April 1, 2011
Discursive Comments On The Oral Argument In The Court of Appeals
In The Madoff Case On March 3, 2011.
The final opponent to argue was Michael Conley of the SEC.
At inception Judge Jacobs asked him to distinguish the SEC's position, to the extent it is distinguishable, from the position of SIPC or the Trustee. Conley replied that the SEC is in agreement with them with regard to whether you look solely at the account statement or to all the books and records, but believes you must value the net equity claim in "constant dollars." (Tr. 63.) The Bankruptcy Court, he said, decided to consider the constant dollar issue after the "initial determination" of net equity is made. (Tr. 63.) Thus, in the words of Justice Leval's question, "that issue of the constant dollars or the inflation adjusted dollars is not before us now." (Tr. 64.) It could be something to subsequently be decided below depending on how the Circuit rules, but it has not been briefed or decided and the Court is not called upon to decide it now.
Conley then reiterated the oft-made point that the Trustee must "discharge all obligations" of Madoff to a customer and said "that's exactly what the Trustee did" here after an extensive investigation. (Tr. 65.) In so saying, Conley was necessarily adopting the position, first advanced by Sheehan, that Madoff had no "obligation" to pay victims the fake profits that his own statements showed he owed them (and which Sheehan ultimately admitted would be recoverable in a fraud suit). It strikes me that it is nothing short of amazing for the SEC -- which was created to protect investors -- to take the position -- deeply injurious to investors -- that the crook does not owe investors what the statements he gave them showed they were owed (and what Madoff did give to people who closed out their accounts). For the agency created to protect investors to instead injure them in this way is further evidence of what has now been known for over two years: the SEC has abdicated its responsibilities, is incompetent, and is completely under the thumb of SIPC instead of supervising it as Congress intended. It is completely understandable that some people -- actually quite a few people, I believe -- think that Mary Schapiro, on whose watch this position was taken, should be dismissed.
None of this came up in the argument, however.
Judge Raggi responded to Conley by saying that "I don't mean to scare anyone by suggesting that this should be treated as cash, but on the one hand that does seem to be what you're calculating and concluding that you can't decide what the value of the security positions is. All you can decide is what's the cash they put in and took out. Then why isn't this a cash position?" (Tr. 66.) Conley's response was that there is a securities position here because the Court had held in New Times "that when a customer gives cash for the purpose of buying securities and then receives confirmations and account statements that suggest that that's what happened, the customer has a legitimate obligation to believe that that's how the cash was being invested." (Tr. 66-67.) Judge Raggi then asked "If that's the case, why isn't the receipt of each account statement something that the customer could reasonably rely on? I mean, to use the old maxim, a decision to hold is a decision to buy. So, you know, if you get told you hold x number of shares in this account statement worth such and such and you don't tell the broker to do anything, you've got that reasonable expectation. Why isn't that this case?" (Tr. 67.) Judge Raggi's question goes back to a point made earlier in this essay: if receipt of a statement creates a legitimate expectation that an investor owns the securities shown in the statement, why doesn't it simultaneously create a legitimate expectation that the securities were purchased at the price shown in the statement? After all, except in the case of a suspected mistake in price, have you ever heard of anyone who thought she owned the securities shown in her statement but that they had been acquired at a different price than shown in the statement?
Conley's answer essentially was that this was done in New Times (where people who bought non existent securities and received statements and confirmations had claims for securities, but there was no basis or evidence for valuing them, so the relevant investors received only their cash-in). To which Judge Raggi said the SEC was "not suggesting that any account holder didn't rely in good faith on what the statement said," and if the statement said a victim owned 200 shares of AT&T, "why isn't that a securities position that can be valued?" (Tr. 68-69.) Conley's response was that it can't be valued because it's the result of fake trades: it cannot be valued because "it's completely divorced from any reality of market trading." (Tr. 69.)
In reply Raggi asked whether the investor would be credited with the amounts shown in his statement if he had bought and held, so that the statement reflected not profits from trades, but profits from the market increase in share price of the stock plus reinvestment of dividends. (Tr. 69.) Conley's answer was that this was "quite akin to the folks in New Times" who had bought securities existing in the real world. (Those investors were not parties to the New Times case -- the parties were the persons who bought securities which did not exist in the real world.) SIPC and the Trustee recognized that the value of the real world securities which people invested in but which the fraudster did not actually buy, plus reinvestments of dividends, could be valued (by looking at real world prices). (Tr. 70.)
Judge Jacobs then said "So the distinction you draw between New Times and the circumstances of this case is in New Times with respect to some of the people who were put into real stocks, you can, looking at folks' records, account statements and market prices, you can actually calculate -- a real number for them." (Tr. 70-71.) Conley's answers were "Precisely," and "That's right." (Tr. 70-71.) Jacobs then said, in further explication of Conley's position, "Whereas if you have a fake stock that never had any value, or if you had real stock that's put through machinations and transactions that are impossible, then you can't calculate that value, and you're in the same situation as the people in New Times who couldn't recover because they had -- their holding of securities was impossible to calculate." (Tr. p. 71.) Conley replied, "That's exactly our position in this case, Your Honor." (Tr. 71.)
Judge Leval then added that in New Times there was no manipulation of account values, and, no "imaginary profits" for those who bought and held, for the duration, securities existing in the real world. (Tr. 71-72.)
As obvious, Conley is maintaining that New Times, and ability or lack of ability to value securities in the market, are controlling. He also maintained that a strategy of fictitious trading must be distinguished from a strategy of buying and holding. These positions are contrary to Congress' oft-previously-stated intent to protect investors, they take no account of Judge Jacobs' comment that perhaps New Times was not fair to the investors who bought the non existent securities to which Conley is comparing non existing trades in Madoff, and they deny protection to and thereby punish persons who give their broker discretion to trade for them instead of merely buying and holding -- even though so many investors do in fact give brokers such discretion and there is not a scintilla of evidence that Congress did not want to protect those investors just as much as those who buy and hold.