A New York federal appeals court sided with the court-appointed bankruptcy trustee for Bernard Madoff's massive Ponzi scheme in ruling that Madoff's victims were not entitled to have their losses upwardly adjusted for interest or inflation. The ruling by the Second Circuit Court of Appeals means that, regardless of the length of victims' investments with Madoff, each will be entitled to their pro rata share of funds recovered by the trustee, Irving Picard. The decision, if not appealed, will ultimately clear the way for the distribution of more than $1 billion currently being held in reserve pending determination of the issue. Victims have already recovered over 50% of their losses.
In the aftermath of a Ponzi scheme, a claims process is often instituted to return recovered assets to victims on a pro rata basis based on approved losses. While a victim's claim is often decreased based on the amount of payments or distributions they received from the scheme during its existence, some of Madoff's victims took the position that they were entitled to an upward adjustment accounting for inflation during the period of their investment and/or interest to reflect the time-value of money. Under this rationale, those victims who had invested with Madoff for a longer period of time would be entitled to an increase in their claim - logically, at the expense of other victims who had not invested with Madoff for such a duration. As the Second Circuit characterized the victims' position,
the claims of Madoff’s earlier investors are unfairly undervalued when compared to the claims of Madoff’s later investors.
Under the statutory framework of the Securities Investor Protection Act ("SIPA"), which governed the liquidation of Madoff's brokerage, the Second Circuit concluded that
an inflation adjustment to net equity is not permissible under SIPA. An inflation adjustment goes beyond the scope of SIPA’s intended protections and is inconsistent with SIPA’s statutory framework.
The Second Circuit gave weight to the absence of an inflation-based adjustment from SIPA's provisions, noting that such a provision would be "nonsensical" given SIPA's intended purpose to remedy broker-dealer insolvencies rather than the outright fraud committed by Madoff. Rather, SIPA aims to restore investors to their position had a liquidation not occurred.
Picard has now survived an impressive assortment of challenges to his use of the "net equity" method as the proper determinant of victim loss calculations. In addition to the now-unsuccessful attempts to tack on interest and inflation, efforts previously failed to force Picard to accept the amount showing on the last statement mailed by Madoff to victims - the "Last Statement Method" - an argument the Second Circuit previous rejected on the basis it
“would have the absurd effect of treating fictitious and arbitrarily assigned paper profits as real and would give legal effect to Madoff’s machinations.”
In re Bernard L. Madoff Inv. Sec. LLC, 654 F.3d 229, 231– 33 (2d Cir. 2011). Like the interest and inflation arguments, the "Last Statement Method" would also have favored long-term Madoff investors who watched as their purported account balances consistently increased. Importantly, each of the methods would have ultimately resulted in a lower payout to investors due to the inverse relationship between the total amount of allowed claims and funds available for victims. Fortunately, the success of Picard and his professionals in recovering assets has resulted in a pot of over $10 billion earmarked for victims.
Notably, the Securities and Exchange Commission supported the victims' position - and opposed the trustee - that SIPA permitted inflation-based adjustments. The Second Circuit concluded that this position was not entitled to any deference typically afforded to administrative interpretations, and remarked that the Commission's interpretation was "novel, inconsistent with its positions in other cases, and ultimately unpersuasive." Indeed, the Court observed that that, while favoring an inflation-based adjustment in this case, the Commission had recently opposed such an adjustment in a "different, long-lasting Ponzi scheme." Given that both scenarios envisioned an outcome where recovered assets would ultimately be insufficient to fully satisfy investor claims, the Second Circuit rejected any basis to further exacerbate this shortfall.
The Second Circuit's Order is below: