Sec. Investor Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC

• Decision Date: 10 September 2013
• Docket Number: Adv. Pro. No. 08–01789 (BRL) SIPA LIQUIDATION (Substantively Consolidated)
• Citation: 496 B.R. 744
• Parties: Securities Investor Protection Corporation, Plaintiff, v. Bernard L. Madoff Investment Securities LLC, Defendant. In re: Bernard L. Madoff, Debtor.
• Court: U.S. Bankruptcy Court — Southern District of New York

496 B.R. 744

Securities Investor Protection Corporation, Plaintiff,

v.Bernard L. Madoff Investment Securities LLC, Defendant.

In re: Bernard L. Madoff, Debtor.

Adv. Pro. No. 08–01789 (BRL) SIPA LIQUIDATION (Substantively Consolidated)

United States Bankruptcy Court, S.D. New York.

Filed September 10, 2013

ARGUING ON THE MOTION ¹

MEMORANDUM DECISION AND ORDER GRANTING, TO THE EXTENT SET FORTH HEREIN, THE TRUSTEE'S MOTION FOR AN ORDER AFFIRMING THE TRUSTEE'S CALCULATIONS OF NET EQUITY AND DENYING TIME–BASED DAMAGES

Burton R. Lifland, United States Bankruptcy Judge

Before the Court is the motion (the “Motion”) of Irving H. Picard, Esq. (the “Trustee”), trustee for the substantively consolidated Securities Investor Protection Act ² (“SIPA”) liquidation of Bernard L. Madoff Investment Securities LLC (“BLMIS”) and Bernard L. Madoff (“Madoff”) seeking an order affirming the Trustee's determination that BLMIS customers'claims for “net equity,” as defined in SIPA section 78 lll(11), do not include interest, time value of money, or inflation adjustments such as constant dollar (collectively, “Time–Based Damages”).

The Trustee's instant Motion raises an issue of first impression: whether to adjust customers' net equity claims to account for any form of Time–Based Damages under SIPA. At stake in the instant Motion is a distribution formula that impacts not only the extent of the entitlements of every single BLMIS claimholder to the limited customer property fund but also whether the approximately $1.4 billion cash reserve may be released.³

Broadly speaking, the Trustee has determined that excluding Time–Based Damages from the net equity calculus is appropriate because it is not only correct legally, but also assures that no customer is entitled to recover profits before other customers recover their principal investment. In contrast, the objecting claimants contend that the inclusion of Time–Based Damages is more consistent with SIPA's protective aims and takes the economic reality of inflation into account by not penalizing earlier customers in an arbitrary fashion.

This Court recognizes that choosing any method for calculating net equity is particularly challenging in light of the complex and unique facts of Madoff's Ponzi scheme, and each method will benefit some victims at the expense of others. Indeed, in this zero sum game “whe[re] funds are limited, hard choices must be made.” In re The Reserve Fund Secs. & Derivative Litig., 673 F.Supp.2d 182, 195 (S.D.N.Y.2009) (quotations omitted). However, the plain language, purpose, framework and distribution scheme of SIPA, as well as Second Circuit precedent,⁴ all support the method chosen by the Trustee. Moreover, permitting the inclusion of Time–Based Damages in the net equity calculus will likely have significant unintended consequences, including favoring certain investors who have already recovered their principal investments at the expense of other investors who have yet to recoup their principal, and potentially providing a windfall for claims traders who were never victims of Madoff's fraud.⁵

Accordingly, for the reasons set forth below, all of the objecting claimants' objections are hereby OVERRULED, and the Trustee's Motion is hereby GRANTED to the extent set forth herein.

BACKGROUND⁶

SIPA aims to protect customers of an insolvent or financially unstable broker-dealerby expediting the return of customer property. See In re Bernard L. Madoff Inv. Sec. LLC, 654 F.3d 229, 239–40 (2d Cir.2011). In order to do so, SIPA grants customers prioritized claims which permit them to share pro rata in customer property to the extent of their net equity. See SIPA § 78 lll(2), (4), (11). For each customer with a valid net equity claim, SIPC advances funds to the SIPA trustee up to the amount of the customer's net equity, not to exceed $500,000. See SIPA § 78fff–3(a).

In the instant SIPA liquidation proceedings of BLMIS, the Trustee is tasked with recovering and distributing customer property to BLMIS's customers, assessing claims, and liquidating any other assets of the firm for the benefit of the estate and its creditors. In 2009, the Trustee determined that the net equity claims of BLMIS customers should be calculated based upon the monies that customers deposited into their BLMIS accounts, less any amounts they withdrew from their BLMIS accounts (the “Net Investment Method”). On March 1, 2010, this Court upheld the Trustee's Net Investment Method, finding it was an interpretation of net equity consistent with the plain language of SIPA, its legislative history, controlling Second Circuit precedent, and considerations of equity and practicality. See Net Equity Decision, 424 B.R. 122 (Bankr.S.D.N.Y.2010), aff'd 654 F.3d 229 (2d Cir.2011), cert. denied, ––– U.S. ––––, 133 S.Ct. 24, 183 L.Ed.2d 675 (2012), ––– U.S. ––––, 133 S.Ct. 25, 183 L.Ed.2d 675 (2012).⁷

At such time, both this Court and the Second Circuit explicitly declined to address the issue of whether the Net Investment Method should be adjusted to account for Time–Based Damages. See Net Equity Decision, 424 B.R. at 125 n.8; In re Bernard L. Madoff Inv. Sec., 654 F.3d at 235 n.6. Therefore, following the denial of certiorari, the Trustee moved this Court for a briefing schedule and hearing on the Time–Based Damages issue. See Notice of Motion for Order Scheduling Hearing on Trustee's Motion Affirming Denial of Time–Based Damages Adjustment to Customer Claims (Dkt. No. 4920). The Court approved the Trustee's motion and entered an order on September 5, 2012, narrowly defining the Time–Based Damages issue as, “whether the Objecting Claimants are entitled to time-based damages adjustments to their net equity customer claims to be paid from the fund of customer property.” ⁸ Scheduling Order (Dkt. No. 5022), p. 4.

The Trustee subsequently filed the instant Time–Based Damages Motion [hereinafter “Tr. Motion”] (Dkt. No. 5038),⁹which returns the Court to this novel SIPA issue. In his Motion, the Trustee seeks an order: (i) affirming the Trustee's determinations of the claims listed on Exhibit A to the Cheema Declaration, to the extent they relate to the recalculation of net equity customer claims based on Time–Based Damages; (ii) affirming the Trustee's denial of the claims to the extent these claims seek amounts in excess of net equity calculated using the Net Investment Method; (iii) affirming the Trustee's interpretation of net equity under SIPA as excluding Time–Based Damages; (iv) expunging the objections to the Trustee's determinations listed on Exhibit A to the Cheema Declaration, insofar as they relate to the recalculation of net equity customer claims based on Time–Based Damages; and (v) allowing the Trustee to release any funds previously reserved for the Time–Based Damages issue.¹⁰See Tr. Motion, p. 1. The Securities Investor Protection Corporation (“SIPC”) submitted a brief in support of the Trustee's Time–Based Damages Motion [hereinafter “SIPC Br.”] (Dkt. No. 5036).

Objecting to the Trustee's Motion, certain claimants (collectively, the “Objecting Claimants”), consisting of both individuals who withdrew more than they deposited with BLMIS (“Net Winners”), as well as ones who withdrew less (“Net Losers”), seek Time–Based Damages for the period of time during which their funds were deposited with BLMIS. Specifically, certain Objecting Claimants seek interest-based adjustments to their net equity claims based on, inter alia: (i) federal claims against BLMIS for securities fraud under the Securities Act of 1933 (the “1933 Act”) and rule 10b–5 promulgated under section 10(b) of the Securities Exchange Act of 1934 (the “1934 Act”), which entitle them to prejudgment interest, (ii) state law claims against BLMIS for conversion, which entitle them to prejudgment interest of 9% per annum under section 5001 of the New York Civil Practice Law and Rules (“CPLR”), and (iii) general claims for lost investment opportunities over time. Others seek inflation-based adjustments to their net equity claims in reliance on the basic economic precept that the value of the dollar changes over time.

On December 10, 2012, the Securities and Exchange Commission (the “SEC”) submitted a brief [hereinafter “SEC Br.”] (Dkt. No. 5142) supporting “the application of constant dollars ¹¹ when determining the value of customers' net equity claims for nonexistent securities positions in a SIPA liquidation proceeding,” but maintaining that this Court “should determine the ultimate appropriateness of using constant dollars based on the Court's own evaluation of the benefits and costs of making an inflation adjustment.” See SEC Br., pp. 18, 2.

Thereafter, certain parties (collectively, the “Customer Group”) requested discovery from the Trustee and his professionals to address whether the costs and burden of calculating and implementing an inflation adjustment to customers' net equity claims would be as significant as suggested by the Trustee. To accommodate such discovery, on January 23, 2013, this Court entered an amended scheduling order. See Dkt. No. 5212. Following the close of discovery, on April 29, 2013, the Customer Group submitted a supplemental opposition brief [hereinafter “Customer Supp. Br.”] (Dkt. No. 5332), as well as the Declaration of Timothy H. Hart, CPA, CFE [hereinafter “Hart Decl.”] (Dkt. No. 5331), to address “precisely the question the SEC left open: whether the costs outweigh the benefits of an inflation adjustment.” Customer Supp. Br., p. 1.

On July 18, 2013, the Trustee filed his reply memorandum (Dkt. No. 5415), along with the Declaration of Vineet Sehgal [hereinafter “Sehgal Decl.”] (Dkt. No. 5416). That same day, SIPC also filed its reply memorandum [hereinafter “SIPC Reply Br.”] (Dkt. No. 5413). Finally, on August 12, 2013, the Customer Group filed the Customers' Opposition to Trustee's Request for Exclusion of Hart Expert Testimony (Dkt. No. 5444). A hearing was held on September 10, 2013.

DISCUSSION

As a...