In a client advisory sent by our office a few months ago, we described a decision in the Madoff saga in which the District Court for the Southern District of New York (the Court) closed off a potential avenue of significant recovery for the Madoff Trustee (the Trustee) and the Ponzi scheme victims by denying the Trustee standing to pursue certain claims against feeder funds – firms that sent investors' funds to Madoff and that failed to detect the fraud. Now, not only has another judge reinforced that decision (see Picard v. JP Morgan Chase and UBS AG, et al., Decision and Order Granting Defendants' Motion to Dismiss Certain Common Law Claims, No. 11-civ-913, Docket #70 (S.D.N.Y. Oct. 31, 2011)) by holding that the Trustee does not have standing to sue the big bank defendants for amounts in excess of $20 billion, but in another decision, the Court has once again curtailed the possible recovery by the Trustee, thus once more holding steadfastly to the law rather than being swayed by the plight of Madoff's victims.
In Picard v. Katz, --- F. Supp. 2d ----, 2011 WL 4448638 (S.D.N.Y. Sep. 27, 2011), the Court limited the Trustee's ability to pursue fraudulent transfer claims in two ways. First, the Court held that the potential disgorgement liability of customers is subject to the safe harbor provision of section 546(e) of the Bankruptcy Code. This holding means that the Trustee cannot recover from customers any monies received from Madoff more than two years before the bankruptcy filing.
Second, having limited the scope of the Trustee's recovery to actual fraudulent transfers made in the two years prior to the bankruptcy filing (and recognizing that every transfer made during this time period was made by Madoff with the actual intent to defraud creditors), the Court turned its attention to the applicability of a defense to actual fraudulent transfers provided by the Bankruptcy Code — namely, that a transferee may retain a transfer taken for value and in good faith by the transferee. The Trustee argued that customers did not act in good faith because they were on inquiry notice of the fraud but failed to diligently investigate Madoff Securities. Disagreeing, the Court held that lack of good faith required a finding that the customers intentionally chose to blind themselves to the red flags that suggest a high probability of fraud. Such a "willful blindness" to the truth, held the Court, would constitute bad faith and allow the Trustee to recover the payments. However, if the customer is "simply confronted with suspicious circumstances [and] fails to launch an investigation of his broker's internal practices ... his lack of due diligence cannot be equated with a lack of good faith."1
Footnotes
1. Addressing the value prong of the fraudulent transfer defense, the Court noted that the amount of invested principal clearly constitutes 'value' to the debtor and likely would be insulated from recovery. The Court mused, however, that customers likely would have much difficulty proving that the amounts they received in excess of their invested principal, e.g., investment gains, would satisfy the 'value' prong of the defense. In a footnote, the Court left open the issue of whether disgorgement of profits is limited to two years.
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