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2nd Cir. Limits Madoff Trustee's Clawback Powers

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By Mark Wilson, Esq. on December 09, 2014 3:58 PM

Bernie Madoff just won't stop popping up everywhere. As you'll recall, the disgraced investor was sentenced to 150 years in prison for defrauding clients out of about $18 billion in a Ponzi scheme that lasted almost 20 years.

What remained of Madoff's company was placed under the control of a trustee, Jean Luc Irving H. Picard. Picard's job is to recover as much as he can, however he can, and attempt to compensate investors who lost money.

Faster than you can say "engage," customers who profited on the scheme decided they wanted to keep those profits.

Set Profit Shields to Maximum

This case presents a confluence of securities and bankruptcy law. On the one hand, there's the Securities Investor Protection Act (SIPA), which allows Picard to recover any profit investors may have made on the Ponzi scheme. This ill-gained profit, theoretically, would then go toward paying investors who've suffered a net loss.

Picard, though, can only "claw back" profits if they're voidable under the Bankruptcy Code. And wouldn't you know it? Securities-related payments can't be voided in bankruptcy. That's how Madoff investors who actually made money on the Ponzi scheme are able to argue that their profits shouldn't be taken away.

Picard had two arguments in response: First, that the fictitious profits were "fraudulent transfers" under state law, which are voidable under the Bankruptcy Code. Second, the fictitious profits are subject to New York's "fraudulent conveyance" law. These arguments, however, have the same problem: They're both barred by the statute of limitations for asserting them.

Pay Up

Picard would have done better in a fight with Nausicaans than at the Second Circuit. The court here decided that, no matter how you slice it, Madoff's fake profits were part of a securities-related payment. Even though all the documents were essentially fake and no buying or selling was going on, the contracts were styled as contracts for trading and established a customer-broker relationship. As the court points out, "The clawback defendants, having every reason to believe that BLMIS was actually engaged in the business of effecting securities transactions, have every right to avail themselves of all the protections afforded to the clients of stockbrokers, including the protection offered by Section 546(e)."

Sure, that makes Bankruptcy Code Section 546 pretty broad, but the court said that was by design, as it uses language that its scope extends not only to actual securities agreements, but to "'any other agreement ... that is similar to' a 'contract for the purchase, sale or loan of a security.'"

Consequently, every investor who made money off the Ponzi scheme is going to assert Section 546 protection for their ill-gotten profits. For Picard, resistance was futile.

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