United States: Second Circuit Affirms Judge Rakoff's Section 546(E) Ruling In Madoff Appeal: Clawback Actions Against "Innocent Investor" Defendants Limited To Transfers Made Two Years Prior To The SIPA Proceeding

The Second Circuit's recent decision in the Madoff clawback actions effectively limited the exposure period that "innocent investor" defendants face for the return of transfers they received in connection with the Bernie Madoff Ponzi scheme to two years prior to the date of its collapse. In re BLMIS, Nos. 12-2557-bk(L), (2d Cir. Dec. 8, 2014) (hereinafter, Second Circuit Decision).

For many individual investors who were sued by Irving H. Picard (the "Trustee"), the trustee for Bernard L. Madoff Investment Securities LLC ("BLMIS"), as "net winners,"1 and thus subject to clawback actions, that designation only heightened their misery -- and potentially left them liable for up to six years of "fictitious profits."2  So when District Court Judge Rakoff in the Southern District of New York (the "District Court") dismissed the Trustee's constructive fraudulent conveyance claims  in 2011 in Picard v. Katz, 462 B.R. 447 (S.D.N.Y. 2011) (Rakoff, J.), many "innocent investor" defendants found some relief in the potential (and often significant) reduction in their litigation exposure.  The District Court's dismissal of those claims was based on the safe-harbor provisions of section 546(e) of the Bankruptcy Code, which shields a trustee from recovering certain securities-related payments.3

Following the Katz decision, Judge Rakoff applied section 546(e) to dismiss the Trustee's constructive fraudulent transfer claims in numerous other clawback actions, and the appeals of those decisions had been consolidated at the Second Circuit since 2012.  With the issuance of the Second Circuit Decision, clawback defendants now have certainty that the Trustee will be limited to reaching back only two years prior to the BLMIS liquidation to recover transfers made to recipients.

Background

The BLMIS liquidation was commenced in December 2008 when Bernie Madoff's Ponzi scheme was discovered and he was arrested.  As part of his mandate to recover assets to distribute to BLMIS customers who suffered losses as a result of the Ponzi scheme, the Trustee commenced nearly 1,000 lawsuits against investors to recover fictitious profits from the "net winners" in order to satisfy claims of "net losers."  The Trustee's claims generally were based on constructive fraudulent transfers4 made by BLMIS as far back as six years preceding the BLMIS liquidation, and actual fraudulent transfers5 in the two years preceding the liquidation.  The defendants in the Katz lawsuit withdrew the bankruptcy court reference and sought dismissal of the Trustee's claims in the District Court, including dismissal of claims for transfers that were protected by section 546(e).

The District Court held that the safe harbor provisions of section 546(e) applied to protect the six-year constructive fraudulent transfer claims from recovery by the Trustee and dismissed those claims.  The District Court found that the payments at issue were settlement payments made by a stockbroker, or otherwise transfers made in connection with a securities contract.  The significant consequence of the Katz holding was to limit the transfers from BLMIS that the Trustee could recover from recipients to a two-year reach back period for actual fraudulent transfers rather than a six-year period for constructive fraudulent transfers.6

Following the Katz decision, hundreds of clawback defendants withdrew the bankruptcy references and sought dismissal of the Trustee's claims for clawback of transfers that were made prior to the two-year period preceding the Madoff SIPA proceeding.  The District Court granted dismissal of the constructive fraudulent transfer claims in those lawsuits as well.  The Trustee appealed the District Court decisions, and the numerous appeals were consolidated at the Second Circuit Court of Appeals.

The Second Circuit Decision

On appeal, the Second Circuit affirmed Judge Rakoff's rulings under section 546(e).  The Second Circuit agreed that the safe-harbor provisions of section 546(e) applied in these cases.  Because there was no dispute that BLMIS was a "stockbroker," the Second Circuit framed the dispositive issue as whether the transfers the Trustee sought to claw back either were "made in connection with a securities contract" or were "settlement payments."  Second Circuit Decision at 13.

The court noted that section 741(7) of the Bankruptcy Code defined "securities contact" in with "extraordinary breadth."  Id.  The court then identified the BLMIS contracts that created a securities contract for the purposes of section 543(e): (i) customer agreements with BLMIS, in which customers authorized BLMIS to open or maintain accounts for the customers' benefit, (ii) trading authorizations, in which customers appointed BLMIS to be their agent to effect securities transactions, and (iii) option agreements authorizing BLMIS to engage in options trading for the customer's account.  Id. at 15.

Having found the existence of a securities contract, the court affirmed that the payments made by BLMIS were made "in connection with" the securities contracts between the parties.  The court rejected SIPC's argument that the payments were not made "in connection" with the securities contracts because there was no true connection between the payment and the contracts.  Instead, the Court noted that section 546(e) "sets a low bar for the required relationship" and does not require the payments to be made "pursuant to," or "in accordance with" the securities contract.  Id. at 21-22.

The court also rejected the Trustee's argument that section 546(e) should not apply because BLMIS never actually made the securities transactions contemplated by the customer agreements.  The court correctly noted that neither sections 741(7) nor 546(e) contains a purchase or sale requirement, rendering it irrelevant whether BLMIS actually completed securities transactions.  Id. at 17-18.

Finally, the Second Circuit affirmed on an independent basis that the transfers were "settlement payments" under the statute, and similarly rejected the Trustee's argument that they could not be settlement payments because BLMIS never actually did any securities trading.

Conclusion

The Second Circuit Decision means the Trustee's claims against "innocent investor" defendants are limited to avoidance of transfers in a two-year reachback period, rather than six years.  In many cases, this represents a significant reduction in the amount that the Trustee can seek to avoid and recover.7  The Second Circuit Decision also provides extensive discussion of the court's reasoning and thus affords a degree of certainty about what the law on this matter for Madoff litigants likely will be going forward.


1 Applying the "net equity" methodology for calculating claims, the Trustee determined which investors were "net winners" and which were "net losers" based on whether those investors withdrew from their BLMIS account(s) more funds than the principal amount that was deposited into such account(s).  The "net equity" methodology thus ignores fictitious profits that may have been reflected in an investor's BLMIS account statements.  This methodology was approved by the Second Circuit in In re BLMIS, 654 F.3d 229 (2d Cir. 2011), cert. denied, 133 S. Ct. 24 (2012), and its application was recently confirmed by the Bankruptcy Court on December 8, 2014, with respect to transfers between multiple BLMIS accounts.  In re BLMIS, Adv. Pro. No. 08-01789, Docket No. 8680 (Bankr. S.D.N.Y. Dec. 8, 2014).

2 Under section 544(a) of the Bankruptcy Code, the Trustee may utilize a state law statute of limitations for bringing avoidance actions.  In New York, the statute of limitations under the Debtor and Creditor Law is six years (CPLR §213(1).

3 Section 546(e) of the Bankruptcy Code provides that a trustee "may not avoid a transfer that is a ... settlement payment ... made by [a] stockbroker ..., or that is a transfer made by [a] ... stockbroker ... in connection with a securities contract ... except under section 548(a)(1)(A) of this title."  11 U.S.C. § 546(e).

4 Constructive fraudulent transfers may be avoided and recovered under the Bankruptcy Code and the corresponding New York statutes where the recipient received the transfer without giving equivalent value.  In the BLMIS lawsuits, the Trustee's theory was that fictitious profits received by investors were not made for value.

5 Actual fraudulent transfers may be avoided and recovered where the transferor made the transfers with actual intent to defraud creditors.  There is a presumption of fraudulent intent for transfers made by perpetrators of a Ponzi schemes.  Section 548(c) of the Bankruptcy Code, however, provides a "good faith" defense to recovery of actual fraudulent transfers where the recipient received the transfer for value and in good faith.

6 In addition, with respect to the actual fraudulent transfer claims, the Katz decision shifted to the Trustee the initial burden to allege that the defendant was willfully blind to the fraud in order to recover payments of principal.  The District Court reasoned that, because payments of fictitious profits could not be made for value, defendants could not satisfy the good faith defense (discussed above at footnote 3) to actual fraudulent transfers to shield payments of fictitious profits.  On the other hand, because payments of principal were made for value, the Trustee would have to allege that the defendant was willfully blind to Madoff's fraud in order to bring the transfer outside of the good faith defense and recover such transfer.

7 In status reports on pending clawback actions, the Trustee has indicated that about one-third of the lawsuits involve mostly recovery of transfers made earlier than the two-year reachback period.  Thus, a substantial number of clawback defendants will benefit from the Second Circuit Decision.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Emails

From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.