03-03-11 Net Equity CT of Appeals

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3 UNCERTIFIED TRANSCRIPT DISCLAIMER
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IN RE: BERNARD L. MADOFF
5 INVESTMENT SECURITIES, LLC
6 March 3, 2011
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UNCERTIFIED ROUGH DRAFT
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proofread, or corrected. Corrections will be made
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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.
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
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'

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.

5
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

23 market price?
24 MR. LAX: Well, the account
25 statements and confirms are books and records.
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

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.
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

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
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

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

9
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

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.

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

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.

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

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

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

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

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

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

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,

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

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
certificated security 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

25 unfairly treated, according to you. And they may
22
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

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
23
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.

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
24
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.
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
25
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

25 question, Your Honor. The SIPC fund, to the best of
26
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

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
27
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.

13 JUDGE LEVAL: So looking at the part
14 that comes from SIPA, are any of the Madoff
15 customers harmed by the application of the last
16 statement approach?
17 MS. WAGNER: They are, Your Honor.
18 JUDGE LEVAL: They may be harmed in
19 the division of the estate pie, the ones who are
20 more recent investors are harmed because a larger
21 percentage goes to the earlier investors whose
22 accounts built up and built up over the years. But
23 how are customers harmed with respect to the part
24 that comes from SIPA?
25 MS. WAGNER: Your Honor, they are
28
1 harmed because the result of the, what is called the
2 cash-in/cash-out approach here is that customers who
3 would otherwise get more from SIPA are going to get
4 less because this will reduce their claim. Because
5 the effect of what the Trustee is doing, he takes
6 the last statement and then he says all your prior

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
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

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

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

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

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

2 way of calculating dischargeable net equity. What
3 am I missing here in your argument?
4 MS. WAGNER: Your Honor, under the
5 nonSIPA laws the customer's rights derive from
6 statements. It does not matter whether the broker
7 buys or doesn't buy the security. Under the law the
8 right of the customer --
9 JUDGE RAGGI: Under all kinds of
10 other laws that would be where liability would
11 happen, I understand that.
12 MS. WAGNER: Then you go to SIPA,
13 which is supposed to protect the customer. Now,
14 does that change everything? I would argue it
15 doesn't change anything. I would argue the customer
16 is still entitled to rely on his statement, does not
17 matter whether the broker bought or didn't buy the
18 securities, the net equity they're saying is
19 definitely conditional, what would have been the
20 value if the submissions ^ had been liquidated, and
21 the SIPC funds are there precisely for a situation
22 in which the broker did not buy the securities he
23 was supposed to buy.
24 So I would argue, Your Honor, that
25 the two situations, the Securities Investor

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

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?

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

8 legible to share pro rata in a fund of customer
9 property. What you have here are at least two types
10 of customers. You have customers who, while the
11 firm was in business, withdraw their principal,
12 perhaps completely innocently and also received what
13 they believed to be profits. However those profits
14 consisted of other investors' monies because no
15 trades were actually made. This was a Ponzi scheme.
16 And then you have a second group of
17 investors and those are people who did not withdraw
18 their principal, whose money is missing because it
19 was used to pay the earlier investors.
20 JUDGE RAGGI: So where is this
21 customer property coming from that you say that in
22 addition to the SIPA maximum of $500,000, where is
23 the customer property coming from?
24 MS. WANG: Customer property is a
25 term that's defined under the statute and it's all
37
1 property that was held by the broker-dealer for

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

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

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

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

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

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

42
1 market reality. Assuming the customer paid $100 for
2 100 shares, $80 was taken by the broker and wasted,
3 and the broker just reflected a transaction for the
4 purchase of 20 shares worth $20.
5 MS. WANG: If the account statement
6 does not reflect market reality so that we're
7 dealing with artificial numbers, then what the
8 customer is entitled to is the $100 back.
9 JUDGE JACOBS: But the market reality
10 is that the stock doubled.
11 MS. WANG: Then is Your Honor saying
12 that even though the trade was not actually placed,
13 what was reflected --
14 JUDGE JACOBS: I'm asking you what
15 would SIPC pay. I'm not saying anything.
16 MS. WANG: I'm trying to understand
17 what the hypothetical is, Your Honor.
18 JUDGE JACOBS: The hypothetical is
19 $100 is invested to buy 100 shares, the broker is
20 faceless, eats up $80 worth, buys only $20. 20

21 shares appears on the account statement, the company
22 goes bust and the stock has doubled in value on the
23 market.
24 MS. WANG: So, if the statement
25 reflects market reality in the sense that -- whether
43
1 or not the securities have actually been bought,
2 then what the customer is owed is in fact what his
3 account statement shows and he is in the same
4 situation as that first group of claimants in the
5 New Times case.
6 JUDGE RAGGI: $40 for the $20
7 investment doubled, worth $40. Even though he gave
8 the fellow 100, you're saying that's all he's
9 entitled to?
10 MS. WANG: No. I'm saying he's
11 entitled to the shares at whatever the stock was
12 trading at on that particular day.
13 JUDGE RAGGI: Even though they were
14 not reported on his statement?

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.
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

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

46
1 discussed earlier, section 78 triple F ^ , where the
2 Trustee can only honor obligations to the extent
3 that they're supported by the books and records or
4 otherwise established to the satisfaction of the
5 Trustee.
6 JUDGE RAGGI: How do the books and
7 records of the debtor ever establish transactions
8 that never take place? And I'm thinking of
9 something very basic so that we avoid any kind of
10 complicated hypothetical. The customer calls the
11 dealer and says buy 100 shares of AT&T today and the
12 broker says, fine, and never does it. I mean, that
13 doesn't appear on his books and records, and yet I
14 don't think you would argue that the customer would
15 have a claim for that, especially if it appears on
16 his account statement, that 100 shares were bought.
17 MS. WANG: Well, I'd like to answer
18 Your Honor's question in the context of this case.
19 JUDGE RAGGI: Please.
20 MS. WANG: Because the books and
21 records in fact showed that no trades had

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

16 prices that were confirmed were outside of the range
17 of real prices on that particular day.
18 JUDGE LEVAL: What you're saying is
19 that the books and records, as I understood in the
20 statute, means the truth that can be determined from
21 the books and records as opposed to the ostensible
22 false statement made?
23 MS. WANG: It means more than just
24 one confirming of the books and records. Certainly
25 the account statements are part of the books and
48
1 records. But under the federal securities laws a
2 broker-dealer has to maintain many types of books
3 and records. I think under rule 17A there are
4 probably more than 20 categories of them. And yet
5 the books and records aren't always dispositive by
6 themselves, because they may be missing, they may be
7 incomplete, they may have false information, and
8 Congress recognized that and so it said that
9 alternatively the claims have to be established to

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

4 Honors. David Sheehan, Baker Hostetler, attorney
5 for the Trustee.
6 I would submit that the Trustee in
7 this case has not only followed reasonably the
8 statutory construction, by doing what he did, but he
9 did so in a reasonable exercise of his discretion.
10 This is a Ponzi scheme. It's a zero sum gain. The
11 customer fund is the money that went in. We can't
12 talk about anything else. Can't talk about profits.
13 Can't talk about stocks.
14 JUDGE JACOBS: The SIPC fund is not
15 the customer fund.
16 MR. SHEEHAN: No. I said the
17 customer fund -- if I said SIPC fund I misspoke.
18 JUDGE JACOBS: No. The SIPC fund is
19 what we're talking about here today.
20 MR. SHEEHAN: There is no SIPC fund
21 without a net equity claim, Your Honor. The way the
22 statute reads is this: You get an advance from SIPC
23 if you have a positive net equity claim. In a zero
24 sum gain the only person that could possibly have
25 that, only person is the person who didn't get his

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

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

16 we're trying to do is to recover the monies that
17 belong in the fund. Because it's a Ponzi scheme,
18 there is only one thing those can be. That's other
19 people's money. By way of example, when we recently
20 settled the Picowers and got $5 billion and put it
21 into the fund, that wasn't profits, that wasn't
22 stock. Mr. Picower had $5 billion of other
23 customer's money, and he gave it back. Who should
24 get that? Who should get that out of that fund?
25 Those people who did not get their money out. It's
52
1 as simple as that.
2 Now, once all of those people, we
3 estimate that to be around $20 billion, give or
4 take. Maybe less, maybe a little bit more. We'll
5 see. We're halfway home, we've collected 10. Give
6 us an opportunity to go get the rest and it's great
7 aspiration that we'll get there, that this Trustee
8 is seeking to obtain $20 billion. He then pays the
9 $20 billion. Now the two customers are on equal

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

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

54
1 were not a total Ponzi scheme but a partial Ponzi
2 scheme, supposing that the investment manager
3 actually managed investments very successfully
4 producing extremely good results, perhaps not quite
5 as good as the one Madoff purported to obtain, but
6 good results so that year after year on balance
7 there were very substantial profits but that as to
8 some of the clients -- let's say it's a common fund
9 or funds invested virtually identically for all
10 investors, and as to a certain number of the
11 investors it was fictitious because the manager, the
12 investment manager was pocketing those monies or
13 using them for other purposes, to gamble, whatever,
14 cigars, so that everybody, all the customers had
15 identical statements, all of the customers showed
16 gradual increases in profits until the day of
17 reckoning, when the whole house of cards came down.
18 But on in day it's ascertained that some of the
19 customers' statements represent the entirely
20 fictitious amounts, whereas others actually have the
21 securities actually purchased for their accounts.
22 So, on that day, how do you account

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

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

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

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

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

23 would have spent it all.
24 JUDGE RAGGI: But that's a separate
25 question.
59
1 MR. SHEEHAN: I know that.
2 JUDGE RAGGI: And doesn't address our
3 concern, that you are asking us to conclude that the
4 obligation for SIPA purposes is different from the
5 debtor's obligation. And I speak only for myself,
6 I'm having some trouble understanding why you think
7 that that is a different obligation.
8 MR. SHEEHAN: I'm not suggesting
9 that -- if you look at Article 8 that my adversary
10 relies upon from which I think this question is
11 emanating, it says that once you have a SIPA
12 proceeding, these rules go by the board, and the
13 reason is because the SIPA rules dominate that.
14 They have to. It's a salutary statute designed to
15 provide certain relief under certain dire
16 circumstances. It isn't business as usual, it isn't

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

11 squarely presented here today, which is how is net
12 equity calculated under the statute, and whether you
13 would look solely to the final account statements as
14 the claimants are doing, or if you look to the final
15 account statements amongst other books and records
16 in evidence, we are in agreement with the position
17 of SIPC and the Trustee.
18 There is a separate issue, a distinct
19 issue, which relates to whether the net equity
20 claims should be valued in constant dollars, which
21 is a position that the commission took, does take;
22 however, the Bankruptcy Court decided in a
23 scheduling order to set that aside and to consider
24 that only after this initial determination is made.
25 And so returning to the statute, in
61
1 our view the Bankruptcy Court correctly rejected two
2 arguments --
3 JUDGE LEVAL: So that issue of the
4 constant dollars or the inflation-adjusted dollars

5 is not before us now?
6 MR. CONLEY: It's not, Your Honor.
7 JUDGE LEVAL: You say it hasn't been
8 decided at the Bankruptcy Court level.
9 MR. CONLEY: It has not been decided,
10 it's not been briefed and so that issue, depending
11 of course on how this Court rules, will ultimately
12 be something that would be decided.
13 JUDGE JACOBS: Are we called upon to
14 rule on that?
15 MR. CONLEY: No, you're not. And
16 again, returning to the two arguments that the
17 Bankruptcy Court rejected, I believe appropriately,
18 with respect to how SIPA works in this context, one
19 relates to that the only provision of SIPA that's
20 relevant to the net equity calculation is the
21 definition of net equity in section 16 paragraph 11
22 and, two, that under that definition customers' net
23 equity is conclusively established simply by
24 reference to the final account statements. In our
25 view both of those contentions are wrong, and the
62
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

24 satisfy these claims, these net equity claims which
25 are based on obligations that the broker has, is if
63
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,

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
64
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.
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
65
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

6 and so on. But then when it came time to calculate,
7 well, what's their net equity, that's a different
8 matter. The claims for securities relates to
9 section 9A under the statute and what the maximum is
10 as Your Honor noted under the SIPA fund to which
11 they would be entitled. The net equity calculation
12 is controlled by different provisions in the statute
13 and this Court concluded that with respect to these
14 bogus securities, you simply couldn't say that they
15 provided a basis for valuing, a basis that could be
16 liquidated or that there was any kind of evidence
17 that the Trustee could look at to say what these
18 were worth.
19 Likewise here the Trustee through the
20 extensive investigation and for precisely the
21 reasons Your Honor noted earlier, the first series
22 of historical fraud upon fraud upon fraud, there was
23 nothing there in these statements that could be
24 valued.
25 JUDGE RAGGI: In that fraud is the
66
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

24 not have a position equal to the last statement in
25 that security?
67
1 MR. CONLEY: I think what you're
2 talking about here, Your Honor, is something that's
3 quite akin to the folks in New Times who weren't the
4 subject of the case, the ones who had a specific
5 investment that they believed they were being put
6 into, which were the real mutual funds.
7 JUDGE RAGGI: But with a direction
8 for constantly new --
9 MR. CONLEY: Exactly. In other
10 words, it's a buy and a hold kind of a situation.
11 And I think that's exactly what transpired there.
12 Although the Court didn't have to speak to it, SIPC
13 and the Trustee in that case saw that, yes, in that
14 circumstance I understood that my money was being
15 invested in a specific security, I received
16 confirmations and account statements which indicated
17 that, and I am entitled to the additional

18 reinvestment credits over time, and I would have the
19 value, I would be entitled on the filing date of the
20 liquidation proceeding to the value of that security
21 or those securities on that date. And that's
22 exactly what happened in New Times. Although as I
23 say, not the subject of appeal.
24 JUDGE JACOBS: The distinction you
25 draw between New Times and the circumstances of this
68
1 case is that New Times with respect to some of the
2 people who were put into real stocks, you can,
3 looking at folks' records, account statements and
4 market prices, you can actually calculate --
5 MR. CONLEY: Precisely, Your Honor.
6 JUDGE JACOBS: -- a real number for
7 them.
8 MR. CONLEY: That's right.
9 JUDGE JACOBS: Whereas, if you have a
10 fake stock that never had any value, or if you had
11 real stock that's put through machinations and

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

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
70
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

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

19 involved a Ponzi scheme and that the reality of a
20 Ponzi scheme, for purposes of a payout that's going
21 to be treating net equity the same whether it's the
22 customer account or the SIPA fund, is that one
23 customer's profits can only be a function of another
24 customer's loss. Do you want to respond to that
25 argument and why you don't think it ought to inform
72
1 our decision here today.
2 MS. CHAITMAN: I think it can't
3 inform your decision because we have a statute which
4 defines net equity as what is owed to the customer.
5 And 8B provides that the Trustee should look at the
6 books and records to determine what is owed to the
7 customer. What is owed to the customer is the
8 balance on the customer's account. Mr. Ponzi lived
9 in the 1920s. He was well known to Congress in 1970
10 when SIPA was enacted. If they had wanted to make a
11 Ponzi scheme exception, they would have put it in
12 the statute. There is no exception for a broker who

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

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
74
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

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

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.
76
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

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

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.)
21 -o0o-
22
23
24
25

03-03-11 Net Equity CT of Appeals

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1 JUDGE JACOBS: At this time we'll

2 hear In Re Bernard L. Madoff Investment Securities,

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

11 up issues in any way?

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

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'

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