The fundamental reasons for the court’s deferral and its ruling were that allowing investors to recover “fictitious amounts” that they were credited with by the fraudster “would allow the customer to recover arbitrary amounts that necessarily have no relationship to reality,” leaves the SIPC unacceptably exposed, the SEC and SIPC agreed that “such an approach is irrational and unworkable,” and the approach “would create potential absurdities” because the numbers would be “entirely artificial.” But this is all nonsense; it is all completely out of step with what is done every day in courts.
As a lawyer and professor who litigated very large antitrust cases involving up to many hundreds of millions of dollars back in the day when this was still real money, I can tell you that every day, in antitrust cases, airplane accident cases, and numerous other kinds of cases, the courts use various methods of finding out what profits would have been, what losses would have occurred, if things had been different. That is one of the things that expert economic witnesses are for. The same kinds of calculations could easily have been done in New Times. One could have chosen to say, for example, that the percentage of interest, dividends and appreciation for the mutual funds that did not exist should have been assumed to be the same as for those which did exist. Or they should have been assumed to be the same as the average over the relevant years for the type of mutual fund -- value fund, growth fund, etc. -- that the non-existent funds were advertised as being. Or investors could be credited with a rate of appreciation plus dividends that was reasonable in the economy during the time period, say 7.5 percent, for example. These kinds of simple calculations -- less sophisticated and much easier to make, I must say, than those involved in cases that I was in -- would mean that the interest and dividends that people were credited with in court were not arbitrary, would pose no threat to SIPC, would not be irrational or cause absurdity, would be grounded in reality and wholly rational. Otherwise, economic calculations taking place every day in courts all over the country are absurd, arbitrary, have no relationship to reality etc. That neither the SEC nor SIPC, nor the federal court whose location in New York causes it to be regarded as the premier federal court in the country in regard to the financial system, could think of such a simple solution, one used every day in all kinds of litigations all over the country, causes one to understand even more deeply the truth of Gary Ackerman’s statement that the two agencies could not find their backsides with two hands with the lights on. Or, as we expressed it equally colorfully in Chicago . . . . . . . . . . . . .
The stupidity of the SEC’s position, and the really horrendous results it will produce if it is followed by the SEC, SIPC and the Trustee in the Madoff case, as is the present intent, are an excellent reason for not following it in Madoff, and for not deferring again to the SEC and SIPC if they were to repeat it in Madoff. For the dumb position, by holding that people should not be credited with the interest, dividends and appreciation shown in their accounts nor with any reasonable substitute calculation, causes them to be denied their “legitimate expectations.”
And investors will be denied their legitimate expectations, rest assured of that. Not only did they legitimately expect that they had amassed appreciation and dividends, but many took action accordingly. They used the money to live, to pay taxes, to pay for children’s education. They took out loans against it that they must now repay somehow.
And just to add horrible insult to horrendous injury, now (1) SIPC and the Trustee will give many of them no SIPC recovery because, relying on the legitimate expectation that they had appreciation in their accounts, over the course of many years many investors took out more than they put in, and (2) the Trustee may try to claw back huge sums from those who took out what they legitimately expected was appreciation in their account.
But there is even more to it than this. Remember that the reason for deferral to and adoption of the SEC’s and SIPC’s dumb position in New Times was that the securities bought by the claimants never existed. Investors thus could never look them up and track them, could never determine whether their performance as reported in the financial press or as reported to the SEC matched the performance shown in the investors’ account statements. That is why it supposedly was arbitrary, irrational, not grounded in reality, etc. to give investors credit for the dividends and interest shown on their accounts. But in Madoff the fraudster claimed to be buying and selling, and the account statements showed, purchases and sales of real securities, Fortune 100 stocks no less. An investor, if suspicious, could, and we now know some did although most had no reason whatsoever to be suspicious, compare what was shown on account statements with actual purchase and sale prices of the same securities in the market at the same times. My understanding is that in most instances the match was perfection itself (although there apparently must have been some (few?) instances when -- due to slip-ups in Madoff’s offices, one would think -- this was not precisely so, a fact which did not become public knowledge when discovered by people hired by big shots to do due diligence).
So the very reason underlying New Times’ holding that fictitious appreciation on securities that never existed would not be credited to investors even though they would fictitiously be credited with securities, does not exist here, is inapplicable here. Here the securities were real, could be checked as to purchase and sale prices. Thus, under the very logic of New Times -- that because the securities never existed, the investors would not be credited with fictitiously-increased amounts that they thought they had, that they legitimately expected they had -- is completely inapplicable in Madoff. For in Madoff the securities did indeed exist.Incidentally, if one asks the perfectly good question, as at least one person has, of whether the Trustee in New Times credited fictitious appreciation to those who owned Vanguard and Putnam funds, funds which did exist but were never bought by the fraudster (and whose performance in the real world could be looked up), the answer is this: while I don’t know for certain, based on statements in the New Times opinion I believe the answer is yes. For the account statements of those investors “‘mirrored what would have happened had the given transactions been executed,’” and those investors, as the court quoted the Trustee as noting, “could have confirmed the existence” of the relevant funds and could have tracked the performance of the actual mutual funds against the amounts shown in their account statements. And apparently, for these reasons, those investors received the actual value of their securities when the fraud was discovered -- actual value which would have included appreciation (or decline). If the answer is therefore yes, as I think, this is certainly unfavorable to the position taken by the Trustee in Madoff. For the investors in Madoff could have confirmed and tracked the performance of the real securities against the performance shown in their account statements, just as could be done by the investors who thought they had bought real mutual funds in New Times.
I shall turn now to one final issue: clawbacks.
Now maybe I’m all wet, but I thought that money withdrawn from Madoff in the last six years cannot be clawed back by the Bankruptcy Trustee if the investor had given equal value and had no knowledge that should have made him suspicious that a fraud might be occurring. This does not seem to enter the news media’s discussions, however, nor investors’ discussions. Rather, often it seems simply to be assumed, I think wrongly, that any monies withdrawn in the last six years can be clawed back. But if an innocent person did not withdraw more than she put in, then I think there cannot be a clawback (unless, perhaps, money was withdrawn within 90 days of December 11th), because the amount put in is “equal value” (or more) to the amount taken out. Picard seems to agree with this.
But let’s face it. There must be lots of people, including older people, who now have taken out more than they put in. These investors would include older people, in their mid to late 70s or 80s, for example, who have long been withdrawing money in order to live. They might include people who had to withdraw money in order to pay their income tax on their Madoff income -- unlike more privileged others, they couldn’t afford to pay their taxes on Madoff income without withdrawing money from Madoff. They might include people who withdrew money to pay for grandchildren’s schooling or to buy a house. Should people like this be subject to clawbacks?
The Trustee, if I understand him correctly, says yes. He says these people are subject to clawbacks although he may forego clawbacks in circumstances he declines to identify other than to indicate that the investor must be innocent and it will help if he/she is very old and poor.
My view is that innocent people should not be subject to clawbacks at all, and I think the Trustee should do a lot more to publicly disclose circumstances that he will regard as “non clawable.” (He already has been accused of saying little in this regard in order to preserve the ability to be arbitrary.) Take, for example, people in their mid to late 70s or 80s who depended on Madoff monies to live, are now wiped out, may lose SIPC recovery because they took out more than they put in, don’t know where their next dollar will come from or how they will buy food. You want to claw back money from people like this? You want blood from a stone? Why not flatly announce that you will leave such people alone if they had no knowledge of possible fraud?
Or take people who withdrew money to pay income tax on phantom Madoff “earnings” because, unlike far wealthier people, they could not pay the tax on such phantom income without withdrawing money. The money those people took out was to pay tax on income that was phony, on income that would never have existed, and on which tax therefore would never have been paid, but for the government’s fantastic negligence -- or worse -- going all the way back to 1992. Yet these people’s withdrawals to pay tax should be clawed back, while the wealthier suffer no such penalty, and should be clawed back for six years although refunds for phony tax payments only go back three years? Gimme a break, as it is said. Why not announce that money used to pay taxes on phony income, taxes which would not have been owed but for the government’s fantastic incompetence, will not be clawable if the victim had no knowledge of Madoff’s fraud?
I think there is a point of view, however - - one which, if I heard him correctly, the Trustee defacto is taking -- which holds that the Trustee is legally obligated by the language of the bankruptcy statute to seek clawbacks. I don’t know if this is true of the statutory language -- somebody should check it out -- but I will assume that it is true. Nonetheless, its presumed truth settles nothing. For the Trustee, like any litigant, like any prosecutor, can always exercise discretion about whom to seek money from, or whom to prosecute and whom to let off the hook, or with whom to settle a matter for a song or with little or no penalty. All this is inherent in our legal system and to claim lack of discretion to take account of important facts is pure “bovine defecation,” as Norman Schwarzkopf so delicately put some matters. Indeed, at his public meeting, the Trustee claimed discretion not to seek clawbacks in cases or in circumstances which he would not elaborate. So here the Trustee should exercise judgment and discretion and not seek clawbacks from the small, injured and innocent and should say he won’t seek them. Focus on the big boys -- the gazillion dollar banks and funds which, it seems, were in some cases both culpable and withdrawing gazillions in the last four to five years.
Unless and until he changes his mind, however, the Trustee apparently will not pledge to lay off small folks who are harmed, are innocent, and were withdrawing monies for understandable purposes like obtaining money needed to live, or to pay tax on the phony income that would not have arisen but for fantastic governmental negligence or complicity, or to pay for kids’ education. If so, I have two suggestions for the injured. First, assert the principle of equitable estoppel against efforts to claw back money -- and efforts to reduce SIPC recoveries. Under that principle, the government -- and here the bankruptcy court trustee and SIPC are the government -- is not permitted to make claims whose assertion is made unjust and inequitable because of its own conduct and statements. Here the conduct of the SEC, governmental conduct of unimaginable horrificness as discussed in prior blogs and as blasted by legislators in hearings, is a co-cause of the disaster that has befallen so many. Here the government is a defacto coconspirator, an aider and abettor, a joint tortfeasor, call it what you will. And here, therefore, the government, the co-cause of the disaster, should be estopped from trying to further screw people by clawing back monies from the innocent or reducing their SIPC recoveries. Justice demands this.
The use of equitable estoppel is my first suggestion. My second is: bring declaratory judgment suits. A declaratory judgment is a type of action used to prevent injury from actions that are almost certain to occur unless a court declares them illegal before they take place, declares them illegal before the fact, as it were. In view of the circumstances of this case, if the Trustee and SIPC do not quickly agree to reverse course and not take the kind of unjust actions under discussion, then I suggest injured investors bring declaratory judgment actions against them. Courts don’t always grant declaratory judgments when asked, and a court that granted one might of course rule against the investors despite the awful circumstances. But it is worth a shot: courts might rule in favor of the investors in advance; investors’ bargaining position would be enhanced, if a court were simply to refuse to rule in advance, by letting the trustee know he is in for a battle royal after he takes the unjust actions; and, were a court to rule against the investors, this would be more grist for the mill of trying to get Congress to act.*
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