Two months from now will bring the five year anniversary of the unraveling of Bernie Madoff’s Ponzi scheme, one of the bookends, along with the collapse of Lehman Brothers., of the extraordinary Fall of 2008. To date, Trustee Irving Picard has recovered over $9.5 billion through litigation and settlements and distributed over $4.7 billion to former Madoff customers. 

Since its commencement, the Securities Investor Protection Act (SIPA) proceeding for Bernard L. Madoff Investment Securities LLC (BLMIS) has seen a vast array of legal battles, ranging from the Trustee’s aggressive pursuit of the owners of the New York Mets to disputes testing the international reach of the U.S. Bankruptcy Courts. At its heart, however, the BLMIS case, as with all SIPA proceedings, has been about the recovery of “customer property” for the satisfaction of “net equity claims of customers.” To that end, the Trustee has had to address three crucial questions under SIPA:

  •  how to determine customer “net equity claim” amounts, which are supposed to be based on the liquidation value of the securities positions of each customer as of the filing date, when such securities never existed;
  • exactly who is a “customer”; and
  •  whether “net equity claims” include damages based on the time value of money. 

Judge Burton Lifland resolved the first two questions in the Trustee’s favor earlier in the case. In the absence of securities whose liquidation value could have been determined, the Trustee put forward, and Judge Lifland approved, the “Net Investment Method” for determining “net equity claims”, subtracting amounts withdrawn from total amounts deposited for each customer and denying claims based on Madoff’s fabricated account statements.  Judge Lifland also ruled in favor of the Trustee’s determination to deny “customer” status to clients of so-called “feeder funds”, holding that only investors who maintained an account at BLMIS constituted “customers” under SIPA. Both rulings were subsequently upheld by the Second Circuit Court of Appeals. 

A few weeks ago, Judge Lifland handed down a decision on the final issue, holding that “net equity claims” do not include damages for interest, inflation adjustment, or otherwise based on the time value of money. In affirming the Trustee’s position (against which $1.4 billion has been reserved), Judge Lifland looked to both the plain language of SIPA and the Act’s underlying purposes. 

First, Judge Lifland noted the absence of any language in the applicable SIPA provisions that would support the inclusion of time-based damages, and contrasted such silence with language in other parts of SIPA and different statutes in which Congress expressly provided for interest payments or inflation adjustments. Next he looked at SIPA’s intent of satisfying “customer expectations”. In Judge Lifland’s view, BLMIS customers could not have had legitimate expectations of receiving any compensation for the period in which their money was invested with BLMIS: 

When they invested in Madoff, they bargained for a market-driven investment designed to fluctuate with the performance of the market; they did not bargain for a contractually guaranteed interest rate or inflation-protected investment vehicle.       

Finally, he looked to the statutory framework of SIPA. He noted that SIPA gives priority to claims based on the recovery of “customer property”, but does not provide specific protection for claims based on broker malfeasance or fraud: 

It was Madoff’s continuous fraudulent activity . . . that misled customers into leaving their investments with BLMIS for extended periods of time . . . Such claims do not constitute net equity claims to be paid out from the customer fund. 

As with the litigation over the Trustee’s Net Investment Method for calculating net equity claims and the denial of “customer” status to investors in feeder funds, Judge Lifland’s decision will go up to the Second Circuit. Judge Lifland even indicated that he would look favorably on a motion for certification of a direct appeal. A ruling by the Second Circuit will fully resolve the last of the three key questions under SIPA and, after five years, permit the case arising from the largest Ponzi scheme in history to follow Lehman Brothers toward its conclusion.