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

Filing 75

REPLY MEMORANDUM OF LAW re: 72 Order,, 73 Memorandum of Law - Trustees Reply to Amicus Brief on Reset to Zero Methodology. Document filed by Irving H. Picard. (Sheehan, David)

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

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

BERNARD L. MADOFF INVESTMENT
SECURITIES LLC,
Debtor,

SIPA LIQUIDATION
(Substantively Consolidated)

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

11 Civ. 03605 (JSR) (HBP)

SAUL B. KATZ, et al.,
Defendants.

TRUSTEE’S REPLY TO AMICUS BRIEF ON “RESET TO ZERO” METHODOLOGY

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
Introduction .................................................................................................................................... 1
Discussion ...................................................................................................................................... 2
I.

The “Reset to Zero” Methodology Results In A Skewed Application Of
Law To BLMIS Accountholders That Runs Afoul Of The Second Circuit
Ruling. .................................................................................................................... 2

Conclusion ...................................................................................................................................... 5

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Table of Authorities
Page(s)
CASES
In re Bernard L. Madoff Inv. Sec.,
--- F.3d ---, 2011 WL 3568936 (2d Cir. Aug. 16, 2011) ............................................... 1, 2, 3, 4
Picard v. Greiff,
No. 11 CV 3775 (JSR) .............................................................................................................. 1
Picard v. Katz,
--- F. Supp. 2d ----, 2011 WL 4448638 (S.D.N.Y. Sept. 27, 2011) .................................. 1, 2, 4
STATUTES
11 U.S.C. § 548(c) ........................................................................................................................... 3
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 reply to the Amicus Brief On “Reset To Zero”
Methodology (“Amicus Defendants”) pursuant to this Court’s order entered on November 28,
2011 (“November 28 Order”) [ECF No. 72]. 1
Introduction
Recognizing the Trustee’s duties of “recovering and distributing customer property,” the
Second Circuit ruled that the “method Mr. Picard selected for carrying out his responsibilities
under SIPA [was] legally sound under the statute.” In re Bernard L. Madoff Inv. Sec., -- F.3d --,
2011 WL 3568936, at *4-5 (2d Cir. Aug. 16, 2011). As endorsed by the Second Circuit, 2 the Net
Investment Method determines whether the cash position of each account was positive or
negative as of December 11, 2008.

Customers were given full credit for all deposits or

“reinvestments” that occurred during the life of the account, contrary to the Amicus Defendants’
assertion. Am. Br 1. Thus, applying the Net Investment Method to all BLMIS accounts
determines: (i) the amount of the net equity claim, or (ii) the amount of fictitious profits received.
The Amicus Defendants advance the “Reset to Zero Method,” which would apply
differing reconciliation methodologies to BLMIS customer accounts depending on which

1

The order entered on November 28 relates to the 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]. The Trustee has previously briefed “footnote 6,” and incorporates herein each of
those submissions. [ECF Nos. 63, 69]. See also Picard v. Greiff, No. 11 CV 3775 (JSR) [ECF
No. 33].
2
The Second Circuit has ruled that use of anything but the Net Investment Method to determine
net equity claims in this liquidation would be “legal error.” Net Investment Ruling, at *17.

methodology minimizes their personal liability—the Reset to Zero Method to some customers
and a hybrid Net Investment/Reset to Zero Method to others.

As set forth below, these

methodologies have anomalous results and unfairly eliminate the beneficial principal balances of
some customers in order to insulate other customers from avoidable transfers. The Trustee’s
duties are to the estate and the customer class as a whole and he must “achieve a fair allocation
of resources among the customers.” Net Investment Ruling, at *31. Unless the Net Investment
Method is used to calculate both net equity claims and avoidance amounts of principal and
fictitious profits, SIPA and the Bankruptcy Code would apply unequally to BLMIS
accountholders and would contravene the Second Circuit Net Investment Ruling. Nothing in the
Bankruptcy Code, SIPA, or the Net Investment Ruling permits this inequitable result.
Nor should the Reset to Zero Method be allowed to undermine the Second Circuitapproved claims determination process and unfairly subject customers to avoidance litigation in
order to have their net equity claim allowed.

Hundreds of claims have been allowed in

accordance with the Second Circuit ruling and have received distributions. The Trustee cannot
isolate the net equity calculation from what is avoidable without unraveling that claims
determination process.
Discussion
I.

The “Reset to Zero” Methodology Results In A Skewed Application Of Law To
BLMIS Accountholders That Runs Afoul Of The Second Circuit Ruling.
As advanced by Amicus Defendants, the Reset to Zero Method erases the history of an

account prior to December 11, 2006 and determines whether an account is a net winner or net
loser based solely on the transactions during the two-year period. Even Amicus Defendants
recognize, however, that this Method cannot be uniformly applied to all accounts.

The

exceptions to the application of the Reset to Zero Method result in numerous permutations that
preclude fair allocation among customers in contravention of SIPA and the Net Investment
2

Ruling. 3
Under the Net Investment Ruling, net losers have a net equity claim for the difference
between their life-to-date deposits and withdrawals. The Reset to Zero Method wipes out the
customers’ investment history prior to December 11, 2006. This inevitably shifts accounts that
were net losers under the Net Investment Method to net winners under the Reset to Zero Method
and impermissibly conflicts with the Second Circuit ruling.
The case of Fred A. Daibes Madoff Securities Trust (“Daibes”), No. 11 CV 08475,
identified on Annex B to the Amicus Brief, is illustrative. Under the Net Investment Method,
Daibes has a net equity claim of $2.1 million over the seven-plus year history of the account. As
of December 11, 2006, this account had a positive principal balance of $10.5 million. During the
two-year period, Daibes withdrew $8.4 million more than he deposited. Therefore, if the Reset
to Zero Method were applied (the positive principal balance were zeroed out), then Dabies would
have no net equity claim and would be subject to an avoidance action of over $8 million dollars,
in violation of the Second Circuit’s ruling. 4
In an attempt to harmonize the Reset to Zero Method with the Second Circuit ruling, the
Amicus Defendants propose that customers such as Daibes could raise “antecedent debt”—
calculated over the life of the account—as an affirmative defense under § 548(c) to the Trustee’s
putative avoidance action for the amount of their principal. However, the Amicus Defendants
3

To the extent that the Katz decision were to be modified on appeal to permit the Trustee to
avoid transfers beyond the two-year period, the Reset to Zero Method, if applied by this Court,
would itself have to be reset to six years and/or the time period governed by the “discovery rule”
under the New York Debtor & Creditor Law. Thousands of accounts would once again shift
between all of the sub-classes of customer categories described herein and would raise endless
permutations.
4
The Reset to Zero Method would similarly result in the denial of net equity claims and create
avoidance liability for hundreds, if not thousands, of customers who have allowable net equity
claims under the Net Investment Method.

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fail to explain how this affirmative defense would apply to net loser accounts that have no
activity in the two-year period and would not be subject to an avoidance action under the Reset
to Zero Method, and yet the Reset to Zero Method would void their net equity claim.
Applying the Reset to Zero Method to net winner accounts results in equally disparate
treatment that also contradicts the Net Investment Ruling. Net winner accounts that have only
deposits in the two-year period appear to have a net equity claim in the guise of a positive
balance as of December 11, 2008 under the Reset to Zero Method. In reality, however, such
accounts do not have a net equity claim. On the other hand, those net winner accounts with
positive balances at December 11, 2006 and who withdrew remaining principal and fictitious
profits during the two-year period are harmed by the Reset to Zero Method because the amount
of withdrawals in the two-year period (previously considered the return of principal under the
Net Investment Method) are now considered avoidable transfers of fictitious profits. Sixteen
accounts of the Amicus Defendants fall into this latter category resulting in additional avoidance
liability of $66.1 million.
The account history for AHT Partners L.P. (“AHT”), No. 11 CV 8488, identified on
Annex B, clearly illustrates this point. AHT opened its account on April 19, 2000 with a deposit
of $10 million. Between that time and December 11, 2006, AHT made no additional deposits
and made nine withdrawals totalling $8.6 million, resulting in a positive principal balance of
$1.4 million as of December 11, 2006. During the two-year period, AHT made one deposit of $8
million and made five withdrawals totaling $12.3 million. Under the Net Investment Method,
AHT is a net winner of $2.9 million ($18 million deposited minus $20.9 million withdrawn), all
of which would be avoidable because the gross withdrawals in the two-year period exceed that
amount. However, under the Reset to Zero Method, the portion of the withdrawals considered

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the return of such principal ($1.4 million) is now considered fictitious profits as the principal has
been reset to zero. Therefore, under the Reset to Zero Method, AHT received a total of $4.3
million of fictitious profits, resulting in an additional $1.4 million of avoidance liability.
The narrow subset of customers that the Reset to Zero Method is truly aimed at is net
winners who had a negative balance at the start of the two-year period and had both deposits and
withdrawals in the two-year period. Their deposits and withdrawals are netted from December
2006 to December 2008, permitting them a clean slate prior to December 2006 and looking only
at the transactional history within the two-year period to determine their avoidance liability.
This scenario insulates avoidable transfers for a small group of customers at the expense of fairly
allocating available resources among all customers. The Net Investment Method approved by
the Second Circuit must be applied to calculate both net equity claims and avoidable amounts of
principal and fictitious profits in order to ensure that all BLMIS customers are treated equally.
Conclusion
For the foregoing reasons, the Trustee respectfully requests that the Court rule that the
Net Investment Method applies for purposes of determining the quantuum of avoidable transfers.
Date: December 6, 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]

Of Counsel:
Oren J. Warshavsky
Email: [e-mail]
Lan Hoang
Email: [e-mail]
Seanna R. Brown
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

300189307

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