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entitled 'Securities Investor Protection Corporation: Interim Report 
on the Madoff Liquidation Proceeding' which was released on March 7, 
2012. 

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United States Government Accountability Office:
GAO: 

Report to Congressional Requesters: 

March 2012: 

Securities Investor Protection Corporation: 

Interim Report on the Madoff Liquidation Proceeding: 

GAO-12-414: 

GAO Highlights: 

Highlights of GAO-12-414, a report to congressional requesters. 

Why GAO Did This Study: 

With the collapse of Bernard L. Madoff Investment Securities, LLC—a 
broker-dealer and investment advisory firm with thousands of clients—
Bernard Madoff admitted to reporting $57.2 billion in fictitious 
customer holdings. The Securities Investor Protection Corporation 
(SIPC), which oversees a fund providing up to $500,000 of protection 
to qualifying individual customers of failed securities firms, 
selected a trustee to liquidate the Madoff firm and recover assets for 
its investors. The method the Trustee is using to determine how much a 
customer filing a claim could be eligible to recover—-an amount known 
as “net equity”—-has been the subject of dispute and litigation. This 
report discusses (1) how the Trustee and trustee’s counsel were 
selected, (2) why the method for valuing customer claims was chosen, 
(3) costs of the liquidation, and (4) disclosures the Trustee has made 
about its progress. GAO examined the Securities Investor Protection 
Act; court filings and decisions; and SIPC, Securities and Exchange 
Commission (SEC), and Trustee reports and records. GAO analyzed cost 
filings and interviewed SIPC, SEC, and SEC Inspector General 
officials, and the Trustee and his counsel. 

What GAO Found: 

The Securities Investor Protection Corporation (SIPC) generally 
followed its past practices in selecting the trustee for the Madoff 
liquidation. SIPC maintains a file of trustee candidates from across 
the country, but given the anticipated complexities of the case, 
officials said the field of potential qualified trustees was limited. 
SIPC has sole discretion to appoint trustees and, wanting to act 
quickly, SIPC senior management considered four trustee candidates. 
After three of the four candidates were eliminated for reasons 
including having a conflict of interest or ongoing work on a large 
financial firm failure, SIPC selected Irving H. Picard, who has 
considerable securities and trustee experience. However, SIPC has not 
documented a formal outreach procedure for identifying candidates for 
trustee and trustee’s counsel, or documented its procedures and 
criteria for selecting persons for particular cases, as internal 
control standards recommend. Having such documented procedures could 
allow SIPC to better assess whether it has identified an optimal pool 
of candidates, and to enhance the transparency of its selection 
decisions. 

A key goal of broker-dealer liquidations is to provide customers with 
the securities or cash they had in their accounts. However, because 
the Trustee determined that amounts shown on Madoff customers’ 
statements reflected years of fictitious investments and profits, he 
chose to determine customers’ net equity using the “net investment 
method” (NIM), which values customer claims based on amounts invested, 
less amounts withdrawn. SIPC senior management and officials of the 
Securities and Exchange Commission (SEC)—-which oversees SIPC—-
initially agreed on the appropriateness of NIM. Over the course of 
2009, however, SEC officials continued to consider alternative 
approaches for reimbursing customers. Although some customers have 
challenged the Trustee’s use of NIM, two courts have held that the 
Trustee’s approach is consistent with the law and with past cases, 
with both courts indicating that using the values shown on customers’ 
final statements would effectively sanction the Madoff fraud and 
produce “absurd” results. In November 2009, SEC commissioners voted to 
support the use of NIM, but with an adjustment for inflation, in an 
approach known as the “constant dollar” method. However, after an SEC 
official’s conflict of interest was made public in February 2011, the 
SEC Chairman directed SEC staff to review whether the commission 
should revote on the constant dollar approach. The matter is currently 
pending. 

As of October 2011, costs of the Madoff liquidation reached more than 
$450 million, and the Trustee estimates the total costs will exceed $1 
billion by 2014. Legal costs, which include costs for the Trustee and 
the trustee’s counsel, are the largest category. While the estimated 
total cost for the Madoff liquidation is double the total for all 
completed SIPC cases to date, the Trustee, SIPC, and SEC note that the 
costs reflect the unprecedented size, duration, and complexity of the 
Madoff fraud. SIPC senior management also said the liquidation costs 
are justified, as litigation the trustee has pursued has produced $8.7 
billion in recoveries for customers to date. Through various reports, 
court filings, and a website, the Trustee has disclosed information 
about the status of the liquidation. SIPC senior management, SEC 
officials, and the U.S. Bankruptcy Court have concluded that the 
Trustee’s disclosures sufficiently address the requirements for 
disclosure under the Bankruptcy Code and the Securities Investor 
Protection Act. 

What GAO Recommends: 

SEC should advise SIPC to (1) document its procedures for identifying 
candidates for trustee or trustee’s counsel, and in so doing, to 
assess whether additional outreach efforts should be incorporated, and 
(2) document a process and criteria for appointment of a trustee and 
trustee’s counsel. SEC and SIPC concurred with our recommendations. 

View [hyperlink, http://www.gao.gov/products/GAO-12-414]. For more 
information, contact A. Nicole Clowers at (202) 512-8678 or 
clowersa@gao.gov. 

[End of section] 

Contents: 

Letter: 

Background: 

SIPC Says It Followed Its Normal Process in Selecting the Trustee, but 
Lacks Documented Procedures and Formal Outreach: 

SIPC and SEC Have Supported, and Courts Have Affirmed, the Trustee's 
Use of the Net Investment Method: 

Cost of the Madoff Liquidation Will Be the Largest to Date, with 
Efforts to Recover Assets Driving Costs: 

SIPC, SEC, and the Bankruptcy Court Have Been Satisfied That the 
Trustee Has Made Sufficient Disclosures: 

Conclusions: 

Recommendations for Executive Action: 

Agency and Third Party Comments and Our Evaluation: 

Appendix I: Objectives, Scope, and Methodology: 

Appendix II: Securities Investor Protection Corporation Fund 
Assessments and Balances, 1990 to 2010: 

Appendix III: Legal Appendix on Determination of Net Equity: 

Appendix IV: Comments from the Securities and Exchange Commission: 

Appendix V: Comments from the Securities Investor Protection 
Corporation: 

Appendix VI: GAO Contact and Staff Acknowledgments: 

Tables: 

Table 1: The Trustee's Experience in Previous SIPA Cases, from 1984 
through 2005: 

Table 2: SIPA Liquidations Involving Ponzi Scheme Cases, from 1995 
through 2012: 

Table 3: Number of Accounts and Value of Claims under NIM and FSM: 

Table 4: Approved Trustee-Related Legal Cost Requests, from December 
2008 through May 2011: 

Table 5: Total Hourly Billings for the Trustee and Trustee's Counsel, 
by Staff Category, from December 2008 through May 2011: 

Table 6: Consultant Costs, May 2009 through September 2011: 

Table 7: SIPC Fund Assessments and Balances, from 1990 to 2010: 

Figures: 

Figure 1: SIPC Fund Balance, from 2000 through 2010: 

Figure 2: Key Events in the Madoff Liquidation, December 2008 to 
January 2012: 

Figure 3: Total Costs of the Madoff Liquidation, by Type, as of 
October 31, 2011: 

Figure 4: Trustee's Counsel Costs, by Category, from December 2008 
through May 2011: 

Figure 5: Partner Hours as a Percentage of Total Attorney Hours, from 
December 2008 through May 2011: 

Figure 6: Distribution of Partner Work, by Hourly Billing Rate 
Quintiles, from February 2011 through May 2011: 

Figure 7: Total Costs as Percentage of Customer Recoveries for Madoff 
and Completed SIPC Cases, for Selected Years from 1979 to 2010, Ranked 
by Cost Percentage: 

Abbreviations: 

ABA: American Bar Association: 

Baker Hostetler: Baker & Hostetler LLP: 

FSM: final statement method: 

NIM: net investment method: 

SEC: Securities and Exchange Commission: 

SEC IG: Securities and Exchange Commission Office of Inspector General: 

SIPA: Securities Investor Protection Act of 1970: 

SIPC: Securities Investor Protection Corporation: 

Treasury: Department of the Treasury: 

[End of section] 

United States Government Accountability Office: 
Washington, DC 20548: 

March 7, 2012: 

The Honorable Scott Garrett:
Subcommittee on Capital Markets and Government Sponsored Enterprises:
Committee on Financial Services:
House of Representatives: 

The Honorable Peter King:
House of Representatives: 

The Honorable Carolyn McCarthy:
House of Representatives: 

The Honorable Ileana Ros-Lehtinen:
House of Representatives: 

With the collapse of Bernard L. Madoff Investment Securities, LLC--a 
broker-dealer and investment advisory firm with thousands of clients--
in December 2008, Bernard Madoff admitted to crafting fictitious 
trades and account statements that showed customer investments 
totaling $57.2 billion. After the fraud was disclosed, investigators 
found no securities were ever purchased for customers. Within days of 
Madoff's arrest, the Securities Investor Protection Corporation 
(SIPC), a nonprofit, nongovernmental membership corporation 
responsible for providing financial protection to customers of failed 
securities firms, put the Madoff firm into liquidation. As part of 
this process, SIPC designated a trustee, attorney Irving H. Picard 
(referred to as the Trustee throughout this report), to oversee the 
liquidation of the firm and recover assets for the benefit of 
investors. 

The Securities Investor Protection Act of 1970 (SIPA) established 
procedures for liquidating failed broker-dealers. In a liquidation 
under SIPA, the trustee establishes a fund of customer property 
consisting of the cash and securities held by the broker-dealer on 
behalf of customers, plus any assets recovered by the trustee, for 
distribution among customers. Amounts in this customer property fund 
generally are distributed to the firm's customers according to the 
value of their account holdings, known as "net equity." Determination 
of net equity is a crucial step in settling customer claims for 
reimbursement from the SIPC fund and distributing any assets recovered 
from a firm's liquidation. According to SIPC, in a typical case, net 
equity is based on amounts reflected on statements from the broker-
dealer firm to the customer, in what is known as the "final statement 
method" (FSM). In the Madoff case, however, the Trustee said he 
determined that securities positions shown on customer statements were 
fictitious. Thus, he decided to value each customer's net equity 
according to the amount of cash deposited less any amounts withdrawn--
a method known as the "net investment method" (NIM). As a result, not 
all customers are eligible to receive funds from the liquidation. 
Further, the Trustee has also been pursuing lawsuits, known as 
"avoidance" or "clawback" actions, to recover funds from customers who 
withdrew more from their accounts than they had invested.[Footnote 1] 
SIPC senior management and officials of the Securities and Exchange 
Commission (SEC), which has oversight responsibilities for SIPC, told 
us they supported the Trustee's decision to use NIM. 

Because of the importance of the decision to use NIM in determining 
customer claims, you asked us to examine a series of questions about 
the actions of SIPC, the Trustee, and SEC as they relate to this 
decision. This report discusses (1) how the Trustee and trustee's 
legal counsel were selected for the Madoff liquidation, (2) the 
process and reasoning for the selection of NIM in determining customer 
claims, (3) the costs of the Madoff liquidation, and (4) the 
information that the Trustee has disclosed about his investigation and 
activities. You also asked us to examine additional issues related to 
the Madoff liquidation, which we will address in a future report, as 
agreed with your offices.[Footnote 2] 

For this report, we reviewed SIPA's requirements, analyzed SIPC 
procedures for trustee selection, and compared the process for 
selecting the trustee for the Madoff liquidation with past cases. We 
also examined how and why the Trustee selected NIM as the method for 
determining customer net equity, including comparing the selection of 
NIM in this case to the methods used in other SIPC Ponzi scheme cases. 
[Footnote 3] We analyzed and summarized court decisions related to the 
Madoff liquidation and selection of NIM. We also analyzed costs of the 
Madoff liquidation, as reported by the Trustee, and examined SIPC and 
Trustee procedures for reviewing and controlling liquidation costs. We 
assessed the cost data to the extent necessary and deemed it 
sufficiently reliable for our purposes of identifying total costs, 
cost components, and trends. We examined SIPA requirements for 
information disclosures that trustees must make, and reviewed 
disclosures the Trustee has made to date. Finally, we interviewed 
officials from SIPC, SEC, and the SEC Office of Inspector General, 
plus the Trustee and his counsel. See appendix I for additional 
information on our scope and methodology. 

We conducted this performance audit from October 2011 to March 2012 in 
accordance with generally accepted government auditing standards. 
Those standards require that we plan and perform the audit to obtain 
sufficient, appropriate evidence to provide a reasonable basis for our 
findings and conclusions based on our audit objectives. We believe 
that the evidence obtained provides a reasonable basis for our 
findings and conclusions based on our audit objectives. 

Background: 

SIPC's mission is to promote confidence in securities markets by 
seeking to return customers' cash and securities when a broker-dealer 
fails. SIPC provides advances for these customers up to the SIPA 
protection limits--$500,000 per customer, except that claims for cash 
are limited to $250,000 per customer.[Footnote 4] SIPC is governed by 
a seven-member board of directors. Its membership is, generally, 
brokers or dealers registered under section 15(b) of the Securities 
and Exchange Act of 1934. Membership is mandatory for all registered 
broker-dealers that do not meet one of the limited statutory 
exemptions.[Footnote 5] As of December 31, 2010, SIPC had 4,773 
members. 

While SIPC is not a federal agency, it is subject to federal 
oversight. Under SIPA, SEC exercises what the U.S. Supreme Court has 
recognized as "plenary," or general, supervisory authority over SIPC. 
[Footnote 6] Specifically, SIPC bylaws and rules are subject to SEC 
review. SEC also may require SIPC to adopt, amend, or repeal any bylaw 
or rule. In addition, SEC can participate as a party in any judicial 
proceeding under SIPA and can file an application in the U.S. District 
Court for the District of Columbia for an order compelling SIPC to 
carry out its statutory obligations. Further, SIPA authorizes SEC to 
conduct inspections and examinations of SIPC, and requires SIPC to 
furnish SEC with reports and records that it believes are necessary or 
appropriate in the public interest or to fulfill the purposes of SIPA. 
All seven members of SIPC's board of directors are appointed by 
federal officials: one is appointed by the Secretary of the Treasury 
and one by the Federal Reserve Board, from among the officers and 
employees of those agencies, and five are appointed by the President, 
subject to Senate confirmation.[Footnote 7] 

SIPC Fund: 

SIPA established a fund (SIPC fund) to pay for SIPC's operations and 
activities. SIPC uses the fund to make advances to satisfy customer 
claims for missing cash and securities, including notes, stocks, 
bonds, and certificates of deposit. The SIPC fund also covers the 
administrative expenses of a liquidation proceeding when the general 
estate of the failed firm is insufficient; these include costs 
incurred by a trustee, trustee's counsel, and other advisors.[Footnote 
8] 

SIPC finances the fund through annual assessments, set by SIPC, on all 
member firms, plus interest generated from its investments in 
Department of the Treasury (Treasury) notes. If the SIPC fund becomes, 
or appears to be, insufficient to carry out the purposes of SIPA, SIPC 
can borrow up to $2.5 billion from the Treasury through SEC, whereby 
SEC would borrow the funds from the Treasury and relend them to SIPC. 
Figure 1 shows the SIPC fund's balance over the past decade, with the 
balance falling after the 2008 financial crisis and beginning to 
recover in 2010. 

Figure 1: SIPC Fund Balance, from 2000 through 2010: 

[Refer to PDF for image: vertical bar graph] 

Year: 2000; 
SIPC Fund Balance: $1.22 billion. 

Year: 2001; 
SIPC Fund Balance: $1.18 billion. 

Year: 2002; 
SIPC Fund Balance: $1.26 billion. 

Year: 2003; 
SIPC Fund Balance: $1.25 billion. 

Year: 2004; 
SIPC Fund Balance: $1.29 billion. 

Year: 2005; 
SIPC Fund Balance: $1.29 billion. 

Year: 2006; 
SIPC Fund Balance: $1.4 billion. 

Year: 2007; 
SIPC Fund Balance: $1.52 billion. 

Year: 2008; 
SIPC Fund Balance: $1.7 billion. 

Year: 2009; 
SIPC Fund Balance: $1.09 billion. 

Year: 2010; 
SIPC Fund Balance: $1.18 billion. 

Year: 2011; 
SIPC Fund Balance: $1 billion. 

Source: SIPC. 

[End of figure] 

According to SIPC senior management, recent demands on the fund, 
including from the Madoff case, coupled with a change in SIPC bylaws 
increasing the target size of the fund from $1 billion to $2.5 
billion, led SIPC to impose new industry assessments that total about 
$400 million annually. The assessments, equal to one-quarter of 1 
percent of net operating revenue, will continue until the $2.5 billion 
target is reached, according to SIPC senior management. The new 
assessments replaced a flat $150 annual assessment per member firm. 
[Footnote 9] Under the new levies, the average assessment for 2010 was 
$91,755 per firm, with a median of $2,095, according to SIPC. See 
appendix II for a history of assessments and assessment rates for the 
SIPC fund. 

Liquidations under SIPA: 

SIPA authorizes SIPC to begin a liquidation action by applying for a 
protective order from an appropriate federal district court if it 
determines that one of its member broker-dealers has failed or is in 
danger of failing to meet its obligations to customers and one or more 
additional statutory conditions are met.[Footnote 10] The broker-
dealer has an opportunity to contest the protective order application. 
If the court issues the order, the court appoints a "disinterested" 
trustee selected by SIPC, or, in certain cases, SIPC itself, to 
liquidate the firm.[Footnote 11] Under SIPA, SIPC has sole discretion 
to select a trustee and trustee's counsel for the liquidation of a 
member broker-dealer firm. SEC has no statutory role in the selection 
of the trustee or trustee's counsel. SIPC attempts to match the size 
of the engagement with the capabilities of service providers. If SIPC 
were not to act immediately, SEC could opt to seek court appointment 
of an SEC receiver, pending SIPC action, according to SIPC senior 
management. After SIPC makes its selection and the trustee is 
appointed, the bankruptcy court holds a disinterestedness hearing, at 
which interested parties can object to the selected individual and 
firm named as counsel. The district court also orders removal of the 
liquidation proceeding to the federal bankruptcy court for that 
district. To the extent that it is consistent with SIPA, the 
proceeding is conducted pursuant to provisions of the Bankruptcy Code. 

While SIPC designates the trustee, that person, once judicially 
appointed, becomes an officer of the court. As such, the trustee 
exercises independent judgment and does not serve as an agent of SIPC. 
Indeed, SIPC-designated trustees and SIPC have occasionally taken 
opposing legal positions in liquidation proceedings.[Footnote 12] 
Under SIPA, the trustee must investigate facts and circumstances 
relating to the liquidation; report to the court facts indicating 
fraud, misconduct, mismanagement, or irregularities; and submit a 
final report to SIPC and others designated by the court. Also, the 
trustee is to periodically report to the court and SIPC on his or her 
progress in distributing cash and securities to customers. The 
bankruptcy court is to grant the trustee and trustee's counsel 
"reasonable compensation" for services rendered and reimbursement for 
proper costs and expenses incurred in connection with the liquidation 
proceeding.[Footnote 13] 

Promptly after being appointed, the trustee must publish a notice of 
the proceeding in one or more major newspapers, in a form and manner 
determined by the court. The trustee also must see that a copy of the 
notice is mailed to existing and recent customers listed on the broker-
dealer's books and records, and provide notice to creditors in the 
manner the Bankruptcy Code prescribes. Customers must file written 
statements of claims. The notice typically informs customers how to 
file claims and explains deadlines. Two deadlines apply. One is set by 
the bankruptcy court supervising the proceeding, and the other by 
SIPA. The bankruptcy court deadline for filing customer claims applies 
to customer claims for net equity and may not exceed 60 days after the 
date that notice of the proceeding is published. Failure to meet the 
deadline can affect whether a customer claim is satisfied with 
securities or cash in lieu of securities. The SIPA deadline occurs 6 
months after the publication date. SIPA mandates that the trustee 
cannot allow any customer or general creditor claim received after the 
6-month deadline, except claims filed by the United States, any state 
or local government, or certain infants and incompetent persons 
(although a request for an extension must be filed before the 6-month 
period has lapsed). 

Once filed, claims undergo various review, according to the Trustee. 
First, the Trustee's claims agent reviews claims for completeness; if 
information is found to be missing, the claims agent sends a request 
for additional information. Next, the Trustee's forensic accountants 
review each claim form, information gathered from the Madoff firm's 
records regarding the account at issue, and information submitted 
directly by the claimant. The Trustee uses the results of this review 
in assessing his determination of the claim. Finally, claims move to 
SIPC, where a claims review specialist provides a recommendation to 
the Trustee on how each claim should be determined. Once that 
recommendation has been made, the Trustee and trustee's counsel review 
it, as well as legal or other issues raised previously. When the 
Trustee has decided on resolution of a claim, he issues a 
determination letter to the claimant. The letter also informs 
claimants of their right to object to the determination and how to do 
so. The bankruptcy court judge overseeing the liquidation rules on a 
customer's objections after holding a hearing on the matter. Decisions 
of the bankruptcy court may be appealed to the appropriate federal 
district court, and then upward through the federal appellate process. 
As of January 27, 2012, the Trustee had received 16,519 customer 
claims in the Madoff proceeding, and reached determinations on all but 
two of them. 

Figure 2 shows a timeline of key events in the Madoff liquidation. 

Figure 2: Key Events in the Madoff Liquidation, December 2008 to 
January 2012: 

[Refer to PDF for image: timeline] 

2008: 

12/11: Madoff arrested, criminally charged with multibillion-dollar 
fraud. 

12/15: U.S. District Court appoints Irving Picard as trustee to 
liquidate Madoff firm, and law firm Baker & Hostetler as trustee's 
council. 

2009: 

1/2: Claim forms mailed to Madoff customers. 

3/2: Securities Investor Protection Corporation (SIPC) announces 
reinstatement of assessments on operating revenues of member firms, to 
build SIPC fund.  

3/12: Madoff pleads guilty to 11 counts, including criminal fraud and 
money laundering.  

6/29: Madoff sentenced to maximum of 150 years in prison.  

7/2: Period to submit claims ends.  

7/29: Trustee files lawsuit against Ruth Madoff, wife of Bernard 
Madoff, seeking $45 million.  

8/5: SIPC agrees to pay undisputed portion of claims up to coverage 
limit even if customer has objected to Trustee's determination of a 
claim.  

10/2: Trustee files lawsuit against four Madoff family members, 
seeking $200 million. 

10/28: SIPC advances reach $500 million, exceeding total of all prior 
cases.  

2010: 

3/1: Addressing key issue, bankruptcy court upholds Trustee's method 
for determining value of customer claims.  

11/26: Trustee files 40 lawsuits against relatives of Madoff and wife, 
plus former employees and relatives, seeking $69 million.  

12/17: In largest recovery, Trustee and U.S. Department of Justice 
announce $7.2 billion settlement with Picower estate, with $5 billion 
allotted to customer claims.  

2011: 

6/28: Bankruptcy court rules against investors in "feeder funds"-—
companies that raised money and placed funds with Madoff firm-—on 
claim that such investors should be treated as individual Madoff 
customers.  

8/16: U.S. Court of Appeals upholds Trustee's method for determining 
value of customer fund.  

10/5: First distribution to customers-—$312 million-—begins.  

11/22: Trustee reaches $326 million settlement with Internal Revenue 
Service to recover taxes paid on behalf of account holders, allegedly 
to make Ponzi scheme appear authentic.  

2012: 

1/17: Trustee report on progress to date: recoveries/settlements at 
$8.7 billion; customer distributions at $325.5 million; and SIPC 
advances at $797.8 million. 

Source: GAO summary of SIPC and court records. 

Note: Some amounts may be approximate. 

[End of figure] 

SIPC Says It Followed Its Normal Process in Selecting the Trustee, but 
Lacks Documented Procedures and Formal Outreach: 

A SIPC liquidation of a member broker-dealer begins when either SEC or 
a securities self-regulatory organization, such as the Financial 
Industry Regulatory Authority, recommends that a firm's failure may 
require SIPC assistance, usually because of theft or other misuse of 
customer assets and insolvency. If SIPC's president, general counsel, 
and vice president for operations agree that a case should be opened, 
the SIPC president requests authority from the SIPC board chair to 
begin the action. 

Upon receiving this authority, the SIPC president selects a trustee 
and trustee's counsel after consultation within SIPC. According to 
SIPC senior management, the SIPC board does not vote on the 
selections. Instead, the selection relies on the judgment of SIPC 
senior management in what they describe as a relatively narrow field 
of specialty. SIPC senior management told us they attempt to match the 
size of the liquidation proceeding with the capabilities of the 
individuals and firms that will perform the liquidation. Typically in 
SIPC cases, the firm selected to act as the trustee's counsel is the 
same law firm of which the trustee is a member, and the statute 
explicitly permits this.[Footnote 14] According to SIPC senior 
management, having a trustee from the same law firm increases 
efficiency and cuts costs, as it provides better communication and 
allows the trustee to make better use of legal resources. 

To assist in selection of a trustee or trustee's counsel, SIPC 
maintains a file of candidates from across the country, which contains 
information such as professional experience and billing rates, and it 
subscribes to an information service that provides background 
information and ratings on lawyers and law firms, and identifies areas 
of specialization. SIPC informally assembles its roster from multiple 
sources, including inquiries from firms interested in SIPC business 
and SIPC's experience with firms it encounters in legal proceedings. 
Where SIPC is unfamiliar with local practitioners, it will seek 
recommendations from SEC staff and local judges. Among firms new to 
its roster, SIPC seeks to build their experience by using them as 
trustee's counsel in relatively small cases in which SIPC itself acts 
as trustee, or by having them serve as counsel in matters in which the 
SIPA trustee or trustee's counsel discover during an investigation a 
previously unknown conflict of interest, according to SIPC senior 
management. At the conclusion of a case, SIPC senior management 
prepares a legal and accounting evaluation of service providers used. 
Included in this evaluation is a recommendation whether to use the 
service provider again. If SIPC staff recommends against a provider, 
SIPC senior management told us, the provider is less likely to be 
selected in the future. We sought to review such evaluations, but SIPC 
senior management declined to provide them to us on the grounds they 
cover privileged attorney work-product information.[Footnote 15] 

According to SIPC senior management, the selection of the Madoff 
trustee followed these past practices. Specifically, according to 
senior management, the SIPC President received a call from SEC on 
December 11, 2008, advising him that Madoff had just turned himself in 
to law enforcement and had admitted to a massive fraud at his firm. 
Because of the likely size and complexity of this case, SIPC senior 
management told us that selecting an experienced attorney to act as 
trustee would be important, which limited the field of potential 
trustees. Upon learning of the failure of the Madoff firm, SIPC senior 
management used their experience and judgment to initially identify 
four potential trustees from their pool of candidates, including Mr. 
Picard. The three others were a former New York municipal finance 
official, who was a lawyer and accountant but had not done a SIPC case 
and was not a member of a law firm; an experienced liquidation 
attorney who was already busy with another large financial firm 
failure; and another candidate from a large New York law firm with 
extensive bankruptcy experience, but that law firm had a disqualifying 
conflict of interest. Because of the situations of the other 
candidates, SIPC contacted Mr. Picard on the morning of December 11, 
2008, and asked him to serve as trustee for the Madoff liquidation. As 
described later, the law firm Mr. Picard would soon join, Baker & 
Hostetler LLP (Baker Hostetler), was named as the trustee's counsel. 
Similarly, SIPC senior management told us that SIPC followed a similar 
process in the recent large failure of MF Global, Inc., in which they 
contacted 5 candidates, drawn from an initial field of about 10, 
before the selection was made. 

Although SIPC senior management said the process in selecting the 
Madoff trustee followed past selection practices, such practices are 
not documented. According to SIPC senior management, current SIPC 
policies do not document the decision process and any criteria applied 
in making selections because senior managers rely on their judgment 
and familiarity with individuals with appropriate experience. Further, 
they noted they must act quickly to get a trustee in place for a 
failed firm as soon as possible, because broker-dealer firms often 
fail with little advance warning. Moreover, they said that getting a 
trustee in place quickly to take over operations of the firm is 
essential to preserving assets and maximizing returns to customers. 

However, federal and private sector standards for internal control 
recommend that an entity document its system of internal controls, by 
such means as management directives, policies, operating instructions, 
and written manuals.[Footnote 16]In the case of trustee selection, 
documented policies and criteria would allow SIPC's oversight agency, 
SEC, to more effectively assess whether SIPC follows consistent 
practices in selecting trustees, as well as increase the transparency 
of SIPC's decisionmaking. SEC officials told us that having SIPC 
better document its selection process would improve SEC's ability to 
oversee SIPC activities, in such areas as determining the extent to 
which SIPC considered the fees charged by trustees or how it addressed 
potential conflict-of-interest situations. SEC officials told us they 
plan to discuss better documenting the trustee selection process and 
criteria with SIPC. 

SIPC also has not documented its outreach process for identifying 
potential candidates to serve as trustees. SIPC senior management told 
us they do not make formal efforts to expand the trustee candidate 
roster, such as by regularly or systematically identifying or 
approaching other parties. They said they view such efforts as 
unnecessary or impractical because the number of attorneys who conduct 
work relevant to broker-dealer bankruptcies is small enough that SIPC 
is already is aware of most of them, or the attorneys already are 
familiar with SIPC. Moreover, according to SIPC senior management, 
actively soliciting candidates could be burdensome for SIPC, by 
producing too much information about too many firms that can quickly 
become outdated. They told us such an undertaking would duplicate 
information already available through its information service 
subscription, and that because SIPA liquidations can be infrequent and 
in more remote areas of the country, it is more efficient to obtain 
current information on qualified firms through the information service 
and the firms' websites. 

However, undertaking additional efforts to more systematically 
identify other candidates, and to document this process, could help 
ensure that the range of choices, which SIPC senior management 
acknowledges is currently limited to a small group with the requisite 
skills, reflects the widest capabilities available. Access to a 
potentially wider pool of candidates could help ensure that SIPC is 
better equipped to meet its responsibilities. SEC officials told us 
that SIPC's goal is to use individuals and law firms capable of high-
quality work, to avoid potentially damaging legal decisions that could 
hinder SIPC in future liquidations. Having a documented, formal 
outreach process would allow SEC to better assess whether SIPC's 
outreach efforts are sufficient for ensuring that SIPC is identifying 
the optimal pool of candidates. SEC officials told us they likely 
would discuss with SIPC senior management whether its roster of 
candidates is sufficiently broad, as a wider pool could preserve 
quality while offering the opportunity for lowering costs.[Footnote 17] 

The Trustee Has Considerable Experience: 

The trustee that SIPC selected for the Madoff liquidation has 
considerable industry and broker-dealer liquidation experience. He 
served as the first U.S. Trustee for the Southern District of New 
York, where his duties included appointing and supervising trustees 
who administer consumer debtors' bankruptcy estates and corporate 
reorganization cases, and who litigate bankruptcy related matters. He 
appointed the trustee for reorganization of O.P.M. Leasing Services, 
Inc., a several-hundred-million-dollar Ponzi scheme case involving 
nonexistent computer equipment leases. He was on the staff of the SEC 
for about 8 years, where he was involved with corporate reorganization 
cases and also served as an assistant general counsel. In private 
practice, he was appointed the receiver in connection with an SEC 
injunction action against David Peter Bloom, a Ponzi scheme case 
involving investor cash losses of about $13 million. Additionally, he 
has been a trustee in 10 other SIPC cases beginning in 1984, although 
these cases were much smaller than the Madoff case, which is, by some 
measures, SIPC's largest case ever.[Footnote 18] He has served as 
trustee's counsel in two other cases. For his first case as trustee, 
Mr. Picard said SIPC contacted him and asked whether he would take the 
position. Subsequently, Mr. Picard said he has indicated to SIPC his 
continuing interest over the years in serving as a trustee, but did 
not solicit particular cases. Table 1 summarizes the Trustee's 
previous SIPC cases. 

Table 1: The Trustee's Experience in Previous SIPA Cases, from 1984 
through 2005: 

Experience as SIPA trustee: 

Jay W. Kaufmann & Company; 
Year: 1984; 
Number of customers: 1,019; 
Customer distributions: $3,134,917; 
Cause of firm's failure: Financial distress; 
Court-approved costs for trustee: $171,579; 
Court-approved costs for trustee's counsel: $128,903. 

Norbay Securities, Inc.; 
Year: 1986; 
Number of customers: 9,103; 
Customer distributions: $16,531,987; 
Cause of firm's failure: Financial distress; 
Court-approved costs for trustee: $256,555; 
Court-approved costs for trustee's counsel: $88,139. 

Investors Center Inc.; 
Year: 1989; 
Number of customers: 700; 
Customer distributions: $2,462,389; 
Cause of firm's failure: Financial distress, failure to comply with 
regulatory standards; 
Court-approved costs for trustee: $516,586; 
Court-approved costs for trustee's counsel: $245,263. 

Faitos & Co., Inc.; 
Year: 1991; 
Number of customers: 39; 
Customer distributions: $1,361,543; 
Cause of firm's failure: Misappropriation; 
Court-approved costs for trustee: $150,959; 
Court-approved costs for trustee's counsel: $39,000. 

U.S. Equity Management Corp.; 
Year: 1995; 
Number of customers: 15; 
Customer distributions: $996,345; 
Cause of firm's failure: Diversion; 
Court-approved costs for trustee: $129,676; 
Court-approved costs for trustee's counsel: $37,039. 

Hanover, Sterling & Co., Ltd.; 
Year: 1996; 
Number of customers: 151; 
Customer distributions: $2,167,974; 
Cause of firm's failure: Unauthorized trading; 
Court-approved costs for trustee: $349,716; 
Court-approved costs for trustee's counsel: $300,627. 

Euro-Atlantic Securities, Inc.; 
Year: 1998; 
Number of customers: 68; 
Customer distributions: $2,130,527; 
Cause of firm's failure: Unauthorized trading; 
Court-approved costs for trustee: $348,963; 
Court-approved costs for trustee's counsel: $212,877. 

Klein Maus & Shire, Inc.; 
Year: 2000; 
Number of customers: 22; 
Customer distributions: $2,739,099; 
Cause of firm's failure: Unauthorized trading; 
Court-approved costs for trustee: $278,195; 
Court-approved costs for trustee's counsel: $275,460. 

Montrose Capital Management Ltd.; 
Year: 2001; 
Number of customers: 10; 
Customer distributions: $917,146; 
Cause of firm's failure: Unauthorized trading; 
Court-approved costs for trustee: $239,716; 
Court-approved costs for trustee's counsel: $122,666. 

Park South Securities, LLC; 
Year: 2003; 
Number of customers: 22; 
Customer distributions: $8,013,121; 
Cause of firm's failure: Conversion and unauthorized trading; 
Court-approved costs for trustee: $1,077,996; 
Court-approved costs for trustee's counsel: $2,843,040. 

Experience as trustee's counsel: 

John Franklin & Associates, Inc.; 
Year: 1986; 
Number of customers: 3; 
Customer distributions: $980,568; 
Cause of firm's failure: Misappropriation; 
Court-approved costs for trustee: [Empty]; 
Court-approved costs for trustee's counsel: $23,265. 

Austin Securities, Inc.; 
Year: 2005; 
Number of customers: 20; 
Customer distributions: $4,041,583; 
Cause of firm's failure: Unauthorized trading; 
Court-approved costs for trustee: [Empty]; 
Court-approved costs for trustee's counsel: $98,855. 

Source: SIPC. 

Notes: In each case, the trustee was a member of the trustee's counsel 
firm. "Conversion" is generally the wrongful possession or disposition 
of another's property as if it were one's own. "Diversion" is 
generally the unauthorized use of funds. 

[End of table] 

According to the Trustee, his involvement in the Madoff case began 
when he received a call from SIPC on December 11, 2008, the day Madoff 
was arrested, asking him to serve as trustee. On December 15, 2008, 
the U.S. District Court for the Southern District of New York 
appointed Mr. Picard as trustee, and his new law firm, Baker 
Hostetler, as trustee's counsel.[Footnote 19] Selection of trustee's 
counsel was not an independent decision; both SIPC and the Trustee 
understood that trustee's counsel would be the Trustee's law firm. 
SIPC designated the Trustee's law firm as trustee's counsel, and the 
court issued an order to that effect. 

Immediately before being formally appointed trustee, Mr. Picard 
changed law firms, joining Baker Hostetler on December 15, 2008. The 
Trustee told us that he had been on a year-to-year contract with his 
previous firm, and in the fall of 2008, with the end of his contract 
approaching and having received no indication it would be renewed, had 
begun to search for new employment. He told us that he explored 
employment with restructuring firms and other law firms, including 
Baker Hostetler, and also considered short-term contract work. After 
SIPC asked him to become the Madoff trustee on December 11, 2008, he 
said he felt he needed to make a decision on joining a firm quickly, 
in advance of his formal appointment, so that he would not be in the 
position of being at one firm and then potentially departing only a 
short time later in connection with the trustee work. Two firms with 
which he was in discussions were not able to come up with offers, the 
Trustee told us, but Baker Hostetler did so. In discussions with Baker 
Hostetler over the weekend of December 13-14, the Trustee said he did 
not bring up the subject of whether he was going to be appointed the 
trustee in the Madoff case, although he said his pending selection was 
known. According to the Trustee, Baker Hostetler representatives told 
him that the firm wanted him to join regardless of whether he would 
become the Madoff trustee. The Trustee noted that having Baker 
Hostetler as trustee's counsel is helpful because the firm has 
significantly more lawyers than his former firm, which makes the case 
easier to manage. He also has been able to rely on the in-house 
expertise of other partners who have assisted him in areas including 
management of remaining Madoff employees when he took on the case; 
real estate leases; intellectual property the Madoff firm owned; sale 
of Madoff assets, such as the market-making and trading side of the 
firm; and tax issues. 

The Trustee also told us that a potential conflict at his former firm 
would have had to be resolved for him to serve as Madoff trustee had 
he remained there. He said that a partner at his former firm was going 
to provide representation in a Madoff-related matter, which could have 
presented a conflict. But the Trustee told us--and the SIPC President 
concurred--that had he accepted the trusteeship while at his former 
firm, arrangements would have been made to eliminate the conflict, so 
that the firm would not represent the other client. As a result, the 
Trustee said that any potential conflict was unrelated to his move 
between firms. The Trustee said he never asked SIPC for advice on what 
firm to join, nor did SIPC offer any guidance. 

According to the Trustee, his compensation at Baker Hostetler is based 
on his overall contributions to the firm, as with other partners, and 
is not directly related to activity of the Madoff liquidation. He also 
noted he attracts other business to the firm in addition to the Madoff 
matter. The Trustee said he pays all court-awarded compensation he 
receives from the case as trustee to Baker Hostetler. He also noted 
that he is a contract partner, not an equity partner, at Baker 
Hostetler, meaning he does not have an ownership interest in the firm. 
The Trustee declined to provide us with details of his employment 
contract, saying Baker Hostetler's practice is for "closed" 
compensation contracts, where details are not known among members of 
the firm, but rather only by firm management. He said, however, that 
with his compensation based on his overall contributions, there are no 
provisions directly tied to the Madoff case, and his compensation does 
not vary specifically based on the results of Madoff case 
developments. He also noted that as trustee, his compensation is not 
on a commission basis, as provided in the Bankruptcy Code.[Footnote 20] 

SIPC and SEC Have Supported, and Courts Have Affirmed, the Trustee's 
Use of the Net Investment Method: 

In valuing customer claims filed as part of the Madoff liquidation, 
the Trustee selected NIM, which determines the amounts that customers 
are owed as the amounts they invested less amounts withdrawn. The 
Trustee, supported at the outset of the case by SIPC and, after nearly 
a year of analysis, by SEC as well, decided against valuing claims 
based on amounts shown on customers' final statements. The parties 
said this was on the grounds that it met statutory requirements, and 
that using statement amounts would effectively sanction the Madoff 
fraud by establishing claims according to the fictitious profits 
Madoff reported. NIM has consistently been used in SIPC liquidations 
involving Ponzi schemes, and the two courts that have considered the 
net equity issue in the Madoff case--the bankruptcy court and the U.S. 
Court of Appeals for the Second Circuit--have affirmed the Trustee's 
decision on this method for determining customer claims.[Footnote 21] 

The Trustee Decided to Use Method Typically Used in Ponzi Scheme Cases: 

In a SIPA liquidation, it is the trustee that decides on the method 
for determining customer claims. SIPA refers to this as calculating a 
customer's "net equity," and the statute generally provides that this 
amount is what would have been owed to the customer if the broker-
dealer had liquidated all their "securities positions," less any 
obligations of the customer to the firm.[Footnote 22] The statute also 
provides that the trustee shall make payments to customers "insofar as 
such obligations are ascertainable from the books and records of the 
debtor or are otherwise established to the satisfaction of the 
trustee."[Footnote 23] 

In SIPA liquidations not involving fraud, trustees typically determine 
that the amounts owed to customers match the amounts shown on their 
final statements--that is, the "final statement method" (FSM). In 
particular, according to SEC officials, in most SIPA liquidations, the 
books and records of the broker-dealer match the amounts shown on 
customers' final statements. In many cases in which a broker-dealer 
fails, customer accounts are transferred to another broker-dealer 
firm.[Footnote 24] However, in cases involving fraud, amounts in 
customer accounts may not correspond to statement amounts--as in the 
Madoff case--and SIPA does not have any particular provisions for 
fraud cases beyond its general terms. 

The Trustee told us that soon after the case began, and once he 
realized the investment advisory unit of the Madoff firm was a Ponzi 
scheme, he concluded that NIM--also known as "money-in/money-out"--was 
appropriate. As noted earlier, this method determines customer net 
equity as customer deposits less customer withdrawals; it does not 
rely upon holdings reported on customers' final statements. Under NIM, 
Madoff claimants are divided into two categories: "net winners," who 
have withdrawn more than the amount they invested with the Madoff 
firm, and "net losers," who have withdrawn less than they invested. 
Following the firm's closure, the Trustee received 16,519 claims and 
denied most of them, chiefly because customers did not have accounts 
with the Madoff firm.[Footnote 25] The Trustee said the firm had 4,905 
active accounts at the time of closure. Determination of claim amounts 
under NIM resulted in 2,356 net loser accounts and 2,459 net winner 
accounts. 

According to the Trustee, the chief reason for rejecting FSM in favor 
of NIM was that adopting customer statement amounts as the basis for 
account values would legitimize Madoff's fraud and cause account 
values to hinge on the fictitious trading and returns that Madoff 
reported to investors. The Trustee took the position that customer 
statements did not show "securities positions" that could be used for 
the net equity determination, because the statements were fictitious. 
Instead, the only Madoff records that reflected reality were those 
detailing the cash deposits and withdrawals of customers. Thus, the 
Trustee asserted that he was required to determine net equity based on 
these records, because they provided the only obligations that could 
be ascertained and established from the firm's books and records. 

The Trustee also said that NIM was the most equitable method for 
Madoff customers. According to the Trustee, using FSM would allow some 
customers to retain fictitious "profits" they had withdrawn that 
actually were misappropriated investments of other customers. 
Moreover, FSM would divert the limited customer assets available from 
the liquidation by paying these fictitious profits at the expense of 
reimbursing real losses. The Trustee also said FSM could conflict with 
his obligation to recover through clawback actions fictitious profits 
that Madoff paid to some: 

investors.[Footnote 26] If the Trustee were less able to make such 
recoveries, less money would be available to return to customers. The 
Trustee told us that he is not aware of any Ponzi case in which FSM 
was used to value customer claims. 

We also found that the Trustee's selection of NIM was consistent with 
use of NIM in previous SIPA liquidations involving Ponzi schemes. 
According to SIPC data, among seven Ponzi scheme cases since 1995, 
including the Madoff case, all used NIM, in whole or in part, 
depending on facts and circumstances of individual accounts. (See 
table 2.) 

Table 2: SIPA Liquidations Involving Ponzi Scheme Cases, from 1995 
through 2012: 

Case: Consolidated Investment Services, Inc.; 
Year: 1995. 

Case: Old Naples Securities, Inc.; 
Year: 1996. 

Case: New Times Securities Services, Inc., and New Age Financial 
Services, Inc.; 
Year: 2000. 

Case: Donahue Securities, Inc., and S.G. Donahue Company, Inc.; 
Year: 2001. 

Case: Northstar Securities, Inc.; 
Year: 2001. 

Case: Continental Capital Securities, Inc.; 
Year: 2003. 

Case: Bernard L. Madoff Investment Securities, LLC; 
Year: 2008. 

Source: SIPC. 

Notes: SIPC told us that information on cases prior to 1995 was not 
readily available. The New Times case, which involved the use of NIM 
for some accounts and FSM for others, has been central to legal 
arguments on net equity determination in the Madoff case; see appendix 
III for details. Not included in the table is the 1997 Ponzi scheme 
case of First Interregional Equity Corporation. According to SIPC 
senior management, this was an atypical case that involved dual 
proceedings under SIPA and chapter 11 bankruptcy. The net equity of 
customers who were victims of the Ponzi scheme was never determined as 
part of the SIPC liquidation. Instead, customers were reimbursed from 
a settlement in the non-SIPA portion of the case. 

[End of table] 

Although the Trustee decided to use NIM to value Madoff customer 
claims, he also chose to recognize a portion of customer statement 
amounts--specifically, those dated before April 1, 1981. The Trustee 
told us this decision was due to gaps in available Madoff or third 
party records prior to that date, and that beginning with April 1, 
1981, more complete and reliable records became available. The Trustee 
said he chose to recognize these older customer statement amounts in 
an attempt to favor customer interests, even though the amounts likely 
reflect some fictitious profits. The impact of this decision, however, 
is relatively minor, according to the Trustee--recognizing about $165 
million in 371 accounts, equal to about 1 percent of total claims 
allowed and about 15 percent of total accounts with approved claims. 

Questions have been raised whether the effect on the SIPC fund 
influenced selection of the net equity method, as acceptance of higher 
customer claims under FSM could have affected SIPC's liability under 
the coverage it provides to investors. However, the Trustee told us 
that effect on the SIPC fund did not enter into his selection, and 
that he did not discuss how the use of NIM would affect the fund with 
either SIPC or SEC. 

SIPC and SEC Both Supported Use of NIM, Although SEC Considered 
Alternatives: 

Like the Trustee, SIPC quickly concluded that NIM was the appropriate 
method for determining customer claims, because of the fraud in the 
case and because using FSM would effectively sanction Madoff's 
activities. According to SIPC senior management, the focus in a net 
equity determination is on individual customer transactions--that is, 
officials do not consider at the case level which method might be 
best. In the Madoff case, the transactions were alike--fictitious. As 
a result, applying a single method of determining net equity to the 
entire Madoff case was appropriate.[Footnote 27] Furthermore, while 
trading and reported investment profits were fictitious, records were 
available on individual customer deposits and withdrawals. Such 
records make NIM calculations possible, according to SIPC. SIPC senior 
management emphasized that final customer account statements are not 
the only "books and records" of the failed firm, as cited in the 
statute.[Footnote 28] 

SIPC senior management told us that when the Madoff case began, they 
quickly began discussions aimed at producing agreement among SIPC, the 
Trustee, and SEC on the method for determining net equity. According 
to SIPC, such agreement was important in order to avoid a situation 
that had arisen in a previous case in which SEC took a position in 
court at odds with SIPC. Further, SIPC senior management said they 
wanted to reach consensus early in the liquidation out of concern that 
SEC would come under pressure to change its position as the extent of 
customer losses became clearer. 

By February 2009, SIPC senior management believed that based on their 
discussions, they had achieved consensus with SEC on use of NIM. These 
discussions included a meeting with the SEC Chairman, who, according 
to SIPC, reported that a majority of commissioners supported NIM. SIPC 
senior management noted that NIM has unpleasant consequences in some 
cases, but that honoring final statements would mean others would 
receive less than the amount of their own contributions. Further, 
adopting FSM would have put at risk a large majority of asset 
recoveries the Trustee has secured, SIPC senior management told us, 
because some funds withdrawn by customers that otherwise could be 
subject to recovery actions under NIM would instead be recognized as 
legitimate under FSM and thus not subject to recovery. 

Although initially agreeing on use of NIM, SEC staff continued to 
research other options in a process that would extend until November 
2009. SEC officials told us their preliminary view in the early days 
of the case was that NIM appeared to be the only feasible alternative, 
because it was the most consistent with the statute and fraud law 
related to Ponzi schemes. However, they said there was no official SEC 
position at the time. SEC's continued examination was of great concern 
to SIPC, according to SIPC senior management, who told us they saw the 
continuing analysis as a reversal of the earlier support for NIM. SIPC 
also said that SEC's continuing analysis raised concerns because SIPC 
needed certainty on method for valuing claims in order to begin 
processing and paying them. 

SEC officials told us they agreed it was important to settle on a 
method as quickly as possible, but that early in the case, a 
considerable amount of research remained necessary to formulate a 
recommendation for the commission's consideration. They said SEC's 
task was not to simply review SIPC's determination, but rather to 
examine the issue independently. With SIPC under considerable pressure 
to start making payments to Madoff customers, SEC's position was that 
the Trustee had to do what he thought was correct. If SEC came to a 
different view later, and the Trustee or the bankruptcy court 
determined changes needed to be made, claims payments would have to be 
adjusted as necessary.[Footnote 29] 

In a SIPA liquidation, SEC seeks to provide the maximum recovery 
possible under the law for former customers, according to SEC 
officials. Toward that end, in addition to NIM and FSM, SEC staff 
considered several net equity methods as part of their review: 

* NIM plus an adjustment based on Treasury notes. The adjustment would 
apply an interest rate based on the yield of 13-week Treasury notes 
for periods in which Madoff customer statements indicated customer 
holdings were not in securities.[Footnote 30] 

* NIM plus an alternative adjustment based on Treasury notes. Under 
this alternative, the adjustment would be made on the assumption 
customers had been fully invested in 13-week Treasury notes for the 
life of their account. This revision was in recognition that positions 
reported on Madoff statements were fabricated. 

* A combination of FSM and NIM, under which FSM would be used to pay 
claims against the SIPC fund up to the maximum protection of $500,000, 
and NIM would be used for claims against assets recovered by the 
trustee. 

* NIM plus an adjustment for inflation (described more fully later in 
this report). 

During their review, SEC officials met with outside parties who 
advocated for FSM.[Footnote 31] These outside parties advanced 
arguments including that the Trustee's view of net equity was at odds 
with the statute and its legislative history and purpose. In a letter 
to SEC, several law firms noted that the typical Madoff customer 
received written trade confirmations and monthly statements, which 
they said are the basis for determining net equity under the statute. 
Further, they said the legislative history shows that Congress 
intended customers to have valid net equity claims even when 
securities reflected on their confirmations and account statements 
were never purchased. The outside parties also argued that the 
Trustee's position would erode investor confidence at a time--during 
the financial crisis--when markets and the securities industry could 
least afford it. They asked that SEC attempt to persuade the Trustee 
to reverse course, or if that was unsuccessful, seek a court order to 
that effect. 

SEC officials characterized the meetings as an opportunity to listen 
and ask questions. They said they did not make any decisions based 
solely on information presented in these meetings, and that in 
general, the outside interests did not advance any new arguments. The 
clients of the law firms were undisclosed, but according to SIPC 
senior management, the parties represented were Madoff customers 
subject to large clawback actions. The SEC Inspector General told us 
that he does not believe there were any improper motivations in the 
lobbying by the outside groups, but that such meetings can create 
appearance problems because other parties, perhaps those with fewer 
resources and which SEC did not hear, might have had a different 
position. SEC officials told us they were open to meeting with any 
parties and did not turn down any requests to meet during this time. 

Over the course of 2009, SEC staff conducted various analyses of past 
cases and alternative approaches for valuing customer claims. After 
receiving various memorandums and briefings, SEC commissioners voted 
in November 2009 to approve the staff's request to submit a brief to 
the bankruptcy court supporting the Trustee's use of NIM. As one 
commissioner said at the time, given the difficult situation it faced, 
the commission did all that it could do legally and equitably in 
opting for NIM. 

Both SIPC senior management and SEC officials agreed with the Trustee 
that the effect on the SIPC fund played no role in the selection of 
NIM. Both said their approach was to make their best determination 
under the statute, without regard to cost. They told us they 
considered any impact on the fund only to identify what actions would 
be necessary for SEC to extend a loan to SIPC, to be funded by SEC 
borrowing from Treasury, should that be necessary to supplement fund 
balances to honor coverage commitments.[Footnote 32] Further, even if 
FSM had been selected, the SIPC fund would not have become insolvent, 
SIPC senior management told us. Under FSM, based on the SIPC coverage 
limit of $500,000 per customer, the SIPC fund's maximum exposure would 
have been $2.1 billion, compared to an expected $889 million outlay 
under NIM.[Footnote 33] 

The use of NIM, rather than relying on final statement amounts, makes 
determination of customer net equity a more expensive process, SIPC 
senior management and SEC officials told us. But as with impact on the 
SIPC fund, they said that cost does not factor into selection of 
method. Instead, SIPC senior management told us, the higher expenses 
are necessary, because of the investigation required after Madoff's 
statements to customers were found to be fabricated. In any case, use 
of FSM would not have avoided substantial administrative costs, 
according to SIPC senior management. Such costs would still have 
totaled several hundred million dollars, they said, to conduct the 
liquidation, pursue recovery actions, and process claims. 

Courts Have Affirmed the Trustee's Use of NIM: 

After the Trustee chose NIM and began to settle claims based on the 
net investments that Madoff customers had made to their accounts, a 
number of customers objected to this approach. As a result, the 
Trustee petitioned the bankruptcy court in August 2009 for proceedings 
to affirm his choice of NIM. Opposing claimants argued that the 
Trustee must use FSM because Madoff statements reflected securities 
positions that they had every reason to believe were accurate and upon 
which they had relied. They emphasized SIPA's purpose of reinforcing 
investor confidence and cited the act's legislative history as 
indicating that securities positions set forth in broker-dealer 
statements need not be accurate to be covered under SIPA. 

The opposing claimants further argued that Madoff's profits, while 
fictitious, may have been received and spent years ago, that customers 
paid taxes on them, and may have foregone other investment 
opportunities in reliance on investment results shown in their 
statements. They further maintained that, at least in the case of 
advances from the SIPC fund, use of FSM would not limit payments to 
reimburse net losers for their losses. This was because they viewed 
the SIPC fund as a source for paying customer claims that operated 
independently of any customer assets recovered by the Trustee. Thus, 
they claimed all customers, both net winners and losers, could receive 
up to $500,000 from the SIPC fund without affecting customer assets 
recovered during the liquidation. 

Both sides contended that precedent dealing with SIPA liquidations 
involving Ponzi schemes supported their calculation method. In March 
2010, the bankruptcy court affirmed the Trustee's determination, 
agreeing with the Trustee, SIPC, and SEC on their key 
arguments.[Footnote 34] The court agreed with the Trustee that net 
equity can be based on "securities positions" only to the extent that 
such positions are "ascertainable from the books and records of the 
debtor" or "otherwise established to the satisfaction of the trustee." 
The court further agreed that in a Ponzi scheme like Madoff's--in 
which no securities were ever ordered or acquired--that "securities 
positions" do not exist, and the trustee cannot pay claims based on 
the false premise that customer positions are what the account 
statements purported them to be. The court added that legitimate 
customer expectations based on false account statements "do not apply 
where they would give rise to an absurd result."[Footnote 35] It said 
the Madoff customer statements "were bogus and reflected Madoff's 
fantasy world of trading activity, replete with fraud and devoid of 
any connection to market prices, volumes, or other realities." 
[Footnote 36] Instead, the court said the only verifiable amounts 
evident from the Madoff firm's books and records are customer cash 
deposits and withdrawals. (For a fuller discussion of legal issues 
involving determination of net equity in the Madoff case, see appendix 
III.) 

The court also found that fairness and "the need for practicality" 
favored NIM.[Footnote 37] It concluded that payments from the SIPC 
fund were inextricably connected to payments from customer assets, 
rejecting the argument by FSM proponents to the contrary. Thus, use of 
FSM for SIPC advance payments would diminish the amount available for 
distribution from the customer asset fund. Because there are limited 
customer funds, any funds paid to reimburse fictitious profits would 
no longer be available to pay other claims. 

The court also agreed with the Trustee that NIM was more compatible 
with efforts to recover assets. The court said that customer 
withdrawals made in furtherance of a Ponzi scheme, and specifically, 
withdrawals based on fictitious profits, can be subject to recovery 
actions. NIM harmonizes the definition of net equity with clawback 
actions, by similarly discrediting withdrawals based on fictitious 
profits, and unwinding, rather than legitimizing, the fraud. The court 
noted that FSM, by contrast, would base compensation to customers on 
the same withdrawals the trustee has the power to seek to recover. 
[Footnote 38] 

In August 2011, the Court of Appeals for the Second Circuit affirmed 
use of NIM as the appropriate method in the Madoff case.[Footnote 39] 
The appeals court found that while SIPA does not prescribe a single 
method for determining net equity in all situations, the Trustee's use 
of NIM was the best proposed method given the statutory definition of 
net equity. The court noted that use of FSM would have the absurd 
effect of legitimizing the arbitrarily assigned paper profits that 
Madoff's fraud produced. The court emphasized that while FSM may be 
appropriate in typical situations, the nature of the Madoff Ponzi 
scheme, including "extraordinary facts" of the Madoff fraud, point 
toward use of NIM. The court rejected the claimants' characterization 
of SIPA as providing an "insurance guarantee" against Madoff's fraud; 
rather, it said, SIPA does not clearly protect against all fraud 
committed by brokers, or insure investors against all losses.[Footnote 
40] 

Customer Claims Would Increase Significantly under FSM Compared with 
NIM: 

According to information we reviewed, the differences in customer net 
equity under the two approaches is significant, because during the 
decades of his fraud, Madoff reported considerable investment gains to 
his investors. According to SIPC, customer claims allowed under NIM 
total about $17.3 billion, while under FSM, the total would be 
approximately $57.2 billion. Table 3 shows a comparison of claims, 
broken down by account size, under the as-adopted NIM and the as-
proposed FSM. 

Table 3: Number of Accounts and Value of Claims under NIM and FSM: 

Less than $1 million: [Empty]. 

Account size: Less than $1 million; 
Under NIM (adopted by Trustee): 
Accounts: 1,204; 
Claims Value: $381.9 million; 
Under FSM (advocated by some customers): 
Accounts: 1,485; 
Claims value: $670.9 million. 

Account size: $1-$2.9 million; 
Under NIM (adopted by Trustee): 
Accounts: 626; 
Claims Value: $1.1 billion; 
Under FSM (advocated by some customers): 
Accounts: 1,372; 
Claims value: $2.5 billion. 

Account size: $3-$4.9 million; 
Under NIM (adopted by Trustee): 
Accounts: 198; 
Claims Value: $754.6 million; 
Under FSM (advocated by some customers): 
Accounts: 569; 
Claims value: $2.2 billion. 

Account size: $5-$9.9 million; 
Under NIM (adopted by Trustee): 
Accounts: 153; 
Claims Value: $1 billion; 
Under FSM (advocated by some customers): 
Accounts: 529; 
Claims value: $3.7 billion. 

Account size: $10 million or greater; 
Under NIM (adopted by Trustee): 
Accounts: 138; 
Claims Value: $14 billion; 
Under FSM (advocated by some customers): 
Accounts: 499; 
Claims value: $48.1 billion. 

Account size: Other; 
Under NIM (adopted by Trustee): 
Accounts: [Empty]; 
Claims Value: [Empty]; 
Under FSM (advocated by some customers): 
Accounts: 5; 
Claims value: $76.9 million. 

Account size: Total; 
Under NIM (adopted by Trustee): 
Accounts: 2,319; 
Claims Value: $17.3 billion; 
Under FSM (advocated by some customers): 
Accounts: 4,459; 
Claims value: $57.2 billion. 

Source: SIPC. 

Note: Totals may not sum due to rounding. 

[End of table] 

As table 3 shows, the number of accounts that potentially would have 
allowable claims under FSM nearly doubles from the corresponding 
number under NIM. This is because FSM generally accepts customer 
statements as accurate representations of holdings, and thus even 
those customers that withdrew more than they invested--net winners--
would also be entitled to have their claims approved. Total account 
value would more than triple. However, this does not necessarily mean 
that customers would recover their statement amounts under FSM. 
Rather, the amounts distributed to customers will depend on how much 
the Trustee can recover during the liquidation. If the amount 
recovered is less than the amount of allowed claims--as is currently 
expected--then customers receive payments based on their relative 
share of total claims. Thus, the significance of using different 
methods for calculating net equity is that the different methods can 
affect customers' relative shares of total claims. In turn, that 
affects the amount of money they ultimately receive. 

Adjusting NIM for Inflation Could Increase the Size of Customer Claims 
and Remains an Outstanding Issue: 

Although SEC supported the Trustee's decision to use NIM, SEC's 
position differed from the Trustee's and SIPC's in one respect: When 
SEC commissioners voted to support NIM, they also said customer 
deposits and withdrawals should be adjusted for inflation. According 
to SEC staff, such adjustments would account for the length of time 
the Madoff firm held customer funds. This has become known as the 
"constant dollar approach."[Footnote 41] To date, neither the 
bankruptcy court nor the appeals court has addressed the merits of the 
SEC position. SEC officials told us they see the constant dollar 
approach as a way to treat customers more fairly and equally. 

SEC's consideration of the constant dollar approach arose from the 
agency review, as described earlier, of potential methods for 
calculating customer claims. SEC officials told us that after they 
rejected FSM and adjustments based on Treasury notes, study continued 
on whether another method consistent with SIPA would allow customers 
to recover more money. However, the focus of their efforts shifted 
from investments that Madoff claimed to have made but did not, and 
toward the time value of money, pegged to when customers made their 
investments, so that customers would be treated equivalently in real 
dollar terms. The concept was that this would recognize the long 
duration of the Madoff fraud. 

Under the constant dollar approach, a customer's series of deposits 
and withdrawals over time would be adjusted for inflation and 
converted into dollar amounts that reflect current price levels. The 
simplest instance would be a single customer deposit made years ago 
that would be converted into current dollars based on price changes 
over the specified period. For example, according to the Consumer 
Price Index, the value of a $10,000 deposit made 20 years ago would be 
$16,125 in 2012 dollars. Calculations would become more involved with 
multiple deposits and withdrawals over time, but the basic reasoning 
of converting past transaction amounts into current dollars would be 
the same, according to SEC officials. 

SEC officials told us their analysis indicated this approach could be 
consistent with case law. Although case law has not specifically 
recognized inflation adjustments, they said, it does provide support 
for the general notion of seeking to treat investors equally. 
Translating that concept to the Madoff case, SEC viewed inflation-
adjustment as a way to treat customers equally over time, during which 
price inflation would occur. In a memorandum to commissioners, SEC's 
Office of General Counsel said that failing to do so would ignore the 
effects of inflation on innocent investors and treat early victims of 
the fraud inequitably compared with later investors. 

SIPC senior management disagrees with SEC's analysis and conclusion, 
saying the statute provides no authority for inflation adjustment and 
that no such authority can be inferred or implied. According to SIPC, 
determination of net equity is a specified mathematical function, and 
the notion of adjusting net equity determinations for inflation is an 
SEC-created approach that the statute does not support.[Footnote 42] 
SIPC senior management also noted that adjusting customer claims for 
inflation has never come up before in any other SIPC case, because the 
fraud in the Madoff case is atypical in having such a lengthy 
duration. While inflation calculations likely could be done, there 
would be large costs in doing so, given the scope of the case and the 
number of transactions. SIPC senior management further noted that if 
inflation-adjustment were permitted, the size of some claims would 
increase. Because the pool of funds to satisfy customer claims is 
fixed, larger payouts to some could depress payments to others, 
according to SIPC senior management. This could lead to litigation 
among customers because some net winners could become net losers. 
[Footnote 43] We reviewed one sample of an inflation-adjusted Madoff 
account that illustrated how claims could change significantly. It 
showed a beginning balance of $130,000 in 1992, followed by a series 
of 23 withdrawals totaling $145,900 made through 2008. Thus, the 
customer had withdrawn $15,900 more than initially invested, and under 
NIM, is a net winner whose claim would be denied. But after adjusting 
the sequence of transactions for inflation, based on specific timing 
and amounts, the customer would become a net loser--having withdrawn 
$29,829 less, in inflation-adjusted dollars, than originally 
contributed. 

The Trustee told us he did not consider a constant dollar approach, as 
it is not in the statute or supported by case law. He concurred with 
SIPC that claim amounts could increase considerably. As an example, he 
said, if a 9 percent annual interest rate, as allowed under New York 
fraud law, were applied, claims could grow by tens of billions of 
dollars, from their currently approved $17.3 billion.[Footnote 44] 

Following disclosure of a conflict of interest by a former SEC 
official in February 2011, SEC has plans to reconsider its position on 
supporting adjusting customer accounts for inflation. With the filing 
of a clawback suit by the Trustee against SEC's former General 
Counsel, it became public that the former official and his brothers 
had inherited a Madoff account from their mother.[Footnote 45] In a 
report on the matter, the SEC Inspector General recommended--and the 
SEC Chairman agreed--that the commission should reconsider the 
inflation-adjustment issue because of concerns about the former 
General Counsel's participation in SEC's decision-making process. 

The involvement of the SEC general counsel's office in the net equity 
issue began in January 2009, before the former General Counsel took 
his position on February 23, 2009. Thus, while the former general 
counsel became involved in the review, he did not initiate it. The 
Inspector General recommended that commissioners revote to avoid any 
possible bias or taint. The SEC Chairman has directed commission staff 
to review whether commissioners should readopt the constant dollar 
approach. 

Cost of the Madoff Liquidation Will Be the Largest to Date, with 
Efforts to Recover Assets Driving Costs: 

Through October 31, 2011, the Trustee reported spending of $451.8 
million for liquidation activities, with final costs expected to 
exceed $1 billion through 2014. To date, the two largest components of 
these costs have been legal costs of the Trustee and trustee's 
counsel, and costs for consultants. Although the Madoff case is 
expected to be SIPC's most costly case to date, the ratio of total 
costs to customer distributions is lower than for some other SIPC 
cases. 

Total Administrative Costs of the Liquidation Have Reached $452 
Million and Are Expected to Exceed $1 Billion: 

Through October 31, 2011, the latest date for which information was 
available, total administrative costs of the Madoff liquidation--
ranging from office expenses to professional services--reached 
approximately $452 million. As shown in figure 3, the two major 
components have been legal costs, chiefly for time spent by the 
Trustee and his counsel, and consultant costs, for work such as 
investigating fraudulent activities of the Madoff firm and analyzing 
customer accounts. Legal costs represent the largest expense, 
according to a series of interim reports the Trustee has filed with 
the bankruptcy court, plus other information we reviewed. 

Figure 3: Total Costs of the Madoff Liquidation, by Type, as of 
October 31, 2011: 

[Refer to PDF for image: pie-chart] 

Trustee: 1%; $4.5 million; 
Other professional: 5.3%; $23.9 million; 
General administrative: 6.7%; $30.2 million; 
Consultants: 39.6%; $178.8 million; 
Trustee's counsel: 47.4%; $214.3 million; 
Total: $451.8 million. 

Source: GAO analysis of Trustee reports. 

Note: General administrative category includes expenses such as 
computer, employee, insurance, office rent, utilities, taxes, and 
supplies. 

[End of figure] 

The Trustee told us that total administrative costs are estimated to 
reach $1.094 billion through 2014.[Footnote 46] The $1.094 billion for 
the Madoff case is approximately double the combined costs of $512.6 
million for all 315 previously completed SIPC customer protection 
proceedings from 1971 through 2010, the latest year for which 
information was available.[Footnote 47] Overall, a Ponzi scheme fraud 
is not necessarily intrinsically more expensive to handle, according 
to the Trustee. For instance, in the Madoff case, forensic analysis to 
determine what occurred at the firm has been similar to investigations 
in other Ponzi scheme cases. However, the Madoff case stands out for 
the duration of the fraud, its size, and the number of people 
involved, according to the Trustee, SEC officials, and SIPC senior 
management. 

Trustee and Trustee's Counsel Costs: 

Although the Trustee directs the liquidation, the bulk of the costs of 
the liquidation are those associated with the legal work performed by 
attorneys of the law firm acting as the trustee's counsel. That firm, 
Baker Hostetler, performs work that includes assisting the Trustee's 
investigation; asset search and recovery, including related 
litigation; case administration; and document review. In addition to 
the Trustee's interim reports, periodic cost applications filed with 
the bankruptcy court for approval contain more detailed information on 
costs incurred by the Trustee and trustee's counsel. Our review of 
these cost applications, which cover from December 2008 through May 
2011, found that costs for the Trustee and trustee's counsel were $230 
million for this period (see table 4).[Footnote 48] 

Table 4: Approved Trustee-Related Legal Cost Requests, from December 
2008 through May 2011: 

Cost category: Trustee compensation; 
Total: $4.9 million. 

Cost category: Trustee's counsel compensation; 
Total: $220.2 million. 

Cost category: Trustee's counsel expenses; 
Total: $4.9 million. 

Cost category: Total; 
Total: $230 million. 

Source: GAO analysis of Trustee and trustee's counsel cost 
applications. 

Notes: Totals may not sum due to rounding. The Trustee's expenses are 
minimal--a total of $2,500--and are not separately identified here. 
For the December 2008 to May 2011 period indicated, the Trustee and 
trustee's counsel have submitted seven cost applications, which the 
bankruptcy court has approved. In February 2012, the Trustee and 
trustee's counsel filed their eighth cost application, covering the 
period June 2011 to September 2011. The eighth application seeks 
approval for a combined total of approximately $48 million in 
compensation and $1.2 million in expenses, and as of the date of our 
report, the request was pending with the court. References in this 
report to the "latest" cost figures do not include amounts from the 
eighth application, and instead refer to court-approved costs through 
May 2011. 

[End of table] 

These costs reflect a substantial number of hours--597,052--that the 
Trustee and trustee's counsel have billed (see table 5). For the most 
recent reporting period, covering February to May 2011, about 100 
partners, who are the most senior staff in the law firm, and 200 
associate attorneys, worked on the case.[Footnote 49] 

Table 5: Total Hourly Billings for the Trustee and Trustee's Counsel, 
by Staff Category, from December 2008 through May 2011: 

Category: Trustee; 
Hours billed: 6,704. 

Category: Trustee's counsel partners; 
Hours billed: 175,250. 

Category: Trustee's counsel associate attorneys; 
Hours billed: 335,191. 

Category: Trustee's counsel nonlegal professional staff; 
Hours billed: 79,907. 

Category: Total; 
Hours billed: 597,052. 

Source: GAO analysis of Trustee and trustee's counsel cost 
applications. 

[End of table] 

Our review of costs for the Trustee and trustee's counsel also 
identified several trends within the overall amounts. 

Attempts to recover assets are driving costs. As shown earlier in 
table 4, the Trustee's costs alone are relatively small compared to 
the trustee's counsel costs. Within this larger category, costs for 
litigation to recover assets have risen sharply to account for a large 
majority of the trustee's counsel costs. As of December 2011, the 
Trustee told us about 1,050 lawsuits have been filed as part of 
efforts to recover assets on behalf of customers. These recovery 
actions are international in scope, with the Trustee reporting more 
than 70 actions involving foreign defendants. For example, actions 
have been filed in the United Kingdom, Bermuda, the British Virgin 
Islands, Gibraltar, and the Cayman Islands. According to the Trustee, 
international investigations have involved identifying the location 
and movement of assets abroad, becoming involved in litigation brought 
by third parties in foreign courts, bringing actions before U.S. and 
foreign courts and government agencies, and hiring international 
counsel for assistance. As figure 4 shows, asset recovery actions--
that is, avoidance or clawback actions--have outpaced all other 
trustee counsel costs as the case has progressed. According to SIPC 
senior management, the considerable expenses of the actions have been 
worthwhile, as the Trustee has produced $8.7 billion in recoveries for 
customers thus far.[Footnote 50] 

Figure 4: Trustee's Counsel Costs, by Category, from December 2008 
through May 2011: 

[Refer to PDF for image: stacked multiple line graph] 

Application period: December 2008 to April 2009; 
Avoidance actions: $0; 
Discovery--depositions and document productions: $0; 
Customer claims: $0.19 million; 
Total Other: $3.09 million; 
Banks and feeder funds: $2.68 million; 
Document review: $0; 
Bankruptcy court litigation and related: $2.02 million; 
Other litigation: $0; 
Case administration: $0; 
Trustee investigation: $7.86 million; 
Internal meetings: $0.47 million. 

Application period: May 2009 to September 2009; 
Avoidance actions: $4.6 million; 
Discovery--depositions and document productions: $0.11 million; 
Customer claims: $3.04 million; 
Total Other: $0.85 million; 
Banks and feeder funds: $4.09 million; 
Document review: $1.39 million; 
Bankruptcy court litigation and related: $2.76 million; 
Other litigation: $0.05 million; 
Case administration: $0.59 million; 
Trustee investigation: $5.56 million; 
Internal meetings: $0.60 million. 

Application period: October 2009 to January 2010; 
Avoidance actions: $4.83 million; 
Discovery--depositions and document productions: $0.2 million; 
Customer claims: $4.32 million; 
Total Other: $1.39 million; 
Banks and feeder funds: $3.96 million; 
Document review: $1.7 million; 
Bankruptcy court litigation and related: $1.54 million; 
Other litigation: $0.85 million; 
Case administration: $0.64 million; 
Trustee investigation: $6.35 million; 
Internal meetings: $0.75 million. 

Application period: February 2010 to May 2010; 
Avoidance actions: $11.87 million; 
Discovery--depositions and document productions: $0.65 million; 
Customer claims: $3.20 million; 
Total Other: $2.69 million; 
Banks and feeder funds: $6.93 million; 
Document review: $1.73 million; 
Bankruptcy court litigation and related: $1.29 million; 
Other litigation: $0.51 million; 
Case administration: $1.41 million; 
Trustee investigation: $6.79 million; 
Internal meetings: $0.72 million. 

Application period: June 2010 to September 2010; 
Avoidance actions: $15.07 million; 
Discovery--depositions and document productions: $1.32 million; 
Customer claims: $2.51 million; 
Total Other: $2.37 million; 
Banks and feeder funds: $8.84 million; 
Document review: $2.1 million; 
Bankruptcy court litigation and related: $1.49 million; 
Other litigation: $1.33 million; 
Case administration: $2.18 million; 
Trustee investigation: $5.09 million; 
Internal meetings: $0.52 million. 

Application period: October 2010 to January 2011; 
Avoidance actions: $28.64 million; 
Discovery--depositions and document productions: $1.22 million; 
Customer claims: $1.81 million; 
Total Other: $2.69 million; 
Banks and feeder funds: $4.27 million; 
Document review: $1.42 million; 
Bankruptcy court litigation and related: $1.30 million; 
Other litigation: $1.15 million; 
Case administration: $2.07 million; 
Trustee investigation: $3.13 million; 
Internal meetings: $0.26 million. 

Application period: February 2011 to May 2011; 
Avoidance actions: $38.69 million; 
Discovery--depositions and document productions: $2.41 million; 
Customer claims: $2.11 million; 
Total Other: $1.82 million; 
Banks and feeder funds: $1.23 million; 
Document review: $1.02 million; 
Bankruptcy court litigation and related: $0.98 million; 
Other litigation: $0.42 million; 
Case administration: $0.41 million; 
Trustee investigation: $0.37 million; 
Internal meetings: $0.27 million. 

Source: GAO analysis of trustee's counsel cost applications. 

[End of figure] 

Partner hours have been declining. In general, billing rates for 
partners at the trustee's counsel firm are higher than rates for 
associate attorneys.[Footnote 51] Thus, the more work partners handle, 
the higher the costs; while the more work that associates perform, the 
lower the costs. Our review showed that partner hours as a fraction of 
total hours claimed by the trustee's counsel have been declining 
steadily, from about 42 percent near the beginning of the case to 
about 28 percent in the most recent period (see figure 5). The Trustee 
told us the partner hours have been declining as case activity has 
shifted. Through the end of 2010, as the Trustee and trustee's counsel 
were busy preparing to file the many complaints brought as part of the 
liquidation, partners were heavily involved in case preparation and 
policy decisions. Later, as cases moved into litigation, associate 
attorneys handled more of the load. 

Figure 5: Partner Hours as a Percentage of Total Attorney Hours, from 
December 2008 through May 2011: 

[Refer to PDF for image: line graph] 

Application period: December 2008 to April 2009; 
Percentage: 38.5%. 

Application period: May 2009 to September 2009; 
Percentage: 41.6%. 

Application period: October 2009 to January 2010; 
Percentage: 37.6%. 

Application period: February 2010 to May 2010; 
Percentage: 35.6%. 

Application period: June 2010 to September 2010; 
Percentage: 34.6%. 

Application period: October 2010 to January 2011; 
Percentage: 32.3%. 

Application period: February 2011 to May 2011; 
Percentage: 28.2%. 

Source: GAO analysis of trustee's counsel cost applications. 

[End of figure] 

Higher-cost people have performed more work. Although the proportion 
of hours attributable to partners has been declining, we also found 
that within each category of professional work at the trustee's 
counsel--partners, associates, and nonlegal staff--higher-cost people 
have been performing a larger share of work. We examined the 
distribution of costs at two points during the Madoff liquidation: the 
second cost application following start-up of the case (covering May 
to September 2009), and the most recent cost application (covering 
February to May 2011). Figure 6 illustrates our findings, showing 
results for the partner category as an example. Partners whose billing 
rates are in the top 20 percent (the top quintile) of all billing 
rates for partners working on the Madoff case accounted for a greater 
share--about a third--of all partner hours compiled, and more than 40 
percent of all partner billings in dollars. By contrast, partners 
whose billing rates are in the bottom 20 percent (the bottom quintile) 
accounted for a smaller share of activity--about 12 percent of hours 
compiled, and about 7 percent of all partner billings in dollars. 
Middle quintiles followed the same trend. We found that similar 
patterns applied for associate attorneys, and nonlegal staff such as 
paralegals, clerks, and librarians.[Footnote 52] The Trustee 
attributed this trend to differences in billing rates among Baker 
Hostetler offices. Most case activity takes place in New York, where 
rates are higher than elsewhere. Attorneys in other offices, where 
rates are lower, provide assistance to New York-based lawyers, the 
Trustee said. 

Figure 6: Distribution of Partner Work, by Hourly Billing Rate 
Quintiles, from February 2011 through May 2011: 

[Refer to PDF for image: vertical bar graph] 

Quintile by hourly rate: 1 (top); 
By hours: 33.8%; 
By billings: 41.5%. 

Quintile by hourly rate: 2; 
By hours: 24.3%; 
By billings: 25.6%. 

Quintile by hourly rate: 3; 
By hours: 17.3%; 
By billings: 16.1%. 

Quintile by hourly rate: 4; 
By hours: 12.3%; 
By billings: 9.5%. 

Quintile by hourly rate: 5 (bottom); 
By hours: 12.3%; 
By billings: 7.3%. 

Source: GAO analysis of trustee's counsel cost applications. 

[End of figure] 

Limited guidance is available to assess the reasonableness of legal 
costs, such as those incurred in the Madoff case. The American Bar 
Association (ABA) publishes "model rules," or recommended professional 
standards, including a model rule on professional conduct, which 
includes legal costs.[Footnote 53] The rules are only advisory, but 
according to ABA, nearly every state patterns its professional conduct 
rules on the ABA model rule. According to ABA, there is no formula for 
determining whether costs charged in specific situations--or, in the 
case of the Madoff case, to hundreds of individual instances of 
litigation--are reasonable. Rather than provide a formula, the ABA 
model rule focuses on reasonability of legal costs and provides a 
number of qualitative factors that can be considered in evaluating 
reasonableness of attorney costs. Among the factors are the time and 
labor required; the novelty and difficulty of the questions involved; 
the skill needed to perform the legal service properly; and the 
experience, reputation, and ability of the lawyer(s) performing the 
services.[Footnote 54] 

Costs for Consultants: 

In addition to the costs for the Trustee and his counsel, there have 
been a number of other professional costs in the Madoff case. Largest 
among them, according to the Trustee, have been $178.2 million in 
consultant costs.[Footnote 55] These costs include, for example, 
forensic accounting services performed as part of the fraud 
investigation. While legal costs have been increasing, consultant 
costs have been decreasing, reflecting their prominence earlier in the 
case (table 6). 

Table 6: Consultant Costs, May 2009 through September 2011: 

Period ending: May 31, 2009; 
Consultant costs: $14.6 million. 

Period ending: October 31, 2009; 
Consultant costs: $34.3 million. 

Period ending: February 28, 2010; 
Consultant costs: $19.1 million. 

Period ending: September 30, 2010; 
Consultant costs: $54.9 million. 

Period ending: March 31, 2011; 
Consultant costs: $29.6 million. 

Period ending: September 30, 2011; 
Consultant costs: $25.7 million. 

Total: 
Consultant costs: $178.2 million. 

Source: GAO analysis of Trustee's interim reports. 

Note: We also obtained information for the single month of October 
2011, which totaled $661,671. 

[End of table] 

Total Costs of the Madoff Liquidation Have Been Within SIPC's Range of 
Experience: 

While the total costs of the Madoff liquidation are expected to be 
higher than all other completed SIPC cases combined, we found that 
costs as estimated thus far, as a percentage of current recoveries for 
customers, have been within the range experienced in past SIPC cases. 
Specifically, we examined SIPC-reported total costs as a percentage of 
distributions to customers in completed SIPC cases.[Footnote 56] We 
grouped these cases on an annual basis, focusing on years in which 
there were at least $50 million in distributions.[Footnote 57] As 
shown in figure 7, the currently estimated total costs of the Madoff 
liquidation, as a percentage of current recoveries, are within the 
range of costs incurred in previous SIPC cases. For individual years, 
the cost percentages have ranged from a low of 0.3 percent (2001) to a 
high of nearly 40 percent (1990, when there were considerable expenses 
in one relatively large case.[Footnote 58]) For the Madoff case--which 
is not yet complete, and as discussed earlier, is atypical--the cost 
percentage is currently 11 percent, based on the latest estimate of 
total cost ($1.094 billion), and $8.7 billion in current recoveries 
from the Trustee's efforts, the $326 million Internal Revenue Service 
(IRS) settlement, plus an expected $888.5 million in SIPC customer 
advances. The ratio for the Madoff case could change, depending on 
future costs incurred and if the Trustee secures additional recoveries. 

Figure 7: Total Costs as Percentage of Customer Recoveries for Madoff 
and Completed SIPC Cases, for Selected Years from 1979 to 2010, Ranked 
by Cost Percentage: 

[Refer to PDF for image: illustrated horizontal bar graph] 

Year: 2001; 
Percentage: 0.3% 
Customer distributions: $11,845,935,313. 

Year: 1987; 
Percentage: 3.4%; 
Customer distributions: $197,792,815. 

Year: 2010; 
Percentage: 5.6%; 
Customer distributions: $890,560,975. 

Year: 1997; 
Percentage: 8.1%; 
Customer distributions: $623,146,465. 

Year: 1983; 
Percentage: 8.6%; 
Customer distributions: $207,094,604. 

Year: 1984; 
Percentage: 9.5%; 
Customer distributions: $124,408,758. 

Year: 1988; 
Percentage: 9.7%; 
Customer distributions: $134,911,794. 

Year: 1999; 
Percentage: 9.9%; 
Customer distributions: $443,052,428. 

Year: 1985; 
Percentage: 10.4%; 
Customer distributions: $502,269,758. 

Madoff: 
Percentage: 11.0%; 
Customer distributions: $9,914,546,672. 

Year: 1981; 
Percentage: 14.3%; 
Customer distributions: $314,991,183. 

Year: 2003; 
Percentage: 14.5%; 
Customer distributions: $77,111,217. 

Year: 1986; 
Percentage: 15.1%; 
Customer distributions: $51,283,635. 

Percentage: 1990; 
38.4%; 
Customer distributions: $103,794,397. 

Total (All years shown): 
Percentage: 2.5%; 
Customer distributions: $15,516,353,342; 
Excluding 2001: 
Percentage: 9.5%; 
Customer distributions: $3,670,418,029. 

Source: GAO analysis of SIPC, Trustee information. 

Notes: Total cost figures do not include the Madoff case. Customer 
distributions for the Madoff case are not complete; figure is based on 
current recoveries by the Trustee, the IRS settlement, and advances 
from SIPC. 

[End of figure] 

The 13 years shown in figure 7 cover 104 cases that together account 
for $15.5 billion in customer distributions.[Footnote 59] Total costs 
for all these cases equal 2.5 percent of customer distributions. We 
note, however, that results for one year--2001--reflect almost 
entirely the outcome of a single large case, in which a firm failed 
but recoveries were sufficient to reimburse all valid customer claims 
fully. Excluding 2001, total costs for all cases as a percentage of 
customer distributions are equal to 9.5 percent.[Footnote 60] 

Various Steps Are Being Taken to Control Madoff Liquidation Costs: 

In a SIPA liquidation, each of the main parties--the trustee, SIPC, 
the bankruptcy court, and SEC--has a role in examining costs. These 
roles vary by the party and the stage of the proceeding. 

Trustee Efforts to Control Costs: 

The Trustee noted that while he previously was at SEC and when serving 
as U.S. trustee, he had experience reviewing fee applications. He 
described a variety of ways by which he seeks to hold down expenses of 
the Madoff liquidation. The general process for approval of costs 
begins with the Trustee, who reviews them before submitting them to 
SIPC for its review, prior to submission to the bankruptcy court. For 
billings, the Trustee conducts a two-level review of Madoff-related 
time entries. Following completion of work, a mid-level attorney 
reviews the billings, and then a partner conducts another review. This 
second review is in tandem with SIPC, the Trustee told us. The purpose 
of these reviews is to determine whether too much time has been billed 
for a particular task. If so, it is written off, the Trustee said. 
Information the trustee's counsel produced for us, covering from 
inception through January 2011, showed about 1 percent of hours worked 
not being billed, with about another 1.5 percent of hours being 
written off after review. The Trustee also said that he does not bill 
for 5 percent to 10 percent of the time he spends on the case. 

The Trustee said a similar review of billings takes place for costs 
submitted by other law firms and consultants that the Trustee and 
trustee's counsel use in their work. The Trustee said that in some 
cases, amounts claimed are reduced. However, the Trustee did not have 
specific amounts for any such reductions. The outside entities also 
discount their billings at least 10 percent, as the Trustee and 
trustee's counsel do, with some providing 11 or 12 percent discounts. 

In addition to billing reviews, the Trustee also described other 
approaches intended to help ensure that costs incurred are necessary 
and reasonable. 

* Teams. Using teams, in which the same people work on similar 
matters, to help achieve greater consistency and efficiency. For 
example, the Trustee uses teams for different tasks, such as motions, 
discovery, and litigation. For litigation, for example, the trustee's 
counsel has set up about 16 teams, which work on similar topics, such 
as employee-related, review of charities, or family-related matters. 
The teams follow cases from beginning to end, taking advantage of 
experience gained through the process and limiting additional costs 
that could occur if staff were assigned work in unfamiliar areas, 
according to the Trustee. 

* Digitizing information. Computerizing information as much as 
possible allows for faster, more efficient retrieval of information. 
This has involved significant up-front costs, but the Trustee noted 
that it reduces costs over time by avoiding the need to undertake time-
consuming, expensive manual searches through thousands of boxes of 
paper material.[Footnote 61] 

* Budgeting work in advance. The Trustee said he uses a process in 
which consultants must fill out project forms and provide budgets, 
which are submitted and must be approved by trustee's counsel. SIPC 
also receives some of these budgets. When bills are received later, 
the trustee's counsel compares the amount claimed with the budget, and 
there have been instances in which costs exceeding budgeted amounts 
have been refused, according to the trustee.[Footnote 62] 

When the Trustee has completed in-house review of costs, he presents 
them to SIPC for review. The Trustee may hold informal discussions 
with SIPC before submitting actual costs for formal consideration. 
SIPC also may contact outside vendors directly to inquire about 
charges. SIPC does not pay for some charges, and following discussions 
with SIPC, the Trustee may decide to write off some costs, according 
to the Trustee. 

SIPC Efforts to Control Costs: 

As SIPC senior management said is typical, at the outset of the case, 
they sought and obtained a 10 percent reduction in the hourly rates of 
the Trustee and trustee's counsel. According to our review, this 10 
percent reduction has produced savings of $25 million through May 
2011. In addition, the Trustee and trustee's counsel have provided 
additional reductions of $5.4 million over costs they said would 
customarily be billed. 

Some have suggested that SIPC should have sought a discount greater 
than 10 percent. For example, the SEC Office of Inspector General has 
reported that an SEC bankruptcy attorney raised questions whether a 10 
percent discount for SIPC cases is sufficient.[Footnote 63] Similarly, 
the Inspector General noted to us that the Madoff case began during 
the recent financial crisis, when law firms' business was suffering, 
and suggested that as a result, SIPC would have had strong leverage to 
negotiate lower compensation for firms. 

SIPC senior management, however, told us that a 10 percent reduction 
is appropriate for several reasons. Above that amount, service 
providers object, and a 15 percent discount is not economical for 
sophisticated work like that required in the Madoff case, according to 
SIPC senior management. Also, SIPC senior management noted that 
liquidation cases such as the Madoff matter draw highly qualified 
talent in opposing counsel, so that as a result, SIPC also must draw 
upon highly qualified providers. Furthermore, the 10 percent discount, 
coupled with "holdbacks"--in which payment of approved amounts is not 
released until later--amount to a significant burden on the service 
provider, according to SIPC. Finally, SIPC senior management said that 
the results the Trustee has produced to date support the costs 
incurred. For these reasons, SIPC has not sought a reduction greater 
than 10 percent in the Madoff case. 

In addition to the 10 percent discount, SIPC has also created 
guidelines for review and approval of costs.[Footnote 64] The 
guidelines cover matters including obtaining a fee discount; 
submitting costs; reviewing costs submitted; and documenting questions 
and discussions relating to the review of costs, including items 
flagged for attention or reduced or written off. Under these 
guidelines, a SIPC attorney reviews each time entry and expense item 
submitted, after which they prepare a memorandum to the SIPC general 
counsel, summarizing findings and making recommendations for approval. 
The general counsel is to review the memo and recommendations, before 
approving, modifying, or rejecting the cost request.[Footnote 65] SIPC 
senior management told us they followed the guidelines in the Madoff 
case.[Footnote 66] Also as part of this portion of the review process, 
SIPC's general counsel makes a line-by-line review of Trustee and 
trustee's counsel invoices, according to SIPC senior management. 

Because costs in the Madoff case are so much greater than in previous 
SIPC cases, the Trustee, working with SIPC, has established 
"litigation budgets" for the many lawsuits resulting from the case. 
[Footnote 67] These budgets detail expected costs of specific 
litigation, and for each case, divide tasks into specific categories, 
including research, drafting, motions, discovery, trial, appeal, and 
collection. According to SIPC senior management, this budgeting 
process is aimed at managing costs in advance or as they are being 
incurred, rather than after-the-fact. In addition, several SIPC 
personnel are in daily contact with the Trustee or trustee's counsel. 
As a result, they are aware what activities are planned, and will 
discuss them ahead of time. They also discuss possible future actions. 
SIPC senior management told us the Trustee has revised certain planned 
actions or changed direction as a result of such discussions during 
the case. 

We sought details on the extent to which SIPC has reduced or 
disallowed expenses submitted by the Trustee. SIPC senior management 
declined to provide documentation of its cost reviews, citing attorney 
work-product privilege. According to SIPC, releasing such information 
could provide an unfair advantage to litigation opponents and 
undermine attempts to recover assets on behalf of customers. 
Similarly, SIPC noted that releasing the litigation budgets could 
allow an opposing party to see how much has been allocated for an 
activity in litigation, which can provide a tactical advantage to 
opposing parties. However, the trustee's counsel provided us 
information on amounts written off at SIPC's request. According to 
this information, the trustee's counsel has written off, at SIPC's 
request, less than 1 percent of hours submitted. For the Trustee, SIPC-
requested reductions to billings have been about 0.02 percent, 
according to the information provided by the trustee's counsel. SIPC 
senior management also declined to provide other cost review-related 
information we requested, again citing attorney work-product privilege. 

The Bankruptcy Court's Role in Evaluating Legal Costs: 

In the Madoff case, the bankruptcy court has a limited ability to 
oversee costs. As noted earlier, the Trustee and trustee's counsel 
submit legal costs to SIPC, which reviews them, before filing with the 
bankruptcy court a recommendation on what the court should approve. 
SIPC files the recommendation after the trustee and trustee's counsel 
file their detailed cost applications with the court. Under SIPA, the 
court must approve cost applications if two conditions are met: (1) if 
there is no reasonable expectation of SIPC recouping its advances, and 
(2) if SIPC recommends to the court that it approve the costs 
requested by the trustee and trustee's counsel. In the Madoff case, 
both conditions have been met. 

For the first condition, SIPC does not anticipate recouping its 
administrative advances because it expects that recoveries by the 
Trustee will be insufficient to cover all approved customer claims. 
SIPC senior management told us that they have opted to devote all 
asset recoveries--of both investor funds and sale of assets of the 
Madoff firm itself--to repaying approved customer claims. If a trustee 
can recover assets that exceed the amount of allowed customer claims, 
SIPC has a priority claim on the excess assets, in order to recoup its 
advances to cover liquidation costs. However, based on expected 
recoveries in the Madoff case, SIPC senior management does not expect 
there will be any excess assets. The current Trustee estimate of 
allowed claims is $17.3 billion, compared with $9.1 billion in Trustee 
recoveries and settlements. Thus, about $8.3 billion in additional 
recoveries would be needed, and based on current Trustee assets, 
lawsuits filed, and the estimated possibilities for recoveries arising 
from that litigation, SIPC senior management does not now expect this 
level of recoveries to occur. 

For the second condition, SIPC has recommended that the bankruptcy 
court approve the legal costs requested in the applications submitted 
to the bankruptcy court. SIPC senior management told us that the 
statute requires the court to defer to SIPC's judgment on the 
appropriateness of expenses because it is SIPC that faces the economic 
risk of covering the costs in situations where SIPC does not expect 
recoveries to be sufficient to recoup its advances. For the first 
seven rounds of approved cost applications to date, the bankruptcy 
court has approved all of the legal compensation and expense requests 
submitted by SIPC for the Trustee and trustee's counsel. Although the 
court has been obliged to approve the cost applications because the 
two conditions have been met, the judge has said in hearings on the 
applications that notwithstanding the statutory requirement, he would 
nevertheless approve the costs on the basis of the work performed. 

SEC Oversight of SIPC Liquidation Expenses: 

Although SEC has oversight authority over SIPC, it does not have a 
direct role in approving costs incurred in any particular SIPC 
liquidation. Instead, fee exams typically take place as part of its 
general examinations of SIPC, and SEC officials told us they plan a 
review of Trustee and trustee's counsel costs in coming months. In a 
March 2011 report, the SEC Inspector General noted that the Madoff and 
Lehman Brothers cases--the two largest liquidations in SIPC history--
had focused new attention on concerns about the amount of trustee 
fees. The report made recommendations to improve SEC's oversight of 
SIPC liquidation costs. For example, the report recommended that SEC 
encourage SIPC to negotiate more vigorously with court-appointed 
trustees to obtain fee reductions greater than 10 percent and to 
develop a more regular process for monitoring SIPC's oversight of 
costs, rather than relying on examinations that do not occur 
regularly. The report also asked SEC to assess whether SIPA should be 
modified to allow bankruptcy judges presiding over SIPA liquidations 
to assess the reasonableness of administrative costs in cases in which 
SIPC pays the costs. The respective units of SEC indicated they 
concurred with these recommendations, and SEC officials told us that 
formal responses are being prepared. 

SIPC, SEC, and the Bankruptcy Court Have Been Satisfied That the 
Trustee Has Made Sufficient Disclosures: 

Trustees for SIPA liquidations generally have the same duties as 
trustees for liquidations under chapter 7 of the Bankruptcy Code. 
Under this chapter, a trustee must make certain information 
disclosures, including: 

* furnishing information about the estate and the estate's 
administration as requested by parties in interest, unless such 
disclosure is restricted by a court order; 

* providing periodic reports and summaries of the operation of the 
bankrupt firm if it continues operating; and: 

* making a final report and filing a final account of the 
administration of the estate with the court and with the U.S. trustee. 

SIPA directs a trustee to make the disclosures required under chapter 
7 but also directs a trustee to include in such reports information on 
progress made in distributing cash and securities to customers. In 
addition, SIPA directs the trustee to promptly investigate the acts, 
conduct, property, liabilities, and financial condition of the firm 
being liquidated and report this information to the court. The trustee 
must also report to the court any facts learned by the trustee 
regarding fraud, misconduct, mismanagement, and irregularities, and 
any causes of action available to the estate as a result; and, as soon 
as practical, submit a statement of the investigation. 

The Trustee Has Disclosed Information in Variety of Ways: 

Through a variety of means, the Trustee has made disclosures that 
address the statutory requirements. As of January 2012, the Trustee 
had issued six interim reports to the bankruptcy court that outline 
progress made in liquidating the Madoff firm. These interim reports 
have been filed approximately every 6 months.[Footnote 68] The first 
report, filed in July 2009, gave the status of the Trustee's 
activities in administering the estate, his progress in addressing 
customer claims, and results to date from his investigation of the 
Madoff firm's activities. The report also included a discussion of 
Madoff's fraudulent scheme, including his admitting to soliciting 
billions of dollars under false pretenses and failing to invest 
customer funds as promised. The Trustee said that extensive 
investigation of the firm's financial affairs inside and outside the 
United States revealed "a labyrinth of interrelated international 
funds, institutions, and entities of almost unparalleled complexity 
and (breadth)." The Trustee also noted that he was providing 
information to, and coordinating efforts with, other parties 
investigating the firm, including SEC, the Federal Bureau of 
Investigation, the U.S. Attorney's Office, and other regulators. The 
Trustee's other five interim reports provide information on similar 
issues, including the status of the investigations. 

The Trustee has also provided various records to the court, as part of 
litigation involving his activities, which provide disclosures of the 
type required under the Bankruptcy Code and SIPA. For example, in a 
motion filed in October 2009 asking the bankruptcy court to affirm the 
use of NIM in determining customer claims, he included the report of a 
consultant hired to review the Madoff firm's activities in detail. 
[Footnote 69] This report described, among other things, how little 
trading was done as part of the investment advisory business, and it 
also included statements from a Madoff firm employee who admitted to 
creating fake investment positions that were reported to customers on 
their statements. 

The Trustee also has provided information to individual Madoff 
customers. To address customer claims, the Trustee told us that he 
provided determination letters to Madoff customers, showing individual 
account transactions and how net equity for their accounts was 
determined. For customers with questions about their claims 
determinations, the trustee's counsel was available to provide 
additional information, which in some cases, involved sharing 
information contained in the records maintained by the Madoff firm. 
The Trustee has also provided information to former Madoff account 
holders seeking information necessary for tax returns or for filing 
fraud claims under homeowner's insurance coverage. The Trustee told us 
he has not provided information about the fraud in general because 
individual customers do not need such information to have their claims 
processed. 

To facilitate access to customer records, the Trustee has created an 
"electronic data room." Initially, access was limited to customers 
sued by the Trustee that were determined to be net winners--those who 
withdrew more than they invested--and who were deemed to have acted in 
good faith without knowledge of the fraudulent nature of the firm's 
activities. In January 2012, the bankruptcy court judge granted a 
motion by the Trustee to expand access to the data room to attorneys 
for nongood faith defendants with whom the Trustee is in litigation. 

In addition, the Trustee maintains a public website that contains a 
large volume of information about the case. It includes a timeline of 
the liquidation and provides data on the amount of customer assets 
recovered, amounts distributed to customers, and amounts committed by 
SIPC to date. The website also includes more than 600 selected court 
filings, which are provided in a searchable database with the original 
documents available for download. These documents date to the start of 
the Madoff liquidation in December 2008. All six interim reports filed 
by the Trustee, plus amendments, are included. In addition, the 
website provides information on the claims process, including links to 
SIPA, SIPC, and orders of the bankruptcy court. The website also has a 
page for the Trustee's hardship program, under which the Trustee does 
not seek to recover assets from customers suffering from particular 
financial or other hardships.[Footnote 70] 

Recently, expert reports produced as part of the Trustee's 
investigation have been made public, which the Trustee said contain 
extensive details on proof of fraud at the Madoff firm and its 
subsequent insolvency. 

Although Some Have Sought Additional Trustee Disclosures, SIPC, SEC, 
and the Bankruptcy Court Say Information Released Has Been Sufficient: 

Although some parties have argued that the Trustee's disclosures have 
not met statutory requirements, SIPC and SEC officials told us they 
view the Trustee's disclosures to date as sufficient. SIPC senior 
management told us that early in the case, the Trustee did not release 
many details, to avoid tipping off potential civil and criminal 
defendants that would become target of legal actions. More recently, 
according to SIPC, as that concern eased, the Trustee has been doing 
an exemplary job in releasing information relevant to account holders 
and the public. SIPC senior management told us they expect the Trustee 
will file a complete report of his investigative activities after 
officials are satisfied that legal actions and investigations will not 
be endangered. While the Trustee has not yet issued such a report, 
complaints filed in the case provide a considerable amount of 
information that will eventually be released, they said. SEC officials 
also told us that while the statute provides no standards for the 
extent of disclosures that must be made, the Trustee has made 
considerable information available, which appears to be complete for 
the relevant topics.[Footnote 71] The officials said some may not like 
decisions the Trustee has made, but there has been no lack of 
information about them. 

An attorney representing former Madoff customers offered a different 
view to us, saying the Trustee has not provided information critically 
important for account holders making claims and those who are the 
subject of clawback actions by the Trustee. In particular, according 
to the attorney, while the Trustee has asserted that all reported 
trading activity was fictitious, and that the Madoff investment 
advisory arm operated independently from the rest of the Madoff firm, 
that cannot be established from information released thus far. The 
attorney told us he believed that more complete disclosure would show 
at least some legitimate trading activity on behalf of customers, 
which is important because investment returns from that activity would 
affect claims determination and what amounts the Trustee could seek to 
claw back. 

In April 2010, attorneys representing various Madoff customers filed a 
motion with the bankruptcy court to compel additional disclosures by 
the Trustee, arguing that reports filed "discuss the nature of his 
investigation in sweeping terms, with a bare minimum of detail and 
only conclusory statements about what has actually been uncovered." 
However, the Trustee told us he believes he has made great efforts to 
respond to the public, noting his interim reports, a recent redesign 
of the website, and his attempts to update case statistics at least 
every couple of weeks. By contrast, he said in a typical chapter 7 
bankruptcy case, the only information available would be documents 
filed with the court. According to the Trustee, there is no 
information, other than litigation-related, that individual account 
holders might want but have not been able to get. 

In his brief opposing the customers' motion to compel additional 
reporting, the Trustee said that in his many filings seeking recovery 
of customer assets, he has detailed the Madoff fraud and identified 
those he alleges were involved or knew of the fraud. He argued that 
the customers seeking additional disclosure were seeking to sidestep 
the Federal Rules of Civil Procedure and Bankruptcy Procedure that 
govern disclosure in litigation. These rules, covering what is known 
as the "discovery process," address matters such as parties making 
inquiries of each other and requests for the production of documents. 
As litigation proceeds, customers seeking greater disclosure will 
receive information through the discovery process and will have 
opportunity to access and challenge the Trustee's evidence, according 
to the Trustee. The attorney representing former Madoff customers, 
however, told us that while the discovery process will provide an 
opportunity for disclosure of some information, that process will be 
prohibitively expensive for many customers, and in any case, is not 
likely to develop case-wide information of value to all customers. 

The bankruptcy judge denied the customers' motion to compel additional 
disclosures from the Trustee, calling the action a discovery dispute, 
rather than a failure by the Trustee to follow the statute. He said 
the Trustee has satisfied his disclosure obligations under SIPA and 
the Bankruptcy Code "by creating a thorough and specific record 
regarding Madoff's fraud." Affirming the Trustee's position, the judge 
said the demands will be satisfied during court-regulated discovery as 
litigation proceeds. The customers filed a motion for leave to appeal 
the bankruptcy court ruling, which the district court denied. 

Conclusions: 

When a broker-dealer firm fails, and large sums of customer assets 
could be at risk, SIPC must move quickly to appoint a trustee and 
trustee's counsel in order to safeguard those assets and to maximize 
the possibility of any recoveries for customers. Toward that end, SIPC 
maintains an informally assembled roster of candidates, and its senior 
management confers before the SIPC president uses his professional 
judgment to select a trustee. In the Madoff fraud, SIPC moved to 
appoint a trustee and trustee's counsel within hours after Madoff was 
taken into custody. 

Notwithstanding the need to move quickly, however, our review 
identified two areas in which SIPC's selection process could be 
improved. First, while SIPC seeks to identify potential trustees for 
its liquidations, it lacks a formal, documented outreach procedure for 
identifying those candidates. Although SIPC believes the field of 
broker-dealer bankruptcy is sufficiently small that the relevant 
parties are known, undertaking additional efforts to more 
systematically identify candidates would help ensure that the range of 
choices reflects the widest capabilities available in the most cost-
effective fashion. Such outreach efforts could be tailored for SIPC's 
purposes, so that they are not excessively time-consuming or resource-
intensive. Second, while SIPC draws on the experience and expertise of 
its senior management in selecting trustees, that process, including 
criteria for selection, is not documented or transparent. This lack of 
transparency can contribute to questions and concerns about SIPC's 
decisions. Better documentation of the selection process and criteria 
could help address some of these concerns. 

Recommendations for Executive Action: 

To help ensure that the pool of providers that could be employed in 
SIPC liquidations is as broad as reasonably possible, and to improve 
the transparency of SIPC's selection of trustee and trustee's counsel 
for liquidations, the SEC Chairman should take the following two 
actions: 

1. Advise SIPC to document its procedures for identifying candidates 
for trustee or trustee's counsel, and in so doing, to assess whether 
additional outreach efforts should be adopted and incorporated. 

2. Advise SIPC to document its procedures and criteria for appointment 
of a trustee and trustee's counsel for its cases. 

Agency and Third Party Comments and Our Evaluation: 

We provided a draft of this report to SEC, SIPC, and the Trustee for 
their review and comment, and we received written comments from SEC 
and SIPC, which are reprinted in appendixes IV and V, respectively. In 
their comments, SEC and SIPC concurred with our recommendations. The 
director of SEC's Division of Trading and Markets said the division 
will recommend that the SEC Chairman implement our recommendations. 
The SIPC President said SIPC will make plans to implement them 
immediately. Regarding documenting and assessing its outreach efforts 
for identifying trustee and trustee's counsel candidates, the SIPC 
President said such efforts may lead to expansion of its file of 
potential service providers and thus allow SIPC to choose from a 
broader base. To achieve this, he indicated SIPC will explore 
expanding SIPC's contacts with relevant professional organizations, to 
locate qualified people and firms that SIPC has not previously 
encountered. Regarding documenting the process by which SIPC 
designates a trustee and trustee's counsel, the SIPC President's 
letter indicated that there is nothing in our recommendation that 
would delay or slow SIPC's progress, and that the need for 
transparency can be achieved as well. The SIPC President also said 
that in implementing both recommendations, SIPC will consult with SEC. 
SIPC, SEC, and the Trustee also provided technical comments, which we 
have incorporated as appropriate. 

We are sending copies of this report to the appropriate congressional 
committees, the SEC Chairman, the SIPC President, and the Trustee for 
the Madoff liquidation. In addition, this report is available at no 
charge on the GAO website at [hyperlink, http://www.gao.gov]. 

If you or your staff have any questions regarding this report, please 
contact me at (202)-512-8678 or clowersa@gao.gov. Contact points for 
our Offices of Congressional Relations and Public Affairs may be found 
on the last page of this report. GAO staff who made major 
contributions to this report are listed in appendix VI. 

Signed by: 

A. Nicole Clowers: 
Director: 
Financial Markets and Community Investment: 

[End of section] 

Appendix I: Objectives, Scope, and Methodology: 

This report discusses (1) how the Trustee and trustee's counsel were 
selected for the Bernard L. Madoff Investment Securities, LLC 
liquidation; (2) the process and reasoning for the selection of "net 
investment method" (NIM) in determining customer claims arising from 
the Madoff fraud; (3) the costs of the subsequent liquidation of the 
Madoff firm; and (4) the information that the Trustee has disclosed 
about his investigation and activities.[Footnote 72] 

To examine how the Trustee and trustee's counsel were selected for the 
Madoff liquidation, we reviewed the requirements of the Securities 
Investor Protection Act (SIPA) for the selection of a trustee, plus 
court filings, correspondence and records of the Securities Investor 
Protection Corporation (SIPC), Standards for Internal Control in the 
Federal Government, the Internal Control - Integrated Framework of the 
Committee of Sponsoring Organizations of the Treadway Commission, 
biographical information for the Trustee, and relevant portions of the 
Bankruptcy Code. We also interviewed SIPC senior management, officials 
of the Securities and Exchange Commission (SEC) and the SEC Office of 
Inspector General (SEC IG), and the Trustee and members of the 
trustee's counsel law firm. 

To examine the process and reasoning for the selection of NIM, we 
reviewed court filings, in particular those related to the Madoff 
fraud; and the Trustee's determination to use NIM, as well as a 
subsequent challenge to that decision. We examined SIPC correspondence 
and records, including information on open and closed SIPC cases 
(Ponzi scheme cases in particular), and customer claims under NIM and 
the final statement method (FSM). We also reviewed SIPC rules, annual 
reports, and board meeting minutes. We reviewed SEC correspondence and 
records, including consideration of net equity methods, arguments 
presented to the agency in support of FSM, and commission meeting 
minutes. We reviewed findings of the SEC IG. Additionally, we 
interviewed SIPC senior management, SEC officials, the SEC Inspector 
General, and the Trustee and members of the trustee's counsel law firm. 

To examine the costs of the Madoff liquidation, we analyzed cost 
information from interim reports submitted by the Trustee to the 
bankruptcy court, covering the period from December 2008 to September 
2011; cost requests submitted by the Trustee and trustee's counsel for 
approval by the bankruptcy court, covering the period from December 
2008 through May 2011; and other records. We discussed with the 
Trustee, trustee's counsel, and SIPC their process for verifying costs 
submitted. Because this cost information is prepared for or approved 
by the bankruptcy court, we determined that no additional steps were 
necessary to assess its reliability and that this data was 
sufficiently reliable for our purposes of identifying total costs, 
cost components, and trends. We also reviewed SIPA provisions related 
to review and approval of legal costs, and SIPC guidance on trustee 
compensation and review of liquidation costs. We reviewed an American 
Bar Association model rule on the reasonability of legal fees, and an 
SEC IG report on SEC's oversight of SIPC costs. In addition, we 
interviewed SIPC senior management, SEC officials, the SEC IG, and the 
Trustee and members of the trustee's counsel law firm generally on the 
topic of Madoff liquidation costs. 

To examine what information the Trustee has disclosed about his 
investigation and activities, we reviewed SIPA's disclosure 
requirements and the duties of trustees under chapter 7 of the 
Bankruptcy Code. We also reviewed court filings related to the 
Trustee's disclosures of information and his interim reports. We 
examined information the Trustee has made public about the 
investigation, including material on his website. In addition, we 
interviewed SIPC senior management, SEC officials, and the Trustee and 
members of the trustee's counsel law firm. 

We conducted this performance audit from October 2011 to March 2012 in 
accordance with generally accepted government auditing standards. 
Those standards require that we plan and perform our audit to obtain 
sufficient, appropriate evidence to provide a reasonable basis for our 
findings and conclusions based on our audit objectives. We believe 
that the evidence obtained provides a reasonable basis for our 
findings and conclusions based on our audit objectives. 

[End of section] 

Appendix II: Securities Investor Protection Corporation Fund 
Assessments and Balances, 1990 to 2010: 

Since 1990, the Securities Investor Protection Corporation (SIPC) has 
assessed its member broker-dealers varying rates to support the fund 
used to protect customers of failed securities firms. Over this 
period, members have paid assessments to the fund based on different 
percentages of either their gross revenues or net operating revenues, 
or have paid a flat-rate amount. 

Table 7: SIPC Fund Assessments and Balances, from 1990 to 2010: 

Year: 1990; 
SIPC member assessments and contributions: $73,029,832; 
Assessment rate: 0.001875; 
Assessment basis: Gross revenue; 
SIPC fund at December 31: $568,587,250. 

Year: 1991; 
SIPC member assessments and contributions: $38,851,496; 
Assessment rate: 0.00065; 
Assessment basis: Net operating revenue; 
SIPC fund at December 31: $678,769,209. 

Year: 1992; 
SIPC member assessments and contributions: $27,217,374; 
Assessment rate: 0.00057; 
Assessment basis: Net operating revenue; 
SIPC fund at December 31: $720,214,522. 

Year: 1993; 
SIPC member assessments and contributions: $32,612,767; 
Assessment rate: 0.00054; 
Assessment basis: Net operating revenue; 
SIPC fund at December 31: $791,366,865. 

Year: 1994; 
SIPC member assessments and contributions: $37,115,454; 
Assessment rate: 0.00073; 
Assessment basis: Net operating revenue; 
SIPC fund at December 31: $867,152,034. 

Year: 1995; 
SIPC member assessments and contributions: $57,831,365; 
Assessment rate: 0.00095; 
Assessment basis: Net operating revenue; 
SIPC fund at December 31: $965,932,279. 

Year: 1996; 
SIPC member assessments and contributions: $2,639,822; 
Assessment rate: $150; 
Assessment basis: Flat; 
SIPC fund at December 31: $1,047,205,945. 

Year: 1997; 
SIPC member assessments and contributions: $1,339,584; 
Assessment rate: $150; 
Assessment basis: Flat; 
SIPC fund at December 31: $1,109,450,764. 

Year: 1998; 
SIPC member assessments and contributions: $1,186,279; 
Assessment rate: $150; 
Assessment basis: Flat; 
SIPC fund at December 31: $1,196,695,240. 

Year: 1999; 
SIPC member assessments and contributions: $1,136,318; 
Assessment rate: $150; 
Assessment basis: Flat; 
SIPC fund at December 31: $1,129,653,262. 

Year: 2000; 
SIPC member assessments and contributions: $1,108,632; 
Assessment rate: $150; 
Assessment basis: Flat; 
SIPC fund at December 31: $1,220,284,553. 

Year: 2001; 
SIPC member assessments and contributions: $1,083,173; 
Assessment rate: $150; 
Assessment basis: Flat; 
SIPC fund at December 31: $1,184,157,015. 

Year: 2002; 
SIPC member assessments and contributions: $1,050,096; 
Assessment rate: $150; 
Assessment basis: Flat; 
SIPC fund at December 31: $1,260,200,497. 

Year: 2003; 
SIPC member assessments and contributions: $1,083,178; 
Assessment rate: $150; 
Assessment basis: Flat; 
SIPC fund at December 31: $1,249,116,852. 

Year: 2004; 
SIPC member assessments and contributions: $972,817; 
Assessment rate: $150; 
Assessment basis: Flat; 
SIPC fund at December 31: $1,287,554,216. 

Year: 2005; 
SIPC member assessments and contributions: $927,597; 
Assessment rate: $150; 
Assessment basis: Flat; 
SIPC fund at December 31: $1,286,092,231. 

Year: 2006; 
SIPC member assessments and contributions: $894,941; 
Assessment rate: $150; 
Assessment basis: Flat; 
SIPC fund at December 31: $1,403,558,035. 

Year: 2007; 
SIPC member assessments and contributions: $852,025; 
Assessment rate: $150; 
Assessment basis: Flat; 
SIPC fund at December 31: $1,522,257,439. 

Year: 2008; 
SIPC member assessments and contributions: $816,322; 
Assessment rate: $150; 
Assessment basis: Flat; 
SIPC fund at December 31: $1,699,039,958. 

Year: 2009; 
SIPC member assessments and contributions: $346,299,978; 
Assessment rate: 0.0025; 
Assessment basis: Net operating revenue; 
SIPC fund at December 31: $1,091,831,811. 

Year: 2010; 
SIPC member assessments and contributions: $409,200,016; 
Assessment rate: 0.0025; 
Assessment basis: Net operating revenue; 
SIPC fund at December 31: $1,181,851,883. 

Source: SIPC. 

[End of table] 

[End of section] 

Appendix III: Legal Appendix on Determination of Net Equity: 

Customer claims in a Securities Investor Protection Act (SIPA) 
liquidation are based on customers' "net equity" as of the filing date 
(Dec. 11, 2008, in the Madoff case). The statute generally provides 
that net equity is what would have been owed to the customer if the 
broker-dealer had liquidated the customer's "securities positions," 
less any obligations of the customer to the firm. Overall, each 
customer's net equity determines the value of each claim. In 
particular, it determines their pro rata share from the customer 
property portion of the insolvent broker-dealer's estate, as well as 
the amount of any advance payment from the Securities Investor 
Protection Corporation (SIPC) fund to which the customer may be 
entitled.[Footnote 73] 

The Trustee chose the "net investment method" (NIM), which focuses on 
investments made and not profits reported, to determine net equity. 
Claimants challenged the method, and it was upheld first by the U.S. 
Bankruptcy Court for the Southern District of New York.[Footnote 74] 
Later, the U.S. Court of Appeals for the Second Circuit affirmed the 
bankruptcy court decision.[Footnote 75] In the following sections, we 
describe the Trustee's position, the positions of the other parties, 
and the two judicial decisions. 

The Parties Advocated for Two Different Net Equity Methods, and the 
Trustee Determined That NIM Was Proper: 

The issue of how to determine net equity in the Madoff case primarily 
involved a choice between two methods with different impacts on the 
two main classes of customers. As is generally true of Ponzi scheme 
frauds, the Madoff claimants were "net winners" or "net losers." The 
net winners were those customers who had withdrawn the full cash 
amount they had invested in the Madoff firm before its collapse, plus 
some "profit" (that is, fictitious gains that actually came from funds 
provided for investment by others). The net losers were customers who 
had paid in more than they had withdrawn at the time the Madoff firm 
collapsed.[Footnote 76] 

The two competing methods for calculating net equity were NIM and the 
"final statement method" (FSM).[Footnote 77] NIM calculates what 
customers are owed as the amounts they invested, less amounts 
withdrawn. FSM calculates net equity based on the amounts shown as 
customers' securities positions on the last statements received from 
the broker-dealer firm; in the Madoff case, as of November 30, 2008. 
[Footnote 78] 

SIPC and the Securities and Exchange Commission (SEC) both supported 
the Trustee's selection of NIM.[Footnote 79] A number of claimants 
argued for use of FSM. These claimants, most of whom were net winners, 
[Footnote 80] challenged the Trustee's choice of NIM. 

Both Sides Claimed the Law Supported Their Position: 

The legal arguments of the parties are reflected in the bankruptcy 
court and Court of Appeals opinions. In addition, the bankruptcy court 
opinion included an exhibit that outlined the competing arguments in 
detail.[Footnote 81] 

The issue of how to determine net equity in the Madoff case turned on 
two key SIPA provisions: One is the definition of "net equity" in 
section 16(11) of the act, which generally requires the trustee to 
determine a customer's net equity by "calculating the sum which would 
have been owed by the [broker-dealer] 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 ..." (emphasis 
added).[Footnote 82] 

The other is section 8(b) of the act, which requires the Trustee to 
determine net equity claims "insofar as such obligations are 
ascertainable from the books and records of the debtor or are 
otherwise established to the satisfaction of the trustee."[Footnote 83] 

The Trustee, supported by SIPC and SEC, took the position that because 
the statements customers received from the Madoff firm were 
fictitious, they did not show "securities positions" that could be 
relied upon for purposes of the net equity determination. Instead, the 
only Madoff firm records that reflected reality were those recording 
the cash deposits and withdrawals of customers. Thus, the Trustee 
argued, the plain language of section 8(b) required the trustee to 
determine net equity based on these records, since they provided the 
only obligations that could be established from the Madoff firm's 
books and records. Accordingly, in his view, NIM was the only legally 
permissible option. 

The Trustee also contended that fairness considerations strongly 
supported use of NIM. Using FSM would exacerbate Madoff's fraud and 
enable some Madoff customers to retain "profits" that were in reality 
the misappropriated investments of other customers. Moreover, FSM 
would divert the limited customer assets available in the bankrupt 
estate by paying imaginary "profits" at the expense of reimbursing 
real losses. The Trustee also argued that using FSM could conflict 
with his obligation to recover the fictitious profits paid out by the 
Madoff firm through avoidance actions.[Footnote 84] 

The claimants advocating use of FSM argued that the plain language of 
section 16(11) required use of this method, because the Madoff firm 
statements reflected securities positions they had every reason to 
believe were accurate and on which that they had relied. They 
emphasized SIPA's purpose to reinforce investor confidence in 
securities markets. In particular, they cited the following passage 
from SIPA's legislative history as indicating that securities 
positions set forth in broker-dealer statements need not be accurate 
in order to be relied upon under the act: 

"What The Customer Gets. A customer generally expects to receive what 
he believes is in his account at the time the stockbroker ceases 
business. But because securities may have been lost, improperly 
hypothecated, misappropriated, never purchased or even stolen, this is 
not always possible. Accordingly, when the customer claims for a 
particular stock exceed the supply available to the trustee in the 
debtor's estate, then customers generally receive pro rata portions of 
the securities claims, and as to any remainder, they will receive cash 
based on the market value as of the filing date."[Footnote 85] 

FSM advocates also argued that the profits Madoff reported, while 
fictitious, may have been withdrawn and spent years ago; that 
customers paid taxes on them; and they may have foregone other 
investment opportunities in reliance on investment results shown in 
their statements. 

Furthermore, they maintained that, at least in the case of advances 
from the SIPC fund, use of FSM would not limit payments to reimburse 
net losers for their losses. They viewed the SIPC fund as a payment 
source for customer claims that operated separately and independently 
from any customer assets in the bankrupt estate. Thus, all claimants, 
both net winners and losers, could potentially receive up to $500,000 
from the SIPC fund without any decrease in customer property. 

Finally, both sides contended that judicial precedent dealing with 
SIPA liquidations involving Ponzi scheme cases (discussed in the 
following section) supported their calculation method. 

The Bankruptcy Court Affirmed the Trustee's Selection of NIM: 

The bankruptcy court affirmed the Trustee's determination of net 
equity method and essentially sided with the Trustee, SIPC, and SEC on 
each of their key arguments. The court concluded: 

"The Court recognizes that the application of the Net Equity 
definition to the complex and unique facts of Madoff's massive Ponzi 
scheme is not plainly ascertainable in law. Indeed, the parties have 
advanced compelling arguments in support of both positions. 
Ultimately, however, upon a thorough and comprehensive analysis of the 
plain meaning and legislative history of the statute, controlling 
Second Circuit precedent, and considerations of equity and 
practicality, the Court endorses the Trustee's Net Investment Method." 
[Footnote 86] 

Specifically, the court agreed with the Trustee that sections 16(11) 
and 8(b) of the act must be read together, so that net equity can be 
based on "securities positions" only to the extent that securities 
positions are "ascertainable from the books and records of the debtor" 
or "otherwise established to the satisfaction of the trustee." The 
court further agreed that in a Ponzi scheme case like the Madoff 
fraud, where no securities were ever ordered or acquired, securities 
positions did not exist, and the Trustee cannot satisfy claims by 
relying upon fictitious account statements that provided fictitious 
securities positions. Instead, only cash deposits and withdrawals were 
verifiable from the books and records of the Madoff firm.[Footnote 87] 
The court added that legitimate customer expectations based on false 
account statements "do not apply where they would give rise to an 
absurd result."[Footnote 88] 

The bankruptcy court also found that fairness favored NIM. It 
concluded that payments from the SIPC fund were inextricably connected 
to payments from customer property, rejecting the argument by FSM 
proponents to the contrary. Thus, use of FSM for purposes of SIPC fund 
advance payments would in fact diminish the amount available for 
distribution from the customer property fund. Citing section 9(a)(1) 
of the act,[Footnote 89] the court observed: 

"SIPC payments therefore serve only to replace missing customer 
property and cannot be ascertained independently of the determination 
of the customer's pro rata share of customer property. Accordingly, 
the SIPA statute does not allow bifurcation of the claims process, 
with customers recovering SIPC payments based on the [Final] Statement 
Method, and recovering customer property shares based on the Net 
Investment Method."[Footnote 90] 

Viewing fairness considerations from this perspective, the bankruptcy 
court stated: 

"While the Court recognizes that the outcome of this dispute will 
inevitably be unpalatable to one party or another, notions of fairness 
and the need for practicality also support the Net Investment Method." 

"As distribution of customer property to the 'equally innocent 
victims' of Madoff's fraud is a zero-sum game, equity dictates that 
the Court implement the Net Investment Method. Customer property 
consists of a limited amount of funds that are available for 
distribution. Any dollar paid to reimburse a fictitious profit is a 
dollar no longer available to pay claims for money actually invested. 
If the [Final] Statement Method were adopted, Net Winners would 
receive more favorable treatment by profiting from the principal 
investments of Net Losers, yielding an inequitable result."[Footnote 
91] 

The bankruptcy court also agreed with the Trustee that NIM was more 
compatible with trustee avoidance powers under the Bankruptcy Code. 

"The Trustee relies on numerous cases, all holding that transfers made 
in furtherance of a Ponzi scheme, and specifically transfers of 
fictitious profits, are avoidable. The Net Investment Method 
harmonizes the definition of Net Equity with these avoidance 
provisions by similarly discrediting transfers of purely fictitious 
amounts and unwinding, rather than legitimizing, the fraudulent 
scheme. The [Final] Statement Method, by contrast, would create 
tension within the statute by centering distribution to customers on 
the very fictitious transfers the Trustee has the power to avoid." 
[Footnote 92] 

Finally, the bankruptcy court concluded that judicial precedent 
involving Ponzi scheme cases, including In re New Times Securities 
Services, Inc., supported use of NIM in the Madoff liquidation. 
[Footnote 93] New Times also concerned a SIPA liquidation arising out 
of a Ponzi scheme fraud. 

In New Times, some investors (known as "real securities claimants") 
had been offered shares in real mutual funds, which the Ponzi schemer-
debtor never purchased. Other investors (known as "fake securities 
claimants") purchased shares in fictitious money market funds with 
fictitious names. The debtor generated monthly statements for both 
sets of investors that showed fictitious securities positions as well 
as interest and dividend earnings. The SIPA trustee in New Times 
treated the two sets of investors differently. He determined that for 
those investors whose fictitious statements reflected the purchase of 
real securities, their net equity for purposes of the act should be 
based on the positions shown in their statements--that is, he applied 
FSM. (This treatment was not before the court in New Times.) However, 
the trustee determined that for investors whose statements reflected 
earnings from the entirely fictitious funds, their net equity was 
limited to their initial investments--that is, he applied NIM to them. 
[Footnote 94] 

The fake securities claimants appealed the trustee's determinations to 
the federal district court. The district court sided with the 
investors, holding that their net equity should be calculated using 
FSM, recognizing the fictitious interest and dividend reinvestment 
earnings shown on their statements. The SIPA trustee then appealed the 
district court's decision. SEC joined SIPC in maintaining that NIM 
should be used to determine the fictitious fund investors' net equity. 

On appeal, the Court of Appeals for the Second Circuit endorsed the 
joint position of SIPC and SEC that net equity of the fake securities 
claimants should be based solely on their initial investments, 
excluding imaginary interest and dividends shown on the statements. 
The appeals court agreed that basing recoveries on fictitious interest 
and dividend amounts would be "irrational and unworkable."[Footnote 95] 

In the Madoff litigation, both parties argued that New Times supported 
their position. The Madoff net winners argued they should be compared 
to the first group of New Times customers, who were supposedly 
invested in real mutual funds, because Madoff's account statements 
showed positions in real securities. Because the real securities 
claimants in New Times had their net equity calculated by FSM, Madoff 
net winners argued they should likewise have their net equity 
calculated by FSM. 

Instead, the bankruptcy court endorsed the position of the Trustee, 
SIPC, and SEC by analogizing Madoff net winners to the fake securities 
claimants in New Times with their fictitious holdings, which led to 
NIM as the appropriate method by which to calculate their net equity. 
[Footnote 96] The court explained that the key precedent set by New 
Times regarding net equity analysis is that customer recovery cannot 
be based on account statements that contain numbers with no relation 
to reality, whether the securities are identifiable by name (as in 
Madoff) or not (as in New Times).[Footnote 97] Reliance on fraudulent 
promises in account statements, the court stated, would create "the 
absurdity of 'duped' investors reaping windfalls as a result of 
fraudulent promises."[Footnote 98] The court also noted that the 
initial investments of real securities claimants in New Times were 
sufficient to acquire their initial securities, and subsequent 
statements listing earnings reflected actual market events. By 
contrast, initial investments by Madoff investors were "insufficient 
to acquire their purported securities positions, which were made 
possible only by virtue of fictitious profits . . . [as] account 
activity was manipulated with the benefit of deliberately calibrated 
hindsight."[Footnote 99] 

The Court of Appeals Affirmed the Bankruptcy Court's Decision: 

The Court of Appeals for the Second Circuit reviewed the bankruptcy 
court's ruling on net equity in the Madoff case on a de novo 
basis.[Footnote 100] It affirmed the bankruptcy court decision, 
holding that while SIPA does not prescribe a single method for 
determining net equity in all situations--: 

"Mr. Picard's selection of the Net Investment Method was more 
consistent with the statutory definition of 'net equity' than any 
other method advocated by the parties or perceived by this Court. 
There was therefore no error.... The statutory definition of 'net 
equity' does not require the Trustee to aggravate the injuries caused 
by Madoff's fraud. Use of the [Final] Statement Method in this case 
would have the absurd effect of treating fictitious and arbitrarily 
assigned paper profits as real and would give legal effect to Madoff's 
machinations."[Footnote 101] 

The Court of Appeals endorsed the reasoning of the bankruptcy court. 
At the same time, it emphasized: 

"In holding that it was proper for Mr. Picard to reject the [Final] 
Statement Method, we expressly do not hold that such a method of 
calculating 'net equity' is inherently impermissible. To the contrary, 
a customer's last account statement will likely be the most 
appropriate means of calculating 'net equity' in more conventional 
cases. We would expect that resort to the Net Investment Method would 
be rare because this method wipes out all events of a customer's 
investment history except for cash deposits and withdrawals. The 
extraordinary facts of this case make the Net Investment Method 
appropriate whereas in many instances, it would not be. The [Final] 
Statement Method, for example, may be appropriate when securities were 
actually purchased by the debtor, but then converted by the debtor." 
[Footnote 102] 

The Court of Appeals also rejected the FSM advocates' characterization 
of SIPA as providing "an insurance guarantee of the securities 
positions set out in their account statements" which should "operate 
to make them whole from the losses they incurred as a result of 
Madoff's dishonesty."[Footnote 103] On the contrary, the Court of 
Appeals observed that SIPA did not necessarily protect against all 
forms of fraud committed by brokers or insure investors against all 
losses. 

Legal Issues Remain: 

The U.S. Court of Appeals for the Second Circuit has affirmed the 
Trustee's use of NIM, but several legal issues remain. Courts have yet 
to rule on whether calculations of net equity under NIM should include 
an adjustment for inflation. A ruling supporting this "constant 
dollar" approach would stand to affect liquidation payouts for a 
significant number of Madoff customers. In addition, the Trustee is 
pursuing a large number of actions against Madoff net winners--known 
as clawbacks or avoidance actions--seeking to recover assets they 
received that exceeded their investments. The outcome of these actions 
likewise will affect liquidation payouts to Madoff customers. Finally, 
petitions seeking review of the appeals court's net equity ruling have 
been filed with the U.S. Supreme Court. 

[End of section] 

Appendix IV: Comments from the Securities and Exchange Commission: 

United States Securities and Exchange Commission: 
Division of Trading and Markets: 
Washington, DC 20549: 

March 2, 2012: 

A. Nicole Clowers: 
Director: 
Financial Markets and Community Investment: 
United States Government Accountability Office: 
441 G Street, NW: 
Washington, DC 20548: 

Dear Ms. Glowers: 

Thank you for the opportunity to comment on the Government 
Accountability Office's draft report Securities Investor Protection 
Corporation: Interim Report on the Madoff Liquidation Proceeding 
("Draft Report"). We have reviewed the Draft Report and have sent to 
your staff certain technical comments. 

The Draft Report makes two recommendations to improve SIPC's process 
for selecting trustees. First, the Draft Report recommends that the 
SEC Chairman advise SIPC to document its procedures for identifying 
candidates to serve as trustee or as trustee's counsel and to assess 
whether additional outreach efforts should be adopted and 
incorporated. In addition, the Draft Report recommends that the SEC 
Chairman advise SIPC to document its procedures and criteria for 
appointing a trustee and a trustee's counsel for each liquidation. The 
Division of Trading and Markets staff will recommend that the Chairman 
take these actions. 

Thank you for the opportunity to comment on the Draft Report. 

Sincerely, 

Signed by: 

Robert W. Cook: 
Director: 

[End of section] 

Appendix V: Comments from the Securities Investor Protection 
Corporation: 

SIPC:
Securities Investor Protection Corporation: 
805 Fifteenth Street, N.W., Suite 800: 
Washington, D. C. 20005-2215: 
(202) 371-8300; FAX (202) 371-8728: 
[hyperlink, http://WWW.SIPC.ORG] 

February 28, 2012: 

By Hand Delivery and E-mail: 

A. Nicole Clowers: 
Director: 
Financial Markets and Community Investment: 
U.S. Government Accountability Office: 
441 G St NW: 
Washington, DC 20548: 

RE: SIPC Interim Report on the Madoff Liquidation Proceeding: 

Dear Ms. Clowers: 

Thank you for the opportunity to review and comment upon the GAO 
Report entitled "Securities Investor Protection Corporation Interim 
Report On The Madoff Liquidation Proceeding." SIPC's staff has 
reviewed the Report and offers the following comments. 

Any report of this nature offers the prospect of reviewing and 
improving the work of the organization that is the subject of the 
examination, and the current report is no exception. The Interim 
Report makes two recommendations, and SIPC will make plans to 
implement those recommendations immediately. 

Documenting and Assessing the "Outreach" Procedure for Service 
Providers: 

First, the GAO recommends that SIPC document its procedures for 
identifying service providers and assess whether additional outreach 
efforts are necessary to extend the prospective talent pool of persons 
who are qualified to serve in SIPC cases. We are pleased that the 
Interim Report recognizes the need to move swiftly when SIPC is 
notified of a brokerage firm failure. Implementing this recommendation 
may lead to the expansion of our existing database of possible service 
providers and thus allow SIPC to choose from a broader base of persons 
with the requisite capabilities. 

Initial thoughts on this matter include expanding SIPC's contacts and 
participation with organizations such as the American Bankruptcy 
Institute, the National Conference of Bankruptcy Judges, and the 
National Association of Bankruptcy Trustees. Individuals and firms 
which SIPC has not previously encountered, but which have the 
necessary skill sets, can be located through these organizations. 

Finally, SIPC will consult with the SEC staff to discuss any 
procedures the Commission currently uses to document and maintain an 
outreach for potential Receivers in various types of
SEC proceedings. 

Documenting the Process by which SIPC Designates a Trustee and Counsel 
at the Outset of a Customer Protection Proceeding: 

Second, the GAO recommends that SIPC document the process by which 
SIPC designates a trustee and counsel when a customer protection 
proceeding needs to be initiated. Once again, I believe the Interim 
Report correctly recognizes the need for virtually immediate action. 
There is nothing in the recommendation that would delay or slow SIPC's 
progress in any way, and the SIPC staff agrees that the need for 
transparency can be accommodated as well.
Among the items that could be documented, contemporaneously, are: 

* The prospective size of the engagement, if known, so as to assure 
that the service providers chosen have adequate resources; 

* Whether the engagement is one which is sufficiently limited in scope 
to introduce a new service provider to a SIPA proceeding or whether 
the engagement necessitates a proven service provider; 

* The specific process used by the service provider to discover 
possible conflicts of interest; 

* Any specific agreement by a service provider to provide a "public 
service discount" from the ordinary rates; 

* Any unique problems presented by the referral from the SEC or self-
regulatory organization, which might require specialized expertise; 

* The persons within the SIPC staff who were consulted with respect to 
the engagement. 

Over time, I am sure the SIPC staff will be able to develop other 
criteria that would be useful in this regard. 

Also, as with the first recommendation, SIPC will consult with the SEC 
staff to discuss any procedures the SEC uses to document the process 
of choosing an SEC Receiver, since the designation of a Receiver by 
the SEC and the designation of a Trustee and Counsel by SIPC are 
clearly analogous. 

Other Matters Addressed by the Interim Report: 

While the Interim Report touches on a wide variety of SIPC's work in 
the Madoff case, I wanted to point out two matters in particular where 
the document makes very important findings. 

First, the Interim Report notes (page 29) that the costs of the Madoff 
liquidation are driven by efforts to recover assets for customers. 
This is absolutely correct, and an important point that needs to be 
emphasized to the public. SIPC and the Trustee agree that cost
containment is important. But maximizing the return to victimized 
claimants takes precedence. 

Second, with respect to the issue of how to measure the correct value 
of any customer claim in the Madoff case, I note that the Interim 
Report correctly states (page 22) that neither SIPC, nor the SEC, not 
the Trustee, took the cost to SIPC of any particular methodology into 
account. Instead, as both the Bankruptcy Court and the Second Circuit 
Court of Appeals noted, using the so-called Final Statement 
methodology in this instance has the absurd effect of legitimizing the 
arbitrarily assigned paper profits that the Madoff fraud produced. 
(The Interim Report notes the Courts' conclusions at page 25.) The use 
of a Final Statement methodology would, as a simple matter of 
arithmetic, diminish the returns to those most harmed by Madoff s 
theft, to wit, those persons who did not receive all of their initial 
deposits with the Madoff firm. 

Going Forward: 

Both the "Interim" title of the Report, and footnote 2 therein, 
indicate that the GAO will continue to study this matter. I hope this 
letter indicates that SIPC has both taken your recommendations to 
heart and looks forward to your input in the future. 

Very truly yours, 

Signed by: 

Stephen P. Harbeck: 
President and CEO: 

[End of section] 

Appendix VI: GAO Contact and Staff Acknowledgments: 

GAO Contact: 

A. Nicole Clowers, (202) 512-8678 or clowersa@gao.gov: 

Staff Acknowledgments: 

In addition to the contact named above, Cody J. Goebel, Assistant 
Director; Rachel DeMarcus; Dean P. Gudicello; Daniel S. Kaneshiro; 
Jonathan M. Kucskar; Marc W. Molino, Barbara M. Roesmann; and 
Christopher H. Schmitt made major contributions to this report. 

[End of section] 

Footnotes: 

[1] Avoidance, or clawback, actions enable a bankruptcy trustee to 
recover for the bankrupt estate certain payments made by the debtor 
prior to the bankruptcy filing. 

[2] We expect our future work will include, among other things, issues 
relating to customer claims and the Trustee's asset recovery actions. 

[3] A Ponzi scheme is an investment fraud that involves the payment of 
purported returns to existing investors from funds contributed by new 
investors. 

[4] The cash limitation amount is subject to potential adjustment for 
inflation every 5 years. According to SIPC, the $500,000 limit for 
securities, rather than the limit for cash, applied in the Madoff 
liquidation. At the start of the Madoff case, the cash protection 
limit was $100,000 per customer. 

[5] 15 U.S.C. § 78ccc(a)(2)(A). This provision exempts certain 
categories of brokers and dealers, including those whose principal 
business is conducted outside of the United States. 

[6] Securities Investor Protection Corporation v. Barbour, 421 U.S. 
412, 417 (1975). 

[7] 15 U.S.C. § 78ccc(c)(2). Three of the presidential appointees come 
from the securities industry. The other two are members of the general 
public not associated with the securities industry for at least 2 
years preceding their appointment. The President designates the chair 
and vice chair from among the general public members. 

[8] In this report, we generally use "costs" to include fees, such as 
hourly billings for attorneys, as well as other expenses incurred. 

[9] In March 2009, SIPC announced that it was increasing the 
assessment, effective April 1, 2009, after determining, pursuant to 
SIPA and SIPC bylaws, that the fund balance was "reasonably likely" to 
remain less than $1 billion for at least 6 months. 

[10] For SIPC to initiate a proceeding, at least one of the following 
other factors must exist: (1) the firm must be insolvent under the 
Bankruptcy Code or unable to meet its obligations as they become due; 
(2) the firm is subject to a court or agency proceeding in which a 
receiver, liquidator, or trustee has been appointed; (3) the firm is 
not compliant with applicable requirements under the Securities 
Exchange Act of 1934 or financial responsibility rules of SEC or 
financial self-regulatory organizations; or (4) the firm is unable to 
show compliance with such rules. In the smallest proceedings (in 
which, among other factors, the claims of all customers are less than 
$250,000), SIPC may directly pay customer claims without filing an 
application for a protective decree with a court and without the 
appointment of a trustee. 

[11] Disinterested means, among other things, that the trustee has no 
outstanding financial obligation with the failed firm or has not been 
employed or acted as attorney for the firm within the last 2 years. 

[12] See, for example, Securities Investor Protection Corp. v. Morgan, 
Kennedy & Co., Inc., 533 F.2d 1314 (2d Cir. 1976); SEC v. Wick, 360 F. 
Supp. 312 (N.D. Ill. 1973); In re Bell and Beckwith, 93 B.R. 569 
(Bankr. N.D. Ohio 1988). 

[13] 15 U.S.C. § 78eee(b)(5)(A). In addition to the use of designated 
counsel, SIPA trustees generally are authorized, with SIPC approval, 
to hire and fix the compensation of personnel necessary to carry out 
liquidations, including officers and employees of the debtor and its 
examining authority, as well as accountants, and to use the services 
of SIPC employees. 15 U.S.C. § 78fff-1(a)(1), (2). 

[14] The statutory provision was adopted in 1978 amendments to SIPA, 
and SIPC supported the change following inquiries from judges about 
whether the practice was permissible, according to the SIPC President. 

[15] According to SIPC senior management, it is important that SIPC 
attorneys be free to express candid opinions on quality of services 
provided. 

[16] See GAO, Standards for Internal Control in the Federal 
Government, [hyperlink, 
http://www.gao.gov/products/GAO/AIMD-00-21.3.1] (Washington, D.C.: 
November 1999), and Committee of Sponsoring Organizations of the 
Treadway Commission, Internal Control - Integrated Framework (1992). 

[17] SIPC senior management estimated that in SIPC's 290 liquidations, 
186 individuals (excluding SIPC) have served as trustee or co-trustee, 
and at least 173 law firms have served as trustee's counsel. They also 
said that when the opportunity arises, SIPC designates firms new to 
SIPA cases. 

[18] For example, according to SIPC senior management, the Madoff 
matter is SIPC's largest case as measured by missing assets and 
misstatement of customer assets, but is not the largest by number of 
customers or size of bankruptcy filing. 

[19] As part of the appointment order, the case was removed to the 
U.S. Bankruptcy Court for the Southern District of New York. 

[20] Section 326(a) of the Bankruptcy Code provides that in a case 
under chapter 7 or chapter 11, the court "may allow reasonable 
compensation…of the trustee for the trustee's services, payable after 
the trustee renders such services, not to exceed 25 percent on the 
first $5,000 or less, 10 percent on any amount in excess of $5,000 but 
not in excess of $50,000, 5 percent on any amount in excess of $50,000 
but not in excess of $1,000,000, and reasonable compensation not to 
exceed 3 percent of such moneys in excess of $1,000,000, upon all 
moneys disbursed or turned over in the case by the trustee to parties 
in interest, excluding the debtor, but including holders of secured 
claims." 

[21] Petitions seeking review of the case have been filed with the 
U.S. Supreme Court. 

[22] 15 U.S.C. § 78lll(11). 

[23] 15 U.S.C. § 78fff-2(b). 

[24] SEC officials told us that whenever feasible, customer accounts 
are quickly transferred to another operating broker-dealer, to 
facilitate customers' orderly receipt of cash and securities, and to 
provide continuing access to brokerage services. In general, if the 
accounts and records are in order, a trustee likely can transfer the 
accounts to another broker-dealer in a process known as a bulk 
transfer. After such a transfer, customers have full access to their 
accounts. If a bulk transfer is not possible, the trustee returns 
customer securities and cash directly to customers on a pro rata basis 
through a claims process. 

[25] According to the Trustee, as of February 2012, customer claims in 
the case break down as follows: 
total claims received: 16,519; 
allowed claims: 2,426; 
denied claims: 2,703; 
other denied claims involving investors that held accounts at third 
parties: 10,976; 
withdrawn claims: 153; and; 
other circumstances: 261. 

[26] SEC officials told us that clawbacks usually have not occurred in 
other Ponzi cases because the duration of the frauds was generally 
shorter, which limits the amount of time that customers had to make 
withdrawals that could be subject to recovery actions. SIPC senior 
management told us SIPA and the Bankruptcy Code authorize clawbacks, 
and that such actions have been brought where Ponzi schemes were 
involved. 

[27] SIPC senior management told us that with the exception of some 
transactions believed to be executed on behalf of insiders to the 
scheme, all purported customer transactions were fictional. SIPC 
senior management also stated that Madoff reviewed securities trading 
data after the fact, selecting securities that had experienced good 
results. He then issued purported purchase and sales confirmations 
based on the already known favorable results. According to SIPC senior 
management, other than activity involving the insiders, there has been 
no indication that any trades claimed on customers' behalf were 
legitimate. 

[28] 15 U.S.C. § 78fff-2(b). 

[29] Within SEC, analysis of the net equity issue took place in three 
divisions: Trading and Markets, which oversees SIPC; the Office of 
General Counsel (OGC), which is responsible for SEC's legal positions; 
and Risk, Strategy, and Financial Innovation, which evaluated possible 
outcomes under different scenarios. The three divisions worked 
collaboratively on the issue, SEC officials told us, but ultimately, 
OGC came to drive the discussions, because it would be OGC that would 
present the agency's legal position. 

[30] SIPC rejected this approach, telling us that customer statements 
were equally as fictitious whether they represented that holdings were 
in securities or other instruments such as cash. Internal SEC 
correspondence we reviewed raised a similar concern. 

[31] SEC officials told us they did not document the number of 
meetings and who attended. 

[32] An SEC Office of Inspector General report addressing portions of 
the Madoff case included comments from SEC personnel suggesting impact 
on the SIPC fund was a matter of concern to SIPC senior management in 
consideration of what net equity method should be used. See SEC Office 
of Inspector General, Investigation of Conflict of Interest Arising 
from Former General Counsel's Participation in Madoff-Related Matters, 
OIG-560 (Washington, D.C.: Sept. 16, 2011). SIPC senior management 
noted to us that these comments were second-hand, and reiterated that 
impact on the fund played no role in their consideration. 

[33] SIPC senior management also told us that the burden customers 
might bear in pursuing a claim, such as financial costs, time 
investment, or other hardship, did not enter into the net equity 
decision. The main reason is that no matter what net equity method is 
used, it remains necessary to investigate the facts and evidence 
supporting claims. In any case, they said, trustee efforts to 
investigate claims can actually lessen the burden for customers. SIPC 
senior management said the Trustee spends considerable time 
reconstructing events and transactions on behalf of customers, and in 
the Madoff case, the Trustee is better positioned to do so than 
customers. 

[34] In re Bernard L. Madoff Investment Securities LLC, 424 B.R. 122 
(Bankr. S.D.N.Y. 2010). 

[35] Id. at 135. 

[36] 424 B.R. at 129-130. 

[37] 424 B.R. at 141. 

[38] Id. at 136. 

[39] In re Bernard L. Madoff Investment Securities LLC, 654 F.3d 229 
(2d Cir. 2011). 

[40] Id. at 239. 

[41] See 424 B.R. at 125, n. 8. 

[42] In addition, according to SIPC senior management, recent 
amendments to SIPA show Congress had no intent to allow inflation 
adjustment for net equity. Following changes made by the Dodd-Frank 
Wall Street Reform and Consumer Protection Act in 2010, there is now 
an inflation-adjustment provision built into SIPC coverage--but not 
for net equity. Rather, it involves determination of the amount of the 
standard maximum cash advance amount in a SIPC case. SIPC advocated 
for this change, executives told us. However, they said, the key point 
is that this provision does not apply to net equity. When adopting the 
change, Congress had the ability to add provisions for inflation-
adjustment of net equity, but did not do so, they said. 

[43] One limited SEC study of about 2,100 accounts showed that 
adjusting for inflation increased estimated payments for 1,033 
accounts, or about half, while reducing estimated payments for 438 
accounts. 

[44] SEC officials noted the 9 percent rate cited by the Trustee is a 
statutory judgment rate, not a measure, such as the Consumer Price 
Index, contemplated as an inflation-adjustment rate under a constant 
dollar approach. 

[45] See OIG-560. The Inspector General told us he found no evidence 
that the former General Counsel's actions on the net equity matter 
were motivated by trying to serve his own financial interests, or that 
he had become subject to a clawback action. 

[46] Further increases are possible, depending on how liquidation 
proceedings develop, the Trustee said, and a new analysis will 
probably be done in the future. 

[47] Costs in the bankruptcy of Lehman Brothers, Inc.--also a SIPC 
customer protection proceeding--are substantial as well. They total 
$498.1 million, according to the most recently available information. 
Unlike the Madoff case, the Lehman costs do not involve any advances 
by SIPC, and instead are being paid from debtor assets. The case is 
not yet complete. 

[48] Because the interim reports and legal cost applications cover 
different periods, information contained in them does not correspond. 
Because the legal cost applications submitted for court consideration 
are more detailed, and because court approval is required for payment, 
our review of Trustee and trustee's counsel legal costs focused on the 
items submitted for court approval. In addition to the legal costs 
submitted by the Trustee and trustee's counsel, 19 other parties, 
mostly special counsel, have also submitted, and won approval of, 
additional costs totaling $25.3 million, or an amount equal to 11 
percent of total Trustee and trustee's counsel costs approved. As of 
February 2012, the Trustee has retained, with the bankruptcy court's 
approval, 17 special counsel, consisting of 13 foreign law firms and 4 
domestic law firms; this number has changed over time. Because our 
review focuses on the Trustee and trustee's counsel, we omit the other 
parties' costs from our discussion. 

[49] The partner figure includes "of counsel" attorneys, who are 
nonpartner lawyers also participating in the case, such as on special 
assignment. 

[50] In addition, as noted earlier, the Trustee in November 2011 
reached a $326 million settlement with the Internal Revenue Service, 
to recover certain foreign withholding taxes paid on behalf of Madoff 
account holders, allegedly to make the Ponzi scheme appear authentic. 

[51] Comparing the billing rates of the trustees in the Madoff case 
and the Lehman Brothers, Inc., liquidation shows them to be roughly 
the same--$850 per hour for Madoff, and $891 for Lehman. A rate 
comparison alone, however, does not take into account how a firm's 
attorney resources are deployed in handling a case, which in turn 
influences total cost. 

[52] We also examined whether individual attorneys' billing rates 
corresponded with experience levels but found considerable variance. 
As a result, we focused on billing rates, not years of experience. 

[53] ABA is a voluntary professional association for the legal field, 
and provides law school accreditation, continuing legal education, 
information about the law, programs to assist lawyers and judges in 
their work, and initiatives to improve the legal system. 

[54] Other factors from ABA's nonexhaustive list are the likelihood, 
if apparent to the client, that the acceptance of the particular 
employment will preclude other employment by the lawyer; the fee 
customarily charged in the locality for similar legal services; the 
amount involved and the results obtained; time limitations imposed by 
the client or by the circumstances; and nature and length of the 
professional relationship with the client. 

[55] Other types, for example, include investment banker fees and SEC 
receiver expenses. 

[56] For our analysis, we defined total costs as administrative cost 
distributions from the estate plus SIPC advances for administrative 
costs. We defined customer distributions as those from the estate plus 
SIPC advances for securities and cash. 

[57] We also excluded cases prior to and including 1978 because 
according to SIPC, the method for covering administrative costs 
changed with SIPA amendments that year. Before the amendments, 
administrative costs could be paid from customer funds. 

[58] This 1990 case was the liquidation of Blinder, Robinson & Co., 
Inc., a Colorado "penny stock," or low price, firm. According to SIPC, 
no other brokerage firm would accept a transfer of this firm's 
customer accounts because they contained essentially worthless 
securities that had been sold to dissatisfied customers, As a result, 
customer claims had to be determined on a position-by-position basis, 
which was expensive. 

[59] The $15.5 billion figure for the selected years is 99.1 percent 
of all distributions for the entire 1979 to 2010 period, according to 
our analysis of SIPC information. 

[60] The single large case was MJK Clearing, Inc., a Minneapolis, 
Minnesota, brokerage firm with about 63,200 retail and 1,800 
institutional customer accounts. MJK also cleared the accounts of 
other broker-dealers, making it responsible for about 175,000 
customers. After the U.S. District Court ordered the firm's 
liquidation, the SIPA trustee arranged transfer of the customer 
accounts to another clearing firm, enabling customers to access their 
funds. The cause of the firm's failure involved defaults by a 
securities lending counterparty. With settlement of the litigation, 
the trustee was able to pay all creditors and return SIPC's advances, 
with interest. Total customer distributions, according to SIPC, were 
$11.8 billion, none of which were ultimately paid by SIPC. 

[61] The firm has also built in-house tools for managing discovery 
that help manage costs, but these are used for other clients as well, 
and not exclusively on the Madoff case. For example, documents have 
been computerized, with the ability to search documents by keyword. 

[62] The Trustee and his counsel do not mark up costs submitted by 
vendors, consultants, or others, according to the Trustee. The Trustee 
reviews invoices, after which they are sent directly to SIPC for 
review and approval. 

[63] See SEC Office of Inspector General, SEC's Oversight of the 
Securities Investor Protection Corporation's Activities, report no. 
495 (Washington, D.C.: Mar. 30, 2011). 

[64] Securities Investor Protection Corporation Guidelines for 
Reviewing Applications and Monthly Invoices For Compensation and 
Reimbursement of Expenses Under Section 5(b)(5) of the Securities 
Investor Protection Act, 15 U.S.C. § 78eee(b)(5). SIPC senior 
management told us these guidelines were likely created in the 1990s, 
and updated in 2003, but could not specify dates. 

[65] The SEC Inspector General confirmed to us SIPC's close review of 
costs submitted in the Madoff case, saying his office's review showed 
all individual cost items were being examined. 

[66] In particular, SIPC senior management told us, each month, SIPC's 
senior associate general counsel for dispute resolution, who is the 
principal SIPC attorney assigned to the Madoff case, closely reviews 
each cost record. The senior associate general counsel has been 
reviewing fees for SIPC for many years, the SIPC President told us, 
and his knowledge and experience are a key part of the process. To 
judge appropriateness of costs claimed, SIPC senior management told us 
the first step is that the person with the most knowledge of the case 
is the person who conducts the initial review. Issues examined include 
whether it appears too senior a lawyer worked on a task, whether too 
many hours were spent on a task, or whether too many people were 
involved with a task. 

[67] According to SIPC senior management, litigation budgets have been 
used in some other SIPA cases since the 1990s. The use of such budgets 
is especially important in the Madoff case, they said, given the 
unprecedented scope of litigation stemming from it. 

[68] These interim reports were filed on July 10, 2009; November 23, 
2009; April 9, 2010 (amended Apr. 14, 2010); October 29, 2010; May 16, 
2011; and November 15, 2011. 

[69] Declaration of Joseph Looby in support of Trustee's Motion for an 
order upholding trustee's determination denying "customer" claims for 
amounts listed on last statement, affirming trustee's determination of 
net equity, and expunging those objections with respect to the 
determinations relating to net equity (Oct. 16, 2009). 

[70] Factors considered in making hardship program decisions include: 
advanced age; inability to pay for necessary living expenses, such as 
housing (including loss of home to foreclosure), food, utilities and 
transportation; inability to pay for necessary medical expenses; need 
to return to work after having previously retired (special 
consideration given to those who can no longer return to their former 
employment); declaring personal bankruptcy; and inability to pay for 
the care of dependents. 

[71] Under SIPA, the trustee reports "shall be in such form and detail 
as (SEC) determines by rule to present fairly the results of the 
liquidation proceeding as of the date of or for the period covered by 
such reports…." 15 U.S.C. § 78fff-1(c). SEC has not issued any such 
rules, but both SEC officials and SIPC senior management told us this 
has not been a significant issue. 

[72] The trustee in the Madoff liquidation is Irving H. Picard; the 
trustee's counsel is the law firm of Baker & Hostetler LLP. 

[73] SIPA authorizes an advance payment of up to $500,000 from SIPC to 
customers with approved claims. 

[74] Securities Investor Protection Corp. v. Bernard L. Madoff 
Investment Securities LLC (In re Bernard L. Madoff Investment 
Securities LLC), 424 B.R. 122 (Bankr. S.D.N.Y. 2010). 

[75] In re Bernard L. Madoff Investment Securities LLC, 654 F.3d 229 
(2d Cir. 2011). 

[76] The bankruptcy court noted that, in general, the net winners were 
concentrated among early Madoff investors, while most net losers were 
later investors. 424 B.R. at 132. 

[77] NIM is also known as the "cash in/cash out" or "money in/money 
out" method, and FSM as the "last statement method." 

[78] As described earlier in this report, the Securities and Exchange 
Commission also considered other methods. However, the two basic 
methods were NIM and FSM, according to our review. 

[79] SEC's position differed from the Trustee's in one respect. SEC 
advocated adding an inflation adjustment to customers' NIM claims, to 
compensate them for the time value of their money. It referred to this 
as the "constant dollar approach." See 424 B.R. at 125, n. 8. Neither 
the bankruptcy court nor the Court of Appeals have addressed the 
merits of the SEC position thus far. 

[80] 424 B.R. at 132, n. 24. 

[81] Id. at 144-153. 

[82] 15 U.S.C. § 78lll(16). 

[83] 15 U.S.C. § 78fff-2(b). 

[84] Avoidance actions, sometimes referred to as "clawbacks," enable a 
bankruptcy trustee to recover for the bankrupt estate certain payments 
made by the debtor prior to the bankruptcy filing. 

[85] H.R. Rep. No. 95-746, 21 (1977), the House report on the 
legislation enacted as the 1978 amendments to SIPA. The context for 
the quoted passage is a 1978 amendment, now section 8(b)(2) of SIPA, 
15 U.S.C. § 78fff-2(b)(2), authorizing trustees to satisfy claims (in 
lieu of cash payments) by purchasing and delivering securities to 
replace those ascertainable from a customer's account. 

[86] 424 B.R. at 125. 

[87] Id. at 135. 

[88] Id. 

[89] 15 U.S.C. § 78fff-3(a)(1): "In order to provide for prompt 
payment and satisfaction of net equity claims of customers of the 
debtor, SIPC shall advance to the trustee such moneys, not to exceed 
$500,000 for each customer, as may be required to pay or otherwise 
satisfy claims for the amount by which the net equity of each customer 
exceeds his ratable share of customer property . . ." (emphasis added 
by the court). 424 B.R. at 134. 

[90] 424 B.R. at 134. 

[91] Id. at 140-141 (footnote and citation omitted). 

[92] Id. at 136 (footnote omitted). The bankruptcy court noted that no 
specific avoidance actions were before it at the time and thus 
expressed no view on the merits of potential defenses to them. Id. at 
136-137. 

[93] 371 F.3d 68 (2d Cir. 2004). This decision is often referred to as 
"New Times I" because of a somewhat related subsequent decision, In re 
New Times Securities Services, Inc., 463 F.3d 125 (2d Cir. 2006) ("New 
Times II"). 

[94] The principal issue addressed in New Times I was whether the fake 
securities claimants had claims for cash or claims for securities. 
This question has not been raised in the Madoff litigation, and 
therefore we do not discuss that aspect of the New Times I decision. 

[95] 371 F.3d at 88. 

[96] The bankruptcy court also considered New Times II, 463 F.3d 125, 
as well as another Ponzi scheme case, In re Old Naples Securities, 
Inc., 311 B.R. 607 (M.D. Fl. 2002), which likewise rejected inclusion 
of fictitious interest earnings in SIPA net equity. 

[97] 424 B.R. at 139. 

[98] Id. (citing New Times II, 463 F.3d at 130). 

[99] Id. 

[100] A de novo review gives no deference to the lower court's rulings. 

[101] 654 F.3d at 235. 

[102] Id. at 238. 

[103] Id. at 239. 

[End of section] 

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