Case: Document: 164 Page: 1 07/11/ bk(L) IN THE. United States Court of Appeals FOR THE SECOND CIRCUIT

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1 Case: Document: 164 Page: 1 07/11/ bk(L) bk(CON), bk(CON), bk(CON), bk(CON) d FOR THE SECOND CIRCUIT IN THE United States Court of Appeals SECURITIES INVESTOR PROTECTION CORPORATION, Plaintiff-Appellee, against BERNARD L. MADOFF INVESTMENT SECURITIES LLC, Defendant, 2427 PARENT CORPORATION et al., ESTATE OF DORIS M. PEARLMAN (IRA), HAROLD J. HEIN et al., LILLIAN BERMAN GOLDFARB et al., MBE PREFERRED LIMITED PARTNERSHIP et al., HHI INVESTMENT TRUST #2, MELVYN I. WEISS and BARBARA J. WEISS et al., MICHAEL MOST, THE KOSTIN CO., MARSHA PESHKIN et al., Claimants-Appellants, IRVING H. PICARD, ON DIRECT APPEAL FROM THE BANKRUPTCY COURT FOR THE SOUTHERN DISTRICT OF NEW YORK Trustee-Appellee. FINAL BRIEF OF IRVING H. PICARD, TRUSTEE-APPELLEE DAVID J. SHEEHAN JORIAN L. ROSE AMY E. VANDERWAL SEANNA R. BROWN BAKER & HOSTETLER LLP 45 Rockefeller Plaza New York, New York (212) Attorneys for Trustee-Appellee Irving H. Picard, as Trustee for the Substantively Consolidated SIPA Liquidation of Bernard L. Madoff Investment Securities LLC and the Estate of Bernard L. Madoff

2 Case: Document: 164 Page: 2 07/11/ TABLE OF CONTENTS Page PRELIMINARY STATEMENT... 1 JURISDICTIONAL STATEMENT... 3 COUNTERSTATEMENT OF ISSUES PRESENTED... 4 COUNTERSTATEMENT OF FACTS... 5 A. The SIPA Liquidation... 5 B. The Net Equity Dispute... 7 C. The Dispute Regarding Time-Based Damages...12 D. The Bankruptcy Court Decision...13 SUMMARY OF ARGUMENT...17 STANDARD OF REVIEW...20 ARGUMENT...20 I. SIPA Does Not Support The Adjustment To Net Equity Sought By Appellants...20 A. The Plain Language Of SIPA Does Not Provide For The Payment Of Time-Based Damages...20 B. Payment Of Time-Based Damages Is Inconsistent With The Purposes Of SIPA...24 C. Payment Of Time-Based Damages Would Thwart SIPA s Distribution Scheme...27 II. III. The Trustee s Determination And The Bankruptcy Court s Opinion Are Consistent With This Court s Net Equity Decision And The Traditional Approach To Ponzi Scheme Distributions...34 A Recent Decision Of This Court Supports The Trustee s Position i-

3 Case: Document: 164 Page: 3 07/11/ TABLE OF CONTENTS (continued) Page IV. While The Trustee s Position Is Entitled To Deference, The Bankruptcy Court Correctly Accorded No Deference To The SEC s Position...43 V. Judicial Estoppel Has No Application...50 CONCLUSION ii-

4 Case: Document: 164 Page: 4 07/11/ TABLE OF AUTHORITIES Cases Page(s) In re A. R. Baron Co., 226 B.R. 790 (Bankr. S.D.N.Y. 1998) Arford v. Miller, 239 B.R. 698 (S.D.N.Y. 1999) In re Bernard L. Madoff Inv. Sec. LLC, 133 S. Ct. 24, 133 S. Ct. 25 (2012) In re Bernard L. Madoff Inv. Sec. LLC, 424 B.R. 122 (Bankr. S.D.N.Y. 2010)... 7, 8, 10 In re Bernard L. Madoff Inv. Sec. LLC, 654 F.3d 229 (2d Cir. 2011)... 11, 35, 38 In re C.J. Wright, 162 B.R. 597 (M.D. Fla. 1993) Calvert v. Radford (In re Consol. Meridian Funds), 487 B.R. 263 (Bankr. W.D. WA 2013) In re Carrozzella & Richardson, 286 B.R. 480 (D. Conn. 2002) CFTC v. Topworth Int l, Ltd., 205 F.3d 1107 (9th Cir. 1999) Chandler v. Bombardier, 44 F.3d 80 (2d Cir. 1994) Chevron U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837 (1984) Commodity Futures Trading Comm n v. Walsh, 712 F.3d 735 (2d Cir. 2013)...passim Connecticut Nat l Bank v. Germain, 503 U.S. 249 (1992) Cunningham v. Brown, 265 U.S. 1 (1924) iii-

5 Case: Document: 164 Page: 5 07/11/ TABLE OF AUTHORITIES (continued) Page(s) Dole Food Co. v. Patrickson, 538 U.S. 468 (2003) Donnell v. Kowell, 533 F.3d 762 (9th Cir. 2008) Horowitz v. Am. Int l Group, Inc., No. 09 Civ. 7312, 2010 WL , at *6 (S.D.N.Y. Sept. 30, 2010), aff d, 498 F. App x 51 (2d Cir. 2012) Intellivision v. Microsoft Corp., 484 Fed. App x 616 (2d Cir. 2012) Jacobson Family Invs., Inc. v. Nat l Union Fire Ins. Co. of Pittsburgh, PA, 955 N.Y.S.2d 338 (1st Dep t 2012) In re John Dawson & Assoc., Inc., 289 B.R. 654 (Bankr. N.D. Ill. 2003) Kansas v. Colorado, 533 U.S. 1 (2001) In re Klein, Maus & Shire, Inc., 301 B.R. 408 (Bankr. S.D.N.Y. 2003) Kusch v. Mishkin (In re Adler, Coleman Clearing Corp.), No (JLG), 1998 WL (Bankr. S.D.N.Y. Aug. 24, 1998), aff d, 208 F.3d 202 (2d Cir. 2000) Mulvaney Mech., Inc. v. Sheet Metal Workers Int l Ass n, Local 38, 288 F.3d 491 (2d Cir. 2002), vacated and remanded, 538 U.S. 918 (2002), aff d on reh g, 351 F.3d 43 (2d Cir. 2003) In re Murel Holding Corp., 75 F.2d 941 (2d Cir. 1935) New Hampshire v. Maine, 532 U.S. 742 (2001) iv-

6 Case: Document: 164 Page: 6 07/11/ TABLE OF AUTHORITIES (continued) Page(s) In re New Times Sec. Servs., Inc., 371 F.3d 68 (2d Cir. 2004)...passim Official Cattle Contract Holders Comm. v. Commons (In re Tedlock Cattle Co., Inc.), 552 F.2d 1351 (9th Cir. 1977) In re Old Naples Sec. Inc., 311 B.R. 607 (M.D. Fla. 2002) Plumbers & Steamfitters Local 490 Severance and Ret. Fund v. Appleton (In re First Ohio Sec. Co.), No , 1994 WL (6th Cir. Nov. 1, 1994) Proctor & Gamble Distrib. Co. v. Sherman, 2 F.2d 165 (S.D.N.Y. 1924) Rodal v. Anesthesia Grp. of Onondaga, P.C., 369 F.3d 113 (2d Cir. 2004) Sanders v. John Nuveen & Co., Inc., 524 F.2d 1064 (7th Cir. 1975) Scholes v. Lehmann, 56 F.3d 750 (7th Cir. 1995) Sec. Investor Prot. Corp. v. Ambassador Church Fin. Dev. Gr p, Inc., 788 F.2d 1208 (6th Cir. 1986), cert. den. sub nom. Pine Street Baptist Church v. Sec. Investor Prot. Corp., 479 U.S. 850 (1986) Sec. Investor Prot. Corp. v. Associated Underwriters, Inc., 423 F. Supp. 168 (D. Utah 1975) Sec. Investor Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC (In re Bernard L. Madoff Inv. Sec. LLC), 496 B.R. 744 (Bankr. S.D.N.Y. 2013)...passim Sec. Investor Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC (In re Madoff Inv. Sec. LLC), 499 B.R. 416 (S.D.N.Y. 2013) v-

7 Case: Document: 164 Page: 7 07/11/ TABLE OF AUTHORITIES (continued) Page(s) SEC v. Aberdeen Sec. Co., Inc., 480 F.2d 1121 (3d Cir. 1973), cert. denied sub nom. Seligsohn v. SEC, 414 U.S (1973) SEC v. Albert & Maguire Sec. Co., 560 F.2d 569 (3d Cir. 1977) SEC v. Credit Bancorp, Ltd., 290 F.3d 80 (2d Cir. 2002) SEC v. Howard Lawrence & Co., 1 B.C.D. 577, 579 (Bankr. S.D.N.Y. 1975) SEC v. Sec. Investor Prot. Corp., No. 11-mc-678 (RLW), 2012 WL (D.D.C. July 3, 2012) SEC v. Sec. Investor Prot. Corp., 872 F. Supp. 2d. 1 (D.D.C. July 3, 2012), motion for summary affirmance granted, SEC v. Sec. Investor Prot. Corp., , 2013 WL (D.C. Cir. Mar. 12, 2013) Skidmore v. Swift & Co., 323 U.S. 134 (1944)... 16, 19, 44, 45 In re Stratton Oakmont, Inc., No. 01 CV 2812, 2003 WL (S.D.N.Y. Nov. 14, 2003)... 28, 39 Till v. SCS Credit Corp., 541 U.S. 465 (2004)... 32, 33 Troll Co. v. Uneeda Doll Co., 483 F.3d 150 (2d Cir. 2007) In re Unified Commercial Capital, Inc., 260 B.R. 343 (Bankr. W.D.N.Y. 2001), aff d sub nom WL (W.D.N.Y. June 21, 2002)... 40, 43 United States v. City of Warren, 138 F.3d 1083 (6th Cir. 1998) vi-

8 TABLE OF AUTHORITIES (continued) Page(s) In the Matter of Waipawa Finance Company Limited, 2011 NZCCLR 14, 57 (7 Feb. 2011, NZHC CIV ) In re Weis Sec., Inc., No. 73 Civil 2332, 1976 WL 820 (S.D.N.Y. Aug. 2, 1976)... 27, 29 Statutes Case: Document: 164 Page: 8 07/11/ U.S.C U.S.C U.S.C. 548(a)(1)(A) U.S.C. 1712a U.S.C. 78ddd(f)-(h) U.S.C. 78eee(a)(4)(B) U.S.C. 78eee(b)(3) U.S.C. 78eee(b)(4)... 3, 5, 6 15 U.S.C. 78fff-(2)(b)... 6, 22, U.S.C. 78fff-2(c)(1) U.S.C. 78fff-(2)(c)(1)(B) U.S.C. 78fff-2(c)(3) U.S.C. 78fff-2(c)(B) U.S.C. 78fff-3(a) U.S.C. 78fff-3(c)(1) U.S.C. 78fff-3(c)(2) U.S.C. 78fff-3(e)(1) U.S.C. 78fff-3(e)(2)-(3) vii-

9 TABLE OF AUTHORITIES (continued) Page(s) 15 U.S.C. 78fff-3(e)(5) U.S.C. 78fff(b) U.S.C. 78fff(d) U.S.C. 78jjj U.S.C. 78lll(11)... 6, U.S.C. 1087rr U.S.C. 1134b U.S.C. 158(d)(2) U.S.C. 158(d)(2)(A)... 3 Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No , 929H(a), 124 Stat (2010) Rules Case: Document: 164 Page: 9 07/11/ C.F.R c3 3(e) C.F.R c C.F.R c3-3a, Ex. A Treas. Reg (b)(1), 7(g) Other Authorities 2 Dan B. Dobbs, Dobbs Law of Remedies: Damages-Equity- Restitution (2d ed. 1993) A Norman J. Singer, Statutes and Statutory Construction (6th ed. 2000) Madoff Ponzi Scheme: Testimony Before the House of Representatives, Financial Services, Capital Markets, Insurance, and Govt. Sponsored Entities, 2009 WL (Dec. 9, 2009)... 10, 35 -viii-

10 Case: Document: 164 Page: 10 07/11/ TABLE OF AUTHORITIES (continued) Page(s) Reserves and Related Measures Respecting the Financial Responsibility of Brokers and Dealers, EXCHANGE ACT RELEASE NO. 9,388, 36 Fed. Reg. 22 (proposed Nov. 24, 1971) ix-

11 Case: Document: 164 Page: 11 07/11/ PRELIMINARY STATEMENT The Securities Investor Protection Act ( SIPA ) requires the Trustee to return customer property to BLMIS customers based on their net equity. To determine each customer s net equity under SIPA in this liquidation, the Trustee applied the net investment method, balancing a customer s withdrawals and deposits over the life of their account. In upholding this method of calculating net equity, this Court recognized that the Trustee may not pay claims based on fictitious amounts and that customers who have not yet received their principal have a priority claim to the customer property collected by the Trustee. Appellants seek to create or augment their net equity claims against the estate by adding an interest or inflation component. However, the bankruptcy court correctly found that such an adjustment is improper and without a legal or equitable basis. SIPA does not provide for any such adjustment to net equity. Nothing in the definition of net equity mentions interest, inflation, or any other damages (collectively, Time-Based Damages ). That Congress did not intend to provide for Time-Based Damages is apparent when the net equity definition is contrasted with other sections of SIPA, which specifically provide for interest or inflation increases. The plain language of SIPA requires that net equity be determined in accordance with the books and records of BLMIS. And there is no support in those books and records for the imposition of a Time-Based Damages adjustment.

12 Case: Document: 164 Page: 12 07/11/ Payment of Time-Based Damages is also inconsistent with SIPA s purposes and its distribution scheme. By seeking inflation or other adjustments, Appellants are attempting to recover amounts beyond the property their net investment that they invested with BLMIS. They are seeking to obtain damages for the loss of purchasing power or opportunity costs caused by BLMIS s misuse of their property. Under SIPA s allocation scheme, such damages claims may only be paid out of the general estate, if they are paid at all. While Appellants argue that Time-Based Damages should be paid to protect their legitimate expectations, the bankruptcy court correctly found that Appellants, as investors in the securities markets, bargained for gains and losses from securities trading (even though such trading did not occur). They did not bargain for protection from inflation or a guaranteed interest rate. As such, the adjustments they seek are unrelated to their legitimate expectations regarding investing with their broker, BLMIS. Appellants position is also inconsistent with this Court s recent decision in Walsh, in which this Court declined to award time-based adjustments in another long-running Ponzi scheme. The Walsh case is similar to this one in that limited assets existed and the investors lost principal had not yet been returned. This Court s rationale in Walsh applies equally here and precludes Appellants from 2

13 Case: Document: 164 Page: 13 07/11/ recovering more than they invested in BLMIS before others have received their principal investment. Finally, this Court has previously stated that the Trustee s determination regarding the appropriate method of calculating net equity is entitled to deference. Here, the Trustee has examined all relevant factors and determined that under SIPA, the calculation of net equity cannot be adjusted to include Time-Based Damages. The bankruptcy court s decision was correct and should be affirmed. JURISDICTIONAL STATEMENT The United States Bankruptcy Court for the Southern District of New York has jurisdiction over this case under SIPA 78eee(b)(4). The bankruptcy court issued a decision on September 10, 2013 affirming the Trustee s determination that net equity under SIPA does not include Time-Based Damages. See Sec. Investor Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC (In re Bernard L. Madoff Inv. Sec. LLC), 496 B.R. 744 (Bankr. S.D.N.Y. 2013) ( Bankruptcy Court Decision ). The bankruptcy court certified an immediate appeal of its decision to this Court under 28 U.S.C. 158(d)(2)(A). DA Notices of appeal and a petition for permission were filed with this Court, and on January 22, 2014, this Court accepted jurisdiction of this direct appeal. DA

14 Case: Document: 164 Page: 14 07/11/ COUNTERSTATEMENT OF ISSUES PRESENTED 1. Net equity under SIPA is the amount a debtor would have owed to a customer if the debtor liquidated the securities positions of the customer, plus any cash deposited to purchase securities. The statute makes no reference to adjustments to net equity based upon interest or inflation. Did the bankruptcy court correctly conclude that net equity must be calculated using the net investment method, consistent with this Court s prior ruling, with no adjustments for interest or inflation? 2. The Securities & Exchange Commission ( SEC ) has taken inconsistent positions in this and other Ponzi schemes as to the use of the constant dollars when making distributions, advocating here that it could be appropriate if the bankruptcy court had so determined in view of the costs and benefits. In other similar instances, the SEC argued that use of constant dollars would not be appropriate. Was the bankruptcy court correct in finding that the SEC s position was not entitled to deference since the SEC s interpretation is unsupported by the plain language of the statute, was not introduced through notice and comment procedures, and is contrary to a position taken by the agency in similar cases? 3. After this Court determined as a matter of law that the Trustee s net investment method was the appropriate manner to determine a customer s net equity, was the bankruptcy court correct in deciding the question of whether the 4

15 Case: Document: 164 Page: 15 07/11/ statutory definition of net equity includes adjustments for interest or inflation as a matter of law? COUNTERSTATEMENT OF FACTS A. The SIPA Liquidation On December 11, 2008, federal agents arrested Bernard L. Madoff ( Madoff ), revealing the existence of the largest Ponzi scheme in history. On December 15, 2008, SIPC filed an application under SIPA 78eee(a)(4)(B), alleging that because of its insolvency, BLMIS needed SIPA protection. The SEC consented to the consolidation of its case with SIPC s action against Madoff. The district court appointed the Trustee under SIPA 78eee(b)(3) and referred the case to the bankruptcy court pursuant to SIPA 78eee(b)(4). Upon his appointment, the Trustee was vested with the powers enumerated by SIPA and the Bankruptcy Code, including the powers to investigate the circumstances of BLMIS s insolvency, to recover funds to maximize the customer property estate, and to equitably distribute those funds to victimized customers. Under section 78fff(b) of SIPA, chapters 1, 3, 5 and subchapters I and II of chapter 7 of the Bankruptcy Code are applicable to the BLMIS liquidation to the extent they are consistent with SIPA. The bankruptcy court entered a claims procedures order (the Claims Procedures Order ) to implement a customer claims process in accordance with 5

16 Case: Document: 164 Page: 16 07/11/ SIPA. DA Customers were required to file claims with the Trustee by July 2, The Trustee would then issue a claim determination in writing. Thereafter, the Claims Procedures Order required claimants who disagreed with the Trustee s claim determination to file objections with the bankruptcy court setting forth the bases of their objection. Id. SIPA provides that customers share pro rata in customer property to the extent of their net equity. SIPA 78fff-(2)(c)(1)(B). Net equity is defined as the dollar amount of the account or accounts of a customer, to be determined by... (A) calculating the sum which would have been owed by the debtor to such customer if the debtor had liquidated, by sale or purchase on the filing date, all securities positions of a customer... minus (B) any indebtedness of such customer to the debtor on the filing date[.] SIPA 78lll(11). SIPA requires that the Trustee make payments to customers based on net equity insofar as the amount owed to the customer is ascertainable from the books and records of the debtor or otherwise established to the satisfaction of the trustee. SIPA 78fff-(2)(b). Accordingly, the Trustee began reviewing the more than 16,500 claims submitted to him by evaluating BLMIS s books and records to calculate each customer s net equity under SIPA. 6

17 Case: Document: 164 Page: 17 07/11/ B. The Net Equity Dispute In December 2008, the Trustee began reconciling the books and records of BLMIS and investigating the claims of the debtor. Numerous federal and state agencies also launched investigations. These parallel investigations revealed that BLMIS was used to perpetrate a massive Ponzi scheme in which the funds invested by some customers were used to pay other customers withdrawal requests. When the scheme collapsed in 2008, money from those BLMIS accounts where deposits exceeded withdrawals (net losers) had been dispersed through the scheme and was in the hands of accountholders who withdrew more than they deposited (net winners). A small fraction of the amount owed to customers was on hand at the debtor at the time of the collapse. Thus, the Trustee was faced with applying the provisions of SIPA against the backdrop of the largest Ponzi scheme in history. Virtually no securities positions existed to liquidate that could be used to value net equity. The Trustee examined the books and records of BLMIS, which showed no securities purchases, only the amounts of cash withdrawn and deposited by customers. He concluded that each customer s net equity under SIPA must be calculated by crediting the amount of cash deposited by the customer into their BLMIS account, less any amounts withdrawn from their BLMIS customer account. This is referred to as the net investment method. In re Bernard L. Madoff Inv. Sec. LLC, 424 B.R. 122, 7

18 Case: Document: 164 Page: 18 07/11/ (Bankr. S.D.N.Y. 2010) (the Bankruptcy Court Net Equity Decision ). Certain customers, however, asserted that they should be entitled to recover the amounts on their last account statement (the last statement method ), even though those statements were fictitious and reflected fake profits and nonexistent trades. Id. The Trustee s investigation, as well as the various federal and state criminal and civil investigations, remained ongoing in Fall Because the issue of calculating net equity was central to the BLMIS liquidation, the Trustee moved the bankruptcy court for a scheduling order to brief the issue in September In response to the Trustee s motion for scheduling, certain claimants submitted oppositions and responses regarding the proper scope of briefing on the net equity issue. DA (collecting objections and responses). At the hearing on scheduling of the dispute, certain parties raised the issue of whether claimants should be credited interest on the amounts deposited. The bankruptcy court expressed its reluctance to expand the dispute beyond the basic issues of whether claimants were entitled to their net investments or were entitled to the amounts on their last statement. DA ( I don't see the need to expand the basic issue. If [interest] is a discrete issue, that could be the subject of a further scheduling order which I would intend to consider at a subsequent conference or hearing where we will address scheduling for the discrete issues that 8

19 Case: Document: 164 Page: 19 07/11/ remain open beyond the basic issues. ). Nonetheless, because no objection was lodged at the hearing, the court permitted the scope of the briefing to be expanded. Id. at Upon further reflection, the Trustee determined that the bankruptcy court s initial view was correct that the interest issue was ancillary and best dealt with as the subject of a separate proceeding. As the late Bankruptcy Judge Lifland noted, the basic issue was whether a customer s net equity should be determined according to the Trustee s net investment method or the last statement method. Only if the bankruptcy court or a higher court were to rule the Trustee s methodology was correct would the separate issue of whether a customer s net investment should be adjusted to account for interest or inflation be implicated. DA Thereafter, consistent with its own preliminary view on the matter, the bankruptcy court entered an order limiting the dispute to choosing between the two competing definitions of net equity: net investment method or last statement method. DA The Trustee, SIPC and the SEC each filed briefs urging that net equity must be calculated based upon customers net investments. See Trustee Memorandum of Law in Support of Trustee s Motion for an Order Upholding Trustee s Determination, In re Bernard L. Madoff Inv. Sec. LLC, Adv. No (SMB) 9

20 Case: Document: 164 Page: 20 07/11/ (Bankr. S.D.N.Y. Oct. 16, 2009), ECF No. 525; Memorandum of SIPC in Support of Trustee s Motion for an Order Upholding Trustee s Determination, In re Bernard L. Madoff Inv. Sec. LLC, Adv. No (SMB) (Bankr. S.D.N.Y. Oct. 16, 2009), ECF No. 519; DA (SEC Brief). The SEC, while noting that the issue was not yet before the Court, indicated that it believed that customer claims should be calculated in constant dollars. 1 DA 196. Two customers filed briefs in support of the net investment method. See Statement of Optimal Strategic U.S. Limited, et al., In re Bernard L. Madoff Inv. Sec. LLC, Adv. No (SMB) (Bankr. S.D.N.Y. Dec. 11, 2009), ECF No. 1051; Response of Brief In Favor of Trustee s Motion on the Net Equity Issue filed by Simon Jacobs, In re Bernard L. Madoff Inv. Sec. LLC, Adv. No (SMB) (Bankr. S.D.N.Y. Dec. 7, 2009), ECF No The bankruptcy court approved the Trustee s net investment method and issued an order affirming the Trustee s calculation of net equity. See Bankruptcy Court Net Equity Decision, 424 B.R The bankruptcy court observed that [a]ny dollar paid to reimburse a fictitious profit is a dollar no longer available to pay claims for money actually invested. Id. at 141. The bankruptcy court found that the Net Investment Method brings the greatest number of investors closest to 1 The SEC s position as set forth in its brief was consistent with its testimony two days prior before the House Subcommittee on the Madoff Ponzi scheme. Michael A. Conley, Madoff Ponzi Scheme, Capital Markets, Ins. & Gov t Sponsored Enters., House Fin. Servs., 2009 WL , at *9-10 (Dec. 9, 2009). 10

21 Case: Document: 164 Page: 21 07/11/ their positions prior to Madoff's scheme in an effort to make them whole. Id. at 142. On appeal, this Court affirmed, holding that the Trustee s methodology was more consistent with the statutory definition of net equity than any other method advocated by the parties or perceived by this Court. In re Bernard L. Madoff Inv. Sec. LLC, 654 F.3d 229, 235 (2d Cir. 2011) (the Net Equity Decision ). This Court stated that other methods would aggravate the injuries caused by Madoff s fraud, and that reliance on the fictitious profits shown on customer statements would have the absurd effect of treating fictitious and arbitrarily assigned paper profits as real and would give legal effect to Madoff s machinations. Id. Because this Court found that the net investment method was superior, it noted that it need not consider whether a SIPA trustee has discretion in selecting a method to calculate net equity. It nonetheless recognized that a a reviewing court could and should accord a degree of deference to such an exercise of discretion so long as the method chosen by the trustee allocates net equity among the competing claimants in a manner that is not clearly inferior to other methods under consideration. Id. at n.7. On June 25, 2012, the United States Supreme Court denied certiorari. In re Bernard L. Madoff Inv. Sec. LLC, 133 S. Ct. 24, 133 S. Ct. 25 (2012). 11

22 Case: Document: 164 Page: 22 07/11/ C. The Dispute Regarding Time-Based Damages Once the order upholding the net investment method became final, the issue of whether net equity under SIPA should be adjusted to account for interest or inflation became ripe. In October 2012, the Trustee moved the bankruptcy court for an order affirming his claims determinations, in which he calculated net equity under SIPA using the net investment method with no adjustments for inflation or interest. In support, he filed a memorandum of law and a declaration from Robert J. Rock opining on the effect of a constant dollars adjustment. See Memorandum of Law in Support of Trustee s Motion for an Order Affirming Trustee s Calculations of Net Equity and Denying Time-Based Damages, In re Bernard L. Madoff Inv. Sec. LLC, Adv. No (SMB) (Bankr. S.D.N.Y. Oct. 12, 2012), ECF No. 5039; DA (Declaration of Robert J. Rock). Various claimants objected, seeking both interest-based and inflation-based adjustments to their net equity claims. In December 2012, the SEC submitted a brief retreating from its earlier position that claims must be calculated in constant dollars, instead leaving that determination to the bankruptcy court based on its own evaluation of the costs and benefits of doing so. DA Thereafter, various claimants sought discovery from the Trustee regarding the costs and benefits of a constant dollar adjustment. After the close of 12

23 Case: Document: 164 Page: 23 07/11/ discovery, certain claimants submitted a supplemental brief and a declaration from an accountant. The Trustee and SIPC filed briefs in response, and the Trustee also filed declaration from his claims agent, Vineet Sehgal of AlixPartners LLP. See Trustee Reply Br., In re Bernard L. Madoff Inv. Sec. LLC, Adv. No (SMB) (Bankr. S.D.N.Y. July 18, 2013), ECF No. 5415; SIPC Reply Br., In re Bernard L. Madoff Inv. Sec. LLC, Adv. No (SMB) (Bankr. S.D.N.Y. July 18, 2013), ECF No. 5413; DA (Declaration of Vineet Sehgal). The Trustee, SIPC, the SEC, and various customers appeared at the hearing before the bankruptcy court. At the hearing, the SEC stated that it did not view SIPA as requiring an adjustment for constant dollars but rather that any adjustment would be discretionary. After a colloquy with the court regarding the position taken by the SEC the Walsh case, a recent Ponzi scheme in which it did not endorse a constant dollars approach, the SEC conceded that it was not asking for any deference for its view. DA 468 ( We re actually not asking for deference here. ). D. The Bankruptcy Court Decision On September 10, 2013, Judge Lifland issued his opinion, upholding the Trustee s method and overruling all objections. Bankruptcy Court Decision, 496 B.R. at 744. The court found that the Trustee s method was consistent with the 13

24 Case: Document: 164 Page: 24 07/11/ plain language and purpose of SIPA, its framework and distribution scheme, as well as this Court s precedent. First, the bankruptcy court found that the Trustee s position was consistent with the plain language of SIPA. The court noted that Congress knows how to make interest or inflation adjustments, having explicitly done so in SIPA and other federal statutes. Moreover, when Congress has provided for inflation adjustments in SIPA, it has done so with a high level of specificity such that these adjustments are carefully and clearly delineated. Id. at The fact that SIPA makes no mention of time-based damages in its definition of net equity, despite the statute having been amended several times, demonstrates that Congress did not intend such adjustments. Id. at 761, n.20. If it were determined that such adjustments should be part of SIPA s statutory scheme, the bankruptcy court found that Congress must enact such a law, not the court. Id. at The bankruptcy court also found that denying Time-Based Damages was consistent with SIPA s purpose of promoting investor confidence and satisfying customers legitimate expectations. Id. at 748. The court found that because of the nature of Madoff s Ponzi scheme, in which the account statements were complete fabrications, there was no way to know what any particular customer would have been owed if securities had been purchased for them in the market without the benefit of hindsight or backdating. Concomitantly, the court found that there was 14

25 Case: Document: 164 Page: 25 07/11/ no way to know whether inflation adjustments would bring net equity claims closer to market reality, as Appellants argue, or push them farther away. Id. at 756. And because customers bargained for a market-driven investment rather than a contractually guaranteed interest rate or an inflation-protected investment vehicle, awarding Time-Based Damages would not be consistent with customers legitimate expectations: it would instead arbitrarily shield them from the risk inherent in the securities market and provide an outcome for which [Appellants] never bargained and SIPA never intended to protect. Id. The bankruptcy court then analyzed this Court s decision in Commodity Futures Trading Comm n v. Walsh, 712 F.3d 735 (2d Cir. 2013), finding that the facts, issues, and argument mirrored the dispute before it. Walsh, like the BLMIS liquidation, involved the distribution of limited assets after a long-running Ponzi scheme. In that case, this Court upheld the district court s approval of a distribution plan that included no inflation adjustments, rejecting a customer s argument that the district court erred by not implementing a constant dollar adjustment. Bankruptcy Court Decision, 496 B.R. at (citing Walsh, 712 F.3d at ). Recognizing that any adjustment to include inflation or interest would come at the expense of victims who had not yet recovered their principal, this Court noted the importance of making victims whole and returning to them their principal. As such, the bankruptcy court held that this Court s reasoning in 15

26 Case: Document: 164 Page: 26 07/11/ Walsh favored the Trustee s proposed interpretation, applying the net investment method with no adjustments for inflation or interest. Id. at Turning to the distribution scheme and general framework of SIPA, the bankruptcy court noted that SIPA is not intended to protect customers from all losses, including claims for damages resulting from a broker s fraud, misrepresentations, or breach of contract. And Appellants arguments for an adjustment based on interest or inflation, the court found, are merely claims for damages: claims for interest-based adjustments seek compensation for [customers ] lost use of their funds while invested with BLMIS, while inflationbased claims are seeking compensation for the diminished purchasing power of the money they invested with BLMIS. Id. at (citing cases). The court found that all of this additional compensation, however, must be excluded from customer net equity claims because it amounts to damages stemming from Madoff s wrongdoing, which are not covered by SIPA. Id. at 760. At best, the bankruptcy court found that such claims must be paid from the general estate. Finally, the court held that the SEC s position on constant dollars was not entitled to either Chevron or Skidmore deference. Id. at (citing Chevron U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837 (1984); Skidmore v. Swift & Co., 323 U.S. 134 (1944)). It found that the SEC failed to introduce its position through notice and comment procedures, instead setting it forth in a brief filed in 16

27 Case: Document: 164 Page: 27 07/11/ Id. at Moreover, the SEC had never advocated the constant dollar approach in any prior litigation on the issue and in fact had opposed it in Walsh. Id. at 753. Because the SEC did not fully endorse constant dollars but instead vaguely observed that circumstances may exist to award them in this case, the bankruptcy court found the SEC s position unprecedented and unsupported in law. Id. For all of these reasons, the bankruptcy court denied any interest or inflation adjustments to net equity and upheld the Trustee s position. Id. Various notices of appeal were filed to the Bankruptcy Court Decision. Thereafter, an immediate appeal to this Court was certified and accepted under 28 U.S.C. 158(d)(2). SUMMARY OF ARGUMENT The bankruptcy court correctly held that BLMIS customer claims for net equity do not include adjustments for Time-Based Damages. To have found otherwise would be inconsistent with the language and purpose of SIPA, as well as a recent decision of this Court. Appellants approach would lead to an inequitable result where, in this case involving the distribution of limited assets, any adjustments would come at the expense of victims who have not yet had their principal investment returned. The plain language of SIPA precludes awarding Time-Based Damages. SIPA includes several interest or inflation adjustments and they are spelled out 17

28 Case: Document: 164 Page: 28 07/11/ clearly and in considerable detail. The lack of any provision for such adjustments in the definition of net equity demonstrates that Congress did not intend them. Adjustments for Time-Based Damages are also inconsistent with the purposes of SIPA, which is to return to customers their property, not compensate them for other injuries suffered as a result of a broker s insolvency. The bankruptcy court was correct in holding that by seeking interest and inflation adjustments, Appellants are not seeking return of their property under SIPA but rather are seeking damages for the loss of purchasing power or opportunity cost caused by BLMIS s misuse of their property. Under SIPA s allocation scheme, such damages claims may, at best, be paid out of the general estate after each customer s principal investment is returned from the customer property estate. As for SIPA s protection of customers legitimate expectations, the bankruptcy court correctly found that Appellants, as investors in the securities market, bargained for gains and losses from securities trading rather than protection from inflation or a guaranteed interest rate. Therefore, Time-Based Damages adjustments therefore would not protect those expectations that related to securities trading. This Court s precedents similarly support the Bankruptcy Court Decision. In the Net Equity Decision and in numerous traditional Ponzi scheme cases, this Court has held that the proper way to divide limited assets among innocent 18

29 Case: Document: 164 Page: 29 07/11/ creditors is to divide them in proportion to the amount each creditor actually lost, and that the most equitable allocation of resources is the one that makes the most victims whole. Accordingly, the Trustee s approach is the only method consistent with this Court s Walsh decision, in which the Court upheld the denial of adjustments for the time-value of money and found cash in/cash out to be the appropriate method of distributing limited assets following a Ponzi scheme, as well as the Net Equity Decision. In making its determination, the bankruptcy court correctly accorded the SEC no deference which the SEC conceded it did not seek in this case. Even if it had, the SEC would not be entitled to any deference here, where its position contradicts the position taken in other cases and is not even consistent with its earlier position in this liquidation. Its assertion that SIPA could but does not necessarily mandate Time-Based Damages is vague and not made with the requisite level of care necessary to accord that position even Skidmore deference. Finally, this Court has recognized that the Trustee has discretion when determining what method would best measure net equity, such that a reviewing court should accord deference as long as the method chosen is not clearly inferior to another approach. Far from being clearly inferior to the method proposed by Appellants, the Trustee s approach is more consistent with the plain language and purposes of SIPA, as well as with basic equity, because it comes 19

30 Case: Document: 164 Page: 30 07/11/ closer to making all customers whole and returning to them their principal investments. STANDARD OF REVIEW This Court reviews de novo the bankruptcy court s interpretation of SIPA. Net Equity Decision, 654 F.3d 229 at 234; In re New Times Sec. Servs., Inc., 371 F.3d 68, 75 (2d Cir. 2004). ARGUMENT I. SIPA Does Not Support The Adjustment To Net Equity Sought By Appellants A. The Plain Language Of SIPA Does Not Provide For The Payment Of Time-Based Damages As the bankruptcy court held, courts must assume that Congress says what it means in a statute. Conversely, the omission of statutory language indicates a lack of intent. Bankruptcy Court Decision, 496 B.R at 754 (citing Connecticut Nat l Bank v. Germain, 503 U.S. 249, (1992); Dole Food Co. v. Patrickson, 538 U.S. 468, 476 (2003)). SIPA contains no language to support applying Time- Based Damages. SIPA provides that customer property of the debtor is distributed to customers of such debtor, who shall share ratably in such customer property on the basis and to the extent of their respective net equities... SIPA 78fff-2(c)(B). Net equity is defined as: 20

31 Case: Document: 164 Page: 31 07/11/ The dollar amount of the account or accounts of a customer, to be determined by calculating the sum which would have been owed by the debtor to such customer if the debtor had liquidated, by sale or purchase on the filing date, all securities positions of such customer... minus any indebtedness of such customer to the debtor on the filing date... SIPA 78lll(11). SIPA does not provide for calculating net equity based on the length of time assets are in a customer account. This omission is meaningful because when Congress intends to include interest or inflation adjustments, it makes that clear. See, e.g., 7 U.S.C. 2014; 11 U.S.C. 104; 12 U.S.C. 1712a; 20 U.S.C. 1087rr; 20 U.S.C. 1134b. Tellingly, other sections of SIPA explicitly provide for interest. For example, SIPA has provisions for interest for late payments by brokers to SIPC, and on loans from the SEC to SIPC. SIPA 78jjj; 78ddd(f)-(h). Moreover, the recent amendments to SIPA in which Congress, among other things, increased the limit of protection for SIPA cash claims from $100,000 to $250,000, provide for these statutory limits to rise with inflation. Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No , 929H(a), 124 Stat. 1856, 1931 (2010). 2 2 Appellants argument that SIPA does not provide for Time-Based Damages because it was drafted prior to the emergence of large-scale, Ponzi-type frauds, see Brief for Certain Claimants- Appellants ( Claimants Joint Br. ) at 34 n.6, In re Bernard L. Madoff Inv. Sec. LLC, No bk(l) (2d Cir. Apr. 29, 2014), ECF No. 113, is belied by these amendments, which occurred after the frauds identified by Appellants (Bayou (2005); Stanford and Madoff (2008); Petters (2009)). If Congress wanted to address the adjustment of net equity for victims of such frauds, it had and continues to have the opportunity to do so. 21

32 Case: Document: 164 Page: 32 07/11/ In making this amendment, Congress included very clear and detailed language regarding how such inflation adjustments should occur. Specifically, SIPC s Board of Directors must consider whether to adjust the cash claim for inflation not later than January 1, 2011, and every five years thereafter. See SIPA 78fff-3(e)(1). The amendments provide a list of particular factors that the SIPC board must consider in deciding whether an adjustment is appropriate, including the economic conditions facing SIPC members, and the potential problems affecting SIPC members. See SIPA 78fff-3(e)(5). Congress also proscribed multi-step processes for calculating and publishing notice of the adjustment. See SIPA 78fff-3(e)(2)-(3). As the bankruptcy court noted, Congress knows how to include interest or inflation adjustments when they are intended. Bankruptcy Court Decision, 496 B.R. at 754. And when Congress intends those adjustments, Congress employs a high degree of specificity to make clear exactly how such adjustments should be made. The fact that such a reference was not included in the net equity definition reveals the intent of Congress with respect to Time-Based Damages. See 2A Norman J. Singer, Statutes and Statutory Construction (6th ed. 2000) ( Where one section of a statute contains a particular provision, omission of the same provisions from a similar section is significant to show different legislative intent for the two sections. ). 22

33 Case: Document: 164 Page: 33 07/11/ SIPA further provides that a customer s net equity claim is determined from the books and records of the broker or otherwise established to the satisfaction of the trustee. SIPA 78fff-2(b); Net Equity Decision, 654 F.3d at 237. The books and records of BLMIS identify cash balances in customer accounts and do not reflect interest payments, inflationary adjustments, or any other type of Time- Based Damages. Appellants reliance on BLMIS customer statements, which they claim support Time-Based Damages by showing the duration of customers investment in BLMIS, is unfounded. These documents show cash withdrawals and deposits and fictitious securities positions; they are devoid of any time-based adjustments. BLMIS did not offer Appellants a guaranteed rate of interest or inflationary factor, and their falsely-promised returns were not based on or adjusted for time. Thus, merely because one can ascertain that a customer first transferred funds to BLMIS 15 years ago does not mean that time-based adjustments are owed, particularly where the debtor s books and record do not reflect time-based adjustments and where the governing statute does not authorize such payments. With no support for Time-Based Damages in the definition of net equity, Appellants attempt to argue by analogy, looking to other sections of SIPA. Appellants reference the requirement that, in making distributions to customers, all securities shall be valued as of the close of business on the filing date (SIPA 23

34 Case: Document: 164 Page: 34 07/11/ fff-2(b)), to argue that SIPA implicitly incorporates Time-Based Damages. Just the opposite: securities can rise or fall in value. If the value of a customer s securities held by the failed broker plummeted in the market, SIPA entitles the customer only to their value as of the filing date, without any adjustment based on how long the customer had been investing with the broker or in a particular security. By valuing customer accounts according to the amounts actually held at the broker as of the filing date, and making no provision for an inflation adjustment, the definition of net equity prohibits such an adjustment. B. Payment Of Time-Based Damages Is Inconsistent With The Purposes Of SIPA The bankruptcy court correctly held that the payment of Time-Based Damages is inconsistent with the purposes of SIPA. Fundamentally, SIPA is designed to protect securities investors against losses stemming from the failure of an insolvent or otherwise failed broker-dealer to properly perform its role as the custodian of customer cash and securities. SEC v. Sec. Investor Prot. Corp., No. 11-mc-678 (RLW), 2012 WL , at *4 (D.D.C. July 3, 2012) (quoting 12 Collier on Bankruptcy (16th ed.)). Accordingly, SIPA is designed to return to customers their property, not compensate them for injuries sustained as a result of an insolvency. SIPA protects customers against the loss of cash and securities on deposit with a broker-dealer. If a customer deposits $100 for the purchase of securities but 24

35 Case: Document: 164 Page: 35 07/11/ closes the account before he places an order with the broker, the customer receives his $100 from the broker. In the event that his broker goes into liquidation before the account is closed, the loss of that $100 is what SIPA protects. Customers cannot receive more in a liquidation than would be received if the broker-dealer were solvent. Moreover, Time-Based Damages bear no relationship to securities investments, whether conceptualized as interest or inflation adjustments. Interest guarantees a particular return rate and inflation protects against the devaluation of currency over time. Investments in securities, on the other hand, fluctuate widely and are subject to market risk. SIPA does not protect against market loss or act as insurance to guarantee an investor a particular return over time in the event of the insolvency of a broker, but instead returns to customers their property entrusted to the broker. What SIPA therefore evinces is a legislative belief that customers are entitled to the benefits or burdens of their own investment decisions. The application of Time-Based Damages would impose an arbitrary scheme that is inconsistent with the language and intent of SIPA. Appellants assert that they had a legitimate expectation of being compensated for the time value of money. But during the period of their investment, Appellants could not have expected to receive adjustments for inflation or other damages on the monies they invested with BLMIS based on the consumer 25

36 Case: Document: 164 Page: 36 07/11/ price index or similar markers. Appellants thought they were invested in the securities markets, not keeping their money in an interest-bearing bank account. Appellants would have expected to see gains (and losses) from securities trading through their broker, regardless of inflation or the consumer price index. Indeed, BLMIS s collapse was precipitated, in part, by the free fall in the securities market in In arguing for an inflation adjustment, Appellants are essentially claiming that they expected to receive their last statement balance or, at the very least, something closer to it than the amount that the net investment method provides. While it is true, as Appellants argue, that SIPA strives to satisfy the legitimate expectations of customers by returning customer accounts in the form they existed on the filing date, it can do so only to the extent that there is some connection between customer accounts and market reality. New Times, 371 F.3d at 88. It is impossible here to have customer accounts reflect market reality because no securities positions existed; instead, the customer statements were after-thefact constructs that were based on stock movements that had already taken place. Net Equity Decision, 654 F.3d at 238. Time-Based Damages are unrelated to the movements that would have occurred in the market because they are not based on securities trading. As such, awarding them would only divorce net equity claims from market realities. And it is not clear that Appellants would be better off in any event: as the bankruptcy court noted, it is possible that Appellants would receive 26

37 Case: Document: 164 Page: 37 07/11/ less with an inflation adjustment to their net equity claim than they would had they truly been invested in the S&P 500 index during the relevant time period. Bankruptcy Court Decision, 496 B.R. at 756. As the bankruptcy court held, [w]hen [customers] invested in Madoff, they bargained for a market-driven investment designed to fluctuate with the performance of the market; they did not bargain for a contractually guaranteed interest rate or an inflation protected vehicle. Id. Adjusting for Time-Based Damages would erase the market risks inherent in the securities transactions that Appellants sought and provide them with a benefit for which they did not bargain, and which customers of legitimate and solvent brokers do not receive. See SEC v. Albert & Maguire Sec. Co., 560 F.2d 569, 572 (3d Cir. 1977) (SIPA does not provide protection against the vagaries of the market ). A $100 investment could be worth twice as much next year, or five years from now, but it could also be worth nothing. SIPC is not an insurer and Time-Based Damages should not be used to attempt to transform it into one. Sec. Investor Prot. Corp. v. Associated Underwriters, Inc., 423 F. Supp. 168, 171 (D. Utah 1975). C. Payment Of Time-Based Damages Would Thwart SIPA s Distribution Scheme Unlike an ordinary bankruptcy case, a SIPA liquidation gives priority to payment of customer net equity claims from the customer property estate, as distinguished from claims of general creditors, which are paid from the general 27