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Baker & Hostetler LLPHearing Date: February 2, 201045 Rockefeller PlazaHearing Time: 10:00 AM (EST) New York, New York 10111Objection Deadline: November 13, 2009Telephone: (212) 589-4200Facsimile: (212) 589-4201David J. SheehanEmail:dsheehan@bakerlaw.comMarc E. HirschfieldEmail:mhirschfield@bakerlaw.comSeanna R. BrownEmail:sbr own@bakerlaw.com
 Attorneys for Irving H. Picard, Esq., Trustee for theSubstantively Consolidated SIPA Liquidation of  Bernard L. Madoff Investment Securities LLC and Bernard L. Madoff 
UNITED STATES BANKRUPTCY COURTSOUTHERN DISTRICT OF NEW YORK 
SECURITIES INVESTOR PROTECTIONCORPORATION,Plaintiff,v.BERNARD L. MADOFF INVESTMENTSECURITIES LLC,Defendant.In re:BERNARD L. MADOFF,Debtor.Adv. Pro. No. 08-01789 (BRL)SIPA Liquidation(Substantively Consolidated)
MEMORANDUM OF LAW IN SUPPORT OF TRUSTEE’S MOTION FOR AN ORDER UPHOLDING TRUSTEE’S DETERMINATION DENYING “CUSTOMER” CLAIMSFOR AMOUNTS LISTED ON LAST CUSTOMER STATEMENT, AFFIRMINGTRUSTEE’S DETERMINATION OF NET EQUITY, AND EXPUNGING THOSEOBJECTIONS WITH RESPECT TO THE DETERMINATIONSRELATING TO NET EQUITY
 
TABLE OF CONTENTSPage
-i-INTRODUCTION..........................................................................................................................1PROCEDURAL HISTORY...........................................................................................................3STATEMENT OF FACTS.............................................................................................................6I.The Structure of BLMIS And Its Collapse.............................................................6II.The Fraudulent Scheme..........................................................................................9A.The Purported “Split-Strike Conversion” Strategy....................................9B.Non-Split-Strike Conversion Customer Accounts...................................12C.Entry Into The BLMIS Fund....................................................................13D.The BLMIS 703 Account.........................................................................14E.Generation Of The BLMIS Customer Statements....................................16F.Customers Did Not Have Enough Funds To Purchase SecuritiesOn Their Statements.................................................................................17G.BLMIS Customers’ Investments Were Never Exposed To TheMarket.......................................................................................................18III.SIPA and SIPC.....................................................................................................20A.Congress Enacted SIPA To Promote And Protect The MarketEconomy By Providing Protection To Customers Against Broker Insolvency.................................................................................................201.The Chandler Act..........................................................................212.SIPA As Enacted In 1970.............................................................223.SIPA As Amended.......................................................................244.Net Equity Under SIPA................................................................245.Use Of SIPC Funds To Satisfy Customer Claims........................256.Determination Of Whether Claims Are For Cash Or For Securities......................................................................................257.The “Books and Records” Requirement.......................................26IV.Customer Claimants.............................................................................................27A.“Net Winners”..........................................................................................27B.“Over-the-Limits Net Losers That Have Received Full SIPCProtection”................................................................................................28C.“Under-the-Limits Net Losers That Will Not Receive A Full$500,000 in SIPC Protection”..................................................................28
 
TABLE OF CONTENTS
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-ii-ARGUMENT...............................................................................................................................30I.The Trustee’s “Cash-In/Cash-Out” Calculation Of Net Equity Mirrors TheStandard Judicial Treatment of Ponzi Schemes And Has Been SpecificallyUpheld Under SIPA..............................................................................................30A.The Standard Treatment Of Ponzi Schemes Is Based On NetInvestment................................................................................................30B.The “Cash In/Cash Out” Methodology Has Been Applied To Prior Ponzi Schemes Under SIPA.....................................................................33C.Fictitious Profits Paid Out In Ponzi Schemes Are Recoverable...............33D.The Second Circuit’s Decision In
 New Times I 
Supports TheTrustee’s Methodology.............................................................................351.
 New Times I 
Held That Customers Have Claims For Securities Where They Receive Confirmation Statementsand That Net Equity Claims In A Ponzi-Scheme CaseShould Not Be Based Upon Fictitious Profits..............................352.SIPA Does Not Protect Customer Expectations In FictitiousProfits...........................................................................................373.Because BLMIS Created Fictitious Transactions In AFictitious Market, Customer Claims Should Not IncludePaper Profits That Have No Relation to Reality..........................40II.The Trustee’s “Cash in/Cash out” Methodology Is The Only OneConsistent With SIPA...........................................................................................44A.The Fictitious Customer Statements Do Not Reflect Real“Securities Positions”...............................................................................44B.The “Books and Records” Requirement Precludes Claims BasedUpon Fictitious Profits.............................................................................44C.“Customer” Claims Cannot Be Based On Fraudulent Transactions........45D.The “Cash In/Cash Out” Method Is The Only One Consistent WithThe Trustee’s Power To Avoid Fraudulent Transfers Under SIPAand Other Applicable Law........................................................................46E.Customers Must Have Valid Net Equity Claims Before They AreEntitled to SIPC Protection.....................................................................49III.
Visconsi v. Lehman Brothers
Does Not Support the Objectors............................51IV.Basing Net Equity Upon Fictitious BLMIS Customer Statements WouldBe Inequitable And Make for Poor Public Policy................................................52CONCLUSION............................................................................................................................53
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