The District Court for the Southern District of New York recently affirmed the Bankruptcy Court’s decision to approve the method used by trustee of the
estate of Bernard L. Madoff Investment Securities LLC (BLMIS) to value the net equity of transfers between BLMIS accounts. See In re BLMIS (Melton Tr. v. Picard), Case No. 1:15-cv-01195-PAE (S.D.N.Y. Jan. 14, 2016).
The Securities Investor Protection Act (SIPA) provides that customers of a failed broker-dealer will “share ratably in such customer property on the basis
and to the extent of their respective net equities.”
Previously, the Second Circuit approved the Net Investment Method, rather than the Last Statement Method, as a proper method to calculate the “net
equity” of a BLMIS customer’s account. In re BLMIS, 654 F. 3d 229 (2011). Under the Net Investment Method, a customer’s net equity is calculated by
netting cash invested into, and withdrawals from, the BLMIS account. Conversely, the Last Statement Method values net equity based on the market value of
the securities reflected in the last BLMIS account statements. The Second Circuit rejected the latter method because BLMIS never actually purchased or sold
securities, so it would be anomalous to give “credit” for the value of securities that were not actually in an account.
The issue recently before the District Court was “how to calculate the net equity in an account when some funds in it came not from a deposit of real money
from the outside world, but from a transfer from another BLMIS account before Madoff’s fraud came to light.”
Trustee’s Method for Calculating Net Equity
To calculate net equity following an inter-account transfer, the trustee employed the Inter-Account Method, which drew from the Net Investment Method.
Under the Inter-Account Method, the trustee would credit a transferee BLMIS account only to the extent of the transferor’s BLMIS account’s net equity, as
calculated under the Net Investment Method.
For instance, assume a $5 million inter-account transfer. Further, assume that the transferor account’s net equity was only $2 million − that is, the
transferor accountholder had put $2 million more into the account than s/he had withdrawn. Under these facts, the transferee account would be credited with
$2 million − the extent of the transferor accountholder’s net equity, rather than $5 million.
The District Court and Bankruptcy Court each upheld the trustee’s decision to use the Inter-Account Method because it was consistent with the Net
Investment Method. Before the District Court, the appellees raised a variety of arguments, including that (i) the Inter-Account Method effectively allows
the trustee to liquidate fraudulent conveyance claims without an adversary proceeding, and (ii) the Inter-Account Method produces arbitrarily unfair
The first argument was rejected because the Inter-Account Method involves a calculation of “net equity” under SIPA, and not recovery of a fraudulent
conveyance claim under the Bankruptcy Code. The second argument was rejected because (a) the Inter-Account Method is not arbitrary but rather consistent
with the Net Investment Method, and (b) the Inter-Account Method “promotes SIPA’s fairness objective because ... it prioritizes the recovery of money for
net losers − those who have yet to recover their principal invested.”
This opinion is important for customers with BLMIS accounts, and particularly those who completed inter-account transfers. Its broader applicability,
however, seems limited, because the ruling turns on the fact that BLMIS was a Ponzi scheme. As a result, this decision does not readily assist the
calculation of “net equity” for customer accounts of failed broker-dealers that, unlike BLMIS, actually invested in real securities. In those situations,
the Last Statement Method, rather than the Net Investment Method, may be more appropriate to determine net equity.