The United States Supreme Court will meet today to decide whether to hear the dispute over the calculation of victim losses stemming from Bernard Madoff's $65 billion Ponzi scheme. The court-appointed trustee, Irving Picard, has notched several court victories affirming his determination that losses should be calculated using the "net investment method", which subtracts any withdrawals or distributions from the total principal invested. Arguing against this method, lawyers for victims whose withdrawals exceeded their principal investment argue that the correct method to determine victim losses should be based on the account value contained in the final statement received before Madoff's fraud was uncovered (the "Last Statement Method") - a position that the Second Circuit Court of Appeals recently termed "absurd". The stakes are high for all investors.
The issue has been fully briefed before the Supreme Court, with the Securities and Exchange Commission also submitting a brief arguing in support of Picard's position. The odds are in favor of Picard, with the Supreme Court granting only approximately 5% of the roughly 10,000 petitions for certiorari received annually. After receiving the petitions, the Supreme Court Justices confer amongst each other in scheduled conferences, where they discuss a list of cases compiled by the Chief Justice that he believes have sufficient merit to warrant discussion. Judges may also nominate a case for further discussion by the group; any cases not selected for discussion are automatically denied. If a case is discussed, the votes of at least four Justices are required to grant certiorari and place the case on the Court's docket. A briefing schedule is then established, and the requisite parties are required to submit briefing establishing their position.
Under the Net Investment Method adopted by Picard, investors whose withdrawals exceeded their invested principal were not only excluded from recognition as a victim, but also subject to "clawback" lawsuits that sought to recover any withdrawals in excess of invested principal. Termed "net winners" in legal parlance, these investors were not subject to the same priority as those victims whose invested principal exceeded any distributions. Perhaps recognizing this, the investors have clung to the position that the final account statements received before Madoff's fraud was uncovered should serve as the true calculation of victim losses. Should the Supreme Court rule in their favor, these so-called "net winners" would theoretically be transformed into victims on equal footing with other investors and entitled to any distributions.
Picard's method, which is routinely used in bankruptcy and receivership proceedings, allows an investor whose total invested principal exceeded all withdrawals to be recognized with a legitimate loss and thus be entitled to submit a claim as a victim. Picard has strenuously argued against the Last Statement Method, saying that calculating losses that way would essentially allow Madoff to dictate the winners and losers among his victims based solely on Madoff's allocation of fictitious profits to each investor's amount. In a brief to a lower court, Picard observed that
the customers that benefited the most from the last customer statement approach were those that were in the Ponzi scheme for the maximum amount of time, which allowed their fictitious profits to accrue year after year.
As Madoff's fraud spanned decades, those who were among the early investors may have significantly boosted their original principal with these fictitious profits. Adopting this method, argued Picard, would "shift limited customer funds from those that have recovered nothing to those that already profited from the scheme."
Picard also stressed that the Net Investment Method was the most equitable solution in what is a "zero-sum game":
Every dollar paid to reimburse a fictitious profit would be one less dollar available to pay a claim for money actually invested. Instead, the Trustee’s approach of returning to customers only their real dollars invested puts all customers on equal footing. To allow Net Equity claims on the basis of anything other than “cash in/cash out” is to permit certain claimants to reap the benefits of Madoff and BLMIS’s fraud at the expense of others.
At the request of the Supreme Court, the SEC submitted a briefing in support of Picard and advocating for the use of the net investment method. Recognizing that only seven Ponzi schemes had been liquidated in the past 18 years, the SEC urged that the dispute was not one that was appropriate for review by the Supreme Court. Additionally, the SEC continually deferred to the decisions handed down by the district court and Second Circuit Court of Appeals. Finally, the SEC noted perhaps the strongest argument in favor of Picard, observing that the Second Circuit's decision " does not conflict with any decision of this Court or of another court of appeals." An issue is often ripe for Supreme Court review when there are splits among the thirteen federal courts of appeal including the DC Circuit and the Federal Circuit.
A decision by the Supreme Court not to grant certiorari will also pave the way for Picard to begin distributing a majority of the assets recovered thus far that have been set aside pending final approval for his distribution method. While Picard made an initial distribution to investors late last year equaling approximately 4.6% of each investor's loss, he acknowledged the amount would have been significantly higher had he not been constrained by this dispute. However, Picard was forced to account for the possibility that the net investment method would be overruled, meaning that the number of victims and corresponding claim amounts would drastically increase with investors previously not entitled to claim victim status. Investors with allowed claims have also received up to $500,000 each in cash advances to cover their losses from the Securities Investor Protection Corporation ("SIPC"), the federally-mandated industry group overseeing the Madoff liquidation, which has distributed over $700 million thus far.
A copy of the SEC Supreme Court brief is here.
A copy of Picard's brief to the Second Circuit Court of Appeals is here.