all of the expenses associated with the agency’s fulfillment of its statutory duties are paid for by members of the securities industry

TO BE NOTED:

Another View: Unwinding Madoff’s Fraud, Fairly

Irving H. Picard, the trustee overseeing the liquidation of Bernard L. Madoff’s investment firm, and Stephen P. Harbeck, the chief executive officer of the Securities Investor Protection Corporation, address some questions and concerns about how the claims of Mr. Madoff’s defrauded investors are being handled.

Over the last several months, there have been many news reports and articles about the liquidation proceeding under the Securities Investor Protection Act for Bernard L. Madoff Investment Securities, or BLMIS, including the recent opinion piece on DealBook from Helen Davis Chaitman. In the interest of encouraging maximum public understanding, Irving H. Picard, the BLMIS trustee, and the Securities Investor Protection Corporation are making the following statement:

Congress created the S.I.P.C. in 1970 in order to provide “greater protection for customers of registered brokers and dealers and members of the national securities exchanges.” The organization has no regulatory authority over brokers or dealers and only becomes involved when a member fails and must be liquidated under the Securities Investor Protection Act.

“In a very real sense, allowing claims for fictitious profits lets the thief — Mr. Madoff — determine who wins and who loses.”

Although the Securities and Exchange Commission has some oversight authority over it, the S.I.P.C. is not a government agency or establishment. In fact, it is a nonprofit membership corporation whose members are almost all registered securities brokers or dealers. Members of the S.I.P.C. pay an annual assessment to the corporation. The amounts paid become part of the S.I.P.C. Fund, which is used, within limits and as needed, to satisfy customers and to pay administrative expenses in liquidation proceedings.

Only if the S.I.P.C. Fund becomes insufficient may the corporation borrow from the United States Treasury. As such, all of the expenses associated with the agency’s fulfillment of its statutory duties are paid for by members of the securities industry. Only as a last resort would taxpayer monies be used.

As was stated in the S.I.P.C.’s last annual report, since its inception, the organization has commenced more than 300 proceedings. Cash and securities totaling approximately $15.7 billion have been distributed to customers in those proceedings. Of that amount, approximately $15.4 billion came from the debtors’ estates and $322.5 million came from the S.I.P.C. Fund. As these numbers make clear, much of the work done by the S.I.P.A. trustee and his counsel in identifying and gathering the assets of the member and distributing them to all customers of the failed brokerage so that the assets can be shared in a fair and equitable way.

As the largest and most complex securities fraud in history, the Madoff firm presents many unique difficulties rarely encountered in the typical failure of a broker or dealer. Because every customer statement was a fiction, the first task was to reconstruct the books and records of the firm from scratch. This entails reconstructing every customer account from the ground up using BLMIS records, bank statements, e-mail messages, records from third parties as well as documents received from customers through the customer claims process. This has been and continues to be an enormously time-consuming endeavor, complicated by the fact that the trustee and his staff have had to work with law enforcement authorities and therefore access to information has required careful coordination.

Moreover, the claims themselves require thorough analysis given the lengthy nature of the fraud, its complexity and the interrelationships of many of the customers. The database tracking this information is enormous and has taken many highly qualified personnel working intensively to get it to the point where the trustee can now begin acting on claims, secure in the knowledge that the available records are reliable. All of the expenses of this work have been paid for by the S.I.P.C. Customer funds are never used to pay for administrative expenses.

To date, the trustee has received more than 8,500 claims for approximately 3,500 accounts. He has allowed customer protection to 51 claims up to this point. Those customers will receive from S.I.P.C. an advance of up to $500,000 in each, for a total of more than $25 million. With the database now in place and the large number of personnel being devoted to this task, the trustee is hopeful that the claims determination process will accelerate in the coming months.

It should also be noted that the $500,000 advance is not “insurance” as some have described it. The Securities Investor Protection Act provides that the S.I.P.C. Fund will protect a customer up to $500,000, of which up to $100,000 may be cash. Thus, if a customer’s account balance is less than $500,000, that customer would receive only the amount allowed on the claim, not the full $500,000 advance.

In the BLMIS liquidation, it is anticipated that most of the allowed claims will exceed $500,000. As a result, most will receive the full S.I.P.C. advance for securities of $500,000. To the extent that any allowed claim is more than $500,000, the customer will have to await a distribution from the fund of customer property being gathered by the trustee pursuant to his powers under the Bankruptcy Code and the act. Thus far, the trustee has recovered more than $1 billion and has taken many actions to enhance that fund so as to maximize the equitable distribution to all customers.

With regard to the amount of an allowed claim, it has been suggested that the allowed claim should include fictitious profits. This would be inappropriate both legally and factually.

First of all, with regard to the SIPC advance, the trustee has already decided, with concurrence from SIPC, to treat all claims as claims for securities even though no securities were ever purchased. Ordinarily, a valid claim for securities is satisfied by delivering the securities to the customer. If the securities are missing, the trustee may buy them for the customer.

However, in order for the trustee to buy securities, the customer must have paid for them, and there must be a fair and orderly market for the securities. If securities cannot be bought, the customer receives the market value of the securities in cash. In this instance, the trustee will not attempt to buy securities for customers for a few reasons. Because many securities were paid for with “profits” from the “sale” of securities that were never actually bought, in some cases going back decades, it is impossible to identify which securities were actually paid for by the customer and therefore, which securities the customer is entitled to receive.

Moreover, even if securities could be identified and could be shown to have been paid for, including fictitious profits gives the customer the benefit of BLMIS’s unlawful allocation of trades with no relation to reality or the marketplace. In a very real sense, allowing claims for fictitious profits lets the thief — Mr. Madoff — determine who wins and who loses.

Finally, the trustee’s purchase of securities, even if possible, would wreak havoc on the securities markets given the volume of securities involved. Here, given the failure by BLMIS to buy any securities, no orderly market could be maintained.

With regard to the distribution from the customer fund, simple logic suggests that it would not be advantageous to include fictitious profits. In a Ponzi scheme, fictitious profits cannot be part of an equitable plan for distribution to customers. By adding fictitious profits, all that would be achieved is increasing the amount of the claims being divided into the amount of the fund gathered by the trustee, thereby diminishing the percentage of recovery that all customers would receive.

Furthermore, those customers who withdrew more than they put in and withdrew fictitious profits, even unknowingly, actually received someone else’s money. They not only got their money back but, by virtue of the fictitious profits, they have received the actual investment dollars of another customer who will necessarily be out of pocket unless the fictitious profits are returned.

In that regard, allowing fictitious profits in the liquidation proceeding will benefit early investors but penalize later ones. Each customer receives a share of customer property that is proportionate to the size of his or her claim. If fictitious profits are allowed, the money put in to the BLMIS scheme by later investors, whose claims will largely be for real dollars, will be used to pay the earlier investors whose claims will be largely based on fictitious profits. In short, the Ponzi scheme would continue by BLMIS even in liquidation if fictitious profits were recognized.

The trustee and S.I.P.C. are fully aware of the hardship these facts may impose upon a number of the customers, and they will not be unmindful of those hardships in individual cases. However, there are many instances where no hardship exists and the inequitable result of not recovering the fictitious profits would be manifest. The trustee and S.I.P.C. are committed to a fair, equitable and compassionate approach to the allowance of customer claims.

We hope the information contained in this statement is helpful. The trustee maintains a Web site at www.madofftrustee.com that provides current information on the proceedings as well as the customer claims process.

Irving H. Picard is the trustee for the liquidation of Bernard L. Madoff Investment Securities LLC, and Stephen P. Harbeck is president and chief executive of the Securities Investor Protection Corporation."