SECURITIES 

INVESTOR 

PROTECTION 

CORPORATION

Interim Report on the 

Madoff Liquidation 

Proceeding

Report to Congressional Requesters

March 2012

GAO-12-414

United States Government Accountability Office

GAO
United States Government Accountability Office

Highlights of GAO-12-414, a report to 

congressional requesters

March 2012

SECURITIES INVESTOR PROTECTION 

CORPORATION

Interim Report on the Madoff Liquidation 

Proceeding 

Why GAO Did This Study

With the collapse of Bernard L. Madoff 

Investment Securities, LLC—a brokerdealer 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 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.

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.

View GAO-12-414. For more information, 

contact A. Nicole Clowers at (202) 512-8678

or clowersa@gao.gov.
Page i GAO-12-414 SIPC

Letter 1 

Background 3

SIPC Says It Followed Its Normal Process in Selecting the Trustee, 

but Lacks Documented Procedures and Formal Outreach 9

SIPC and SEC Have Supported, and Courts Have Affirmed, the 

Trustee’s Use of the Net Investment Method 16

Cost of the Madoff Liquidation Will Be the Largest to Date, with 

Efforts to Recover Assets Driving Costs 31

SIPC, SEC, and the Bankruptcy Court Have Been Satisfied That the 

Trustee Has Made Sufficient Disclosures 48

Conclusions 52

Recommendations for Executive Action 53

Agency and Third Party Comments and Our Evaluation 53

Appendix I Objectives, Scope, and Methodology 55

Appendix II Securities Investor Protection Corporation Fund Assessments and 

Balances, 1990 to 2010 57

Appendix III Legal Appendix on Determination of Net Equity 58

Appendix IV Comments from the Securities and Exchange Commission 68

Appendix V Comments from the Securities Investor Protection Corporation 69

Appendix VI GAO Contact and Staff Acknowledgments 72

Tables

Table 1: The Trustee’s Experience in Previous SIPA Cases, from 

1984 through 2005 14

Contents
Page ii GAO-12-414 SIPC

Table 2: SIPA Liquidations Involving Ponzi Scheme Cases, from 

1995 through 2012 19

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

FSM 27

Table 4: Approved Trustee-Related Legal Cost Requests, from 

December 2008 through May 2011 33

Table 5: Total Hourly Billings for the Trustee and Trustee’s 

Counsel, by Staff Category, from December 2008 through 

May 2011 34

Table 6: Consultant Costs, May 2009 through September 2011 39

Table 7: SIPC Fund Assessments and Balances, from 1990 to 2010 57

Figures

Figure 1: SIPC Fund Balance, from 2000 through 2010 5

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

January 2012 9

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

October 31, 2011 32

Figure 4: Trustee’s Counsel Costs, by Category, from December 

2008 through May 2011 35

Figure 5: Partner Hours as a Percentage of Total Attorney Hours, 

from December 2008 through May 2011 36

Figure 6: Distribution of Partner Work, by Hourly Billing Rate 

Quintiles, from February 2011 through May 2011 38

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 41
Page iii GAO-12-414 SIPC

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

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Page 1 GAO-12-414 SIPC

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 

 
 

Page 2 GAO-12-414 SIPC

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.1

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.

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.

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.3

 

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.

We analyzed 

and summarized court decisions related to the Madoff liquidation and 

selection of NIM. We also analyzed costs of the Madoff liquidation, as 

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.
 

Page 3 GAO-12-414 SIPC

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.

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.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.5

While SIPC is not a federal agency, it is subject to federal oversight. 

Under SIPA, SEC exercises what the U.S. Supreme Court has 

As of December 31, 2010, 

SIPC had 4,773 members.

 

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.

Background 
 

Page 4 GAO-12-414 SIPC

recognized as “plenary,” or general, supervisory authority over SIPC.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.7

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.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.

 

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.

SIPC Fund
 

Page 5 GAO-12-414 SIPC

Figure 1: SIPC Fund Balance, from 2000 through 2010

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.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.

 

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.
 

Page 6 GAO-12-414 SIPC

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.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.11

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, SIPCdesignated trustees and SIPC have occasionally taken opposing legal 

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.

 

10For 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. 

11Disinterested 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.

Liquidations under SIPA
 

Page 7 GAO-12-414 SIPC

positions in liquidation proceedings.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.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 brokerdealer’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 

 

12See, 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).

1315 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).
 

Page 8 GAO-12-414 SIPC

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.
 

Page 9 GAO-12-414 SIPC

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

Note: Some amounts may be approximate.

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, 

SIPC Says It Followed 

Its Normal Process in 

Selecting the Trustee, 

but Lacks 

Documented 

Procedures and 

Formal Outreach
 

Page 10 GAO-12-414 SIPC

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.14

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.

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.

15

 

14The 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.

15According to SIPC senior management, it is important that SIPC attorneys be free to 

express candid opinions on quality of services provided. 
 

Page 11 GAO-12-414 SIPC

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 
 

Page 12 GAO-12-414 SIPC

written manuals.

16

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 brokerdealer 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.

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.

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 

 

16See GAO, Standards for Internal Control in the Federal Government, 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). 
 

Page 13 GAO-12-414 SIPC

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.17

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-hundredmillion-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.18

 

17SIPC 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.

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.

18For 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. 

The Trustee Has 

Considerable Experience
 

Page 14 GAO-12-414 SIPC

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

Year

Number of 

customers

Customer 

distributions

Cause of 

firm’s failure

Courtapproved costs

for trustee 

Court-approved 

costs for

trustee’s counsel

Experience as SIPA trustee

Jay W. Kaufmann & 

Company

1984 1,019 $3,134,917 Financial distress $171,579 $128,903

Norbay Securities, Inc. 1986 9,103 16,531,987 Financial distress 256,555 88,139

Investors Center Inc. 1989 700 2,462,389 Financial distress, 

failure to comply with 

regulatory standards

516,586 245,263 

Faitos & Co., Inc. 1991 39 1,361,543 Misappropriation 150,959 39,000

U.S. Equity Management 

Corp.

1995 15 996,345 Diversion 129,676 37,039 

Hanover, Sterling & Co., Ltd. 1996 151 2,167,974 Unauthorized trading 349,716 300,627 

Euro-Atlantic Securities, Inc. 1998 68 2,130,527 Unauthorized trading 348,963 212,877

Klein Maus & Shire, Inc. 2000 22 2,739,099 Unauthorized trading 278,195 275,460

Montrose Capital

Management Ltd.

2001 10 917,146 Unauthorized trading 239,716 122,666

Park South Securities, LLC 2003 22 8,013,121 Conversion and 

unauthorized trading

1,077,996 2,843,040

Experience as trustee’s counsel

John Franklin & Associates, 

Inc.

1986 3 980,568 Misappropriation — 23,265

Austin Securities, Inc. 2005 20 4,041,583 Unauthorized trading — 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.

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.19

 

19As part of the appointment order, the case was removed to the U.S. Bankruptcy Court 

for the Southern District of New York. 

Selection of trustee’s counsel was not an independent decision; both 

SIPC and the Trustee understood that trustee’s counsel would be the 
 

Page 15 GAO-12-414 SIPC

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.
 

Page 16 GAO-12-414 SIPC

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.20

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 

 

20Section 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.” 

SIPC and SEC Have 

Supported, and 

Courts Have Affirmed, 

the Trustee’s Use of 

the Net Investment 

Method 
 

Page 17 GAO-12-414 SIPC

Circuit—have affirmed the Trustee’s decision on this method for 

determining customer claims.21

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 brokerdealer had liquidated all their “securities positions,” less any obligations of 

the customer to the firm.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.”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.24

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 

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.

 

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

2215 U.S.C. § 78lll(11).

2315 U.S.C. § 78fff-2(b). 

24SEC 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.

The Trustee Decided to 

Use Method Typically Used 

in Ponzi Scheme Cases
 

Page 18 GAO-12-414 SIPC 

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.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 

 

25According 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. 
 

Page 19 GAO-12-414 SIPC

investors.26

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.)

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.

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

Case Year

Consolidated Investment Services, Inc. 1995

Old Naples Securities, Inc. 1996

New Times Securities Services, Inc., and New Age Financial Services, Inc. 2000

Donahue Securities, Inc., and S.G. Donahue Company, Inc. 2001

Northstar Securities, Inc. 2001

Continental Capital Securities, Inc. 2003

Bernard L. Madoff Investment Securities, LLC 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.

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 

 

26SEC 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.
 

Page 20 GAO-12-414 SIPC

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.

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.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.28

 

27SIPC 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.

2815 U.S.C. § 78fff-2(b). 

SIPC and SEC Both 

Supported Use of NIM, 

Although SEC Considered 

Alternatives
 

Page 21 GAO-12-414 SIPC

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, 
 

Page 22 GAO-12-414 SIPC

and the Trustee or the bankruptcy court determined changes needed to 

be made, claims payments would have to be adjusted as necessary.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.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.31

 

29Within 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.

These outside parties advanced arguments including that the 

Trustee’s view of net equity was at odds with the statute and its legislative 

30SIPC 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.

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

Page 23 GAO-12-414 SIPC

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, 
 

Page 24 GAO-12-414 SIPC

should that be necessary to supplement fund balances to honor coverage 

commitments.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.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.

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 

 

32An 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. 

33SIPC 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.

Courts Have Affirmed the 

Trustee’s Use of NIM
 

Page 25 GAO-12-414 SIPC

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.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.”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.”36

 

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

2010).

Instead, the court said the only verifiable 

amounts evident from the Madoff firm’s books and records are customer 

35Id. at 135.

36424 B.R. at 129-130. 
 

Page 26 GAO-12-414 SIPC

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.37

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.

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.

38

In August 2011, the Court of Appeals for the Second Circuit affirmed use 

of NIM as the appropriate method in the Madoff case.39

 

37424 B.R. at 141.

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 

38Id. at 136. 

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

Page 27 GAO-12-414 SIPC

Madoff’s fraud; rather, it said, SIPA does not clearly protect against all 

fraud committed by brokers, or insure investors against all losses.40

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 asproposed FSM.

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

Under NIM

(adopted by Trustee)

Under FSM

(advocated by some customers)

Account size Accounts Claims Value Accounts Claims value

Less than $1 million 1,204 $381.9 million 1,485 $670.9 million

1-2.9 million 626 1.1 billion 1,372 2.5 billion

3-4.9 million 198 754.6 million 569 2.2 billion

5-9.9 million 153 1 billion 529 3.7 billion

10 million or greater 138 14 billion 499 48.1 billion

Other — — 5 76.9 million

Total 2,319 $17.3 billion 4,459 $57.2 billion

Source: SIPC. 

Note: Totals may not sum due to rounding.

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 

 

40Id. at 239.

Customer Claims Would 

Increase Significantly 

under FSM Compared with 

NIM
 

Page 28 GAO-12-414 SIPC

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.

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.”41

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.

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.

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 $16,156 in 2012 dollars. Calculations 

would become more involved with multiple deposits and withdrawals over 

 

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

Adjusting NIM for Inflation 

Could Increase the Size of 

Customer Claims and 

Remains an Outstanding 

Issue 
 

Page 29 GAO-12-414 SIPC

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 SECcreated approach that the statute does not support.42

 

42In 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.

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 
 

Page 30 GAO-12-414 SIPC

losers.43

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.

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.

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.45

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 

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 decisionmaking process.

 

43One 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.

44SEC 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 inflationadjustment rate under a constant dollar approach.

45See 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.
 

Page 31 GAO-12-414 SIPC

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.

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.

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.

Cost of the Madoff 

Liquidation Will Be 

the Largest to Date, 

with Efforts to 

Recover Assets 

Driving Costs

Total Administrative Costs 

of the Liquidation Have 

Reached $452 Million and 

Are Expected to Exceed $1 

Billion
 

Page 32 GAO-12-414 SIPC

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

Note: General administrative category includes expenses such as computer, employee, insurance, 

office rent, utilities, taxes, and supplies.

The Trustee told us that total administrative costs are estimated to reach 

$1.094 billion through 2014.46 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.47

 

46Further increases are possible, depending on how liquidation proceedings develop, the 

Trustee said, and a new analysis will probably be done in the future.

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 

47Costs 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. 
 

Page 33 GAO-12-414 SIPC

duration of the fraud, its size, and the number of people involved, according 

to the Trustee, SEC officials, and SIPC senior management.

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).48

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

through May 2011

Dollars in millions

Cost category Total 

Trustee compensation $4.9 

Trustee’s counsel compensation 220.2 

Trustee’s counsel expenses 4.9 

Total $230 

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

 

48Because 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.

Trustee and Trustee’s Counsel 

Costs
 

Page 34 GAO-12-414 SIPC

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.

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.49

Table 5: Total Hourly Billings for the Trustee and Trustee’s Counsel, by Staff 

Category, from December 2008 through May 2011

Category Hours billed

Trustee 6,704

Trustee’s counsel partners 175,250

Trustee’s counsel associate attorneys 335,191

Trustee’s counsel nonlegal professional staff 79,907

Total 597,052

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

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 

 

49The partner figure includes “of counsel” attorneys, who are nonpartner lawyers also 

participating in the case, such as on special assignment.
 

Page 35 GAO-12-414 SIPC

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.50

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

 

50In 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.
 

Page 36 GAO-12-414 SIPC

Partner hours have been declining. In general, billing rates for partners 

at the trustee’s counsel firm are higher than rates for associate 

attorneys.51

Figure 5: Partner Hours as a Percentage of Total Attorney Hours, from December 

2008 through May 2011

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 fig. 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.

 

51Comparing 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. 
 

Page 37 GAO-12-414 SIPC

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.52

 

52We 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.

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.
 

Page 38 GAO-12-414 SIPC

Figure 6: Distribution of Partner Work, by Hourly Billing Rate Quintiles, from 

February 2011 through May 2011

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.53

 

53ABA 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.

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 
 

Page 39 GAO-12-414 SIPC

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.54

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.55

Table 6: Consultant Costs, May 2009 through September 2011

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).

Period ending Consultant costs (in millions)

May 31, 2009 $14.6

October 31, 2009 34.3

February 28, 2010 19.1

September 30, 2010 54.9

March 31, 2011 29.6

September 30, 2011 25.7

Total $178.2

Source: GAO analysis of Trustee’s interim reports.

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

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 

 

54Other 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.

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

Costs for Consultants

Total Costs of the Madoff 

Liquidation Have Been 

Within SIPC’s Range of 

Experience 
 

Page 40 GAO-12-414 SIPC

customers in completed SIPC cases.56 We grouped these cases on an 

annual basis, focusing on years in which there were at least $50 million in 

distributions.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 case58

 

56For 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.

). 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.

57We 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.

58This 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. 
 

Page 41 GAO-12-414 SIPC

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

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.

The 13 years shown in figure 7 cover 104 cases that together account for 

$15.5 billion in customer distributions.59

 

59The $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.

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 
 

Page 42 GAO-12-414 SIPC

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.60

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.

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 

 

60The 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.

Various Steps Are Being 

Taken to Control Madoff 

Liquidation Costs 

Trustee Efforts to Control 

Costs
 

Page 43 GAO-12-414 SIPC

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 timeconsuming, expensive manual searches through thousands of boxes 

of paper material.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.62

 

61The 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.

62The 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.
 

Page 44 GAO-12-414 SIPC

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.

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.63

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.

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.

 

63See 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).

SIPC Efforts to Control Costs
 

Page 45 GAO-12-414 SIPC

In addition to the 10 percent discount, SIPC has also created guidelines 

for review and approval of costs.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.65 SIPC senior management told us they followed the guidelines 

in the Madoff case.66

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.

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.

67

 

64Securities 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.

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 

65The 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.

66In 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. 

67According 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. 
 

Page 46 GAO-12-414 SIPC

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.

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 

The Bankruptcy Court’s Role in 

Evaluating Legal Costs
 

Page 47 GAO-12-414 SIPC

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.

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 

SEC Oversight of SIPC 

Liquidation Expenses
 

Page 48 GAO-12-414 SIPC

recommendations, and SEC officials told us that formal responses are 

being prepared.

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.

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.68

 

68These interim reports were filed on July 9, 2009; November 23, 2009; April 9, 2010 

(amended Apr. 14, 2010); October 29, 2010; May 16, 2011; and November 15, 2011. 

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 

SIPC, SEC, and the 

Bankruptcy Court 

Have Been Satisfied 

That the Trustee Has 

Made Sufficient 

Disclosures 

The Trustee Has Disclosed 

Information in Variety of 

Ways
 

Page 49 GAO-12-414 SIPC

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.69

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.

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.

 

69Declaration 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).
 

Page 50 GAO-12-414 SIPC

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.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.

 

70Factors 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.
 

Page 51 GAO-12-414 SIPC

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.71

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.

The officials said some may not like decisions the 

Trustee has made, but there has been no lack of information about them.

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 

 

71Under 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.

Although Some Have 

Sought Additional Trustee 

Disclosures, SIPC, SEC, 

and the Bankruptcy Court 

Say Information Released 

Has Been Sufficient
 

Page 52 GAO-12-414 SIPC

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.

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 

Conclusions 
 

Page 53 GAO-12-414 SIPC

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.

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.

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 

Recommendations for 

Executive Action

Agency and Third 

Party Comments and 

Our Evaluation
 

Page 54 GAO-12-414 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 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. 

A. Nicole Clowers

Director

Financial Markets and

Community Investment
Appendix I: Objectives, Scope, and 

Methodology

Page 55 GAO-12-414 SIPC

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.1

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 

 

1

The trustee in the Madoff liquidation is Irving H. Picard; the trustee’s counsel is the law 

firm of Baker & Hostetler LLP. 

Appendix I: Objectives, Scope, and 

Methodology 
Appendix I: Objectives, Scope, and 

Methodology

Page 56 GAO-12-414 SIPC

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.
Appendix II: Securities Investor Protection 

Corporation Fund Assessments and Balances, 

1990 to 2010

Page 57 GAO-12-414 SIPC

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

SIPC member assessments 

and contributions Assessment rate Assessment basis SIPC fund at December 31

1990 $73,029,832 0.001875 Gross revenue $568,587,250

1991 38,851,496 0.00065 Net operating revenue 678,769,209

1992 27,217,374 0.00057 Net operating revenue 720,214,522

1993 32,612,767 0.00054 Net operating revenue 791,366,865

1994 37,115,454 0.00073 Net operating revenue 867,152,034

1995 57,831,365 0.00095 Net operating revenue 965,932,279

1996 2,639,822 $150 Flat 1,047,205,945

1997 1,339,584 $150 Flat 1,109,450,764

1998 1,186,279 $150 Flat 1,196,695,240

1999 1,136,318 $150 Flat 1,129,653,262

2000 1,108,632 $150 Flat 1,220,284,553

2001 1,083,173 $150 Flat 1,184,157,015

2002 1,050,096 $150 Flat 1,260,200,497

2003 1,083,178 $150 Flat 1,249,116,852

2004 972,817 $150 Flat 1,287,554,216

2005 927,597 $150 Flat 1,286,092,231

2006 894,941 $150 Flat 1,403,558,035

2007 852,025 $150 Flat 1,522,257,439

2008 816,322 $150 Flat 1,699,039,958

2009 346,299,978 0.0025 Net operating revenue 1,091,831,811

2010 409,200,016 0.0025 Net operating revenue 1,181,851,883

Source: SIPC.

Appendix II: Securities Investor Protection 

Corporation Fund Assessments and 

Balances, 1990 to 2010
Appendix III: Legal Appendix on Determination 

of Net Equity

Page 58 GAO-12-414 SIPC

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.1

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.2 Later, the U.S. 

Court of Appeals for the Second Circuit affirmed the bankruptcy court 

decision.3 In the following sections, we describe the Trustee’s position, 

the positions of the other parties, and the two judicial decisions.

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.4

 

1

SIPA authorizes an advance payment of up to $500,000 from SIPC to customers with 

approved claims.

2

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).

3

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

4

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. 

Appendix III: Legal Appendix on 

Determination of Net Equity

The Parties Advocated for 

Two Different Net Equity 

Methods, and the Trustee 

Determined That NIM Was 

Proper
Appendix III: Legal Appendix on Determination 

of Net Equity

Page 59 GAO-12-414 SIPC

The two competing methods for calculating net equity were NIM and the 

“final statement method” (FSM).5 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 brokerdealer firm; in the Madoff case, as of November 30, 2008.6

SIPC and the Securities and Exchange Commission (SEC) both 

supported the Trustee’s selection of NIM.7 A number of claimants argued 

for use of FSM. These claimants, most of whom were net winners,8

challenged the Trustee’s choice of NIM.

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.9

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).10

 

5

NIM is also known as the “cash in/cash out” or “money in/money out” method, and FSM 

as the “last statement method.” 

6

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.

7

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. 

8

424 B.R. at 132, n. 24.

9

Id. at 144-153.

1015 U.S.C. § 78lll(16).

Both Sides Claimed the 

Law Supported Their 

Position 
Appendix III: Legal Appendix on Determination 

of Net Equity

Page 60 GAO-12-414 SIPC

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.”11

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.12

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:

 

1115 U.S.C. § 78fff-2(b). 

12Avoidance 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. 
Appendix III: Legal Appendix on Determination 

of Net Equity

Page 61 GAO-12-414 SIPC

“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.”

13

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.

 

13H.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.
Appendix III: Legal Appendix on Determination 

of Net Equity

Page 62 GAO-12-414 SIPC

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.”

14

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.15 The court added that legitimate customer expectations 

based on false account statements “do not apply where they would give 

rise to an absurd result.”16

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 

 

14424 B.R. at 125. 

15Id. at 135.

16Id.

The Bankruptcy Court 

Affirmed the Trustee’s 

Selection of NIM
Appendix III: Legal Appendix on Determination 

of Net Equity

Page 63 GAO-12-414 SIPC

distribution from the customer property fund. Citing section 9(a)(1) of the 

act,17

“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.”

the court observed:

18

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.”

19

 

1715 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.

18424 B.R. at 134.

19Id. at 140-141 (footnote and citation omitted).
Appendix III: Legal Appendix on Determination 

of Net Equity

Page 64 GAO-12-414 SIPC

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.”

20

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.21

In New Times, some investors (known as “real securities claimants”) had 

been offered shares in real mutual funds, which the Ponzi schemerdebtor 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.

New Times also 

concerned a SIPA liquidation arising out of a Ponzi scheme fraud.

22

 

20Id. 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. 

21371 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”).

22The 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.
Appendix III: Legal Appendix on Determination 

of Net Equity

Page 65 GAO-12-414 SIPC

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.”23

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.24 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).25

 

23371 F.3d at 88. 

Reliance on fraudulent promises in account statements, the 

court stated, would create “the absurdity of ‘duped’ investors reaping 

24The 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. 

25424 B.R. at 139. 
Appendix III: Legal Appendix on Determination 

of Net Equity

Page 66 GAO-12-414 SIPC

windfalls as a result of fraudulent promises.”26 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.”27

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.28

“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.”

It 

affirmed the bankruptcy court decision, holding that while SIPA does not 

prescribe a single method for determining net equity in all situations— 

29

 

26Id. (citing New Times II, 463 F.3d at 130).

27Id. 

28A de novo review gives no deference to the lower court’s rulings.

29654 F.3d at 235. 

The Court of Appeals 

Affirmed the Bankruptcy 

Court’s Decision
Appendix III: Legal Appendix on Determination 

of Net Equity

Page 67 GAO-12-414 SIPC

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.”

30

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.”31

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.

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. 

 

30Id. at 238.

31Id. at 239.

Legal Issues Remain
Appendix IV: Comments from the Securities 

and Exchange Commission

Page 68 GAO-12-414 SIPC

Appendix IV: Comments from the Securities 

and Exchange Commission
Appendix V: Comments from the Securities 

Investor Protection Corporation

Page 69 GAO-12-414 SIPC

Appendix V: Comments from the Securities 

Investor Protection Corporation
Appendix V: Comments from the Securities 

Investor Protection Corporation

Page 70 GAO-12-414 SIPC
Appendix V: Comments from the Securities 

Investor Protection Corporation

Page 71 GAO-12-414 SIPC
Appendix VI: GAO Contact and Staff 

Acknowledgments

Page 72 GAO-12-414 SIPC

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

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.

Appendix VI: GAO Contact and Staff 

Acknowledgments 

GAO Contact

Staff 

Acknowledgments 

(250636)
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