SEC Supports Cash-In/Cash-Out Method To Value Madoff Customer Claims, Agreeing With Picard And SIPC

Any lingering thoughts that anyone may have had that the SEC would propose valuing customer claims against Madoff using a different standard than advocated by Madoff bankruptcy trustee Irving Picard and SIPC were dashed today, when the SEC’s Deputy Solicitor, Michael A. Conley, testified today before the Capital Markets, Insurance, and Government Sponsored Enterprises Subcommittee of the House of Representatives.

The issue is this: 

There have been two primary approaches proposed for establishing the value of claims by Madoff customers. The first is known as the "final account statement method." Under this method, it is argued that the net equity in customer accounts should be based upon the securities positions shown on the final account statements customers received before the Madoff firm was placed in liquidation. Because customers rely on the information in their account statements to keep track of their investments, proponents of this method contended that these documents reflected their "legitimate expectations" of what was in customer accounts when the Madoff firm failed.
 
The second principal approach to resolving customer claims is the "cash-in/cash-out" method. Proponents of this method contended that because the account statements showed fictitious transactions and returns that were part of an overall fraudulent scheme, the securities positions shown on those statements were not a legitimate basis for determining the customers' net equity. Instead, they argued that net equity must be determined by crediting the amount of cash the customer deposited in the account, and subtracting any amounts withdrawn from the account.
 
Conley today came out strongly in favor of the cash-in/cash-out method. He stated that the SEC based its recommendation on the conclusion that the claims of the Madoff investors could not be valued based on the balance shown on their final account statements. Conley stated that although this approach would allow most Madoff account holders to receive payments on their claims, “those payments would be based on account balances reflecting amounts that Madoff himself concocted that bear no relation to reality.” The account statements Madoff sent to the customers “showed the results of a Ponzi scheme designed as an investment program, with positions selected after the fact to produce pre-determined results. Neither SIPA nor any of the cases interpreting that statute can be read to support an approach that would value claims based on the fictitious investment returns of such a scheme.”
 
In Conley’s view, Madoff essentially promised customers that he would pick "winning" stocks for them, did not tell them which stocks he would purchase, waited to see which stocks did well, and then falsely reported that he selected stocks that met their investment expectations. The account statements that Madoff sent to his customers “were illegitimate tallies of a fraudulent scheme and provide no basis for calculating those customers' net equity.” Therefore, he continued, the SEC concluded that “the most reasonable way to measure the value of the Madoff customers' net equity” was to look to the money those customers invested with Madoff.
 
Finally, Conley recognized that although the final account statement approach favored earlier customers at the expense of later customers, the cash-in/cash-out method favored later customers at the expense of earlier customers by treating a dollar invested in 1987 as having the same value as a dollar invested in 2007. He stated that, in the SEC's view, to achieve a fair and economically accurate allocation among Madoff customers who invested and withdrew funds in different historical periods, it was appropriate to convert the dollars invested into "time-equivalent" or constant dollars.
 
The next step is likely a court decision on this issue. It will be heavily litigated.