The bankruptcy court judge overseeing the liquidation rules on a  customer’s objections after holding a hearing on the matter. Having a  documented, formal outreach process would allow SEC to better assess  whether SIPC’s outreach efforts are sufficient for ensuring that SIPC is  identifying the optimal pool of candidates. SIPC and SEC Have Supported, and Courts Have Affirmed, the Trustee’s Use of the Net Investment Method

In valuing customer claims filed as part of the Madoff liquidation, the  Trustee selected NIM, which determines the amounts that customers are  owed as the amounts they invested less amounts withdrawn. SIPC and SEC Both Supported Use of NIM, Although SEC Considered Alternatives

Like the Trustee, SIPC quickly concluded that NIM was the appropriate  method for determining customer claims, because of the fraud in the case  and because using FSM would effectively sanction Madoff’s activities. Over the course of 2009, SEC staff conducted various analyses of past  cases and alternative approaches for valuing customer claims. 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. 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. The SEC Chairman has directed commission staff to review  whether commissioners should readopt the constant dollar approach. Cost of the Madoff Liquidation Will Be the Largest to Date, with Efforts to Recover Assets Driving Costs

Through October 31, 2011, the Trustee reported spending of $451.8  million for liquidation activities, with final costs expected to exceed $1  billion through 2014. 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. customers in completed SIPC cases. Finally, SIPC senior management said that the results the  Trustee has produced to date support the costs incurred. First,  while SIPC seeks to identify potential trustees for its liquidations, it lacks a  formal, documented outreach procedure for identifying those candidates. Recommendations for Executive Action

To help ensure that the pool of providers that could be employed in SIPC  liquidations is as broad as reasonably possible, and to improve the  transparency of SIPC’s selection of trustee and trustee’s counsel for  liquidations, the SEC Chairman should take the following two actions:  1. Advise SIPC to document its procedures for identifying candidates for  trustee or trustee’s counsel, and in so doing, to assess whether  additional outreach efforts should be adopted and incorporated. Advise SIPC to document its procedures and criteria for appointment  of a trustee and trustee’s counsel for its cases. In their  comments, SEC and SIPC concurred with our recommendations. Appendix I: Objectives, Scope, and Methodology

This report discusses (1) how the Trustee and trustee’s counsel were  selected for the Bernard L. Madoff Investment Securities, LLC liquidation;  (2) the process and reasoning for the selection of “net investment  method” (NIM) in determining customer claims arising from the Madoff  fraud; (3) the costs of the subsequent liquidation of the Madoff firm; and  (4) the information that the Trustee has disclosed about his investigation  and activities. 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. We examined information the Trustee  has made public about the investigation, including material on his  website. Appendix II: Securities Investor Protection Corporation Fund Assessments and Balances, 1990 to 2010

Since 1990, the Securities Investor Protection Corporation (SIPC) has  assessed its member broker-dealers varying rates to support the fund  used to protect customers of failed securities firms. SIPC and the Securities and Exchange Commission (SEC) both  supported the Trustee’s selection of NIM. 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.”
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.
Why GAO Did This Study

With the collapse of Bernard L. Madoff Investment Securities, LLCa broker-dealer and investment advisory firm with thousands of clientsBernard 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 recoveran amount known as net equityhas been the subject of dispute and litigation. This report discusses (1) how the Trustee and trustees counsel were selected, (2) why the method for valuing customer claims was chosen, (3) costs of the liquidation, and (4) disclosures the Trustee has made about its progress. GAO examined the Securities Investor Protection Act; court filings and decisions; and SIPC, Securities and Exchange Commission (SEC), and Trustee reports and records. GAO analyzed cost filings and interviewed SIPC, SEC, and SEC Inspector General officials, and the Trustee and his counsel.

What GAO Found

The Securities Investor Protection Corporation (SIPC) generally followed its past practices in selecting the trustee for the Madoff liquidation. SIPC maintains a file of trustee candidates from across the country, but given the anticipated complexities of the case, officials said the field of potential qualified trustees was limited. SIPC has sole discretion to appoint trustees and, wanting to act quickly, SIPC senior management considered four trustee candidates. After three of the four candidates were eliminated for reasons including having a conflict of interest or ongoing work on a large financial firm failure, SIPC selected Irving H. Picard, who has considerable securities and trustee experience. However, SIPC has not documented a formal outreach procedure for identifying candidates for trustee and trustees 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 SIPCinitially 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 Trustees use of NIM, two courts have held that the Trustees 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 officials 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 trustees 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 Trustees disclosures sufficiently address the requirements for disclosure under the Bankruptcy Code and the Securities Investor Protection Act.

What GAO Recommends

SEC should advise SIPC to (1) document its procedures for identifying candidates for trustee or trustees 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 trustees counsel. SEC and SIPC concurred with our recommendations.