roughly 64 billion or

3 thereabouts.

4 So you now have people who are owed

5 fake profits who will be eligible for SIPC

6 protection, which means that SIPC would of course

7 have to advance that much more.

8 JUDGE JACOBS: I'm a little confused.

9 I thought that your argument would be that if SIPC

10 paid out $500,000 to any given investor, SIPC would

11 then be subrogated to a 500,000-dollar claim against

12 the estate.

13 MS. WANG: That's absolutely correct.

14 To the extent that any single customer has been

15 fully satisfied out of a SIPC advance, SIPC steps

16 into the shoes of that customer and takes his share

17 or his or her share of customer property. So that

18 there is no double recovery by that customer.

19 JUDGE JACOBS: And that does seem to

20 me to suggest that a 500 maximum payment by SIPC


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21 could have some impact on other investors in the

22 bankruptcy proceeding simply because of the claims

23 that SIPC would have by virtue of having paid that

24 claimant in the SIPC process.

25 MS. WANG: I'm not sure that I'm


39

1 following Your Honor.

2 JUDGE JACOBS: If SIPC subrogated to

3 the claim, then having paid out the $500,000, SIPC

4 has a 500,000-dollar claim against the --

5 MS. WANG: Yes, standing issues of

6 the customer. Theoretically what should happen or

7 what happens is that the Trustee accumulates the

8 fund of customer property, that fund is distributed

9 pro rata among customers and then to the extent that

10 there is any shortfall, the SIPC protection is

11 available.

12 JUDGE RAGGI: But it all relates to

13 how the customer property is divided up. If the

14 only way anyone were to be compensated was through


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15 SIPC, one customer's receipt of $500,000 does not

16 affect whether another customer will receive an

17 amount up to $500,000. That's what the law

18 provides, right, each of them can receive that,

19 depending on how net equity is calculated. Dollars

20 given to one person will not take it away from

21 another.

22 MS. WANG: That's true, Your Honor,

23 but that's not how the statute work because it does

24 affect -- ^ ???

25 JUDGE RAGGI: Right.


40

1 MS. WANG: Right. ^ CK

2 JUDGE LEVAL: So if I understand

3 correctly then, when SIPC is subrogating to the

4 customer's positions with respect to claims against

5 the estate --

6 MS. WANG: The fund of customer

7 property, yes.

8 JUDGE LEVAL: Then to the extent that


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9 SIPC pays one customer based on that customer's

10 inflated long-term position that grew much, much

11 larger than the customer's initial investment,

12 notwithstanding withdrawals, SIPC's payment of the

13 full $500,000 to that customer will reduce another

14 customer's entitlement because SIPC then becomes a

15 claimant against the estate.

16 MS. WANG: That's correct, Your

17 Honor.

18 JUDGE JACOBS: Now when SIPC becomes

19 a claimant against the estate, asserting a

20 500,000-dollar claim, that doesn't mean that SIPC

21 will recover $500,000 even if there is sufficient

22 funds. It may well be that SIPC will have paid out

23 more money under the governing statute than gives it

24 the ability to recover that whole amount in the

25 bankruptcy.


41

1 MS. WANG: Well, again SIPC stands in

2 the shoes of the customer, so SIPC won't receive


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3 anything more or less than the customer would be

4 entitled to.

5 JUDGE JACOBS: Let me give you this

6 hypothetical, because I'd just like to understand

7 what your position is.

8 Assume that a customer gives the

9 broker, a broker $100 to buy 100 shares of a blue

10 chip stock, blue chip corporation. The broker takes

11 $80 and blows it on cigars. The stock doubles in

12 value, on the market, the broker then goes bust.

13 Seems to me there's three possible options. Either,

14 according to SIPC, the customer gets the $20, which

15 is the value of 20 shares on the account statement,

16 or the customer gets $100, which is what was

17 invested, or the customer gets $200, which is the

18 value of what should have been on the account

19 statement. What's SIPC's position?

20 MS. WANG: Well, there are a number

21 of variables. We're assuming that the customer has

22 received an account statement? Are we assuming that

23 the account statement reflected in all respects

24 market reality?

25 JUDGE JACOBS: No, it doesn't reflect


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15 MS. WANG: I may have misunderstood

16 Your Honor's question. But as I understood it, the

17 customer received an account statement which

18 reflects the purchase of 100 shares of stock, and

19 that trade --

20 JUDGE JACOBS: No. It reflects the

21 purchase of 20 shares of stock, at a dollar each.

22 But the customer gave $100 to purchase 100 shares.

23 MS. WANG: I'm sorry. I

24 misunderstood your question.

25 JUDGE JACOBS: By the time everything


44

1 went bust the company doubled in value. So what

2 does SIPC pay or what does SIPC argue that it should

3 pay?

4 MS. WANG: A customer is protected --

5 a customer by definition is protected against the

6 loss of cash for securities that have been converted

7 by the broker. That's in the definition of

8 customer.


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9 JUDGE JACOBS: So the customer gets

10 $200?

11 MS. WANG: The customer gets whatever

12 his account statement shows that reflects market

13 reality. But to the extent that the entire sum was

14 not invested and doesn't appear on that statement,

15 then he gets the balance in cash.

16 JUDGE JACOBS: Okay. I think I

17 understand your position.

18 MS. WANG: I hope I understood Your

19 Honor's position. I apologize if I confused you.

20 JUDGE RAGGI: To the extent we have a

21 fraud here in which individuals invested money and

22 were repeatedly told through their account

23 statements that they were now, they now had holdings

24 of several multiples of their original investments,

25 and to the extent you also agree that the


45

1 perpetrator of the fraud would be liable to them for

2 the account statement amount, I'm not sure why you


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3 want a different calculation for SIPC ^ after all.

4 You're not going to have to pay anyone full dollar,

5 it's going to be $500,000 plus whatever customer

6 monies were recounted. Why should there be

7 differing ways of assessing the customer's net

8 equity, depending on who's being sued or who's going

9 to be giving the money?

10 MS. WANG: It depends on the facts of

11 the case, Your Honor. And our obligation is to make

12 sure that the statute is correctly enforced. We are

13 not just looking at SIPC's liability here. That's

14 probably the last of our concerns.

15 JUDGE RAGGI: Have you taken the view

16 that it would have been error for the Trustee to

17 have treated net equity by reference to the account

18 statements, that he would have been precluded by the

19 statute from doing so?

20 MS. WANG: Yes, Your Honor.

21 JUDGE RAGGI: And where in the

22 statute is the language that would have precluded

23 him from looking to the account statement for the

24 net equity?

25 MS. WANG: It's the language that was



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22 occurred --

23 JUDGE RAGGI: As in my hypothetical,

24 no trades occurred.

25 MS. WANG: Yes. But they showed


47

1 it --

2 JUDGE RAGGI: And in New Times no

3 trades had occurred in the established stocks.

4 MS. WANG: Right. But I think, as I

5 understood Your Honor's question, the question is

6 how can the books and records show a nonevent?

7 Well, for example, the books and records showed

8 confirmation of a certain number of trades and yet

9 the volume of trades being put on on that particular

10 day, or actually the amount of fictitious trades

11 that were being confirmed far exceeded the volume of

12 actual trades.

13 JUDGE RAGGI: You mean that the

14 market.

15 MS. WANG: Correct. Prices. The


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10 the satisfaction of the Trustee.

11 I see that my time is up. Thank you,

12 Your Honors.

13 JUDGE LEVAL: It says insofar as

14 ascertainable from the books and records.

15 MS. WANG: Correct, Your Honor.

16 JUDGE LEVAL: And that supports the

17 implication that you're arguing, that one just

18 doesn't take what is stated on the ostensible books

19 and records and treat it as fact. You have to see

20 what can be ascertained from a study of the entirety

21 of the books and records.

22 MS. WANG: Absolutely, Your Honor.

23 JUDGE LEVAL: In this case,

24 demonstrates a Ponzi scheme which nobody ever had

25 any investment made.


49

1 MS. WANG: Absolutely correct, Your

2 Honor. Thank you.

3 MR. SHEEHAN: Good morning, Your


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50

1 money out. There can't be anybody else who has a

2 claim for a SIPC advance. It's an advance. It is

3 an advance against the money owed to you by the

4 broker. If the broker doesn't owe you any money, he

5 gave it all back and then some, there is no SIPC

6 advance. There is no $500,000.

7 JUDGE RAGGI: ^ ??? the broker who

8 told people over the course of 30 years that they

9 had statements that increased at the rate of 15

10 percent a year or whatever owes them only what they

11 put in at the start of the 30-year investment? You

12 think that's all the broker owes these people?

13 MR. SHEEHAN: In a Ponzi scheme, yes.

14 Absolutely. Why would he owe them anything more?

15 The statute --

16 JUDGE RAGGI: /SPH*G fraud.

17 MR. SHEEHAN: Fraud is a general

18 creditor claim. That's what's getting confused

19 here. We're talking about two funds. The customer

20 funds the property is the cash and securities

21 deposited with the broker. The broker has an


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22 obligation to pay that --

23 JUDGE RAGGI: The government of the

24 United States, the SEC thinks it's the current value

25 of the money, not just what they put in 30 years


51

1 ago.

2 MR. SHEEHAN: I don't know if I agree

3 with that. I think it's only what they put in. If

4 the property was never invested, if in fact there's

5 no profits, no transaction, how did the fund grow?

6 Where does it come from? ^ CK

7 JUDGE RAGGI: The injury from the

8 fraud is that if the individuals had known it wasn't

9 going to be invested, they would have put it

10 somewhere else and hoped to profit from it.

11 MR. SHEEHAN: Absolutely. And when

12 they have a general creditor claim, then they get

13 that access to those funds. Let me explain just

14 what I mean by that.

15 What we're trying to do here, what


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10 footing. Those who got their money out and got some

11 on top of that are now equal to those who got their

12 money out of the fund of customer property. That's

13 the goal, the priority of the statute. That's what

14 the statute is all about, is that these who did not

15 get their money out get the opportunity, through the

16 customer fund, that priority. Once that priority is

17 satisfied, then all of them are on equal footing and

18 they all have a fraud claim, you're absolutely

19 right, Your Honor. At the end of the day all of

20 them look and say to us, to the Trustee, I have a

21 claim here. I thought I had 30 years worth of

22 profits. I don't have them now. What are you going

23 to do about that? Well, what this Trustee is doing

24 and what we have done is instituted suits, suits to

25 recover not just the $20 billion but the damages


53

1 that were inflicted by those who participated and

2 perpetuated this fraud. At the end of the day our

3 hope is that there would be a second fund, there


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4 will indeed be a general creditor fund and all of

5 these appellants here will have the opportunity

6 then, but only then, to participate.

7 Imagine, would it be fair to adopt

8 their approach and suggest that I take the $5

9 billion from this Trustee and give half of it to

10 people who already got all of their money back and

11 tell the people who didn't get their money back,

12 you're not getting half of this, we're giving it

13 over here because we're using the last statement?

14 The Trustee's approach here is the

15 only reasonable construction of the statute, the

16 only reasonable exercise of discretion. Anything

17 short of that, anything short of what I've just

18 described leads to the absurd result, Your Honor,

19 that you alluded to when you said the law does not

20 countenance absurd results, the absurd result that

21 we would be giving other people's money --

22 JUDGE LEVAL: May I ask you a

23 question, a somewhat different hypothetical?

24 MR. SHEEHAN: Yes, Your Honor.

25 JUDGE LEVAL: Supposing that this



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23 to the different customers? There isn't enough to

24 go around. Do you give full value to some and only

25 the cash that they put in to the others? Or do you


55

1 treat them identically so that the ones who actually

2 had the securities in their accounts get less than

3 what their accounts actually had in them? How do

4 you deal with that?

5 MR. SHEEHAN: I think the answer is

6 just as Your Honor suggested at the very end of your

7 hypothetical. SIPC protects the customer for the

8 cash and securities they put into the hands of that

9 broker. And if it's converted by the broker, then

10 they get their money back.

11 So this hypothetical you have, the

12 cash and securities of one set of customers is

13 there, and they get that back and they should and

14 that's what the statute mandates. But what has

15 happened to the other customers is that

16 unfortunately for them their money has been


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17 absconded with. That doesn't mean at the end of the

18 day that all they get back is the cash that they put

19 in, but the fund doesn't have any additional

20 dollars, can't manufacture that, but they would be

21 entitled to, I believe in that particular instance,

22 though, would be an advance. Unlike because I think

23 they had money in --

24 JUDGE LEVAL:

25 MR. SHEEHAN: Yeah, I think that


56

1 would be so. But that's not true when you're

2 dealing with an entire Ponzi scheme, and the only

3 people that can participate in that would be what

4 we're dealing with here.

5 For example, what has happened here

6 is those people who didn't get their money out,

7 which we are deemed priority claimants that are

8 getting the benefit of the fund, have already

9 received over $700 million from the SIPC funds and

10 they will then receive, on top of that, the monies


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11 from the customer fund that we accumulate. That

12 makes sense. They didn't have their money back so

13 therefore they get their advance and we try through

14 the $700 million, et cetera, to pay them those

15 monies. But other than that, to give advances to

16 people that already got their money out doesn't fit

17 under the statutory scheme of trying to, going all

18 the way back to the idea, what are we trying to do

19 here? We're trying to take a specific class of

20 customers and give them priority. That's not going

21 to work if you start giving that money, the money of

22 other people. And I think that really is what

23 determines this. I really think it's so controlling

24 here. I don't think it's alien to the scheme at

25 all. I think this Trustee has embraced it.


57

1 JUDGE LEVAL: How do you reconcile

2 with the obligation of the debtor, if the, as was

3 stated earlier, if the debtor owes each customer

4 what is on their statement, what the SIPA statute


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5 speaks of is the obligation of the debtor, that the

6 Trustee shall promptly discharge all the obligations

7 of the debtor?

8 MR. SHEEHAN: Which is why we -- I'm

9 sorry, I apologize. That's exactly why we have 78

10 triple F 2B. You can't just use the statement. I

11 made a statement that caused some concern among some

12 of the appellants and that is that who in their

13 right mind would rely upon the statement. That

14 caused some concern.

15 JUDGE LEVAL: You don't dispute that

16 those statements represent the obligation of the

17 debtor?

18 MR. SHEEHAN: I do dispute that. I

19 think they are one piece of evidence that ^ shows

20 the obligation of the debtor. That's it, one piece,

21 one of many, all of which we have to look at. We

22 have to look at the entire books and records.

23 This Trustee is mandated by this

24 statute to do a complete and thorough investigation.

25 That's what he's done. And that complete and



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58

1 thorough investigation yielded the truth that what

2 we have here is no trades, no profits.

3 JUDGE JACOBS: I'm trying to

4 understand how the statement doesn't represent the

5 obligation of the debtor assuming, under the statute

6 we have here, that people were permitted to rely

7 upon this and a defrauder undertook to pay them that

8 and in reliance they left their money in his hands.

9 MR. SHEEHAN: I didn't say it didn't

10 represent it. I said standing alone it's not

11 determinative. You cannot just take, as Your Honor

12 said earlier --

13 JUDGE JACOBS: Standing alone it

14 would work fine at a fraud trial, it seems to me.

15 MR. SHEEHAN: At a fraud trial that's

16 true.

17 JUDGE JACOBS: Well, that's -- the

18 debtor would be Madoff Securities and at a fraud

19 trial they would be a defendant and they would owe

20 that.

21 MR. SHEEHAN: And they sure as heck

22 would and they wouldn't get any of it because Bernie


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17 dealing with your broker on a daily basis. This is

18 a catastrophe and it's only in that catastrophe that

19 the Trustee can operate the way he does, but not

20 being bound by simply the statement itself but by

21 the statute suggests that you look beyond that to

22 the books and the records. Thank you.

23 MR. CONLEY: Good morning. May it

24 please the Court -- it's afternoon, actually.

25 Michael Conley for the SEC.


60

1 I would like to address this morning

2 briefly why the Bankruptcy Court's ruling in this

3 case is entirely consistent with what SIPA provides

4 about how net equity claims are to be determined.

5 JUDGE JACOBS: It would help me at

6 least if you started out distinguishing your

7 position to the extent it is distinguished from that

8 of SIPC and/or the Trustee.

9 MR. CONLEY: Yes, Your Honor.

10 With respect to the issue that's


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1 Bankruptcy Court correctly ruled so.

2 Section 1611 essentially defines net

3 equity by describing a formula for calculating it.

4 It says, in essence, that the net equity is equal to

5 what the broker owes or the broker's obligations to

6 the customer or X minus what the customer's

7 obligations are to the broker, or Y. But what

8 section 1611 does not do is say how the broker

9 determines what X and Y are. And in order to that

10 you look to section 8B of the statute or 78 FFF-2B,

11 which I refer to as 8B. And that brings us back to

12 the language that the Court has spent some time

13 focusing on.

14 It says that the Trustee is to

15 discharge all obligation of a debtor to a customer

16 relating to, or net equity claims based upon

17 securities or cash, and then the critical words,

18 insofar as such obligations, one, are ascertainable

19 from the books and records of the debtor, broker,

20 or, two, are otherwise established to the

21 satisfaction of the Trustee.

22 In our view what that means basically

23 is that under 8B the only way that a Trustee can


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24 satisfy these claims, these net equity claims which

25 are based on obligations that the broker has, is if


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1 the broker -- is if the Trustee is able to conclude

2 that they are ascertainable in either of those two

3 ways. And that's exactly what the Trustee did in

4 this case, he looked at the books and records and he

5 looked at the other evidence, after having conducted

6 an extensive investigation, which is also required

7 by the statute under section 7D, and found what we

8 all know to be true now.

9 JUDGE RAGGI: Let me ask you a

10 concern I have. Because there are the two different

11 maximums that can be provided, the 100,000 for cash

12 and 500,000 for securities positions, everyone -- no

13 one is disputing that what we've got here is

14 securities positions. And yet it seems to me that

15 net equity is being calculated in terms of cash.

16 MR. CONLEY: Net equity is being

17 calculated in terms of cash here, Your Honor,


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18 because the Trustee concluded that that was the only

19 thing at the end of the day that was evident --

20 JUDGE RAGGI: I don't mean to scare

21 anyone by suggesting that this should be treated as

22 cash, but on the one hand that does seem to be what

23 you're calculating and concluding that you can't

24 decide what the value of the securities positions

25 is. All you can decide is what's the cash they put


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1 in and took out. Then why isn't this a cash

2 position?

3 MR. CONLEY: Well, it's not a cash

4 position, Your Honor, because of what this Court

5 held in New Times. And in New Times the Court held

6 that when a customer gives cash for the purpose of

7 buying securities and then receives confirmations

8 and account statements that suggest that that's what

9 happened, the customer has a legitimate obligation

10 to believe that that's how the cash was being

11 invested.


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12 JUDGE RAGGI: If that's the case, why

13 isn't the receipt of each account statement

14 something that the customer could reasonably rely

15 on? You take the old maximum decision to hold, the

16 decision to buy? If you get told you hold X number

17 of shares in this account statement with such and

18 such and you don't tell the broker to do anything,

19 you've got that reasonable expectation. Why isn't

20 that this case?

21 MR. CONLEY: I think for precisely

22 the reason that the Court ultimately, or the result

23 that the Court ultimately determined was appropriate

24 in New Times. Remember, with respect to the

25 customers in New Times, the ones who were actually


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1 the subject of the appeal, the ones who invested in

2 the bogus mutual fund, the Court determined two

3 things. First, that those folks had claims for

4 securities based upon their having paid money for

5 securities and gotten confirmations and statements


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1 account holder, and as I understand it, you're not

2 suggesting that any account holder didn't rely in

3 good faith on what the statement said.

4 So to that extent, the last statement

5 says that instead of holding ten shares of AT&T when

6 he started, he now owns 200 shares. Why isn't that

7 a securities position that can be valued?

8 MR. CONLEY: It's not a securities

9 position that can be valued because it's completely

10 detached from any reality of market trading. The

11 only way that you get to the number that's next to

12 the real security name is through the series of

13 transactions, none of which actually took place or

14 reasonably could have, because remember at each

15 stage you're coming up with fictitious profits that

16 are being used and purportedly reinvested to expand

17 the number of these real shares that you purportedly

18 own.

19 JUDGE RAGGI: What if the arrangement

20 with the client, instead of it being buy whatever

21 you think is in my best interest, had been in one

22 stock, buy it and use all dividends and whatever to

23 buy more, over a 30-year period. Would the customer


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12 transactions that are impossible, then you can't

13 calculate that. You're in the same situation as the

14 people in New Times who couldn't recover because

15 they had -- their holding of securities was

16 impossible to calculate.

17 MR. CONLEY: That's exactly our

18 position in this case, Your Honor.

19 I see that my time has expired.

20 JUDGE LEVAL: Furthermore, in New

21 Times, when the people who received a statement

22 showing real stocks, as to them, their account

23 showed not retrospectively, but prospectively, that

24 they were investing in these real funds, and then

25 they stayed in those funds for the entire duration


69

1 of the -- they stayed ostensibly for the entire

2 duration of the fraud. So that there was no

3 manipulation, there was no manipulation by the fund

4 manager of their account values, giving them

5 imaginary profits on all these different days. They


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6 just were told as of the start you've invested in

7 this fund and what they end up with was what was the

8 performance of that fund over all the period that

9 they were in, which was not necessarily good or bad.

10 It didn't reflect imaginary fluctuations of profit.

11 MR. CONLEY: That's exactly right,

12 Your Honor.

13 JUDGE JACOBS: Thank you. Ms.

14 Chaitman?

15 MS. CHAITMAN: My name is Helen Davis

16 Chaitman. I'm with Becker & Poliakoff. I represent

17 approximately 500 Madoff investors.

18 Some of my clients began investing

19 with Mr. Madoff in the 1960s. Some of them started

20 investing in the 1980s. What the Trustee has done

21 is taken the position that no statement that my

22 clients received over a period of up to 50 years is

23 binding, because the Trustee, ignoring the Statute

24 of Limitations, is netting out deposits and

25 withdrawals going back 50 years. There is no basis


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1 in the law to do that. If you look at this Court's

2 decision in New Times the Court recognized that the

3 purpose of SIPA was to provide insurance to

4 investors who were giving up the right to

5 certificate its securities. And that insurance is

6 limited to the SIPC advance of up to $500,000 per

7 customer.

8 You have from your questions

9 indicated that you understand that that is different

10 from the fund of customer property. It was Congress

11 that decided that a customer's net equity claim

12 would be determined for both purposes in exactly the

13 same way.

14 Congress didn't say that any SIPC

15 Trustee has the right in his discretion to determine

16 whether that's the fair way. It's not a question of

17 fair.

18 JUDGE JACOBS: Let me ask you this.

19 Suppose you have a, not a securities claim under

20 SIPA, but a cash claim. In that case wouldn't the

21 Trustee be able to go back 10, 20 or 30 years in

22 order to find out how much the proper amount of the

23 cash, this was deposited, this was withdrawn, this

24 was deposited, that was withdrawn. It could be for


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25 20 years, couldn't it?


71

1 MS. CHAITMAN: I don't believe so,

2 Your Honor, because I think that the Trustee would

3 be bound by the last statement. I'd like to just

4 say that with respect to section 8B it doesn't

5 contradict the definition of net equity because 8B

6 doesn't ask the Trustee to determine whether the

7 securities were ever purchased. They weren't

8 purchased for the customers in New Times where the

9 SEC and SIPC both recognized that those customers

10 were entitled to be paid the appreciated inflated

11 value of the securities, regardless of the fact that

12 the broker didn't buy them. It was never supposed

13 to be a test whether the broker purchased the

14 securities. This statute was enacted precisely for

15 a situation where the broker didn't purchase the

16 securities. That's why we have it.

17 JUDGE RAGGI: The Trustee though

18 takes the position with us that none of these cases


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13 decides to not buy securities for all of his

14 customers. There is no exception for a broker who

15 buys and sells, rather than buys and holds. The

16 contemplation was to provide a limited amount of

17 protection to a customer, just like FDIC insurance.

18 When President Nixon signed the statute into law, he

19 said I am signing a statute which will provide to

20 securities customers the same kind of protection

21 that the FDIC provides to bank depositers. Can you

22 imagine a liquidator of a bank coming into this

23 Court and saying, I'm only going to pay up to

24 $250,000 based on the net investment in a bank

25 deposit going back 50 years? I'm going to eliminate


73

1 all interest on which that depositer has paid taxes?

2 That's the situation we have here.

3 I would ask the Court to consider

4 what SIPC is really doing is saving approximately $1

5 billion because the number of customers whose claims

6 have not been allowed based on this net investment


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7 hearing, who coincidentally are all the people who

8 were the long-term investors, like my 91-year-old

9 client who retired in 1970 and took mandatory IRA

10 withdrawals out of his account for 21 years. Of

11 course he took out more money than he put in. But

12 that's the purpose that people invest in the stock

13 market.

14 JUDGE JACOBS: What do you say to

15 Mr. Sheehan's argument, the Trustee's argument that

16 SIPA does provide you an advance on what you will be

17 entitled to in the bankruptcy proceedings, and that

18 in the bankruptcy proceedings there's not going to

19 be any pay based on these hypothetical investments?

20 MS. CHAITMAN: The statute mandates

21 that SIPC promptly replace the securities in a

22 customer's account, not two years after $200 million

23 had been spent on forensic accountants. Promptly

24 replace the securities. The legislative history

25 indicates the purpose is to get that investor right


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1 back in the stock market. This is an investor who

2 gave up the right to certificate securities which

3 benefited the Wall Street firms which were funding

4 the SIPC insurance. It's not a question that SIPC

5 doesn't have the obligation to make the advance

6 unless and until it's satisfied that it will be

7 repaid on its subrogation claim. That's nowhere in

8 the statute. It's simply like any other insurance

9 company to the extent that they pay, they stand in

10 the shoes of the insured, once the insured is paid

11 in full. But that SIPC advance has to be made

12 promptly. That word is throughout the statute. And

13 this is what Congress intended. This is a remedial

14 statute to compensate victims who rely upon a

15 broker's obligation to purchase securities reflected

16 on his statement.

17 JUDGE RAGGI: Let me ask you the

18 question that we've dealt with with other counsel,

19 too. 78 FFF 2B says that you pay those obligations

20 only to the extent they're ascertainable from the

21 books and records of the debtor or otherwise

22 established to the satisfaction of the Trustee.

23 When the Trustee goes into these books and records

24 he finds out that there was never any transaction


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25 done on a particular day. Rather, it was post hoc


75

1 representations that transactions had been done in

2 order to relay profits that had never been realized,

3 and that that is not really a securities

4 transaction.

5 So, to that extent it's not finding a

6 net equity position in that. Why isn't that within

7 the Trustee's discretion?

8 MS. CHAITMAN: Because the Trustee

9 has an obligation to honor the net equity, which is

10 the obligation of the broker --

11 JUDGE RAGGI: But only insofar as

12 these two things are satisfied, that's statutory.

13 MS. CHAITMAN: There is nothing in

14 the books and records of Madoff that indicates that

15 he doesn't owe to each investor the November 30th,

16 2008 account balance.

17 JUDGE RAGGI: But what it is not

18 though is any transaction either conducted on that


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19 day or even reported on that day. The transaction

20 is only reported after the fact and concocted

21 because it was profitable. That's different from

22 telling someone today, I bought a particular stock

23 for you because then the customer takes the risk.

24 Here, by telling it only after the fact, there was

25 never any risk.


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1 MS. CHAITMAN: Your Honor, in New

2 Times there was no evidence in the debtor's books

3 and records that the customers whose statement

4 showed existing securities that the debtor ever

5 purchased those securities. It's exactly the same

6 thing here. There is nothing in this record which

7 indicates that any of the prices for the securities

8 were invalid. If someone in 1960 bought IBM stock

9 and sold it and then bought it again and sold it and

10 bought it again, it would have appreciated in value.

11 There is no reason to disallow --

12 JUDGE RAGGI: That's like my telling


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13 you today that ten years ago I bought Intel and had

14 a huge profit in it.

15 MS. CHAITMAN: How can a customer,

16 the people standing before you invested in Madoff

17 through seven investigations conducted by the SEC of

18 Mr. Madoff over an 18-year period. If the SEC --

19 JUDGE RAGGI: There's not a

20 suggestion that your clients are in any way culpable

21 for this. The question though is whether or not the

22 Trustee in paying pursuant to this statute has some

23 discretion about how to calculate net equity.

24 MS. CHAITMAN: Not for purposes of

25 the SIPC payment. The SIPC payment has to be based


77

1 upon the last statement. There is a provision in

2 SIPA which says that SIPC cannot change the

3 definition of net equity. That's how important this

4 definition was to Congress. In order to induce

5 confidence in the capital market so that people

6 would give up the requirement of holding


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7 certificated securities. And there is nothing in

8 the statute which says it only protects customers

9 who have a buy and hold strategy or customers who

10 fail to delegate to their manager or their broker

11 the right to invest in his discretion. There is no

12 limitation in the statute. So it covers every one

13 of these Madoff investors who had a legitimate

14 expectation that they owned the securities on their

15 statements.

16 JUDGE JACOBS: Thank you very much.

17 Thank you all. We will reserve decision.

18 COURT CLERK: The Court stands

19 adjourned.

20 (Proceedings adjourned 12:36 p.m.)

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03-03-11 net equity ct of appeals

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