Government Accountability Office to Review Madoff Trustee's Performance

Bowing to pressure from a New Jersey Congressman, the Government Accountability Office ("GAO") formally agreed to review the SIPC Trustee's handling of the liquidation of Bernard Madoff's failed investment brokerage.  In response to a request by New Jersey Congressman and current chairman of the House Financial Services Subcommittee on Capital Markets and Government Sponsored Enterprises Scott Garrett (R-NJ), the GAO agreed to conduct a "comprehensive evaluation" of the multiple individuals and entities involved in the liquidation of Bernard L. Madoff Investment Securities LLC.  These include Trustee Irving Picard and his attorneys at Baker Hostetler, the Securities Investor Protection Corporation, and the Securities and Exchange Commission.  Chief among Garrett's concerns are SIPC's selection of Picard as trustee, methodology behind victim identification and compensation determination, and other aspects of Picard's work to date.

Congressman Garrett's office published a letter sent to the GAO on June 3, 2011 requesting a formal review of Picard.  However, while several reasons are provided as grounds for the review, it becomes clear that the primary impetus for such a review stems from Congressman Garrett's continuing disagreement with Picard over the method used to calculate losses of Madoff's victims.  Picard has utilized the so-called "net winner" method, in which an investor's losses are determined by calculating the difference between the initial principal invested and any subsequent distributions prior to the scheme's collapse.  Thus, an investor with an initial investment of $100,000 who makes withdrawals of $40,000 during the pendency of the scheme would have a net investment amount of $60,000.  Yet, according to Congressman Garrett, the victims' final account statements, rather than cash deposits minus withdrawals, should be used to calculate losses.

Such a position has already been rejected by United States Bankruptcy Judge Burton Lifland, who approved Picard's use of the "net winner" method in a March 2010 order.  According to Judge Lifland, Picard's approach was better supported by legislative history and superior to the "the false premise that customers’ securities positions are what the account statements purport them to be."  Both the SEC and SIPC supported Picard's interpretation, under which the so-called "net losers" stand to recover a larger percentage of their losses than had the "net winners" also been included in the calculation.  

In response, Congressman Garrett introduced the "Equitable Treatment of Investors Act" in February 2011.   In particular, the bill sought to 

"properly shield innocent individual investors who have already been defrauded and financially devastated by Bernie Madoff from further ‘clawbacks’ by the Securities Investor Protection Corp. (SIPC) Trustee.”

Under the bill, customers would be entitled to rely on their account statements as evidence of obligations owed them by their broker.  Thus, customer losses from Madoff's scheme would approach in excess of $50 billion according to customer's final account statements, rather than the $17 billion of customer losses estimated by Picard.  The benefits of such an approach come with an important caveat; while more investors will be entitled to distributions from Picard, each investor will ultimately receive less of a pro rata distribution.  

While Congressman Garrett's legislation is still pending, Picard is moving forward in making a first interim distribution to investors after recently obtaining judicial approval.  The GAO has stated that its review will start within one to three months.