In Re: Bernard L. Madoff

Filing

OPINION, Affirmed, by DJ PNL RR, FILED.[365897] [10-2378, 10-2676, 10-2677, 10-2679, 10-2684, 10-2685, 10-2687, 10-2691, 10-2693, 10-2694, 10-2718, 10-3188, 10-3579, 10-3675]

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10-2378-bk(L)
In re: Bernard L. Madoff Inv. Sec. LLC

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UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
August Term, 2010
(Argued: March 3, 2011

Decided: August 16, 2011)

Docket Nos. 10-2378-bk(L); 10-2676-bk(con); 10-2677-bk(con);
10-2679-bk(con); 10-2684-bk(con); 10-2685-bk(con); 10-2687bk(con); 10-2691-bk(con); 10-2693-bk(con); 10-2694-bk(con);
10-2718-bk(con); 10-2737-bk(con); 10-3188-bk(con); 10-3579bk(con); 10-3675-bk(con)
- - - - - - - - - - - - - - - - - - - -x
IN RE: BERNARD L. MADOFF INVESTMENT
SECURITIES LLC,
Debtor.*
- - - - - - - - - - - - - - - - - - - -x
Before:

JACOBS, Chief Judge, LEVAL and RAGGI,
Circuit Judges.

Former investors with Bernard L. Madoff appeal from an

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order entered by the United States Bankruptcy Court for the

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Southern District of New York (Lifland, J.) in the

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liquidation proceedings of Bernard L. Madoff Investment

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Securities LLC under the Securities Investor Protection Act.

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The Trustee, Irving H. Picard, concluded that the investors’

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“net equity,” which determines how customer property will be

*

Consolidated docket number 10-2737-bk was dismissed
with prejudice by stipulation of the parties on December 10,
2010. Fed. R. App. P. 42(b).

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distributed in the wake of Madoff’s fraud, should be

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calculated based on the Net Investment Method.

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bankruptcy court affirmed the decision of the Trustee and

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certified its decision for immediate appeal to this Court.

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28 U.S.C. § 158(d)(2).

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appeal from the bankruptcy court, and for the following

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reasons, we hold that the Trustee’s determination as to how

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to calculate “net equity” under the Securities Investor

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Protection Act is legally sound in light of the

The

This Court accepted the direct

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circumstances of this case and the relevant statutory

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language.

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bankruptcy court.

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Accordingly, we affirm the order of the

HELEN DAVIS CHAITMAN, Becker & Poliakoff,
LLP, New York, New York (Peter Schuyler,
on the brief), for Appellants Diane and
Roger Peskin, et al.
KAREN E. WAGNER, Davis Polk & Wardwell
LLP, New York, New York (Brian S.
Weinstein, Jonathan D. Martin, on the
brief), for Appellants Sterling Equities
Associates, Arthur Friedman, David Katz,
Gregory Katz, Michael Katz, Saul Katz, L.
Thomas Osterman, Marvin Tepper, Fred
Wilpon, Jeff Wilpon, Richard Wilpon, Mets
Limited Partnership.
BARRY R. LAX, Lax & Neville, New York,
New York (Brian Neville, Brian Maddox, on
the brief), for Appellants Mary Albanese,
et al.

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Seth C. Farber, Kelly A. Librera, Dewey &
LeBoeuf LLP, New York, New York, for
Appellant Ellen G. Victor.
Stephen Fishbein, Richard F. Schwed,
Shearman & Sterling LLP, New York, New
York, for Appellants Carl J. Shapiro, et
al.
Carole Neville, Sonnenschein Nath &
Rosenthal LLP, New York, New York, for
Appellants Marsha Peshkin IRA, Michael
and Meryl Mann, Barry Weisfeld.
Matthew Gluck, Jonathan M. Landers, Brad
N. Friedman, Jennifer L. Young, Milberg
LLP, New York, New York, Stephen A.
Weiss, Christopher M. Van de Kieft,
Parvin K. Aminolroaya, Seeger Weiss LLP,
New York, New York, for Appellants The
Aspen Company, et al.
David B. Bernfeld, Jeffrey L. Bernfeld,
Bernfeld, DeMatteo & Bernfeld, LLP, New
York, New York, for Appellants Michael
Schur and Edith A. Schur.
David Parker, Matthew J. Gold, Jason
Otto, Kleinberg, Kaplan, Wolff & Cohen,
P.C., New York, New York, for Appellants
Lawrence Elins, Malibu Trading and
Investing, L.P.
Stanley Dale Cohen, New York, New York,
for Appellants Lee Mellis, Jean
Pomerantz, Bonnie Savitt.
Jeffrey A. Mitchell, Gibbons, P.C., New
York, New York, for Appellant Donald G.
Rynne.
Daniel M. Glosband, Goodwin Procter LLP,
Boston, Massachusetts (Larkin M. Morton,
Goodwin Procter LLP, New York, New York,
on the brief) for Appellants Jeffrey A.
Berman, et al.
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Chryssa V. Valletta, Phillips Nizer LLP,
New York, New York for Appellants Herbert
Barbanel, Alice Barbanel.
Lawrence R. Velvel, pro se, Andover,
Massachusetts, for Appellant Lawrence R.
Velvel.
JOSEPHINE WANG, General Counsel,
Securities Investor Protection
Corporation, Washington, District of
Columbia (Kevin H. Bell, Senior Associate
General Counsel for Dispute Resolution,
Christopher H. Larosa, Associate General
Counsel, Lauren Attard, Staff Attorney,
on the brief), for Appellee Securities
Investor Protection Corporation.
DAVID J. SHEEHAN, Baker Hostetler LLP,
New York, New York (Thomas D. Warren,
Wendy J. Gibson, Seanna R. Brown, on the
brief), for Appellee Irving H. Picard, as
Trustee for the Substantively
Consolidated Securities Investor
Protection Act Liquidation of Bernard L.
Madoff Investment Securities LLC and
Bernard L. Madoff.
MICHAEL A. CONLEY, Deputy Solicitor for
Securities & Exchange Commission,
Washington, District of Columbia (David
M. Becker, General Counsel, Mark D. Cahn,
Deputy General Counsel, Jacob H.
Stillman, Solicitor, Katharine B.
Gresham, Assistant General Counsel, on
the brief), for Amicus Curiae Securities
& Exchange Commission.
DENNIS JACOBS, Chief Judge:
In the aftermath of a colossal Ponzi scheme conducted

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by Bernard Madoff over a period of years, Irving H. Picard

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has been appointed, pursuant to the Securities Investor

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Protection Act, 15 U.S.C. § 78aaa et seq. (“SIPA”), as

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Trustee for the liquidation of Bernard L. Madoff Investment

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Securities LLC, id. § 78eee(b)(3).

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Picard has the general powers of a bankruptcy trustee, as

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well as additional duties, specified by the Act, related to

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recovering and distributing customer property.

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1.

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out decades of fraud.

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is whether the method Mr. Picard selected for carrying out

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his responsibilities under SIPA is legally sound under the

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language of the statute.

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we affirm the order of the United States Bankruptcy Court

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for the Southern District of New York (Lifland, J.).

Pursuant to SIPA, Mr.

Id. § 78fff-

Essentially, Mr. Picard has been charged with sorting
The question presented by this appeal

We hold that it is.

Accordingly,

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BACKGROUND

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The facts surrounding Bernard Madoff’s multibillion

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dollar Ponzi scheme are widely known and were recounted in

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detail by the bankruptcy court.

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Inv. Sec. LLC, 424 B.R. 122, 125-32 (Bankr. S.D.N.Y. 2010);

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see also, e.g., In re Beacon Assocs. Litig., 745 F. Supp. 2d

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386, 393-94 (S.D.N.Y. 2010); Anwar v. Fairfield Greenwich

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Ltd., 728 F. Supp. 2d 372, 387, 389-90 (S.D.N.Y. 2010);

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re Tremont Sec. Law, State Law & Ins. Litig., 703 F. Supp.

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2d 363, 367-68 (S.D.N.Y. 2010).

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In re Bernard L. Madoff

For our purposes, a few

In

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facts suffice.

When customers invested with Bernard L.

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Madoff Investment Securities LLC (“BLMIS”), they

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relinquished all investment authority to Madoff.

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collected funds from investors, claiming to invest those

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funds pursuant to what he styled as a “split-strike

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conversion strategy” for producing consistently high rates

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of return on investments.2

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strike conversion strategy supposedly involved buying a

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basket of stocks listed on the Standard & Poor’s 100 Index

J.A. Vol. II at 292.

Madoff

The split-

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and hedging through the use of options.

However, Madoff

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never invested those customer funds.

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generated fictitious paper account statements and trading

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records in order to conceal the fact that he engaged in no

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trading activity whatsoever.

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monthly account statement listed securities transactions

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purportedly executed during the reporting period and

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purported individual holdings in various Standard & Poor’s

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100 Index stocks as of the end of the reporting period, the

Instead, Madoff

Even though a customer’s

2

A select group of Madoff’s family members, close
friends, and employees held “non-split strike” accounts.
Madoff provided these customers with invented account
statements that reflected even greater investor success than
the unwavering returns purportedly earned for his splitstrike customers. In re Bernard L. Madoff, 424 B.R. at 13031. The non-split strike customers are not parties to this
appeal.
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statement did not reflect any actual trading or holdings of

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securities by Madoff on behalf of the customer.

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the Trustee’s investigation revealed many occurrences where

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purported trades were outside the exchange’s price range for

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the trade date.”

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Other now revealed irregularities make it clear that “Madoff

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never executed his split-strike investment and hedging

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strategies, and could not possibly have done so.”

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point out just two examples, “an unrealistic number of

“In fact,

In re Bernard L. Madoff, 424 B.R. at 130.

Id.

To

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option trades would have been necessary to implement the . .

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. [s]trategy” and “one of the money market funds in which

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customer resources were allegedly invested through BLMIS . .

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. has acknowledged that it did not even offer investment

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opportunities in any such money market fund from 2005

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forward.”

Id.

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As is true of all Ponzi schemes, see Cunningham v.

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Brown, 265 U.S. 1, 7 (1924) (describing the “remarkable

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criminal financial career of Charles Ponzi”), Madoff used

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the investments of new and existing customers to fund

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withdrawals of principal and supposed profit made by other

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customers.

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investor funds, so these funds were never exposed to the

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uncertainties or fluctuations of the securities market.

Madoff did not actually execute trades with

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Fictional customer statements were generated based on after-

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the-fact stock “trades” using already-published trading data

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to pick advantageous historical prices.

J.A. Vol. I at 365-

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66, 371, 512; J.A. Vol. II at 291, 293.

The customer

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statements documented an astonishing pattern of continuously

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profitable trades, approximating the profits Madoff had

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promised his customers, but reflected trades that had never

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occurred.

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customers always appeared to earn positive annual returns,

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the dreamt-up rates of return Madoff assigned to different

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customers’ accounts varied significantly and arbitrarily.

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In re Bernard L. Madoff, 424 B.R. at 130.

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customer statements reflected unvarying investor success;

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but the only accurate entries reflected the customers’ cash

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deposits and withdrawals.

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Although Madoff’s scheme was engineered so that

Thus, the

J.A. Vol. I at 513.

Madoff’s scheme collapsed when the flow of new

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investments could no longer support the payments required on

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earlier invested funds.

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122, 132 n.7 (2d Cir. 2008) (describing typical Ponzi scheme

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“where earlier investors are paid from the investments of

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more recent investors . . . until the scheme ceases to

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attract new investors and the pyramid collapses”).

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final customer statements issued by BLMIS falsely recorded

See Eberhard v. Marcu, 530 F.3d

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The

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nearly $64.8 billion of net investments and related

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fictitious gains.

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on this appeal that any victim knew or should have known

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that the investments and customer statements were

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fictitious.

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investors relied on their customer statements for purposes

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of financial planning and tax reporting, to their terrible

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detriment.

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J.A. Vol. I at 505.

It is not contended

It is unquestioned that the great majority of

When Madoff’s fraud came to light, the Securities and

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Exchange Commission filed a civil complaint in the United

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States District Court for the Southern District of New York,

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alleging that Madoff and BLMIS were operating a Ponzi

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scheme.3

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(“SIPC”), a nonprofit corporation consisting of registered

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broker-dealers and members of national securities exchanges

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that supports a fund used to advance money to a SIPA

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trustee, then stepped in.4

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Comm’n v. Packer, Wilbur & Co., 498 F.2d 978, 980 (2d Cir.

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1974).

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seeking a decree that the customers of BLMIS are in need of

The Securities Investor Protection Corporation

15 U.S.C. § 78ccc; Sec. & Exch.

SIPC filed an application in the civil action

3

Madoff was arrested and charged with securities
fraud; he pleaded guilty to an eleven-count criminal
indictment and was sentenced to 150 years’ imprisonment.
4

By virtue of its registration with the SEC as a
broker-dealer, BLMIS is a member of SIPC.
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the protections afforded by SIPA.

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§ 78eee(a)(3)(A).

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application; the protective order appointed Mr. Picard as

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Trustee for the liquidation of the business of BLMIS and the

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SIPA liquidation proceeding was removed to the bankruptcy

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court.

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Corp. v. BDO Seidman, LLP, 222 F.3d 63, 67 (2d Cir. 2000).

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15 U.S.C.

The district court granted SIPC’s

Id. § 78eee(b)(3)-(4); see also Sec. Investor Prot.

SIPA establishes procedures for liquidating failed
broker-dealers and provides their customers with special

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protections.

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property,” separate from the general estate of the failed

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broker-dealer, is established for priority distribution

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exclusively among customers.

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consists of cash and securities received or held by the

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broker-dealer on behalf of customers, except securities

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registered in the name of individual customers.

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§ 78lll(4).

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assets to the extent of the customer’s “net equity.”

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§ 78fff-2(c)(1)(B).

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In a SIPA liquidation, a fund of “customer

The customer property fund

15 U.S.C.

Each customer shares ratably in this fund of
Id.

Under SIPA:

The term “net equity” means the dollar amount of
the account or accounts of a customer, to be
determined by-(A) calculating the sum which would have been
owed by the debtor to such customer if
the debtor had liquidated, by sale or purchase
on the filing date, all securities positions
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of such customer . . . ; minus
(B) any indebtedness of such customer to the
debtor on the filing date . . . .
Id. § 78lll(11).

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In many liquidations, however, the assets in the

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customer property fund are insufficient to satisfy every

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customer’s “net equity” claim.

In such a case, SIPC

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advances money to the SIPA trustee to satisfy promptly each

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customer’s valid “net equity” claim.

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accounts, the maximum advance is $500,000 per customer.

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§ 78fff-3(a).

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maximum advance is substantially less.

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(d).

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id. § 78fff-2(a)(2), who is charged with determining

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customer claims in writing.

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filed with the bankruptcy court.

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For securities
Id.

For customers with claims for cash, the
Id. § 78fff-3(a)(1),

Under SIPA, all claims must be filed with the trustee,

A customer’s objection must be

In satisfying customer claims in this case, Mr. Picard,

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as the SIPA Trustee, determined that the claimants are

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customers with claims for securities within the meaning of

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SIPA.

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“net equity” should be calculated by the “Net Investment

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Method,” crediting the amount of cash deposited by the

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customer into his or her BLMIS account, less any amounts

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withdrawn from it.

The Trustee further concluded that each customer’s

J.A. at 274.
11

The use of the Net

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Investment Method limits the class of customers who have

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allowable claims against the customer property fund to those

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customers who deposited more cash into their investment

4

accounts than they withdrew, because only those customers

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have positive “net equity” under that method.

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customers objected to the Trustee’s method of calculating

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“net equity” and argued that they were entitled to recover

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the market value of the securities reflected on their last

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BLMIS customer statements (the “Last Statement Method”).

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After the filing of a number of objections, the Trustee

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moved the bankruptcy court for an order affirming his use of

12

the Net Investment Method of calculating “net equity.”

13

SIPC and the SEC submitted briefs supporting the Trustee’s

14

motion.5

15

Some

Both

After a hearing, the bankruptcy court upheld the

16

Trustee’s use of the Net Investment Method on the ground

17

that the last customer statements could not “be relied upon

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to determine [n]et [e]quity” because customers’ account

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statements were “entirely fictitious” and did “not reflect

5

The SEC further argued that the Net Investment Method
should be applied using inflation-adjusted dollars. The
Trustee argued that the issue whether the Net Investment
Method should be adjusted to account for inflation or
interest was beyond the scope of the briefing and took no
position on it.
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actual securities positions that could be

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liquidated . . . .”

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135.

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“net equity” under SIPA “must be read in tandem with SIPA

5

section 78fff-2(b), which requires the Trustee to discharge

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[n]et [e]quity claims only ‘insofar as such obligations are

7

[1] ascertainable from the books and records of the debtor

8

or [2] are otherwise established to the satisfaction of the

9

trustee.’”

In re Bernard L. Madoff, 424 B.R. at

The bankruptcy court reasoned that the definition of

Id. (quoting 15 U.S.C. § 78fff-2(b)(2)).

The

10

bankruptcy court emphasized that the “BLMIS books and

11

records expose a Ponzi scheme where no securities were ever

12

ordered, paid for or acquired[,]” and concluded the Trustee

13

could not “discharge claims upon the false premise that

14

customers’ securities positions are what the account

15

statements purport them to be.”

16

Method, unlike the Last Statement Method, allowed Mr. Picard

17

to (in the bankruptcy court’s phrase)“unwind[], rather than

18

legitimiz[e], the fraudulent scheme.”

19

bankruptcy court reserved decision on the issue of whether

20

the Net Investment Method should be adjusted to account for

21

inflation or interest.

22

court certified an immediate appeal to this Court, over

23

which this Court accepted jurisdiction, pursuant to 28

24

U.S.C. § 158(d)(2)(A).

Id.

The Net Investment

Id. at 136.

Id. at 125 n.8.

13

The

The bankruptcy

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DISCUSSION
We review the legal conclusions of the bankruptcy

3

court, including its interpretation of SIPA, de novo.

4

Turner v. Davis, Gillenwater & Lynch (In re Inv. Bankers,

5

Inc.), 4 F.3d 1556, 1560 (10th Cir. 1993).

6

our independent review, we consider that the views of the

7

Securities & Exchange Commission (“SEC”) and SIPC are

8

“entitled to respect, but only to the extent that [they

9

have] the power to persuade.”

In conducting

Chao v. Russell P. Le Frois

10

Builder, Inc., 291 F.3d 219, 228 (2d Cir. 2002) (internal

11

quotation marks and alterations omitted); see also In re New

12

Times Sec. Servs., Inc., 371 F.3d 68, 76 (2d Cir. 2004)

13

(“New Times I”) (observing “that the drafters of SIPA

14

clearly envisioned roles for both the SEC and SIPC in

15

administering the statute”).

16

The positions of the parties on appeal are as follows.

17

Mr. Picard asserts that the objecting BLMIS claimants are

18

customers with claims for securities under SIPA and that the

19

plain language of SIPA dictates that their “net equity” be

20

calculated based on the Net Investment Method.

21

amicus curiae, supports the Trustee’s view that, here, the

22

Net Investment Method is required by the language of SIPA.

23

The SIPC--deemed to be a party in interest as to all matters

14

The SEC, as

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arising in a SIPA proceeding--urges this Court to affirm the

2

order of the bankruptcy court, which holds that on the

3

present facts the Net Investment Method (and not the Last

4

Statement Method) correctly measures “net equity.”

5

objecting BLMIS claimants contend that the Last Statement

6

Method is mandated by the language of SIPA; that they had a

7

legitimate expectation that their customer statements were

8

accurate; that SIPA is designed to protect this legitimate

9

expectation; and that the Net Investment Method undermines

10
11

The

the purpose of the statute.
First, accepting that the objecting BLMIS claimants are

12

“customers” under SIPA, they are customers with claims for

13

securities.

14

the Trustee argue the plain language of SIPA supports their

15

(irreconcilable) positions, we conclude that the statutory

16

language does not prescribe a single means of calculating

17

“net equity” that applies in the myriad circumstances that

18

may arise in a SIPA liquidation.6

19

v. Aberdeen Sec. Co., 480 F.2d 1121, 1123 (3d Cir. 1973)

20

(“The intent of Congress to protect customers of financially

Second, while the objecting BLMIS claimants and

6

See Sec. & Exch. Comm’n

The two competing methods of calculating “net equity”
proposed by the parties to this litigation are the only two
methods at issue here. We do not hold that they are the
only possible approaches to calculation of “net equity”
under SIPA.
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distressed security dealers is clear, but the specifics of

2

precise resolution of individual situations are clouded by

3

the provisions of a statute which range far from the clarity

4

of blue sky one might expect in this area of the law.”);

5

McKenny v. McGraw (In re Bell & Beckwith), 104 B.R. 842, 848

6

(Bankr. N.D. Ohio 1989) (rejecting “plain meaning” arguments

7

as to meaning of “allocation” under SIPA as “not

8

persuasive”).

9

for differing approaches to ascertaining the fairest method

Differing fact patterns will inevitably call

10

for approximating “net equity,” as defined by SIPA.

11

U.S.C. § 78fff-2(b)(2).

12

See 15

Mr. Picard’s selection of the Net Investment Method was

13

more consistent with the statutory definition of “net

14

equity” than any other method advocated by the parties or

15

perceived by this Court.

16

SIPA serves dual purposes: to protect investors, and to

17

protect the securities market as a whole.

18

Prot. Corp. v. Barbour, 421 U.S. 412, 415 (1975).

19

of the BLMIS claimants as customers with claims for

20

securities and calculating “net equity” based on the Net

There was therefore no error.7

7

See Sec. Inv.
Treatment

We express no view on whether the Net Investment
Method should be adjusted to account for inflation or
interest, an issue on which the bankruptcy court has not yet
ruled and which is not before us on this interlocutory
appeal.
16

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Investment Method effectuates these purposes.

As the

2

bankruptcy court observed, “[a]ny dollar paid to reimburse a

3

fictitious profit is a dollar no longer available to pay

4

claims for money actually invested.

5

Method were adopted,” those claimants who have withdrawn

6

funds from their BLMIS accounts that exceed their initial

7

investments “would receive more favorable treatment by

8

profiting from the principal investments of [those claimants

9

who have withdrawn less money than they deposited], yielding

If the Last Statement

10

an inequitable result.”

11

at 141.

12

require the Trustee to aggravate the injuries caused by

13

Madoff’s fraud.

14

case would have the absurd effect of treating fictitious and

15

arbitrarily assigned paper profits as real and would give

16

legal effect to Madoff’s machinations.

17
18

In re Bernard L. Madoff, 424 B.R.

The statutory definition of “net equity” does not

Use of the Last Statement Method in this

I
The threshold issues are whether the BLMIS claimants

19

are “customers” within the meaning of SIPA and, if so,

20

whether they are customers with claims for securities or

21

customers with claims for cash.

22

claimants are not “customers,” 15 U.S.C. § 78lll(2)(A), they

23

are not entitled to the protection of SIPA at all, see Sec.

17

If the objecting BLMIS

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1

Inv. Prot. Corp. v. Pepperdine Univ. (In re Brentwood Sec.,

2

Inc.), 925 F.2d 325, 327 (9th Cir. 1991).

3

“[t]he term ‘customer’ includes . . . any person who has

4

deposited cash with the debtor for the purpose of purchasing

5

securities.”

6

Res. Mgmt. (In re ESM Gov’t Sec., Inc.), 812 F.2d 1374, 1376

7

(11th Cir. 1987) (observing “that it is the act of

8

entrusting the cash to the debtor for the purpose of

9

effecting securities transactions that triggers the customer

10

Under SIPA,

15 U.S.C. § 78lll(2)(B)(i); see also Tew v.

status provisions” (emphasis omitted)).

It also includes:

11
12
13
14
15
16
17
18
19
20

15 U.S.C. § 78lll(2)(A).

21

claimants are customers with claims for securities within

22

the meaning of SIPA.

23

. . . [a person] who has a claim on account of
securities received, acquired, or held by the
debtor in the ordinary course of business as a
broker or dealer from or for the securities
accounts of such person for safekeeping, with a
view to sale, to cover consummated sales, pursuant
to purchases, as collateral, security, or for
purposes of effecting transfer.
We conclude that the BLMIS

While SIPA does not--and cannot--protect an investor

24

against all losses, it “does . . . protect claimants who

25

attempt to invest through their brokerage firm but are

26

defrauded by dishonest brokers.”

27

Corp. (In re Primeline Sec. Corp.), 295 F.3d 1100, 1107

28

(10th Cir. 2002).

Ahammed v. Sec. Inv. Prot.

SIPA provides this protection by ensuring
18

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1

that claimants who deposited cash with a broker “for the

2

purpose of purchasing securities,” 15 U.S.C. §

3

78lll(2)(B)(i), are treated as customers with claims for

4

securities.

5

‘customer’ definition is the entrustment of cash or

6

securities to the broker-dealer for the purposes of trading

7

securities.”

8

791, 801 (6th Cir. 1995) (emphasis added).

9

This is so because the “critical aspect of the

Appleton v. First Nat’l Bank of Ohio, 62 F.3d

The legislative history supports the view that the

10

BLMIS claimants are customers with claims for securities.

11

“Throughout the [House Report on SIPA,] ‘investors’ is used

12

synonymously with ‘customers,’” and it is clear that an

13

individual who had documentation of his status as a “trading

14

customer . . . was to be protected.”

15

F.O. Baroff Co., 497 F.2d 280, 283 (2d Cir. 1974).

16

treating the BLMIS claimants as customers with claims for

17

securities protects their “legitimate expectations” as

18

investors in the securities market.

19

2 (1978), reprinted in 1978 U.S.C.C.A.N. 764, 765.

20

Similarly, SIPA’s implementing regulations bolster the

21

shared view of the Trustee, SIPC, and the SEC that a

22

claimant who has “written confirmation” that securities have

23

been purchased or sold on his or her behalf should be

19

Sec. & Exch. Comm’n v.
Indeed,

S. Rep. No. 95-763, at

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1

treated as a customer with a claim for securities.

17

2

C.F.R. §§ 300.501(b)(1), 300.502(a)(1).

3

not, however, mandate that this “written confirmation” form

4

the basis for calculating a customer’s “net equity.”

The regulation does

5

II

6

The BLMIS claimants object that the only way their

7

“legitimate expectations” can be protected is by calculating

8

“net equity” by reference to their last customer statements.

9

We conclude, however, that while the BLMIS customer

10

statements confirm that the BLMIS claimants are properly

11

treated as customers with claims for securities, the last

12

customer statements are not useful for ascertaining “net

13

equity.”

14

with the language of the statute itself.”

15

Ron Pair Enters., Inc., 489 U.S. 235, 241 (1989).

16

provisions interact.

17

equity” is determined by:

18
19
20
21
22
23
24
25
26
27
28
29

We “begin[] where all such inquiries must begin:
United States v.
Two

SIPA provides that a customer’s “net

(A) calculating the sum which would have been owed
by the debtor to such customer if the debtor had
liquidated, by sale or purchase on the filing date
[of the protective order]-(i) all securities positions of such customer
. . . minus
(B) any indebtedness of such customer to the
debtor on the filing date . . . .
15 U.S.C. § 78lll(11) (emphasis added).
20

At the same time,

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1

SIPA provides that the Trustee should make payments to

2

customers based on “net equity” insofar as the amount owed

3

to the customer is “ascertainable from the books and records

4

of the debtor or [is] otherwise established to the

5

satisfaction of the trustee.”

6

added).

7

Id. § 78fff-2(b) (emphasis

The objecting BLMIS claimants contend that their

8

“securities positions” should be determined by reference to

9

the “liquidat[ion]” value, id. § 78lll(11)(A), of the

10

securities listed on their last customer statements.

11

Trustee argues that the customer statements do not reflect

12

“securities positions” that could be “liquidated” because

13

the account statements were wholly the invention of Madoff

14

and do not reflect actual securities positions; that any

15

pay-out of “net equity” therefore also requires a review of

16

the “books and records” of BLMIS; and that “the books and

17

records of the debtor reveal that the last statements are a

18

fiction.”

19

The

Br. of Appellee Picard at 28.

We agree with Mr. Picard that a SIPA trustee’s

20

obligation to reimburse customers based on “net equity” must

21

be considered together with SIPA’s requirement that the

22

Trustee discharge “obligations of the debtor to a customer

23

relating to, or net equity claims based upon . . .

21

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1

securities . . . insofar as such obligations are

2

ascertainable from the books and records of the debtor or

3

are otherwise established to the satisfaction of the

4

trustee.”

5

Prot. Corp. v. Lehman Bros. Inc., 433 B.R. 127, 133 (Bankr.

6

S.D.N.Y. 2010) (“Under SIPA, the Trustee is required to

7

determine a ‘customer’ claim based on the ‘net equity’ of

8

the customer as shown on the books and records of the

9

debtor.” (footnote omitted)).

15 U.S.C. § 78fff-2(b)(2); see also Sec. Investor

This accords with our usual

10

practice of examining the “overall structure and operation”

11

of a statute.

12

Servs., 511 F.3d 324, 329 (2d Cir. 2007).

13

particular section in a statute can be understood in context

14

with and by reference to the whole statutory scheme, by

15

appreciating how sections relate to one another.”

16

Hous. Auth. v. Martinez, 277 F.3d 138, 144 (2d Cir. 2002).

17

“In other words, the preferred meaning of a statutory

18

provision is one that is consonant with the rest of the

19

statute.”

20

Puello v. Bureau of Citizenship & Immigration
“The meaning of a

Auburn

Id.

When the terms of the statute are read together, the

21

statute directs that a SIPA trustee should determine a

22

customer’s entitlement to recover “net equity” based both on

23

the statutory definition of that term and by reference to

24

the books and records of the debtor.
22

While the language of

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1

the statute clearly requires a SIPA trustee to distribute

2

customer property based on “net equity,” the statute does

3

not define “net equity” by reference to a customer’s last

4

account statement.

5

equity” should be calculated if a dishonest broker failed to

6

place a customer’s funds into the security market,

7

notwithstanding that the customer “deposited cash with the

8

debtor for the purpose of purchasing securities,” id. §

9

78lll(2)(B)(i).

10

Nor does it say specifically how “net

Here, the profits recorded over time on the customer

11

statements were after-the-fact constructs that were based on

12

stock movements that had already taken place, were rigged to

13

reflect a steady and upward trajectory in good times and

14

bad, and were arbitrarily and unequally distributed among

15

customers.

16

Trustee’s rejection of the Last Statement Method for

17

calculating “net equity.”

18

permitted the objecting claimants to recover based on their

19

final account statements, this would have “affect[ed] the

20

limited amount available for distribution from the customer

21

property fund.”

22

The inequitable consequence of such a scheme would be that

23

those who had already withdrawn cash deriving from imaginary

These facts provide powerful reasons for the

In addition, if the Trustee had

In re Bernard L. Madoff, 424 B.R. at 133.

23

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1

profits in excess of their initial investment would derive

2

additional benefit at the expense of those customers who had

3

not withdrawn funds before the fraud was exposed.

4

of these facts, the Net Investment Method better measures

5

“net equity,” as statutorily defined, than does the Last

6

Statement Method.8

7

Net Investment Method is appropriate because it relies

8

solely on unmanipulated withdrawals and deposits and refuses

9

to permit Madoff to arbitrarily decide who wins and who

10
11

loses.”

Because

As the bankruptcy court reasoned, “[t]he

In re Bernard L. Madoff, 424 B.R. at 140.

In holding that it was proper for Mr. Picard to reject

12

the Last Statement Method, we expressly do not hold that

13

such a method of calculating “net equity” is inherently

14

impermissible.

To the contrary, a customer’s last account

8

Because we find that, in this case, the Net
Investment Method advocated by Mr. Picard is superior to the
Last Statement Method as a matter of law, we have no need to
consider whether a SIPA trustee may exercise discretion in
selecting a method to calculate “net equity.” Fraud is
endlessly resourceful and the unraveling of weaved-up sins
may sometimes require the grant of a measure of latitude to
a SIPA trustee. It therefore appears to us that that in
many circumstances a SIPA trustee may, and should, exercise
some discretion in determining what method, or combination
of methods, will best measure “net equity.” We have no
reason to doubt that a reviewing court could and should
accord a degree of deference to such an exercise of
discretion so long as the method chosen by the trustee
allocates “net equity” among the competing claimants in a
manner that is not clearly inferior to other methods under
consideration.
24

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1

statement will likely be the most appropriate means of

2

calculating “net equity” in more conventional cases.

3

would expect that resort to the Net Investment Method would

4

be rare because this method wipes out all events of a

5

customer’s investment history except for cash deposits and

6

withdrawals.

7

Net Investment Method appropriate, whereas in many

8

instances, it would not be.

9

example, may be appropriate when securities were actually

10

purchased by the debtor, but then converted by the debtor.

11

Indeed, the Last Statement Method may be especially

12

appropriate where--unlike with the BLMIS accounts at issue

13

in this appeal--customers authorize or direct purchases of

14

specific stocks.

15

Stratton Oakmont, Inc.), No. 01-CV-2812 RCC, 01-CV-2313 RCC,

16

2003 WL 22698876 (S.D.N.Y. Nov. 14, 2003).

17

We

The extraordinary facts of this case make the

The Last Statement Method, for

See generally Miller v. DeQuine (In re

Ascertaining the proper measure of “net equity” in a

18

given case is for the ultimate purpose of issuing payments

19

to customers; so, the ability to deduce payment amounts (to

20

the satisfaction of the trustee) will bear upon the method

21

selected for calculating “net equity.”

22

Net Investment Method allows the Trustee to make payments

23

based on withdrawals and deposits, which can be confirmed by

24

the debtor’s books and records, and results in a
25

In this case, the

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1

distribution of customer property that is proper under SIPA.

2

III

3

Under the circumstances of this case, the limitation on

4

the objecting customers’ recovery imposed by the Net

5

Investment Method is consistent with the purpose and design

6

of SIPA.

7

investors against financial losses arising from the

8

insolvency of their brokers.”

9

Inc., 463 F.3d 125, 127 (2d Cir. 2006) (“New Times II”)

“The principal purpose of SIPA is to protect

In re New Times Sec. Servs.,

10

(internal quotation marks omitted).

11

to “protect capital markets by instilling confidence in

12

securities traders.”

13

Kennedy & Co., 533 F.2d 1314, 1317 (2d Cir. 1976).

14

main purpose [i]s . . . not to prevent fraud or conversion,

15

but to reverse los[s]es resulting from brokers’ insolvency.”

16

In re Stratton Oakmont, 2003 WL 22698876, at *5; see also

17

Appleton, 62 F.3d at 801; In re Brentwood Sec., 925 F.2d at

18

326.

19

SIPA is also intended

Sec. Investor Prot. Corp. v. Morgan,
“SIPA’s

The BLMIS claimants characterize the overall statutory

20

scheme as an insurance guarantee of the securities positions

21

set out in their account statements.

22

SIPA should operate to make them whole from the losses they

23

incurred as a result of Madoff’s dishonesty.

26

They maintain that

We disagree.

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1

While this Court has referred to SIPC as providing a “form

2

of public insurance,” Packer, Wilbur & Co., 498 F.2d at 985,

3

it is clear that the obligations imposed on an insurance

4

provider under state law do not apply to this

5

congressionally-created “nonprofit membership corporation.”

6

Barbour, 421 U.S. at 413; see also, e.g., Rosenbluth

7

Trading, Inc. v. United States, 736 F.2d 43, 46 (2d Cir.

8

1984) (observing that although Social Security is often

9

referred to as insurance, “[m]anifestly, social security is

10

not traditional insurance, and consequently principles

11

applicable to [insurance policies] . . . need not be

12

imported uncritically into lawsuits involving social

13

security”).

14

insurance under New York law and, in the event of a SIPA

15

liquidation, New York law governs the relative ability of

16

implicated parties to obtain the benefit of insurance

17

coverage.

18

(Matter of F.O. Baroff Co.), 555 F.2d 38, 41-42 (2d Cir.

19

1977) (stating claimant in SIPA liquidation may share in

20

insurance held by bankrupt debtor).

21

Moreover, a registered broker-dealer may obtain

See generally Am. Bank & Trust Co. v. Davis

It is not at all clear that SIPA protects against all

22

forms of fraud committed by brokers.

23

Ctr., Inc., 129 B.R. 339, 353 (Bankr. E.D.N.Y. 1991)

24

(“Repeatedly this Court has been forced to tell claimants
27

See In re Investors

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1

that the fund created for the protection of customers of

2

honest, but insolvent, brokers gives them no protection when

3

the insolvent broker has been guilty of dishonesty, breach

4

of contract or fraud.”); H.R. Rep. No. 91-1613, at 1 (1970),

5

reprinted in 1970 U.S.C.C.A.N. 5254, 5255 (stating “[t]he

6

primary purpose of [SIPA] . . . is to provide protection for

7

investors if the broker-dealer with whom they are doing

8

business encounters financial troubles”).

9

that the statute is not designed to insure investors against

But it is clear

10

all losses.

11

983 (“SIPA was not designed to provide full protection to

12

all victims of a brokerage collapse.”); Sec. Investor Prot.

13

Corp. v. Associated Underwriters, Inc., 423 F. Supp. 168,

14

171 (D. Utah 1975) (SIPA does not “guarantee that customers

15

will recover their investments which may have diminished as

16

a result of, among other things, market fluctuations or

17

broker-dealer fraud”).

18

availability of advances under SIPA to cushion the impact of

19

Madoff’s fraud.

20

See, e.g., Packer, Wilbur & Co., 498 F.2d at

But, no party has contested the

In any event, SIPA is intended to expedite the return

21

of customer property, and SIPC provides advances on customer

22

property.

23

the statute as “cash and securities . . . at any time

Customer property, in turn, is a term defined by

28

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1

received, acquired, or held by or for the account of a

2

debtor from or for the securities accounts of a customer,

3

and the proceeds of any such property transferred by the

4

debtor, including property unlawfully converted.”

5

§ 78lll(4).

6

statements, there were no securities purchased and there

7

were no proceeds from the money entrusted to Madoff for the

8

purpose of making investments.

9

“ratably” in customer property on the basis of their “net

10

equity,” id. § 78fff-2(c)(1)(B); so if customers receive

11

SIPC advances based on property that is a fiction, those

12

advances will necessarily diminish the amount of customer

13

property available to other investors, including those who

14

have not recouped even their initial investment.

15

the main purpose of determining “net equity” is to achieve a

16

fair allocation of the available resources among the

17

customers, the Trustee properly rejected the Last Statement

18

Method as it would have undermined this objective.

Here, notwithstanding the BLMIS customer

19
20

15 U.S.C.

Moreover, customers share

Because

IV
The objecting claimants maintain that a pair of

21

decisions of this Court--New Times I and New Times II--

22

dictate that the Last Statement Method be used to calculate

23

“net equity.”

We conclude that, to the contrary, our

29

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1

precedent is consistent with the Trustee’s decision to

2

utilize the Net Investment Method under the circumstances of

3

this case.

4

case would have been an impermissible means of calculating

5

“net equity.”

And, use of the Last Statement Method in this

Like the BLMIS litigation, the New Times cases arose

6
7

out of a Ponzi scheme.

After the New Times scheme was

8

exposed, a SIPA trustee was appointed and a liquidation

9

proceeding commenced.

New Times I, 371 F.3d at 71.

The

10

SIPA trustee divided the claimants into two groups.

One

11

group of claimants had been misled to believe that they were

12

investing “in mutual funds that in reality existed.”

13

74.

14

their account statements mirrored what would have happened

15

had the given transaction been executed.”

16

quotation marks omitted).

17

treated these claimants as customers with claims for

18

securities and reimbursed them based on their account

19

statements.

20

“fraudulently induced” to buy “shares in bogus mutual funds”

21

that did not exist.

22

treated these claimants as customers with claims for cash;

23

they objected; and the district court sustained their

24

objections, holding that they had claims for securities and

Id. at

“[T]he information that these claimants received on

Id. (internal

The New Times SIPA trustee

The second group of claimants were

Id. at 71.

30

The New Times trustee

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1

that their “net equity” should be determined by reference to

2

their customer statements.

3

SIPC appealed.9

4

Id.

The New Times Trustee and

This Court ruled [i] that the New Times claimants who

5

believed they had invested in mutual funds that did not, in

6

fact, exist, should be treated as customers with claims for

7

securities, but [ii] that their “net equity” could not be

8

calculated by reference to the “fictitious securities

9

positions reflected in the Claimants’ account statements.”

10

Id. at 75.

11

view of the SEC and SIPC that “basing customer recoveries on

12

fictitious amounts in the firm’s books and records would

13

allow customers to recover arbitrary amounts that

14

necessarily have no relation to reality . . . [and would]

15

leave[] the SIPC fund unacceptably exposed.”

16

(internal quotation marks omitted).

17

made-up values of fictional securities would be “unworkable”

18

and would create “potential absurdities.”

19

it was held that “each Claimant’s net equity should be

20

calculated by reference to the amount of money the Claimants

21

originally invested with the Debtors (not including any

The New Times I Court was persuaded by the joint

9

Id. at 88

Calculations based on

Id.

Accordingly,

The New Times claimants who were originally treated
as customers with claims for securities and compensated
based on their customer statements were never before this
Court.
31

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365897

fictitious interest or dividend reinvestments).”

35

Id. at 71.

In New Times II, this Court concluded that investors in

3

New Times Securities Services who, prior to the SIPA

4

proceeding, “were induced to liquidate their accounts . . .

5

and make a loan of the imaginary funds to the brokerage

6

house and to [the principal]” were not customers within the

7

meaning of SIPA.

8

could only legitimately have expected to be treated as

9

lenders unprotected by SIPA.

10

New Times II, 463 F.3d at 126, 129.

They

Id. at 130.

Taken together, New Times I and New Times II militate

11

in favor of limiting recovery by BLMIS claimants to their

12

Net Investment.

13

unlike the appellants in New Times I because their customer

14

statements reflected investments in real stocks listed on

15

the Standard & Poor’s 100 Index.

16

BLMIS claimants are similarly situated to the New Times

17

appellants in a crucial respect: assessing “net equity”

18

based on their customer statements would require the Trustee

19

to establish each claimant’s “net equity” based on a fiction

20

created by the perpetrator of the fraud.

21

New Times I decision, the New Times II Court stated:

22
23
24
25
26

True, the objecting BLMIS claimants are

However, the objecting

Commenting on the

The court declined to base the recovery on the
rosy account statements telling customers how well
the imaginary securities were doing, because
treating the fictitious paper profits as within
the ambit of the customers’ “legitimate
32

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2
3
4
5
6

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expectations” would lead to the absurdity of
“duped” investors reaping windfalls as a result of
fraudulent promises made on fake securities.
Id. at 130 (quoting New Times I, 371 F.3d at 87-88).
Madoff constructed account statements retrospectively,

7

designating stocks based on advantageous historical price

8

information and arbitrarily distributing profits among his

9

customers.10

It would therefore have been legal error for

10

the Trustee to “discharge claims upon the false premise that

11

customers’ securities positions are what the account

12

statements purport them to be.”

13

424 B.R. at 135.

14

“net equity” by reference to impossible transactions.

15

Indeed, if the Trustee had done otherwise, the whim of the

16

defrauder would have controlled the process that is supposed

17

to unwind the fraud.

18

In re Bernard L. Madoff,

The Trustee properly declined to calculate

In any event, SIPA covers potentially a multitude of

19

situations; no one size fits all.

20

Chicago v. Wyatt, 517 F.2d 453, 459 n.12 (2d Cir. 1975)

21

(stating SIPA “liquidation procedures have been carefully

22

designed to allow flexibility”).

23

appointed to oversee the liquidation underlying the New

24

Times cases calculated “net equity” in one manner is not
10

See Exch. Nat’l Bank of

The fact that the trustee

Some purported trades were settled outside the Stock
Exchange’s price range for the trade dates.
33

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1

determinative as to the proper method of ascertaining “net

2

equity” in this case.11

3

“net equity” based on customer statements for those

4

claimants whose account statements “mirrored what would have

5

happened had the given transaction[s] been executed.”

6

Times I, 371 F.3d at 74 (internal quotation marks omitted).

7

Here, however, the BLMIS customer statements reflect

8

impossible transactions and the Trustee is not obligated to

9

step into the shoes of the defrauder or treat the customer

10

The New Times trustee calculated

New

statements as reflections of reality.

11

CONCLUSION

11

A SIPA liquidation is a hybrid proceeding. See 15
U.S.C. § 78fff-1(a) (“A trustee shall be vested with the
same powers and title with respect to the debtor and the
property of the debtor, including the same rights to avoid
preferences, as a trustee in a case under Title 11.”); id.
§ 78fff(b) (“To the extent consistent with the provisions of
this chapter, a liquidation proceeding shall be conducted in
accordance with, and as though it were being conducted under
[the Bankruptcy Code].”); see also In re Housecraft Indus.
USA, Inc., 310 F.3d 64, 71 (2d Cir. 2002) (stating
bankruptcy trustee may avoid fraudulent transactions). As
the bankruptcy court ruled, “SIPA and the [Bankruptcy] Code
intersect to . . . grant a SIPA trustee the power to avoid
fraudulent transfers for the benefit of customers.” In re
Bernard L. Madoff, 424 B.R. at 136. The objecting BLMIS
claimants point out that no avoidance power has been invoked
in this case. True, however--in the context of this Ponzi
scheme--the Net Investment Method is nonetheless more
harmonious with provisions of the Bankruptcy Code that allow
a trustee to avoid transfers made with the intent to
defraud, see 11 U.S.C. § 548(a)(1)(A), and “avoid[s] placing
some claims unfairly ahead of others,” In re Adler, Coleman
Clearing Corp., 263 B.R. 406, 463 (Bankr. S.D.N.Y. 2001).
34

Case: 10-2378

Document: 480-1

Page: 35

08/16/2011

365897

35

1

For the reasons set forth above, we affirm the order of

2

the United States Bankruptcy Court for the Southern District

3

of New York (Lifland, J.) and hold that use of the Net

4

Investment Method for calculating the “net equity” of the

5

BLMIS customers was proper.

35