Debating Madoff

Andrew Ross Sorkin and I debate the Madoff/Divorce/Paul Weiss thing in the comments to this post over at Dealbook.

BTW, I do agree with Andrew about the pro bono point that Felix Salmon brought up -- this is not really pro bono work, rather a benefit that all employees of big firms get (even the associates, to some degree:  for example, coop closing are done by "in house" people.). Of course, one might wonder how much family law experience the folks at Paul Weiss actually have . . . 

Comments

[Bob]

One of your points to Sorkin is insightful, interesting, and utterly wrong.

You correctly recognize the difference between a mistake about the *value* of a thing and its *existence*. You then point out that while people often believe that money in a financial institution is "their thing," it really isn't.

Your point is that an accountholder (at least at a bank) has a debtor-creditor relationship with the bank rather than a property interest in particular dollars held by the *bank*.

That's Banking Law 101 -- the law treats the relationship as a debtor-creditor one for certain purposes.

But Financial Institution Law 201 says that a customer's interests in the contents of a *brokerage* account are governed by Article 9 of the UCC, the Securities Investor Protection Act, and a good chuck of the broker-dealer rules in the '33 and '34 Act. This is not just a debtor-creditor relationship. The brokerage is supposed to have actual securities backing what the accountholder is told he or she has, although the brokerage has (simplified) some ability to borrow and substitute shares. Its a sort of truncated property interest where (simplified) the brokerage can borrow and replace fungible securities with identical ones.

Bank accounts are similarly neither pure contract relationships, nor pure property interests, but somewhere on a spectrum in between. They're also governed by UCC-9. The contents of the account are actual existent property, but the property interest is held by the bank rather than the accountholder, which allows the bank to lend etc. against deposits. That there is actual *property* in the account, not just a debit, is why (for example) the government can bring an in rem action to seize monies on deposit at a bank.

[Stephen Lubben]

Thanks for the comments Bob, which are useful even if I don't think they prove I was "utterly wrong." What you are getting at is that banks use fractional reserves, while other financial institutions largely don't, although insurance companies might be an example of the contrary. I don't think that changes the nature of the relationship -- a customer has a priority claim, and often an insured claim, but its still a debt claim.

[Bob]

No, I'm not getting at the point of fractional reserves. The point I'm getting at is that a brokerage account isnt a simple debtor-creditor relationship. Post-SIPA the "propertyness" of a brokerage account is truncated, so the brokerages don't have to move actual paper with each transaction, etc. But it is still a property right at issue, or at least a right that is more propertyish than contractish.

You say that a customer has "a priority claim, and often an insured claim, but it's still a debt claim."

Not true. Brokerage accounts like those Madoff was supposedly maintaining for his customers are not mere bank accounts. Brokerage customers have a property interest in "their" securities held by the broker. It's only when the broker commingles (I.e., converts) customer property or otherwise misappropriates it, that a brokerage customer is left with what you call a "priority claim." (It actually isn't a priority claim, it's a property claim against an insufficient res, but bankruptcy lawyers sometimes gloss over the distinction.) That's UCC-9 and SIPA.

In the Madoff scheme, clients deposited money or securities for the benefit of their accounts, and Madoff converted the funds and commingled them into a common pool. Once commingled no client can properly identify "his" money in the pool (as a matter of the common law of express and equitable trust-see in re scheck) and the clients are thus unable to vindicate their property interest (except from the "customer property" res).

This is one of the legal issues central to the so-called "net equity" appeal from the Madoff receivership that's pending before the Second Circuit. What I've said here is, I think, common ground among the parties to that appeal.

P.S.: if you'd like to know why I'm so sure about all of this, feel free to email me.