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

Filing 84

DECLARATION of David J. Sheehan in Support re: 82 MOTION to Strike the Expert Report and Testimony of John Maine.. Document filed by Irving H. Picard. (Attachments: # 1 Exhibit 1, # 2 Exhibit 2, # 3 Exhibit 3, # 4 Exhibit 4, # 5 Exhibit 5, # 6 Exhibit 6, # 7 Exhibit 7-1, # 8 Exhibit 7-2, # 9 Exhibit 8, # 10 Exhibit 9, # 11 Exhibit 10)(Sheehan, David)

Exhibit 1

Picard v. Katz, No. 11 Civ. 3605 (JSR)
Expert Report of John Maine
I.

Introduction
I have been retained by Davis Polk & Wardwell to provide expert

testimony in the litigation known as Picard v. Katz. I have been asked to testify
regarding topics including private wealth management practices in the financial
industry, how brokers operate with regard to client assets and the customer’s
ability to do due diligence with respect to broker operations, and the nature of
securities brokerage accounts, including those in this case.
This report presents my observations and conclusions.
II.

Summary of Qualifications and Compensation
Attached to this report, as Exhibit A, is my curriculum vitae, detailing my

qualifications as an expert in the securities industry. Also attached, as Exhibit B,
is a list of cases in the last four years in which I have testified as an expert. I am
compensated at the rate of $385 per hour.
III.

Facts and Data Relied Upon
In forming my opinions as presented in this report, I relied upon my years

of experience in the financial industry, which includes involvement in over fifteen
hundred arbitrations and court cases between customers and brokers, in which I
usually represent the broker. I reviewed sample account documents issued by
Bernard L. Madoff Investment Securities (“BLMIS”), including trade
confirmations, monthly statements and 1099s. I also reviewed the Broker Check
Report regarding BLMIS prepared by the Financial Industry Regulatory Authority
(“FINRA”), which is available on FINRA’s website. Finally, I reviewed the

amended complaint, the memoranda of law submitted with respect to Defendants’
motion to dismiss the amended complaint, and the Court’s opinion thereon dated
September 27, 2011.
IV.

Summary of Opinions
A.

Investment Management Vehicles

An individual or entity that wishes to invest in securities may consider
doing so in various ways. Two of the most common include using the services of
a broker-dealer and investing in some type of pooled fund.
A “broker-dealer” is, among other things, engaged in the business of
buying or selling securities for customers. In this regard, the broker-dealer
functions as a securities intermediary that maintains securities accounts for
customers, i.e. a broker. In addition to operating as an agent, the broker-dealer
may operate as a dealer, i.e. buying or selling for its own account. Because
broker-dealers buy and sell securities directly for specific customers, they are
different from hedge funds or mutual funds. Hedge funds and mutual funds also
trade in securities, but they are not “middle men” acting for customers. Instead,
they sell investors percentage interests in the funds themselves and distribute
investment returns proportionately to each interest holder.
When a customer invests through a broker-dealer, the customer provides
funds to the broker for the purchase of securities that will be held for the benefit
of the customer. After purchasing a security the customer is entitled to the
benefits of owning that specific security. In addition, the customer can give the

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broker specific instructions about the operation of his account, i.e., what securities
to buy or hold.
When a customer invests in a pooled fund such as a hedge fund or a
mutual fund, he is not buying a specific security—he is buying a portion of a pool
of assets, and he owns a percentage of that fund. The investor will receive his
proportional share of the investment results generated by that fund. He cannot
buy or sell any security that is part of the pool, he can only buy and sell an interest
in that pool.
Broker-dealers may also invest in a functionally similar manner for
customers. They can pool client assets and trade blocks of securities on behalf of
multiple customers. All of the customers are then given the average price paid or
received on those trades. Bulk transactions of this type are very typical in private
wealth management accounts. Based on my experience, I would estimate that
nearly 95% of private wealth managers use this technique to trade on behalf of
customers. I understand that BLMIS used this technique, buying and selling
baskets of securities that were then allocated to customers.
B.

Investment Advice

In my experience, most wealthy individuals hire professionals to manage
their investment securities, whether they invest through a broker or in a fund.
There are several reasons for this. First, successful people are generally busy
doing whatever has made them successful. Monitoring the markets requires an
enormous investment of time, time that a successful person normally does not

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have. Retaining an experienced professional permits a busy customer to use his
time to engage in his own area of expertise while still participating in the market.
Second, while wealthy investors may have sophisticated knowledge of
their own career specialty, this does not mean that they have sophisticated
knowledge of the financial markets. Even if they did take the time to manage
their own investments, it is unlikely that customers who are not financial market
experts will achieve as good a return as will a professional. To be in the best
position to be successful, an investor should have a high level of expertise and
sophistication regarding securities and markets. Investment markets are complex,
and increasingly dominated by investment professionals. Moreover, the markets
are increasingly global. While in the past an individual investor might have been
able to focus primarily on investment opportunities in domestic companies with
which they were personally familiar, in today’s global economy, evaluating
investment opportunities requires consideration of global market trends and
industry changes.
Third, as securities markets have become increasingly sophisticated, so
have investment strategies. Many of the new techniques used in investing, such
as employing securities options to hedge investments, are normally carried out by
specialists. A non-professional investor would likely be unable to achieve results
that could compete with those attainable by such specialists.
Therefore, to save time and in the hope of achieving better returns,
wealthy investors generally turn to professionals, whose careers are devoted to
analyzing investment opportunities and strategies. To accomplish these goals,

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investors often open a private wealth management account with an investment
professional. Nearly all brokerage firms have private wealth management groups,
and it is one of the fastest growing parts of the financial industry.
Such professionals are often “registered investment advisors,” persons
registered with the Securities and Exchange Commission (“SEC”) who manage
the investments of others. An investment advisor with more than $100 million
under management must register with the SEC. Such professionals are generally
compensated in one of three ways. They can charge clients a fee, they can
generate commissions on trades, or they can employ some combination of the two
methods.
C.

Discretionary vs. Non-Discretionary Accounts

Brokerage accounts fall into two categories: non-discretionary and
discretionary.
In non-discretionary accounts, the customer retains decision-making
authority, and the broker must obtain the customer’s consent prior to making any
trades. A person who wants to be responsible for the management of his account
will likely have a non-discretionary account so that he can invest according to his
own strategy.
In a discretionary account, the customer delegates all investment decisionmaking authority to the broker. The customer gives the broker the right to decide
on the investment strategy, which will guide the broker’s decisions as to which
securities to buy or sell, and when to buy or sell them. In a discretionary account,
the broker does not need to obtain the client’s consent prior to making trades.

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In my experience, the majority of private wealth management accounts are
discretionary. This is because, as discussed, most wealthy investors do not have
the time or sophistication to make their own investment decisions. Acting with
discretion, a broker can act quickly, using his professional judgment to invest in
today’s fast-paced markets, without waiting for consent to each and every trade.
In fact, most private wealth managers will not accept non-discretionary
accounts. Their performance is judged on their the rates of return. When trading
on behalf of hundreds of customers, it would take an enormous amount of time to
obtain informed consent from each customer. This could hinder their ability to
implement strategies in fast-moving markets, and possibly impair their ability to
obtain the desired returns. Therefore, both the broker and the customer benefit if
the broker is given discretion.
However, brokers with discretion understand that they have great
responsibility to their customers. Within the financial industry, discretionary
accounts are considered to impose a higher level of duty, and allow an investor to
hold his advisor accountable for his performance.
D.

Customer Reports

Regardless of whether an investor’s account with a broker is nondiscretionary or discretionary, that investor will receive the same standard
documents detailing the activity conducted in his account. These documents
include confirmations, which are sent after each purchase and sale to notify the
customer as to what was bought or sold. The confirmation confirms that a
security has been bought or sold, pursuant to an agreement between the broker-

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dealer and his customer. For example, a trade confirmation might show that a
customer purchased one share of IBM stock at $48 per share on a particular day.
A brokerage statement is issued monthly or quarterly. It is a “snapshot” of
the status of the brokerage account at the end of the period, and shows all
transactions made during the statement period as well as the customer’s position
at the end of the period—how many shares of stock or other securities are held for
the customer at that time. In the example above, the statement would reflect the
purchase of the IBM stock for $48 on the trade day, and the current value of the
IBM stock on the day as of which the statement was issued, and any other
positions in the account at the end of the period.
Brokers also issue 1099 forms on an annual basis. 1099 forms reflect
income generated by dividends and interest on investments and are used by the
Internal Revenue Service (“IRS”) to calculate an investor’s tax liability. They
also reflect the gross proceeds of all the year’s sale transactions.
E.

The Importance of the Confirmations and Statements

The reports issued by broker-dealers are critically important because, in
the modern securities markets, they represent the customer’s only evidence of
ownership.
The modern world of securities trading is quite different from that of fifty
years ago. Securities trading is based on individual purchases and sales at agreed
prices. In past decades, this process took place at a physical location such as a
stock exchange, and brokers would exchange tangible paper stock certificates

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representing a stake in the issuing company. Investors would receive these paper
certificates and rely on them as representing the securities they purchased.
Now, stock trades happen digitally, with a computer system matching up
the bid and ask prices. Electronic trading has greatly increased the pace and
volume of trading in today’s market. This increased volume has made the
issuance of paper documentation for each and every share an impossibility.
Therefore, brokers now employ centralized custody of securities through entities
such as the Depository Trust & Clearing Corporation (“DTCC”). The DTCC
maintains a central depository of securities and allows for electronic transfer of
shares between brokers, eliminating the trade of paper stock certificates.
Investors no longer receive paper certificates. Instead, investors now rely
upon their confirmations and brokerage statements, which represent that
investor’s entitlement to ownership of the securities listed, in the amounts
identified. Brokers issue confirmations and brokerage statements in electronic or
hard copy form, or use some combination of the two. There is nothing unusual
about a broker issuing trade confirmations and brokerage statements in paper
form only.
These documents can be analogized to a statement issued with respect to a
checking account at a bank. A bank customer receives a statement showing funds
held in his name at the bank. The customer “owns” and is able to request those
funds at any time. The customer cannot, however, go the bank and see “his”
money. Similarly, a brokerage statement represents the broker’s debt to the
customer for the securities listed on the statement. The customer “owns” the

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stock on the statement. The customer cannot, however, go to his broker and see
“his” stock. Therefore, like the bank customer, the brokerage customer must
instead rely upon his statement.
A brokerage customer is also entitled to rely on the accuracy of a broker’s
statement primarily because the financial industry is one of the most heavily
regulated industries in our economy. A host of governmental and nongovernmental organizations play a role in this regulation, including the SEC,
FINRA, and state regulatory agencies.
The SEC is a government commission created by Congress to protect
investors. The SEC is responsible for administering all major federal legislation
governing the securities industry. Brokers are required to file extensive
information about their financial condition on a periodic basis with the SEC.
Federal securities laws and regulations impose strict requirements on brokers
when dealing with customer funds and securities held for customers. The SEC
staff regularly performs inspections and examinations on all registered brokers to
monitor their compliance with the applicable law and regulations. Through its
Enforcement Division, the SEC investigates violations of the securities rules,
including rules prohibiting fraud and false or misleading statements in materials
distributed to investors. The SEC is empowered to bring lawsuits and enforce
penalties against entities that violate the federal securities laws.
FINRA is the largest self-regulatory organization overseeing the financial
industry. All companies who wish to sell securities in the U.S. are required to
register with FINRA. FINRA has regulatory oversight over all securities firms

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that do business with the public, and aims to protect investors by ensuring the
integrity of the securities industry. FINRA licenses individuals and enforces rules
governing their behavior, and is authorized by the SEC to discipline registered
representatives and member firms that fail to comply with the laws or with
FINRA’s rules. Like the SEC, FINRA also performs examinations and
inspections of member brokers to monitor their compliance with the law and
regulations. FINRA also maintains the Central Registry Deposit (“CRD”), a
database maintaining extensive records of the activities of every member firm and
representative, including that member’s disciplinary record.
FINRA-registered firms and employees are subject to extensive reporting
requirements, including the requirements of reporting any customer complaints
and submitting annual financial statements to the Authority.
In addition to the SEC and FINRA, brokers are subject to regulation in
each of the states. In New York, where BLMIS operated, the Investor Protection
Bureau protects investors from frauds perpetrated by brokers, dealers, salesmen
and investment advisors by investigating any customer complaints.
Because there is no need to do so, due in part to the extensive regulatory
schemes overseeing brokers, most brokerage clients do not review their
statements to make sure they accurately reflect, for example, the then-current
market price or trading volume for specific securities bought or sold by the broker.
The customer is entitled to assume that the broker has done, or will do, whatever
is necessary to perform the obligation he has undertaken to the customer. If the
broker has taken the customer’s money in return for an obligation to buy a

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particular stock at a particular price, the customer need not do anything else to
make sure that the broker actually buys the stock. In the securities industry, the
issuance of a trade confirmation binds the broker to fulfill whatever was
memorialized in the confirmation. The customer has no way of policing the
broker’s internal operation, and consequently is not required to be concerned
about it.
Thus, most customers receive their statements, look at the bottom line
stating the value of their portfolio to determine whether the value increased or
decreased, and then file the statement away to give to their tax preparer. There is
no need to do any more investigation and, in my experience, most customers do
not.
F.

Opinions Regarding BLMIS Accounts

Based on my many years of experience in the financial industry and
exposure to thousands of trade confirmations and account statements, it is my
opinion that the confirmations and statements issued by BLMIS were entirely
standard, and that there was no substantive basis, from the point of view of an
investor, to distinguish a BLMIS brokerage account from any other brokerage
account.
The trade confirmations issued by BLMIS were typical of those issued by
any brokerage house. The trade confirmations identified the trade date when the
transaction was entered into, and the settlement date, reflecting the date when the
transaction closed. The confirmations specifically identified the number of shares
bought and sold of a certain stock, and included a CUSIP number, which stands

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for “Committee on Uniform Securities Identification Procedures” and reflects a
number assigned to U.S. and Canadian registered stocks and U.S. government and
municipal bonds. The confirmations were standard, and looked similar to
confirmations issued by any broker.
Like all monthly brokerage account statements, the BLMIS statements
were dated, identified the name and address of the broker, included a specific
account number corresponding to the named account holder, reflected the
purchase and sale of specifically identified securities and stated the price at which
they were bought and sold. The statements also provided a summary statement of
the market value of all securities held in the account, and a year-to-date summary
of cash transactions, income, and sales proceeds. These are the same types of
standard details found on any monthly brokerage account statement. The BLMIS
statements looked similar to statements issued by any broker.
The 1099s issued by BLMIS also correspond to standard 1099s issued by
any bank or broker. Moreover, the fact that BLMIS issued these 1099s was
another basis for a customer to feel comfortable that the information they received
from BLMIS about their investments was accurate, because 1099s are submitted
to and reviewed by the IRS. It would be counter-intuitive to think that that a
fraudulent broker would submit false 1099s to the IRS for its review.
It is also my expert opinion that the following facts about BLMIS and
Bernard Madoff himself would justify an investor in relying on both the trade
confirmations and monthly account statements.

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First, the trade confirmations and statements reflected that BLMIS was a
member of FINRA, NSX, SIPC, NSCC and DTC. FINRA, discussed earlier, is
the largest self-regulatory agency overseeing the financial industry. NSX is the
“national stock exchange,” the nation’s first all-electronic stock exchange, and
was formerly known as the Cincinnati Stock Exchange. SIPC, the Securities
Investor Protection Corporation, is a non-profit corporation that protects
customers of member broker-dealers by compensating them when a brokerage
firm is closed due to bankruptcy or other financial difficulties and customer assets
are compromised. NSCC is the National Securities Clearing Corporation,
providing clearing, settlement, risk management and general counterparty services
for broker-to-broker trades. DTC, the Depository Trust Company, also provides
settlement services for clearing securities trades.
BLMIS’ membership in each of these entities would be expected of a
broker-dealer that cleared its own trades. Membership in these organizations
conveys that BLMIS was, in fact, a broker-dealer, and would entitle a customer to
expect that his trade confirmations and account statements were accurate.
Mr. Madoff’s stature in the financial community was another factor on
which investors might legitimately rely when considering whether their trade
confirmations and account statements are accurate. Mr. Madoff was a former
chairman of the NASDAQ stock market and vice-chairman of the board of
governors of the National Association of Securities Dealers. He had many highly
sophisticated investors. His prominent place in the financial industry would

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further justify a customer’s expectation that his confirmations and statements
accurately represented his investments.
Moreover, by the time the Madoff fraud was revealed, BLMIS had been in
operation for many decades. I have frequently been involved in cases in which a
broker was engaged in a Ponzi scheme, and I have never seen one last more than a
few years. Obviously, in this case, BLMIS appeared to be performing its
obligations to customers for a very long time—apparently buying securities after
taking customer funds, recording purchases and sales, and returning funds upon
demand. The longevity and apparent normality of BLMIS’ business model
provides yet another reason for an investor to trust that BLMIS was a legitimate
enterprise and that its confirmations and statements were accurate and reliable.

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EXHIBIT A

JOHN MAINE

EXPERT WITNESS & CONSULTANT – SECURITIES

EDUCATION
B.A. Magna Cum Laude
Dartmouth College
INDUSTRY EXPERIENCE
• Retail Stockbroker
• Institutional Salesperson
• National Institutional Sales Manager – responsible for recruiting and
managing a nationwide sales force
• Resident Sales Manager of a 100 person branch office
• Regional Director for a 1,000 person region with revenues in excess of 200 million
• Member of the Board of Directors of Smith Barney and Executive
Vice-President of the Firm
EXPERT WITNESS CREDENTIALS
• Retained approximately 1700 times, given testimony on approximately 700 occasions in
over 40 states.
• Testified in State and Federal courts in various jurisdictions, in arbitration proceedings, in
mediations and in SRO disciplinary hearings.
TOPICS
Alternative Investments
Among the topics qualified to present expert testimony:
Annuities
Auction Rate Securities
Back office procedures
Broker forgivable notes
Churning and excessive trading
Commissions and mark-ups
Damages
Employment issues
Hedge Funds
Hedging strategies for concentrated positions
High Yield Bonds and other complex debt instruments
Inter-firm hiring disputes and raiding
Limited Partnerships
Managed Money
Municipal Bonds
Mutual Funds
Options trading
Private Equity/Private Placements
Registered Investment Advisor issues
Regulatory disciplinary matters
REITs & TICs
Retirement strategies
Rule #144 and other control stock issues
Suitability
Supervision and Compliance
Trading away
U-4 and U-5 filings
This is meant to be a representative list but is not all inclusive
PAST LICENSES HELD
NYSE-Registered Representative
NYSE-Branch Office Manager
ASE, CBT, NASD, NYSE-Registered Options Principal
NASD-General Securities Principal
National Futures Association-Associated Person
References available on request
63 WEST SHORE ROAD, BELVEDERE, CA 94920
PHONE [phone] • FAX [phone] • E-MAIL: [e-mail]

EXHIBIT B

JOHN MAINE
CASES AND ARBITRATIONS IN WHICH I HAVE TESTIFIED AS AN
EXPERT WITHIN THE PAST FOUR YEARS
Court Cases
Vargas v. Kearney
State Court, Placer County, California 2009
Eastburn v. Cole
State Court, Marin County, California 2009
Roberts v. Bisno
State Court, Alameda County, California 2009
Stephens v. Kellett Capital Management
State Court, Marin County, California 2010
State of Colorado v. E*Trade Securities
State Court, Denver, Colorado 2011
Arbitrations
Charter v. Hakim
Dodell v. Tannenbaum
Pelosi v. Barretto
Crowder v. Wells
Swerling v. Stringer
Torina v. Piro
Wagenhals v. Dwyer
Abel v. Lou
Pinazzi v. Norman
Den-Mat v. Zihailo
Simon v. Miller
Dobson v. Clayton
King v. A.G. Edwards
Ludvigson v. Schwarz
Holzberg v. Cameron
Boys v. Buckley
Crusing v. Aldis
Allalouf v. Torvala
Garrett v. Escudero
Moffatt v. Stanford Group
Waldrop v. UBS PaineWebber
Batemen v. Forster
Schultz v. Smith Barney
Chodorow v. Safavi

Stratton v. Richmond
Benci v. Rudningen
Kellman v. Moskowitz
Edward v. UBS
Hayden v. Robertson Stephens
Orourke v. Baylin
Hoover v. Foreman
Weiss v. Berk
Hale v. Horwitz
Brady v. Ygenlasis
Riciputo v. UBS
Wong v. Smith Barney
Stoyanoff v. Leary
Postiglione v. CSFB
Turmon v. Smith
Arner v. UBS
Clark v. Sussman
Hong v. Mullen
Chamberlain v. McMahon
Sage v. Bear Stearns
Weinreb v. Winter
Fitzwilson v. Andrew Chase
Gilliland v. McGeorge
Stroehmann v. Peloquin
Adler v. Selig
Richards v. Forster
Guinn v. Meidell
Colucci v. Burns
Miller Johnson v. Northland
Sessaman v. Easterday
Kramer v. Poutre
Eansor v. Calderone
Benezra v. Chamberlain
Musser v. Vick
Ventura v. Baum
Silva v. Morgan Stanley
Muir v. PSI
Scher v. BofA
McCubbins v. Flanagan
Maltz v. Virnoche
RLR Management v. Garrity
Herta v. Hartwyck
Mayne v. Burke
Hunt v. Jackson
Paul v. Wilmot
Grant v.Wilhite
Elzarka v. Kromholt
Kennedy v. Leach
McElhatton v. Kuhne

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Van Hoose v. Markow
Perloff v. Hallman
Micha v. Bank of California
Zuk v. Margollla
DeHaven v. Jackson
Sunde v. Clark
Cohen v. Haas
Tsui v. Bailey
Dickerson v. Bar Lev
Bostian v. Gallo
Spencer v. Santoro
Hokk v. AG Edwards
Winstead v. UBS
Gale v. Stocklan
Jone v. Lee
Palmer v. Coulter
Ramsey v. Bohland
Van Muyden v. Springer
Goldsberry v.Dunas
Berkowitz v. Maegher
Parziale v. Ohanian
Schwab v. Raymond James
Madrid v. Lancaster
Van Order v. Bagocus
Welkom v. Cole
Money Concepts v. ProEquities
Cathcart v. Zinolli
Arenson v. Clark
Weinreb v. Garabedian
Blitz v. Kabarin
Eastburn v. Cole
Beesemeyer v. A.G. Edwards
Melton v. Deutsche Bank
Beesemeyer v. Barniyak
Quinault v. Hoheimer
Reiter v. Weaver
Bloom v. Ross
Thompson v. Urbolic
Brown v. JP Morgan
Sardis v. Frankel
Riverside v. Frankel
Waks v. Goodenough
Roberts v. Jerger
Nielsen v. Schwab
NYSE v. Poock
Smith v. Citigroup
Grymkowski v. Grossblatt
Bernik v. Shemano
Smith v. Schwab

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Misha v. Lowi
Brezden v. SunAmerica
Paulson v. Bear Stearns
Nopuenta v. Choy
DeLaura v. Peter
Postigo v. Schwab
Glenn v. UBS
Strand v. Morgan Stanley
Ross v. Schwab
Archer v. Schwab
Greenberg v. Cole
Thompson v. Wesson
A.G. Edwards v. Raymond James
Brown v. Schwab
Kelly v. Schwab
Wilfong v. Morgan Keegan
Lerman v.Daifoitis
Edwards v. Shah
Rivkin v. Schwab
Applbaum v. Stone & Youngberg
Robeson v. Schwab
Leone v. WMFS
Goldstein v. Piper Jaffray
Sherman v. Citi
Schweiterman v. Schwab
Neves v. WaMU
Biomemedics v. DB
Mauny v. Schwab
Pelley v. Schwab
Garcia v. Gilford
Erickson v. Schwab
Lovins v. UBS
Hayes v. Schwab
Wachovia v. Stifel
Abramson v. Citi
Virginia Lake v. RBC
Brown v. Finestone
Intervac v. Citigroup
McCray v. Wachovia
Phelan v. KCM
Hougie v. Schwab
Oathout v. Schwab
Matracaria v. Jefferies
Hill v. Schwab
Cooper v. Morgan Keegan
Tripp v. UBS
Aucoin v. UBS
Wells Fargo v. Stifel
Chapman v. Citigroup

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Lichtenberg v. JPM
Gordon v. PFS
Empire v. Stockcross
TGS v. Merrill
Cogan v. U.S. Bancorp
Vollstedt v. Schwab
Manley v. Deutsche Bank
Gritz v. Royal Alliance
Wells Fargo v. Stifel Nicholas
Joslen v. Akiyama
Neel v. OPCO
Citigroup v. Perry
Smolensky v. Neuberger Berman
Stirling v. Wells Fargo
Madhok v. Schwab

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