Investors who argue that fake profit in the Bernard Madoff fraud should be included in their repayment claims must wait to see if the judge overseeing the liquidation of Madoff’s defunct business will side with them.

U.S. Bankruptcy Judge Burton Lifland in New York didn’t issue a ruling yesterday after a four-hour hearing in which he listened to arguments from investors and lawyers.

Lifland will determine how much money, if any, victims may get from the industry-financed Securities Investor Protection Corp., which must repay as much as $500,000 for each qualifying claim.

“There are very complex issues here,” Lifland said at the end of the hearing. “No matter how I come down and rule, it’s going to be unpalatable to some degree to one party or another.”

Lifland didn’t say when he would make a decision.

The liquidation of New York-based Bernard L. Madoff Investment Securities LLC is the biggest such case undertaken by SIPC, court records show.

The case is Securities Investor Protection Corp. v. Bernard L. Madoff Investment Securities LLC, 08-01789, U.S. Bankruptcy Court, Southern District of New York (Manhattan).

Thousands of customers have objected to trustee Irving Picard’s methodology, arguing he is wrongfully calculating claims based on their cash deposits minus withdrawals instead of using amounts listed on Madoff’s final account statements.

Picard, hired by SIPC to repay victims of the $65 billion fraud, has said that using account statements to set claims would let the con man decide who gets what, and include fake profit from trades that didn’t really happen.

‘Changed Procedure’

Victims argue that SIPC, which was chartered by the U.S. in 1970 to wind down failed brokerages, is required to set claims based on customers’ legitimate expectations from their accounts. They say Picard changed the procedure to avoid massive payouts.

“They’re wrong — they’re wrong about their positions,” Picard’s lawyer, David Sheehan, told Lifland. “The statute is clear. The legislative history is clear.”

Sheehan told the judge that “the last customer statement, being a concoction of a fraudster, cannot be something upon which you rely. No one in their right mind would suggest you should use the last statement.”

“As soon as we give money to someone who took all their money out, we’re taking money from another customer — stolen money,” Sheehan said.

Sheehan said the claims must be set fairly to ensure no victim gets more than a fair share of money recovered by Picard through lawsuits, which he estimated could eventually be close to $10 billion.

Laughs, Murmurs

Lifland threatened to remove some observers in the packed courtroom after Picard’s lawyer was twice interrupted by laughing and murmurs.

“I’m not swayed by your reactions,” Lifland said. “Let’s have some decorum in the courtroom.”

The U.S. Securities and Exchange Commission in December told Lifland it generally supported Picard’s “cash-in, cash- out” method. The agency said it would be fairer to victims if Picard adjusted the claims for inflation.

“Customer claims should be partly principal and partly earnings,” the agency’s lawyer, Katherine Gresham, told the judge yesterday. “The commission agrees with the trustee that customer claims for net equity should not be based on the securities positions on the final account statements.”

A SIPC payment “is not insurance the way the FDIC insures bank deposits,” Gresham said.

Customer claims in the case will also determine what share victims receive from lawsuits filed by Picard against Madoff’s biggest investors and beneficiaries, including hedge funds and the con man’s wife, Ruth. About a dozen such cases seek the return of about $15 billion in allegedly fake profit.

Owing Money

Under Picard’s calculation, some victims may end up owing money if they took out more than they put in. Last week, the family of deceased New York real estate magnate Norman F. Levy agreed to pay Picard $220 million for victims to settle claims the family withdrew more than it deposited with Madoff.

Helen Chaitman, a victim who is representing other customers in the case, has said Picard’s method is improper and is slowing down the liquidation process by requiring in-depth analysis of customer records to set claims

Chaitman, who testified Dec. 9 in Washington at a congressional subcommittee hearing about the case, earlier sued Picard and accused him of representing the interests of the brokerage industry instead of those of victims.

“I know the people in this room feel they’ve been wronged terribly by Madoff, then the regulatory agencies, and now Mr. Picard,” Sheehan said in court yesterday. “But this is a Ponzi scheme. It’s a zero sum game. I know no one in this room wants to accept that.”

Left Destitute

Karen Wagner, a lawyer for Madoff customer Sterling Equities Inc., told the judge that “many customers who have been left destitute by this fraud will receive nothing under Mr. Picard’s definition of net equity.”

Josephine Wang, an SIPC lawyer, said in court yesterday that “we are not questioning the innocence of the victims in this case. We have great sympathy for them, but there are certain presumptions that are made under the law and if they choose to rely on the bad acts of Madoff then they have to accept the consequences.”

“Both the SEC and SIPC have had their motives questioned in this case, that our intent is not to enforce the law,” Wang said. “That is not only absolutely false, truly it goes beyond the pale.”

Madoff, 71, pleaded guilty in March and was sentenced on June 29 to 150 years in prison for using money from new clients to pay earlier investors in the world’s biggest Ponzi scheme.