Irving H. Picard v. Saul B. Katz et al

Filing 59

FILING ERROR - WRONG DOCUMENT TYPE SELECTED FROM MENU - BRIEF re: 41 Order, (TRUSTEES MEMORANDUM OF LAW SUPPORTING THE CALCULATION OF PRINCIPAL AND FICTITIOUS PROFIT UNDER THE NET INVESTMENT METHOD). Document filed by Irving H. Picard.(Sheehan, David) Modified on 10/25/2011 (ka).

UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
In re:

Adv. Pro. No. 08-01789 (BRL)

BERNARD L. MADOFF INVESTMENT
SECURITIES LLC,

SIPA LIQUIDATION

Debtor,

(Substantively Consolidated)

IRVING H. PICARD, Trustee for the Liquidation of Adv. Pro. No. 10-05287 (BRL)
Bernard L. Madoff Investment Securities LLC,
v.

Plaintiff,

11 Civ. 03605 (JSR) (HBP)

SAUL B. KATZ, et al.,
Defendants.

(Oral Argument Requested)

TRUSTEE’S MEMORANDUM OF LAW SUPPORTING THE CALCULATION OF
PRINCIPAL AND FICTITIOUS PROFIT UNDER THE NET INVESTMENT METHOD

BAKER & HOSTETLER LLP
45 Rockefeller Plaza
New York, New York 10111
Telephone: [phone]
Facsimile: [phone]
Attorneys for Irving H. Picard, Trustee for the
Substantively Consolidated SIPA Liquidation of
Bernard L. Madoff Investment Securities LLC
and Bernard L. Madoff

Table of Contents
Page
Background .................................................................................................................................... 1
Preliminary Statement .................................................................................................................... 2
Legal Discussion ............................................................................................................................ 4
I.

The Net Investment Method comports with the Trustee’s avoidance
powers. ................................................................................................................... 4

II.

The Net Investment Method complies with the netting rule applied in
Ponzi cases. ............................................................................................................ 5

III.

The Net Investment Method ensures equal treatment for all customers. ............... 8

IV.

The Net Investment Method provides the Trustee with the correct method
for determining net profits avoidable and recoverable from Defendants in
the two years prior to the Filing Date. ................................................................... 9

Conclusion ................................................................................................................................... 12

-i-

Table of Authorities
Page(s)
CASES
In re Adler, Coleman Clearing Corp.,
263 B.R. 406 (Bankr. S.D.N.Y. 2001) .......................................................................................4
Armstrong v. Collins,
No. 01 Civ. 2437, 2010 WL 1141158 (S.D.N.Y. Mar. 24, 2010) .............................................6
Bayou Accredited Fund, LLC v. Redwood Growth Partners (In re Bayou Group, LLC),
396 B.R. 810 (Bankr. S.D.N.Y. 2008) .......................................................................................8
Bayou Superfund, LLC v. WAM Long/Short Fund II, L.P. (In re Bayou Group, LLC),
362 B.R. 624 (Bankr. S.D.N.Y. 2007) ...................................................................................5, 6
In re Bernard L. Madoff Inv. Sec.,
--- F.3d ---, 2011 WL 3568936 (2d Cir. Aug. 16, 2011) ................................................ passim
In re Bernard L. Madoff Inv. Sec. LLC,
424 B.R. 122 (Bankr. S.D.N.Y. 2010) .......................................................................................4
Christian Bros. High Sch. Endowment v. Bayou No Leverage Fund, LLC (In re Bayou
Group, LLC),
439 B.R. 284 (S.D.N.Y. 2010)...................................................................................................6
Cunningham v. Brown,
265 U.S. 1 (1924) .......................................................................................................................8
Daly v. Radulesco (In re Carrozzella & Richardson),
247 B.R. 595 (B.A.P. 2d Cir. 2000)...........................................................................................8
Donell v. Kowell,
533 F.3d 762 (9th Cir.), cert. denied, 129 S. Ct. 640 (2008) .............................................5, 6, 7
In re Dreier LLP,
452 B.R. 391 (Bankr. S.D.N.Y. 2011) .......................................................................................5
Jobin v. Youth Benefits Unlimited (In re M&L Business Mach. Co.),
59 F.3d 1078 (10th Cir. 1995) ...................................................................................................8
In re Lake States Commodities, Inc.,
253 B.R. 866 (Bankr. N.D. Ill. 2000) ........................................................................................7
Mishkin v. Siclari (In re Adler, Coleman Clearing Corp.),
277 B.R. 520 (Bankr. S.D.N.Y. 2002) .......................................................................................8
In re Moore,
39 B.R. 571 (Bankr. M.D. Fla. 1984) ........................................................................................7
-ii-

Table of Authorities
(continued)
Page(s)
Noland v. Morefield (In re Nat’l Liquidators, Inc.),
232 B.R. 915 (Bankr. S.D. Ohio 1998)..................................................................................6, 7
Picard v. Cohmad Sec. Corp.,
454 B.R. 317 (Bankr. S.D.N.Y. 2011) .......................................................................................5
Picard v. Katz,
--- F. Supp. 2d ----, 2011 WL 4448638 (S.D.N.Y. Sept. 27, 2011) ................................. passim
SEC v. Credit Bancorp., Ltd.,
No. 99 Civ. 11395, 2000 WL 1752979 (S.D.N.Y. Nov. 29, 2000) ...........................................8
Sender v. Buchanan (In re Hedged-Investments Assoc., Inc.),
84 F.3d 1286 (10th Cir. 1996) ...................................................................................................7
Wing v. Dockstader,
No. 2:08 Civ. 776, 2010 WL 5020959 (D. Utah Dec. 3, 2010) .................................................6
STATUTES
11 U.S.C. § 510(c) ..........................................................................................................................1
11 U.S.C. § 548(a)(1) .......................................................................................................................7
11 U.S.C. § 548(a)(1)(A) ....................................................................................................... passim
11 U.S.C. § 548(c) ...........................................................................................................................2
15 U.S.C. § 78aaa et seq. .................................................................................................................1

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Irving H. Picard (the “Trustee”), trustee for the liquidation of the business of Bernard L.
Madoff Investment Securities LLC (“BLMIS”) under the Securities Investor Protection Act
(“SIPA”), 15 U.S.C. § 78aaa et seq., and the substantively consolidated estate of Bernard L. Madoff
(“Madoff”), respectfully submits this memorandum of law pursuant to this Court’s order entered on
September 28, 2011 (“September 28 Order”) [ECF No. 41], and the Court’s Opinion and Order
dated September 27, 2011, Picard v. Katz, --- F. Supp. 2d ----, 2011 WL 4448638, at *4 n.6
(S.D.N.Y. Sept. 27, 2011) [ECF No. 40], on Defendants’ Motion to Dismiss the Amended
Complaint or, in the Alternative, for Summary Judgment (“Motion”) [ECF Nos. 20-25], supporting
the calculation of principal and fictitious profit from the inception of the BLMIS customer accounts.
Background
The Court’s decision in Katz sustained the Trustee’s Amended Complaint only as to Count
One (actual fraud under § 548(a)(1)(A) of the Bankruptcy Code) and Count Eleven (equitable
subordination under § 510(c) of the Bankruptcy Code). 1 Section 548(a)(1)(A) of the Bankruptcy
Code permits the Trustee to avoid payments made by BLMIS to its customers within two years of
the commencement of BLMIS’s SIPA liquidation, which is deemed to have occurred on December
11, 2008 (“Filing Date”). The decision further stated that there is an open question on the Motion
as to “whether the Trustee can avoid as profits only what defendants received in excess of their
investment during the two year look back period 2 specified by section 548 or instead the excess they
received over the course of their investment with Madoff.” Katz, 2011 WL 4448638, at *4 n.6. In
1

Count Eleven is not relevant to the issue raised by the Court that is the subject of this
Memorandum.
2

The term “look back period” used in this Memorandum refers to the time period before the Filing
Date specified in applicable statutes during which transfers may be avoided. Section 548 of the
Bankruptcy Code, for example, specifies a two-year look back period in which fraudulent transfers
may be avoided, while the New York Debtor and Creditor Law limits the avoidance period to six
years.

the September 28 Order, the Court requested briefing to promptly resolve the open question, which
was framed as “whether, in determining what portion of that sum should be considered principal
and what portion profits, reference should be made only to that [two-year] period or should be made
to earlier transfers as well.” See September 28 Order. 3
Preliminary Statement
The issue presented by the Court implicates not only the resolution of this avoidance action
but the legal process used to unwind Madoff’s colossal Ponzi scheme. After its inevitable collapse,
the Trustee was charged with sorting out decades of fraud in an equitable and fair manner according
to the governing law. Because it was a Ponzi scheme, BLMIS’s customers either lost principal to
the scheme or received all of their principal back as well as other people’s money. In determining
customer claims under SIPA and seeking to recover customer property for equitable distribution,
the Trustee has taken a uniform approach that gives all customers the benefit of every principal
deposit made during the life of their investment relationship with BLMIS.
The Second Circuit ruled that the “Net Investment Method,” which credits for the life of the
account the amount of cash a customer deposited into his BLMIS account, less any amounts
withdrawn from it, was the only legally sound and fair approach to calculate a customer’s “net
equity” claim under SIPA. In re Bernard L. Madoff Inv. Sec. LLC, 654 F.3d 239, 2011 WL
3568936, at *5, *12 (2d Cir. 2011) (the “Net Investment Ruling”). As applied to all BLMIS
customer accounts, the Net Investment Method distinguishes: (1) the customers that lost principal
3

The Trustee submits that this issue is not appropriate for resolution at the motion to dismiss stage
to the extent it forces a determination of the two-year transfers alleged to be avoidable under section
548(a)(1)(A). The underlying facts with respect to the amount of recoverable net profits are alleged
in the Trustee’s Amended Complaint (see Appendix I, Exh. B and Appendix II, Exhs. B and C to
the Amended Complaint, Adv. Pro. No. 10-05287, ECF No. 34 (Mar. 18, 2011)), and, together with
Defendants’ affirmative defenses under section 548(c), cannot be finally determined prior to
discovery and the introduction of evidence at trial.

2

over the course of their investment with BLMIS (often referred to as “net losers”), from (2) the
customers that received the return of their principal as well as the principal of other investors in the
form of fictitious profits over the course of their investment with BLMIS (often referred to as “net
winners”). Under the Net Investment Ruling, only those customers who lost principal are entitled to
an allowed customer claim.
As applied in the litigation context, the Net Investment Method is also the proper way to
determine whether a customer has received fraudulent transfers. Case law is uniform that transfers
of fictitious profits in a Ponzi scheme are avoidable under federal and state fraudulent conveyance
laws. Transfers of principal are also recoverable, but are subject to different standards than
transfers of fictitious profits. Thus, in every case, a trustee must determine whether transfers consist
of principal and/or fictitious profits in order to avoid and recover those transfers under the relevant
statutory framework. To do so, reference must be made to the entire investment relationship to
determine at what point a customer’s withdrawals exceeded the amount of principal invested. This
is consistent with both established precedent and the Net Investment Ruling.
Using any other method for calculating the amount of transfers of principal and fictitious
profits that may be avoided would lead to arbitrary and unfair results, as demonstrated by the impact
on Defendants’ accounts here. The Court has limited the Trustee to avoiding those transfers that
occurred in the two-year period preceding the Filing Date. 4 The Trustee’s Amended Complaint sets
forth the two-year transfers (the “Two Year Transfers”), which, using the Net Investment Method as
the basis for calculating the amounts, alleges that Defendants received transfers consisting of

4

The Trustee has moved for leave to appeal the Court’s decision in Katz; the Amended Complaint
sought to avoid and recover transfers under provisions of the Bankruptcy Code and the New York
Debtor and Creditor law other than section 548(a)(1)(A) and beyond the two-year period. While
that matter is pending, this Memorandum refers to the Two Year Transfers defined above.

3

$301,027,523 of principal and $83,309,162 of fictitious profits. By contrast, if the Net Equity
balances for all of the accounts were reset to zero as of December 11, 2006, the amount of
avoidable transfers in the form of fictitious profits received by Defendants would increase to over
$215,000,000 because Defendants would not be credited with any principal deposits prior to that
date.
Using the Net Investment Method to determine net equity claims and the amount of
avoidable transfers gives all customers—both those with allowed claims and those subject to
avoidance—the full benefit of the principal deposits they made with BLMIS. This brings the
“greatest number of investors closest to their positions prior to Madoff’s scheme in an effort to
make them whole.” In re Bernard L. Madoff Inv. Sec. LLC, 424 B.R. 122, 142 (Bankr. S.D.N.Y.
2010). Any other method of calculating the amount of principal lost or returned to customers would
deprive customers of their principal invested and their right to credit that principal against the
transfers received within the two-year period. Such a result would skew the legal basis on which
the Trustee seeks to avoid fraudulent transfers made by BLMIS in all of the avoidance actions and
arbitrarily shift the net equity position of each customer in violation of the Net Investment Ruling.
Legal Discussion
I.

The Net Investment Method comports with the Trustee’s avoidance powers.
Although the Second Circuit noted in its Net Investment Ruling that the Trustee’s avoidance

powers were not at issue on appeal, it stated its view that “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).” In re Bernard L. Madoff Inv. Sec., 2011 WL 3568936,
at *12 n.10 (emphasis in original). Applying the Second Circuit’s reasoning in this avoidance
4

litigation, the Net Investment Method fairly subjects customers having negative “net equity” to
potential avoidance liability under section 548(a)(1)(A) for the amount of principal and fictitious
profits they received.
II.

The Net Investment Method complies with the netting rule applied in Ponzi cases.
The Net Investment Method, in conjunction with the applicable statutory look back period,

complies with established precedent for determining whether a customer has potential avoidance
liability and in what amount. In the context of a fraudulent investment scheme, virtually every
court to address the question has held “unflinchingly,” In re Dreier LLP, 452 B.R. 391, 440 n.44
(Bankr. S.D.N.Y. 2011), that payments to an investor in excess of the principal amounts invested
are voidable as fraudulent transfers because they are not taken for value. See, e.g., id.; Picard v.
Cohmad Sec. Corp., 454 B.R. 317, 333 (Bankr. S.D.N.Y. 2011); Bayou Superfund, LLC v. WAM
Long/Short Fund II, L.P. (In re Bayou Group, LLC), 362 B.R. 624, 636 (Bankr. S.D.N.Y. 2007); see
also Katz, 2011 WL 4448638, at *4.
Thus, in cases involving fraudulent schemes where the payments by the debtor are
comprised of principal and fictitious profits, courts apply a two-step process to determine the full
extent of a transferee’s liability and calculate the amount recoverable under the relevant statutory
scheme. The first step is to determine whether the investor is liable through the use of the “netting
rule,” Donell v. Kowell, 533 F.3d 762, 771 (9th Cir.), cert. denied, 129 S. Ct. 640 (2008), which is
synonymous with the Net Investment Method upheld by the Second Circuit.
In Donell, an investor in a Ponzi scheme deposited approximately $23,000 and withdrew
$73,000 during the life of his account, resulting in $50,000 of fictitious profits. The Ninth Circuit
found that the receipt of $50,000 in fictitious profits established the investor’s potential liability,
explaining that the “[a]mounts transferred by the Ponzi scheme perpetrator to the investor are netted
against the initial amounts invested by that individual. If the net is positive, the receiver has
5

established liability, and the court then determines the actual amount of liability, which may or may
not be equal to the net gain, depending on factors such as whether transfers were made within the
limitations period . . . .” Id. at 771; see also Armstrong v. Collins, No. 01 Civ. 2437, 2010 WL
1141158, at *29 (S.D.N.Y. Mar. 24, 2010); Noland v. Morefield (In re Nat’l Liquidators, Inc.), 232
B.R. 915, 918 n.2 (Bankr. S.D. Ohio 1998). This comports with the Net Investment Ruling, which
looks to whether the claimant’s transactions with the Ponzi scheme resulted in positive (greater
deposits than withdrawals) or negative (greater withdrawals than deposits) net equity. See In re
Bernard L. Madoff Inv. Sec., 2011 WL 3568936, at *3, *8.
The second step is to determine the actual amount of liability under the relevant fraudulent
conveyance statutes, i.e., the amount of avoidable transfers the trustee may recover. While all
transfers of fictitious profits in a Ponzi scheme are avoidable as fraudulent transfers, see, e.g.,
Christian Bros. High Sch. Endowment v. Bayou No Leverage Fund, LLC (In re Bayou Group, LLC),
439 B.R. 284, 337-38 (S.D.N.Y. 2010); In re Bayou Group, LLC, 362 B.R. at 629-30; Wing v.
Dockstader, No. 2:08 Civ. 776, 2010 WL 5020959, at *5 (D. Utah Dec. 3, 2010), the applicable
statutory look back period restricts the time period in which specific transfers may be avoided.
Donell, 533 F.3d at 772 (“Only transfers made within the limitations period are avoidable.”).
Irrespective of the look back period for transfers, however, courts hold that the deposits must be
viewed over the life of the account to determine whether transfers in the avoidance period consist of
fictitious profits or principal. See, e.g., id. at 771; In re Nat’l Liquidators, Inc., 232 B.R. at 918-20.
Thus, in Donell, once the district court determined the “good faith” investor’s liability for
the receipt of avoidable transfers by netting his withdrawals against his investments during the life
of the account, the court “properly limited” the recovery to the three transfers of fictitious profits
totaling $26,000 that occurred during the applicable four-year statute of limitations period under

6

California law. 533 F.3d at 773. In In re Hedged Investments, the Tenth Circuit applied the netting
rule to a “good faith” investor’s entire 12-year investment history with the debtor and determined
that the investor received a total of $1.25 million of fictitious profits from a Ponzi scheme. Sender
v. Buchanan (In re Hedged-Investments Assoc., Inc.), 84 F.3d 1286, 1288-89 (10th Cir. 1996). The
trustee was permitted to recover more than $248,000—everything the investor received during the
one-year look back period—because the investor had “invested not one red cent” during the look
back period applicable in that case. Id. at 1288. In In re Nat’l Liquidators, Inc., the court used the
netting analysis to arrive at the amount of fictitious profits that an investor received from a Ponzi
scheme recoverable under section 548(a)(1). 232 B.R. at 918 n.2 (“In order to determine the
amount of the Defendants’ false profits, the total amount invested by the Defendants ($229,600)
should be subtracted from the total amount paid by the Debtor to the Defendants ($601,250),
resulting in total false profits of $371,650.”).
The rule developed in these cases is that the entire investment history is necessary to
calculate the principal or profit that an investor received, without regard to the look back period or
statutory defense. See also In re Lake States Commodities, Inc., 253 B.R. 866, 871 (Bankr. N.D. Ill.
2000) (“To determine the amount recoverable from an investor, payments received from the
perpetrators of a scheme are ‘netted’ against the amounts invested.”) (citation omitted); In re
Moore, 39 B.R. 571, 573 (Bankr. M.D. Fla. 1984) (netting account activity beyond statutory
avoidance period and holding investor liable for transfers of fictitious profits during avoidance
period). While the law may restrict avoidance and recovery of those transfers that occurred within a
certain time period, determining the quantum of fraudulent transfers requires consideration of the
entire transactional history.

7

III.

The Net Investment Method ensures equal treatment for all customers.
As stated in the seminal Ponzi scheme case, “equality is equity and this is the spirit of the

bankrupt law.” Cunningham v. Brown, 265 U.S. 1, 13 (1924) (holding that all investors in a Ponzi
scheme must be treated equally). Thus, “[i]n a Ponzi scheme, or other scenario where creditors are
almost exclusively defrauded parties, there is no distinguishing characteristic which promotes the
interests of one over the other. Consequently . . . it is to the detriment of all other similarly situated
creditors to favor one defrauded party over another.” Jobin v. Youth Benefits Unlimited (In re M&L
Business Mach. Co.), 59 F.3d 1078, 1082 (10th Cir. 1995).
Fraudulent transfer laws are not punitive provisions “designed to punish the transferee,” but
instead “place the transferee in the same position as other similarly situated creditors who do not
receive fraudulent [transfers].” Bayou Accredited Fund, LLC v. Redwood Growth Partners (In re
Bayou Group, LLC), 396 B.R. 810, 827 (Bankr. S.D.N.Y. 2008). Implementing these principles,
the Second Circuit recognized that adherence to the Net Investment Method enables the Trustee to
“avoid placing some claims unfairly ahead of others.” In re Bernard L. Madoff Inv. Sec., 2011 WL
3568936, at *12 n.10.
To ensure fair results, and to comply with the Net Investment Ruling and longstanding
principles of SIPA and other federal and bankruptcy law that mandate treating similarly situated
parties equally, 5 the Trustee has consistently applied the Net Investment Method to all customer
accounts. Each customer has been given full credit for all deposits that occurred during the life of
the account. Transfers to customers were not deemed fictitious profits until the withdrawals from

5

See, e.g., Cunningham, 265 U.S. at 13; Daly v. Radulesco (In re Carrozzella & Richardson), 247
B.R. 595, 601-02 (B.A.P. 2d Cir. 2000); Mishkin v. Siclari (In re Adler, Coleman Clearing Corp.),
277 B.R. 520, 563 (Bankr. S.D.N.Y. 2002); SEC v. Credit Bancorp., Ltd., No. 99 Civ. 11395, 2000
WL 1752979, at *13 (S.D.N.Y. Nov. 29, 2000).

8

each account exceeded the amount of the deposits. Whether applied for the purpose of determining
a customer’s net equity claim or potential avoidance liability, every customer and the transactions
within their accounts were treated the same.
Conversely, by cutting short the period in which deposits are credited, customers’ cash
positions, i.e., their net equity claims, would inevitably shift, running afoul of the Second Circuit’s
Net Investment Ruling. For example, some accounts that had negative net equity under the Net
Investment Method may have positive net equity if the calculation began at zero on December 11,
2006. Some accounts that had negative net equity would have an even greater amount of negative
net equity, even though they had deposits in the preceding years that would actually offset those
amounts. And some accounts that had positive net equity may wind up with negative net equity,
even though the Net Investment Ruling holds that those accounts have an allowable net equity
claim.
Moreover, none of the potential outcomes above would be tied to the actual principal
invested and lost—which the Second Circuit held is the only reliable touchstone in this case—and
would effectively add another layer to Madoff’s “arbitrary machinations.” In re Bernard L. Madoff
Inv. Sec., 2011 WL 3568936, at *5. Because the Second Circuit has deemed the Net Investment
Method binding on the determination of net equity claims, which encompasses a cash in/cash out
analysis over the lifetime of the BLMIS accounts, any calculation other than the Net Investment
Method would impermissibly undermine the Second Circuit’s ruling and “aggravate the injuries
caused by Madoff’s fraud.” Id.
IV.

The Net Investment Method provides the Trustee with the correct method for
determining net profits avoidable and recoverable from Defendants in the two years
prior to the Filing Date.
The Court in Katz determined that the Trustee may avoid and recover transfers from BLMIS

to Defendants under section 548(a)(1)(A) of the Bankruptcy Code during the two-year period from
9

December 11, 2006, to the Filing Date. Katz, 2011 WL 4448638, at *3, *5. Consistent with SIPA
and in light of the Net Investment Ruling and the above precedents, and relying upon BLMIS’s
books and records for the cash in/cash out transactions, the Trustee’s Amended Complaint describes
in detail the Two Year Transfers to Defendants that the Trustee alleges are avoidable. 6
In this case, if the Net Equity balances for all of the accounts were reset to zero dollars as of
December 11, 2006, that would have a negative effect on Defendants because the amount of
transfers avoidable as fictitious profits would increase from the amount set forth in the Amended
Complaint. Under the Net Investment Method, the Trustee calculated that Defendants’ gross
withdrawals from their BLMIS accounts in the two-year period equals $384,336,685. Am. Compl.
¶ 1108. Of that amount, $301,027,523 equals principal and $83,309,162 constitutes fictitious
profits. Id. If, however, the Court were to calculate the two-year principal and fictitious profits by
starting with a balance of zero dollars in Defendants’ BLMIS accounts on December 11, 2006,
Defendants’ gross withdrawals would remain constant at $384,336,685, but the amount of principal
withdrawn would drop to $165,847,310, and the amount of fictitious profits would jump to
$218,489,375. See Am. Compl., Appendix I, Exhibit B. 7 Thus, applying the “reset to zero”
methodology almost triples the amount the Trustee would be able to avoid and recover as fictitious
profits. See Katz, 2011 WL 4448638, at *4 n.6 (“. . . the trustee might well prevail on summary
judgment seeking recovery of the profits . . . ”).
6

Attached to the Trustee’s Amended Complaint as Appendix I, Exh. B, and Appendix II, Exhs. B
and C are schedules that, among other facts, reflect the total amount of Defendants’ deposits into
their BLMIS accounts during the lifetime of the accounts and transfers from BLMIS to Defendants
within the statutory avoidance periods, that is, within two years and six years, respectively. The
Two Year Transfers reflect only those transfers to Defendants during the two years prior to the
Filing Date.
7

This calculation is based on the aggregate of the post-December 10, 2006 cash deposits and cash
withdrawals in columns 4 and 5 of Appendix I, Ex. B, respectively, for all 185 accounts.

10

The reason for this disparity is clear. The Net Investment Method employed by the Trustee
properly allocates an investor’s principal deposits over the life of his account, reducing his fictitious
profits at the moment of each new deposit. To start all accounts at a zero balance as of December
11, 2006 would cancel out all of these past credits, counting only the cash in/cash out over that
limited time period. This would unfairly punish those investors who made deposits outside of the
two years in favor of those who invested and took their profits near the end of the scheme.
This dynamic is illustrated by the transactions in one of Defendants’ accounts at issue here,
1KW435. See Am. Compl., Appendix I, Exhibit B-227. The account opened with a deposit via
wire transfer in the amount of $67,937,120 on July 27, 2006, four and one-half months prior to the
start of the two-year look back period. Id., column 4. Following this initial deposit, all successive
transactions took place during that two-year period. During that time, specifically between
December 26, 2006 and July 9, 2008, the account had eight redemptions, in the total amount of
$51,102,500, id., column 5, and only one additional deposit on November 14, 2007, in the amount
of $1,200,000. Id., column 4. As a result of these actual cash transactions, the “net cash activity”
during the two-year look back period for this account demonstrates that the account holder
withdrew $49,902,500 more than it deposited over the same period.
The Net Investment Method would consider these withdrawals the return of principal
because it takes into account the opening deposit, which occurred outside the look back period.
And, according to the Court, avoidance of principal requires a higher level of culpability than
fictitious profits. See Katz, 2011 WL 4448638, at *4-*5. However, assuming the clock were reset
to zero dollars as of December 11, 2006, the amount of cash withdrawn during the two-year look
back period would exceed the amount deposited during that time by a total of $49.9 million, which
sum would then constitute fictitious profits subject to avoidance, essentially as a matter of law.

11

This result would deprive Defendants of the proper credit for the principal they invested outside of
the two-year period. As this example demonstrates, using any method other than the Net
Investment Method to calculate which portion of the Two Year Transfers constitutes principal or
profit would upset the uniform application of established precedent to customers’ deposits and
withdrawals in contravention of the Second Circuit Ruling.
Conclusion
For the foregoing reasons, the Trustee respectfully requests that the Court rule that the Net
Investment Method applies for purposes of calculating which portion of the Two Year Transfers
constitute principal or profit.

Date: October 24, 2011
New York, New York

By: /s/ David J. Sheehan
BAKER & HOSTETLER LLP
45 Rockefeller Plaza
New York, New York 10111
Telephone: [phone]
Facsimile: [phone]
David J. Sheehan
Email: [e-mail]
Geraldine E. Ponto
Email: [e-mail]
Mark F. Skapof
Email: [e-mail]
Seanna R. Brown
Email: [e-mail]
Jacqlyn R. Rovine
Email: [e-mail]
Attorneys for Irving H. Picard, Trustee for the
Substantively Consolidated SIPA Liquidation
of Bernard L. Madoff Investment Securities
LLC and Bernard L. Madoff

12