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Re: Of Markopolos And Madoff, New Times, Conventional Wisdom, SIPC, Clawbacks, Equitable Estoppel, Declaratory Judgment

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Message Lawrence Velvel

            Ackerman subsequently got after the SEC’s General Counsel, who was attempting to pull the wool over the Committee’s eyes as to why the SEC officials were refusing to discuss what happened on the Madoff matter.   That jerk tried to seriously mislead the Committee as to the reasons the SEC witnesses wouldn’t talk.  When he got blasted for giving one bullshit reason or another, he would then ignore that reason or repair to another.  He apparently wasn’t claiming the 5th Amendment privilege against self incrimination.  He wouldn’t say yes or no as to whether he was claiming Executive Branch privilege, other than to later claim it was one of the reasons for not answering questions.  But he hadn’t put the question of executive privilege to the Department of Justice.  But it wasn’t just his interpretation, it was the position of the agency.  But the Commission, not he, makes decisions for the agency -- yet the Commission hadn’t considered specific reasons for taking the position here, although it somehow supposedly approved the refusals to answer.


            The General Counsel was engaged in gobbledygook.  Ackerman disgustedly ended by saying “. . . you came here and fumble through make believe answers that you . . . concoct and attribute it to executive privilege, that you’ve not consulted with the Executive Branch on.”


            “Make believe answers.”  “Concoct.”  What a hoot.  And how true, figuratively if not literally.


            Congressman Kanjorsky, the head of the subcommittee holding the hearing indicated at various times that under the SEC’s position it can’t make disclosures now about what happened because the Madoff matter is under internal investigation and is in litigation, it won’t be able to make disclosures for years into the future because the matter will continue to be in litigation, and it thus will be of no help to Congress in determining what needs to be done.  Kanjorski is absolutely right about the SEC’s position before Congress -- a position which, by the way, the SEC cannot continue unless it also intends for its Inspector General’s report to not be made public, to remain secret, thereby exacerbating the Madoff matter.  The SEC’s current position is sheer hypocrisy, sheer self protectiveness -- as is true of all the (largely incompetent) federal agencies (the secrecy and self protectiveness of DOD and now the DOJ too are legendary).  It also causes one to be even more certain than American experience in the last four decades already makes certain anyway that the Inspector General’s report will be a whitewash insofar as the SEC finds it possible to present a whitewash. 


            Let me now turn to the last two major topics of this posting, involving ideas not fired up by the February 4th hearing, but instead relating to a subject hanging over the heads of Madoff victims from December 11th onward.  (September 11th and December 11th.  What an unlovely symmetry. Does anyone remember that November 11th was the day the guns stopped in 1918? (Armistice Day.))


            It has long been feared and the Trustee, Irving Picard, appeared to time and again confirm at a public meeting on February 20th, that the amount an investor will be credited with will not be the amount shown in his/her account on the November 30th statement. For that amount includes not only the principal the investor put (and left) in, but also the phantom income with which the investor was credited by Madoff. Thus, for example, suppose an investor put in principal of $475,000, was credited with phony income of $100,000 (for a total of $575,000), but took out $75,000.  The amount shown on the November 30th statement will be $500,000 ($475,000 originally invested, plus $100,000 in phony income, minus $75,000 taken out.)  If one is not credited with the phantom income of $100,000 (on which she paid taxes), the amount she has is only $400,000 (the $475,000 initially invested, minus the $75,000 taken out).


            This is important with regard to SIPC, which can advance up to $500,000.  If the investor’s holdings total $500,000, as is the case if the $100,000 of phantom income shown on the November 30th statement is included in his Madoff holdings, then he will recover $500,000 from SIPC:  $475,000 in principal, plus $100,000 phantom income, minus $75,000 taken out equals $500,000, so SIPC will pay $500,000.  But if the phantom income of $100,000 included in the statement is subtracted from the investor’s holding, the investor will get only $400,000 from SIPC.  $475,000 in principal, plus zero for phantom income, minus $75,000 taken out equals $400,000, so SIPC will pay only $400,000. 


            So the question is:  will the investor be credited with the $100,000 in phantom income (on which she paid taxes) when SIPC calculates how much to pay her?  The conventional wisdom, based on the New Times case in the Second Circuit Court of Appeals, and Irving Picard, say no. But the New Times case said no on the facts of that case, in the context of those facts and none other.  Are those facts the same as, and the holding therefore equally applicable to, the Madoff situation?  Unthinkingly, yes.  Thoughtfully, not at all.  Not one little bit.


            In the New Times situation there were two kinds of investors.  One kind was those who were fraudulently induced to buy, through the fraudster, shares of mutual funds that actually existed, such as Vanguard and Putnam funds.  After victims gave him their money, the fraudster never bought the mutual funds.  Instead he stole the money. But he sent the investors account statements which tracked the actual funds (though he hadn’t bought them) and which enabled the victims, as the court said the Trustee noted, to “have confirmed the existence of those funds and [to have] tracked the funds’ performance against [the fraudster’s] account statements.”


            People who were induced to purchase mutual funds that actually existed, and on which they could have checked, thus received, as I understand it, SIPC protection of up to $500,000 if the value of the real securities they thought they had purchased would have equaled $500,000 when the fraud was exposed.


            But the investors who thought they had purchased real, existing mutual funds -- just as Madoff’s victims thought he was buying for their account real, existing stocks of Fortune 500 companies, real Treasuries, and real puts and calls -- were emphatically not the investors involved in the New Times appellate case.  The investors in the New Times appellate case were in a wholly different position.  They were people who invested in new mutual funds which were supposedly offered by the fraudster but which did not in fact exist.  Let me repeat this:  unlike the Vanguard and Putnam funds, which did exist, the funds bought by the claimants in the New Times appeal did not exist. This made all the difference in the case, for reasons I shall discuss.


            Thus, the appellate court, early in its opinion, made the following statement:


To be clear -- and this is the crucial fact in this case -- the New Age funds in which the Claimants invested never existed. They were not organized as mutual funds, they were never registered with the SEC and they did not issue any of the requisite prospectuses for investors.  [First and third emphases supplied, second emphasis in original.]


            The first of the two specific issues decided by the court was whether the claimants  in the case should be credited with owning securities, rather than merely having a claim for cash, even though the mutual funds they thought they invested in never existed, i.e., the securities never existed.  After much legalistic mumbo jumbo, including extensive mumbo jumbo about whether it should defer to the opinion of SIPC, defer to the opinion of the SEC, and which it should defer to more, the court mumbojumboed its way to holding that the victims had claims for securities, a claim that creates $500,000 of SIPC protection rather than only the $100,000 of protection given to cash.  When one cuts through all the legalistic mumbo jumbo, the fundamental reason for this ruling is that holding that the investors owned securities (not mere cash), even though they did not really own securities, better accomplishes the purposes of the Securities Investor Protection Act (SIPA) to “‘provide protection to customers of broker-dealers . . . to reinforce the confidence that investors have in the U.S. securities markets.’”  The “statutory goals [are] promoting investor confidence and providing protection to investors,” and these are better achieved by holding that investors owned securities.  They had “‘legitimate expectations’” of ownership of securities, expectations “based on written confirmation of transactions” that the fraudster sent them,” and investor protection and confidence, the goals of SIPA, were best served by honoring their “legitimate expectations,” as was urged by the SEC, to which the court deferred.


            But when it came to the second issue in the case, the court’s tune changed because the mutual funds had never existed.  Again the court deferred to the SEC (which agreed with SIPC on this issue though they had disagreed on the prior one).  So deferring, the court ruled that the investors should be credited only with the amounts they invested, and not with the dividends and interest the fraudster had credited to their accounts.  In other words, though the court did not mention its own inconsistency, and did not even appear to recognize that there was inconsistency, on the second issue the court frustrated investors’ expectations, failed to protect them, and harmed investor confidence.  For the investors obviously must have expected that they had in their account the dividends and interest reflected in their account statements, just as they thought on the first issue that they had securities, not cash.  But while the court honored their legitimate expectation that they had securities, it frustrated their equally legitimate expectation that they had amassed dividends and interest.


            Why, then, did the court, deferring to the SEC and SIPC, rule that investors did not have interest and dividends in their accounts?  What are the reasons for this ruling, are they valid, and, valid or not, do they apply in the Madoff matter? 

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Lawrence Velvel Social Media Pages: Facebook page url on login Profile not filled in       Twitter page url on login Profile not filled in       Linkedin page url on login Profile not filled in       Instagram page url on login Profile not filled in

Lawrence R. Velvel is a cofounder and the Dean of the Massachusetts School of Law, and is the founder of the American College of History and Legal Studies.
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