A New York appellate court issued an opinion today affirming the method used to determine loss amounts suffered by victims of Bernard Madoff's colossal Ponzi scheme. Under this method, each Madoff victim's net equity was calculated by crediting the amount of cash deposited by the customer into his or her account, less any amounts withdrawn from the account. Irving Picard, the court-appointed trustee overseeing the liquidation of Madoff's failed broker-dealer, had faced opposition from groups of investors (the "Objecting Investors") who instead urged the use of each investor's last reported account statement balance before Madoff's scheme was exposed.
Following United States Bankruptcy Judge Burton R. Lifland's opinion affirming Picard's use of the net investment method, several investor groups appealed the decision to the Second Circuit Court of Appeals. Addressing the arguments of Picard and the Objecting Investors, Chief U.S. Circuit Judge Dennis Jacobs first noted that SIPA's statutory language "does not prescribe a single means of calculating net equity that applies in the myriad circumstances that may arise in a SIPA liquidation." Instead, such a determination should be based on specific fact patterns. Weighing the differing approaches set forth by the parties, Judge Jacobs concluded that:
Mr. Picard's selection of the Net Investment Method was more consistent with the statutory definition of net equity than any other method advocated by the parties or perceived by this Court. There was therefore no error...If the Last Statement Method were adopted, those claimants who have withdrawn funds from their BLMIS accounts that exceed their initial investments would receive more favorable treatment by profiting from the principal investments of those claimants who have withdrawn less money than they deposited, yielding an inequitable result.
Further elaborating on this reasoning, Judge Jacobs emphasized the underlying fact that the customer statements were nothing more than after-the-fact constructs that were simply molded to reflect historical market transactions. Adoption of the Last Statement Method, theorized Judge Jacobs, would simply serve to serve as a stamp of judicial approval of Madoff's fraud. He concluded that the use of the Last Statement Method in this case would have the absurd effect of treating fictitious and arbitrarily assigned paper profits as real and would give legal effect to Madoff's machinations.
The ruling today has several important ramifications. First, investors who withdrew more than their original principal investment, termed net winners by Picard, are not entitled to share in any funds recovered by Picard for the benefit of defrauded investors. To date, that amount has increased to over $10 billion. Second, by virtue of excluding these so-called net winners from any right to recovered funds, the number of customers with viable claims is diminished, and more funds are available to investors whose invested principal exceeded any withdrawals.
The decision has implications for the now-ongoing process of distributing recovered funds back to defrauded investors. As previously covered by Ponzitracker, Picard filed a motion with the court in May seeking approval of his plan to make the first interim distribution to investors. In that motion, he outlined several theoretical calculations of the percentage each investor would expect to receive under the first distribution, with the variations resulting from different figures for the total amount of allowed claims. When the motion was filed, Judge Burton Lifland's approval of Picard's use of the net investment method to calculate distribution to investors had been appealed to the Second Circuit. While Picard sought to use the figure of $17.3 billion, which represented his estimate of the total principal losses suffered by Madoff investors, the pendency of the net investment method decision forced him to instead use the much-larger figure of nearly $57 billion to calculate investor distributions, which represented the aggregate amount of purported holdings as determined by each investor's final account statement. Thus, investors would receive a lower pro rata share of their claim amount. As Picard stated,
Were the Net Equity Decision to be reversed, those claims of net winner customers that have been denied to date may become allowable and eligible for a distribution from the Customer Fund. In order to ensure that there are funds sufficient to make a pro rata distribution in that eventuality, the Trustee is maintaining significant reserves, which decrease the amount available for distribution from approximately 44% to approximately 13%.
Additional pending appeals further reduced the pro rata amount of each investor's proporsed distribution down to just over 4% of each approved claim. Barring the grant of certiorari (review) by the United States Supreme Court, investors with allowed claims now stand to receive a greater amount in future distributions. Picard has indicated that the first interim distributions are scheduled to commence in September, and it remains unknown as to whether those amounts could change in light of this decision.
A copy of the Second Circuit opinion is here.