Case 20-1334, Document 73, 08/06/2020, 2902485, Page1 of 180 20-1334
IN THE United States Court of Appeals FORd THE SECOND CIRCUIT
IN RE: BERNARD L. MADOFF INVESTMENT SECURITIES LLC, Debtor.
IRVING H. PICARD, TRUSTEE FOR THE LIQUIDATION OF BERNARD L. MADOFF INVESTMENT SECURITIES LLC, Plaintiff-Appellant,
SECURITIES INVESTOR PROTECTION CORPORATION, Appellant, —against—
LEGACY CAPITAL LTD., KHRONOS LLC, Defendants-Appellees.
ON APPEAL FROM THE UNITED STATES BANKRUPTCY COURT FOR THE SOUTHERN DISTRICT OF NEW YORK
BRIEF AND SPECIAL APPENDIX FOR PLAINTIFF-APPELLANT
ROY T. ENGLERT, JR. DAVID J. SHEEHAN MATTHEW M. MADDEN SEANNA R. BROWN LESLIE C. ESBROOK AMY E. VANDERWAL ROBBINS, RUSSELL, ENGLERT, BAKER & HOSTETLER LLP ORSECK, UNTEREINER & SAUBER LLP 45 Rockefeller Plaza 2000 K Street NW, 4th Floor New York, New York 10111 Washington, D.C. 20006 (212) 589-4200 (202) 775-4500 Attorneys for Plaintiff-Appellant Special Counsel to the Trustee Irving H. Picard, Trustee for the Liquidation of Bernard L. Madoff Investment Securities LLC Case 20-1334, Document 73, 08/06/2020, 2902485, Page2 of 180
TABLE OF CONTENTS
Page
STATEMENT OF JURISDICTION ...... 1
ISSUES PRESENTED ...... 2
STATEMENT OF CASE ...... 3
A. The Collapse Of BLMIS’ Ponzi Scheme And The Resulting SIPA Liquidation ...... 3
B. The District Court’s 2014 Good Faith Decision ...... 4
C. The Bankruptcy Court Proceedings ...... 7
1. The Trustee’s Complaint ...... 7
2. The Bankruptcy Court’s Decision ...... 13
SUMMARY OF ARGUMENT ...... 15
STANDARD OF REVIEW ...... 18
ARGUMENT ...... 18
Transferees On Inquiry Notice Of A Broker-Dealer’s Fraud Do Not Take Funds In Good Faith Even If Their Inaction Does Not Amount To Willful Blindness ...... 18
A. Broker-Dealer Liquidations Are Conducted In Accordance With The Bankruptcy Code Except As Otherwise Stated By SIPA ...... 21
B. The Bankruptcy Code’s Fraudulent Transfer Statutes Apply In SIPA Liquidations ...... 23
C. Transferees On Inquiry Notice Of A Debtor’s Fraud Cannot Establish, As A Defense To A Trustee’s Avoidance And Recovery Of A Fraudulent Transfer, That They Received Funds “In Good Faith” ...... 26
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D. The District Court Erred By Expanding Transferees’ Good Faith Defenses In SIPA Liquidations ...... 29
1. SIPA Incorporates The Full Extent Of The Bankruptcy Code’s Fraudulent Transfer Statutes, Including Their Good Faith Defenses ...... 30
2. The Federal Securities Laws, If They Apply At All, Do Not Require Equating “Good Faith” With A “Lack Of Fraudulent Intent”...... 38
Good Faith Is An Affirmative Defense That Transferee- Defendants Must Plead With Their Answer, And For Which Trustee-Plaintiffs Have No Pleading Burden ...... 40
A. Good Faith Is An Affirmative Defense That Transferee- Defendants Have The Burden To Plead ...... 41
B. Neither SIPA Nor Other Considerations Require The Trustee To Plead A Transferee’s Lack Of Good Faith ...... 45
C. The Trustee Has No Burden To Plead A Subsequent Transferee’s Knowledge Of The Transfer’s Voidability ...... 50
The Amended Complaint Alleges Facts From Which Appellees’ Willful Blindness And Knowledge Of Voidability Can Plausibly Be Inferred At The Pleading Stage ...... 51
A. The Amended Complaint Plausibly Alleges Legacy Capital’s Willful Blindness To Fraud ...... 52
B. The Amended Complaint Pleads Recoverable Subsequent Transfers To Khronos ...... 64
CONCLUSION ...... 69
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TABLE OF AUTHORITIES
Page(s)
Cases
Aaron v. SEC, 446 U.S. 680 (1980) ...... 39
Abbas v. Dixon, 480 F.3d 636 (2d Cir. 2007) ...... 45
Adelphia Recovery Tr. v. Bank of Am., N.A., No. 05 Civ. 9050 (LMM), 2011 WL 1419617 (S.D.N.Y. Apr. 7, 2011), aff’d, 748 F.3d 110 (2d Cir. 2014) ...... 24
Anderson News, L.L.C. v. Am. Media, Inc., 680 F.3d 162 (2d Cir. 2012) ...... 55
Anwar v. Fairfield Greenwich Ltd., 728 F. Supp. 2d 372 (S.D.N.Y. 2010) ...... 61
Arista Recs. LLC v. Doe 3, 604 F.3d 110 (2d Cir. 2010) ...... 54
Ashcroft v. Iqbal, 556 U.S. 662 (2009) ...... passim
Banner v. Kassow, No. 96-5040, 1996 WL 680760 (2d Cir. Nov. 22, 1996) ...... 26, 65
Bash v. Textron Fin. Co. (In re Fair Fin.), 834 F.3d 651 (6th Cir. 2016) ...... 62
Bell Atl. Corp. v. Twombly, 550 U.S. 544 (2007) ...... passim
In re BLMIS LLC, 654 F.3d 229 (2d Cir. 2011) ...... 18, 22, 26
Bonded Fin. Servs., Inc. v. Eur. Am. Bank, 838 F.2d 890 (7th Cir. 1988) ...... 24, 27
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Bostock v. Clayton Cnty., Ga., 140 S. Ct. 1731 (2020) ...... 35
Brown v. Third Nat’l Bank (In re Sherman), 67 F.3d 1348 (8th Cir. 1995) ...... 27
Buchwald Capital Advisors LLC v. JP Morgan Chase Bank, N.A. (In re M. Fabrikant & Sons, Inc.), 480 B.R. 480 (S.D.N.Y. 2012), aff’d, 541 F. App’x 55 (2d Cir. 2013) ...... 63
CarVal UK Ltd. v. Giddens (In re Lehman Bros., Inc.), 791 F.3d 277 (2d Cir. 2015) ...... 22
Christian Bros. High Sch. Endowment v. Bayou No Leverage Fund, LLC (In re Bayou Grp. LLC), 439 B.R. 284 (S.D.N.Y. 2010) ...... 24, 25, 26, 28
City of New York v. Beretta U.S.A. Corp., 524 F.3d 384 (2d Cir. 2008) ...... 18
Cohen v. S.A.C. Trading Corp., 711 F.3d 353 (2d Cir. 2013) ...... 55
Dekalb Cnty. Pension Fund v. Transocean Ltd., 817 F.3d 393 (2d Cir. 2016) ...... 40
FTC v. Morton Salt Co., 334 U.S. 37 (1948) ...... 44
GEOMC Co., Ltd. v. Calmare Therapeutics Inc., 918 F.3d 92 (2d Cir. 2019) ...... 49
Glob.-Tech Appliances, Inc. v. SEB S.A., 563 U.S. 754 (2011) ...... 40, 53
Gold v. First Tenn. Bank Nat’l Assoc. (In re Taneja), 743 F.3d 423 (4th Cir. 2014) ...... 28, 42
Goldman v. Capital City Mortg. Corp (In re Nieves), 648 F.3d 232 (4th Cir. 2011) ...... 27, 37, 42
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Gomez v. Toledo, 446 U.S. 635 (1980) ...... 47, 48
In re Good Hope Refineries, Inc., 9 B.R. 421 (Bankr. D. Mass. 1981) ...... 50
Gowan v. Westford Asset Mgm’t (In re Dreier LLP) 462 B.R. 474 (Bankr. S.D.N.Y. 2011) ...... 62
Gredd v. Bear, Stearns Sec. Corp. (In re Manhattan Inv. Fund Ltd.), 359 B.R. 510 (Bankr. S.D.N.Y. 2007) ...... 24
Grede v. Bank of N.Y. Mellon Corp. (In re Sentinel Mgmt. Grp., Inc.), 809 F.3d 958 (7th Cir. 2016) ...... 28, 36
In re Handy Andy Home Improvement Ctrs., Inc., 199 B.R. 376 (Bankr. N.D. Ill. 1996) ...... 50
Hardaway v. Hartford Pub. Works Dep’t, 879 F.3d 486 (2d Cir. 2018) ...... 45, 48
Hayes v. Palm Seedlings Partners (In re Agric. Rsch. & Tech Grp., Inc.), 916 F.2d 528 (9th Cir. 1990) ...... 27
Intel Corp. Inv. Pol’y. Comm. v. Sulyma, 140 S. Ct. 768 (2020) ...... 36
IRS v. Nordic Vill., Inc. (In re Nordic Vill., Inc.), 915 F.2d 1049 (6th Cir. 1990), rev’d on other grounds, United States v. Nordic Vill., Inc., 503 U.S. 30 (1992) ...... 42
Javierre v. Cent. Altagracia, 217 U.S. 502 (1910) ...... 43
Jobin v. McKay (In re M & L Bus. Mach. Co.), 84 F.3d 1330 (10th Cir. 1996) ...... 28
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Jones v. Bock, 549 U.S. 199 (2007) ...... 16, 46
Lynch v. City of New York, 952 F.3d 67 (2d Cir. 2020) ...... 56
Mano-Y&M, Ltd. v. Field (In re Mortg. Store, Inc.), 773 F.3d 990 (9th Cir. 2014) ...... 42
United States ex rel. Mari. Admin. v. Cont’l Ill. Nat’l Bank & Tr. Co. of Chicago, 889 F.2d 1248 (2d Cir. 1989) ...... 44
Marshall v. Picard (In re BLMIS LLC), 740 F.3d 81 (2d Cir. 2014) ...... 23, 26, 27
McKelvey v. United States, 260 U.S. 353 (1922) ...... 44
Meacham v. Knolls Atomic Power Lab’y, 554 U.S. 84 (2008) ...... 43
In re Nat’l Cen. Fin. Enters., 846 F. Supp. 2d 828 (S.D. Ohio 2012) ...... 63
Nat’l Commc’ns Ass’n Inc. v. AT & T Corp., 238 F.3d 124 (2d Cir. 2001) ...... 47
Perkins v. Haines, 661 F.3d 623 (11th Cir. 2011) ...... 42
Perry v. Merit Sys. Prot. Bd., 137 S. Ct. 1975 (2017) ...... 44, 48
Picard v. ABN AMRO Bank N.A., No. 10-05354 (SMB), 2020 WL 1584491 (Bankr. S.D.N.Y. Mar. 31, 2020) ...... 54
Picard v. Cohmad Sec. Corp. (In re BLMIS LLC), 454 B.R. 317 (Bankr. S.D.N.Y. 2011) ...... 5
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Picard v. Katz, 462 B.R. 447 (S.D.N.Y. 2011) ...... passim
Picard v. Legacy Capital Ltd., 548 B.R. 13 (Bankr. S.D.N.Y. 2016) ...... passim
Picard v. Merkin (In re BLMIS), 515 B.R. 117 (Bankr. S.D.N.Y. 2014) ...... 62, 67
Picard v. Merkin (In re BLMIS LLC), 440 B.R. 243 (Bankr. S.D.N.Y. 2010) ...... 5, 68
POM Wonderful, LLC v. Coca-Cola Co., 573 U.S. 102 (2014) ...... 39
Rodriguez v. United States, 480 U.S. 522 (1987) ...... 35
Rombach v. Chang, 355 F.3d 164 (2d Cir. 2004) ...... 39
Rothman v. Gregor, 220 F.3d 81 (2d Cir. 2000) ...... 40
Silverman v. K.E.R.U. Realty Corp. (In re Allou Distribs., Inc.), 379 B.R. 5 (Bankr. E.D.N.Y. 2007) ...... 67
SIPC v. Barbour, 421 U.S. 412 (1975) ...... 21
SIPC v. BLMIS (In re Madoff Sec.), 516 B.R. 18 (S.D.N.Y. 2014) ...... passim
SIPC v. Stratton Oakmont, Inc., 234 B.R. 293 (Bankr. S.D.N.Y. 1999) ...... 67
Smith v. SIPI, LLC (In re Smith), 811 F.3d 228 (7th Cir. 2016) ...... 42
State of N.Y. v. United Parcel Serv., Inc., 253 F. Supp. 3d 583 (S.D.N.Y. 2017) ...... 53
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Templeton v. O’Cheskey (In re Am. Hous. Found.), 785 F.3d 143 (5th Cir. 2015) ...... 27
Tiffany (NJ) Inc. v. eBay, Inc., 600 F.3d 93 (2d Cir. 2010) ...... 36
Unencumbered Assets, Tr. v. JP Morgan Chase Bank, 604 F. Supp. 2d 1128 (S.D. Ohio 2009) ...... 62
United States v. Chu, 183 F. App’x 94 (2d Cir. 2006) ...... 53
United States v. Fofanah, 765 F.3d 141 (2d Cir. 2014) ...... 53
United States v. Joly, 493 F.2d 672 (2d Cir. 1974) ...... 53
United States v. Nektalov, 461 F.3d 309 (2d Cir. 2006) ...... 53
Wallach v. Altmeyer (In re Altmeyer), 268 B.R. 349 (Bankr. W.D.N.Y. 2001) ...... 66
Williams v. FDIC (In re Positive Health Mgmt.), 769 F.3d 899 (5th Cir. 2014) ...... 42
Statutes
11 U.S.C. § 548...... passim
11 U.S.C. § 548(a)(1) ...... 23
11 U.S.C. § 548(a)(1)(A) ...... 24, 42
11 U.S.C. § 548(c) ...... passim
11 U.S.C. § 550...... passim
11 U.S.C. § 550(a) ...... 43, 67
11 U.S.C. § 550(a)(1)-(2) ...... 25
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11 U.S.C. § 550(b) ...... passim
11 U.S.C. § 550(b)(1) ...... passim
15 U.S.C. § 77k ...... 39
15 U.S.C. § 77l(a)(2) ...... 39
15 U.S.C. § 78aaa...... 31
15 U.S.C. § 78bbb...... 21, 33
15 U.S.C. § 78eee(b)(2)(A) ...... 1
15 U.S.C. § 78eee(b)(3) ...... 22
15 U.S.C. § 78eee(b)(4) ...... 1, 4
15 U.S.C. § 78fff-1(a) ...... 22
15 U.S.C. § 78fff-1(b) ...... 23
15 U.S.C. § 78fff-2(b) ...... 47
15 U.S.C. §78fff-2(c)(3) ...... passim
15 U.S.C. § 78fff(a) ...... 4
15 U.S.C. § 78fff(b) ...... passim
15 U.S.C. § 78j(b) ...... 39
15 U.S. C. § 78lll(2) ...... 4
15 U.S. C. § 78lll(4) ...... 4, 22
15 U.S.C. § 78q(a)(2) ...... 38
15 U.S.C. § 78r ...... 40
28 U.S.C. § 157(d) ...... 1
28 U.S.C. § 158(d)(2) ...... 1
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28 U.S.C. § 1334(b) ...... 1
Rules
Fed. R. Bankr. P. 2004 ...... 16, 17, 49, 50
Fed. R. Bankr. P. 2004(b) ...... 50
Fed. R. Civ. P. 8 ...... 67
Fed. R. Civ. P. 8(a) ...... 54
Fed. R. Civ. P. 8(c) ...... 44
Fed. R. Civ. P. 8(c)(1) ...... 16, 44, 45
Fed. R. Civ. P. 12(b)(6) ...... 18, 55, 64, 65
Fed. R. Civ. P. 26 ...... 17, 50
Fed. R. Civ. P. 56(g) ...... 13
Other Authorities
Pub. L. No. 91-598, § 2, 94 Stat. 1636, 1637 (1970) ...... 33
Pub. L. No. 95-283, § 1(a), 84 Stat. 1636, 1636 (1970) ...... 31
Pub. L. No. 95-283, § 6(c), 84 Stat. 1636, 1647 (1970) ...... 32
Pub. L. No. 95-283 § 8, 92 Stat. 249, 259 (1978) ...... 32
Pub. L. No. 95-598, § 308(g), 92 Stat. 2549, 2675 (1978) ...... 32
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STATEMENT OF JURISDICTION
The bankruptcy court had subject-matter jurisdiction under 28
U.S.C. § 1334(b) and 15 U.S.C. §§ 78eee(b)(2)(A) and 78eee(b)(4) over this case brought by Irving H. Picard (the “Trustee”), as trustee for the estate of Bernard L. Madoff Investment Securities LLC (“BLMIS”) under the Securities Investor Protection Act, 15 U.S.C. §§ 78aaa–lll
(“SIPA”),1 and the substantively consolidated chapter 7 estate of
Bernard L. Madoff (“Madoff”). The district court withdrew the
reference to the bankruptcy court under 28 U.S.C. § 157(d).
On remand, the bankruptcy court dismissed certain counts of the
Trustee’s Amended Complaint and entered judgment. The Trustee
appealed the judgment. This Court authorized direct appeal. This
Court has jurisdiction under 28 U.S.C. § 158(d)(2).
1 Except as otherwise noted, citations in this brief to “SIPA” are to the sections of the Act as codified in Title 15 of the United States Code. Case 20-1334, Document 73, 08/06/2020, 2902485, Page13 of 180
ISSUES PRESENTED
SIPA authorizes trustees liquidating broker-dealers to avoid broker-dealers’ fraudulent transfers and to recover proceeds from initial and subsequent transferees under Sections 548 and 550 of the
Bankruptcy Code, 11 U.S.C. §§ 548, 550. Those bankruptcy statutes, however, state that transferees may keep those transfers if they took them “in good faith.” Id. §§ 548(c), 550(b). The issues presented are:
I. Whether the courts below erred by holding that transferees on inquiry notice of a broker-dealer’s fraud nevertheless are protected by the statutory “good faith” defense so long as they do not willfully blind themselves to the fraud.
II. Whether the courts below erred by holding that SIPA shifts the burden of pleading a transferee’s affirmative defense of good faith to the plaintiff trustee.
III. If the district court did not err with respect to the standard for good faith or the pleading burden, whether the Amended Complaint plausibly pleaded defendants’ willful blindness to fraud at BLMIS and the bankruptcy court therefore erred by dismissing the pertinent counts of that Complaint.
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STATEMENT OF CASE
A. The Collapse Of BLMIS’ Ponzi Scheme And The Resulting SIPA Liquidation
Bernard Madoff stole billions of dollars from innocent victims through his Ponzi scheme, but he did not act alone. Various financial institutions, feeder funds, and investment professionals—including
Appellees—enabled Madoff’s scheme by burying their heads in the sand, to the detriment of other customers.
Beginning in 1992, Madoff told investors that he employed an investment strategy—called “split-strike conversion”—under which
BLMIS purchased a basket of stocks designed to track the returns of the S&P 100 Index, and hedged those positions by buying and selling options on those equities—called a “collar.” A95–96 ¶ 20. But BLMIS
never purchased securities on behalf of its customers. A96 ¶ 23. It sent
them monthly statements detailing falsified trades and fictitious gains.
A96–97 ¶ 24. Customer deposits were commingled and used to satisfy
withdrawal requests from other customers, benefit Madoff and his
family, and prop up BLMIS’ proprietary trading. Id. ¶¶ 23-24.
In December 2008, Madoff’s Ponzi scheme collapsed. Under SIPA,
the Securities Investor Protection Corporation (“SIPC”) obtained a
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protective decree placing BLMIS into liquidation and appointing the
Trustee. See SEC v. Madoff, No. 08-cv-10791 (LLS) (S.D.N.Y. Dec. 15,
2008), ECF Nos. 5, 6. As SIPA § 78eee(b)(4) requires, the district court referred the SIPA liquidation to the bankruptcy court.
In a SIPA liquidation, a trustee focuses on promptly returning property to customers. SIPA § 78fff(a). “Customer property,” in a SIPA liquidation, is a protected fund the Trustee uses to pay customer claims.
Id. § 78lll(2), (4). To maximize the availability of that fund to pay customers equitably and ratably, the Trustee commenced more than
1000 actions, under Sections 548 and 550 of the Bankruptcy Code, to recover customer property that BLMIS had fraudulently transferred with the intent to defraud its customers and other creditors. 11 U.S.C.
§§ 548, 550.
One of those actions was against Appellees. In it, the Trustee seeks to recover $213 million of initial transfers from Legacy Capital, and $6 million of subsequent transfers from Khronos LLC.
B. The District Court’s 2014 Good Faith Decision Sections 548(c) and 550(b) of the Bankruptcy Code state that initial and subsequent transferees can keep any property fraudulently
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transferred by a debtor if the transferee took that property for value and “in good faith.” 11 U.S.C. §§ 548(c), 550(b). Defendants in many of
the Trustee’s actions moved to dismiss his complaints on that basis. In
several of those cases, the bankruptcy court (Lifland, J.) denied those
motions because good faith is an affirmative defense to avoidance and
recovery of a fraudulent transfer and therefore need not be addressed in
the Trustee’s complaints. See, e.g., Picard v. Cohmad Sec. Corp. (In re
BLMIS LLC), 454 B.R. 317, 331 (Bankr. S.D.N.Y. 2011); Picard v.
Merkin (In re BLMIS LLC), 440 B.R. 243, 256 (Bankr. S.D.N.Y. 2010).
Hundreds of other defendants, including Appellees, moved the
district court to withdraw the reference to the bankruptcy court to
address that issue. SIPC v. BLMIS (In re Madoff Sec.), No. 12-mc-
00115 (JSR) (S.D.N.Y. June 25, 2012), ECF No. 197, at 3. The district court (Rakoff, J.) agreed to determine whether SIPA or the federal securities laws alter the legal standards and pleading burden for the good faith defense to avoidance and recovery. Id., ECF No. 201.
The Trustee argued that the answer was no. First, he explained that bankruptcy, district, and appellate courts across the country construe good faith, under Sections 548(c) and 550(b) of the Bankruptcy
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Code, as being absent if a transferee’s knowledge puts it on inquiry notice of a debtor’s fraud and it does not diligently investigate. SIPA expressly incorporates those bankruptcy statutes for broker-dealer
liquidations. The Trustee argued that nothing in SIPA or the securities
laws sets a different standard for transferees in SIPA cases to
demonstrate their good faith. Second, the Trustee argued that good
faith is an affirmative defense that the transferee must plead and
prove, and that the Trustee has no obligation to negate good faith in his
complaint.
The district court disagreed. SPA1–13 (SIPC v. BLMIS (In re
Madoff Sec.), 516 B.R. 18, 22-24 (S.D.N.Y. 2014) (the “Good Faith
Decision”)). First, the court held that, in SIPA cases, a transferee’s
inquiry notice of potential fraud does not show that it lacked good faith;
instead a transferee acts in good faith unless it willfully blinds itself to
a high probability of fraud. SPA4–9. Although acknowledging contrary
“precedent” in bankruptcy cases, SPA5, the court concluded that
scienter requirements located in “federal securities laws” were
inconsistent with an inquiry notice standard of good faith, that SIPA is
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made subject to those securities laws, and therefore that “the
Bankruptcy Code must yield” to them. SPA6.
Second, the district court concluded that, although transferees have the burden of pleading their affirmative defense of good faith in
“ordinary bankruptc[ies],” in SIPA cases the Trustee must plausibly allege that a transferee lacked good faith. SPA11–12. The court deemed that holding necessary to fulfill SIPA’s “twin goals” of maintaining investor confidence and securities-market stability, SPA11, and to fulfill the requirement that a plaintiff’s complaint must plausibly state a claim for relief. Id. (citing Ashcroft v. Iqbal, 556 U.S. 662, 678
(2009), and Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007)).
C. The Bankruptcy Court Proceedings
1. The Trustee’s Complaint In July 2015, the Trustee filed an Amended Complaint against
Appellees Legacy Capital and Khronos. A90. Counts I-VII seek to
recover approximately $213 million in initial transfers of BLMIS
customer property to or for the benefit of Legacy Capital. A123–24
¶¶ 142–46, A141 Ex. A. Count VIII seeks to recover approximately $6
million in subsequent transfers of BLMIS customer property to
Khronos—some via Legacy Capital, and most via Montpellier Resources
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Ltd., a fund that invested in BLMIS through Legacy Capital. A124–25
¶¶ 147–55.2
Legacy Capital, according to the Amended Complaint, is a British
Virgin Islands Corporation that operated as a single-purpose vehicle
that invested solely with BLMIS. A98 ¶¶ 32–33. It is run by Jimmy
Mayer and his son, Rafael Mayer. Id. ¶ 33.
One of Legacy Capital’s major investors was Meritage Fund Ltd.,
an investment fund under the umbrella of Renaissance Technologies
LLC. Rafael Mayer sat on the committee responsible for overseeing
Meritage’s investments (the “Meritage Oversight Committee”). A99–
100 ¶¶ 40–41. The Amended Complaint alleges that, through that
Committee, Rafael Mayer—and, by imputation, Legacy Capital—either
came to know that Madoff was not trading securities as advertised or
willfully blinded themselves to the ongoing fraud.
In late 2003, based on suspicions related to the lack of correlation
between BLMIS’ returns and the market’s returns, Renaissance
2 The Amended Complaint’s allegations are pleaded in the alternative to the extent of any double counting between initial transfers to Legacy Capital and subsequent transfers to Khronos. See A90 ¶ 155.
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attempted to replicate Madoff’s strategy using Legacy Capital’s BLMIS statements. A101 ¶¶ 46–47. The results of Renaissance’s analysis were shared with Rafael Mayer and the other members of the Meritage
Oversight Committee. Id. That analysis—the “Renaissance
Proposal”—determined that there were not enough options in the entire market to support BLMIS’ purported options trading. Id. It also
detailed that a very high percentage of purported equity trades were
bought below the daily closing price and sold above the daily closing
price. Id. What’s more, the Renaissance Proposal put BLMIS in the
market on days account statements showed that BLMIS was out of the
market; and the Renaissance Proposal determined that BLMIS’ sizable
purported trading activity inexplicably failed to generate any market
“footprint.” Id. Finally, the Renaissance Proposal reported that
Renaissance tried to replicate BLMIS’ purported split-strike conversion
strategy but could not do so. Id.
The Renaissance Proposal generated further skepticism about
BLMIS among members of the Meritage Oversight Committee. Several
members voiced concerns about the legitimacy of Madoff’s operations.
One member, Paul Broder, described his concern about what Madoff
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was really up to as “background radiation” that “has never really gone away.” Id. ¶ 49.
In a series of frantic email exchanges after receipt of the
Renaissance Proposal, Committee members discussed still other indicia of fraud layered onto those findings. They addressed, for example,
BLMIS’ highly unusual decision not to collect customary management and performance fees, which left hundreds of millions of dollars on the table, and the possibility that BLMIS lacked a sufficiently independent auditor. A101 ¶ 50, A104–05 ¶¶ 62–64, A110 ¶¶ 85, 87, A115 ¶ 105,
A116 ¶ 110. As the evidence of fraud mounted, one member of the
Meritage Oversight Committee, Nathaniel Simons, remarked to Rafael
Mayer and others that “Madoff’s head would look pretty good above
[New York Attorney General] Elliot Spitzer’s mantle.” A101 ¶ 50. The
Committee member who had supervised Renaissance’s analysis, Henry
Laufer, later explained that BLMIS’ trade timing “was statistically almost impossible” and that BLMIS’ reported trade “prices were just too good from any mode of execution that we were aware of that was legitimate.” A107–08 ¶¶ 74–76. Similarly, Broder later testified that, based on what the Meritage Oversight Committee learned about
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BLMIS’ timing, he “knew it wasn’t possible.” A108–09 ¶ 78 (emphasis added).
When Rafael Mayer wrote Broder about the Renaissance
Proposal’s findings, Broder replied with an email dripping with sarcasm befitting the moment. Broder scripted a list of unanswerable questions that someone could put to Madoff about his fraud. Broder suggested to
Rafael Mayer that:
• If Madoff said he traded options over the counter (“OTC”), then Mayer should “ask (in innocent amazement!): So you can do this kind of volume on OEX OTC Options?!?!” A103–04 ¶ 59.
• Regarding Madoff’s mysterious options-trading counterparties, Broder suggested asking Madoff, “Gee, what kind of banks are big enough to [trade with you] (more animated amazement!!!).” Id. (alteration in allegation).
• When it came to Madoff’s inexplicably miraculous trade execution, Broder proposed telling Madoff that “We have noticed that the strike [price] on the OTC options trade[s] we do with you always seems to be close to the closing price of the underlying—is this for convenience purposes (try to look as though this is a really serious question).” A104 ¶ 60.
But these were not serious questions, and Rafael Mayer knew it. In early 2004, every member of the Meritage Oversight Committee but
Rafael Mayer voted to redeem Meritage’s BLMIS investment. A122
¶ 138. Rafael Mayer, however, persuaded the Committee to delay half of Meritage’s redemption to give Legacy Capital a chance to replace that
11 Case 20-1334, Document 73, 08/06/2020, 2902485, Page23 of 180
portion and retain the corresponding BLMIS investment (and fees).
Legacy Capital secured a loan from BNP Paribas (“BNP”) just a few months later, and Meritage withdrew the remainder of its investment.
Id. ¶ 139.
Around the same time, Legacy Capital hired Khronos to analyze the past and future activity in its BLMIS account. Khronos is managed by none other than Rafael Mayer and his brother, David Mayer.
Khronos thus knew what Rafael Mayer knew. Together, Khronos and
Legacy Capital learned even more troubling information pointing to
BLMIS’ fraud. Khronos’ monthly analyses of Legacy Capital’s
(manufactured) BLMIS account statements and (fictitious) trade confirmations confirmed that the improbably consistent returns on
Legacy Capital’s investment were, in fact, impossible. A101–02 ¶ 52,
A107 ¶ 71, A109 ¶ 80, A112–14 ¶¶ 94–101.
But the Mayers kept a lid on the fraud they had uncovered. The
Amended Complaint alleges, on information and belief, that, after
Legacy Capital retained Khronos, Rafael and David Mayer prevented anyone else from reviewing Legacy Capital’s BLMIS account statements. A101–02 ¶ 52. Legacy Capital went on to pull its principal
12 Case 20-1334, Document 73, 08/06/2020, 2902485, Page24 of 180
and fictitious profits out of BLMIS, while Khronos siphoned off millions of dollars in fees from Legacy Capital and Montpellier Resources.
2. The Bankruptcy Court’s Decision The bankruptcy court dismissed the Amended Complaint except as to BLMIS’ transfer of fictitious profits to Legacy Capital.3 SPA14–55
(Picard v. Legacy Capital Ltd., 548 B.R. 13 (Bankr. S.D.N.Y. 2016)).
First, the bankruptcy court held that the Amended Complaint
sufficiently alleges the first prong of Legacy Capital’s willful
blindness—that Legacy Capital had a subjective belief in the high
probability of fraud at BLMIS. SPA48; see also SPA37. “Legacy
strongly suspected that, at a minimum, BLMIS’ options trades were not
real.” SPA48 (emphasis added). The court further held, however, that
3 In 2018, the Trustee moved for summary judgment on his claim to recover fictitious profits that BLMIS transferred to Legacy Capital within two years of the commencement of BLMIS’ liquidation. Trustee’s Mem. of Law in Supp. of Mot. for Summ. J., No. 10-05286 (Bankr. S.D.N.Y. Dec. 21, 2018), ECF No. 192. The bankruptcy court granted the Trustee summary judgment under Rule 56(g) on the prima facie elements of his claim to recover those funds. SPA60–92. The parties later agreed to the entry of judgment against Legacy Capital on the non-dismissed portion of Count I in the amount of $79,125,781. A3872. Legacy Capital cross-appealed from that aspect of the bankruptcy court’s final judgment. A3942–43.
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the Amended Complaint does not allege the second willful-blindness
prong—that Legacy Capital took deliberate steps to avoid confirming
the truth. Id. It concluded that the Trustee’s allegation that “Legacy
hired Khronos to conduct due diligence” meant that it was not plausible
that Legacy Capital had been willfully blind. SPA48.
Next, the bankruptcy court held that, because Khronos and
Legacy Capital shared principals, the willful blindness allegations
against them were indistinguishable. SPA53. Accordingly, it held that
the Amended Complaint also did not allege that Khronos lacked good
faith or knew of the voidability of the initial transfers from BLMIS
under Section 550(b)(1). Id. It also held that the Trustee was required
to plead facts establishing that all of the alleged subsequent transfers of
BLMIS customer property to Khronos, in the form of fees paid to it by
Montpellier Resources, tie back to specific initial transfers from BLMIS.
SPA50–51.
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SUMMARY OF ARGUMENT
The decision of the bankruptcy court, applying novel standards created by the district court, cannot be upheld unless the courts below were correct in holding that “good faith” requires the absence of “willful blindness,” and that the Trustee bears the burden of pleading the absence of that affirmative defense, and that the Amended Complaint did not meet those standards. But this Court, reviewing de novo, should accept none of those three holdings.
I. When a transferee is on inquiry notice of a fraud, it lacks good faith under the Bankruptcy Code. Requiring “willful blindness” asks far too much.
“Inquiry notice” has long been the standard in ordinary bankruptcy cases, but the district court held that SIPA cases are different because unspecified “securities laws” trump the Bankruptcy
Code. Not a word in SIPA supports that holding. SIPA specifies that the Code applies unless inconsistent with SIPA. The district court misread the unambiguous statutory phrase “this chapter”—meaning
SIPA—as if it meant all securities laws. Both the codified version of
SIPA and the Statutes at Large show that the relevant provision cannot
15 Case 20-1334, Document 73, 08/06/2020, 2902485, Page27 of 180
possibly mean what the district court held it meant. And, even if securities laws were somehow relevant to SIPA, they provide no support for interposing the concept of willful blindness from criminal law into
“good faith” under the Bankruptcy Code.
Besides misreading statutory text, the district court deemed a
SIPA-specific standard necessary to promote SIPA’s policies. But a
court has no license to treat its view of statutory policies as the law
without any supporting statutory text. And the court’s conception of the
logical outgrowth of SIPA’s policies is debatable at best.
II. It was error to transform an affirmative defense into an
element of the Trustee’s case that he must negate in his complaint.
Decades of settled law, encapsulated in Federal Rule of Civil Procedure
8(c)(1), require the defendant to plead—not the plaintiff to negate—
affirmative defenses. “Good faith” is an affirmative defense. That fact
ends the analysis. See Jones v. Bock, 549 U.S. 199, 212-13 (2007).
The district court tried to justify shifting the pleading burden by
citing the Twombly/Iqbal line of cases, the purposes of SIPA, and the
ability of the Trustee to obtain early discovery under Bankruptcy Rule
2004. But Twombly and Iqbal bear on how a plaintiff meets the
16 Case 20-1334, Document 73, 08/06/2020, 2902485, Page28 of 180
pleading burden already accorded to him under the substantive law, not on what constitutes an element of his case. Nor can SIPA’s purposes rewrite the Federal Rules, SIPA, or the Bankruptcy Code. And they would not justify the district court’s conclusions even if they were relevant. Finally, the discovery available under Bankruptcy Rule 2004 is no substitute for Rule 26 discovery and is available in every bankruptcy case, not just SIPA cases, yet the district court used it to craft a SIPA-specific rule.
The bankruptcy court extended the district court’s flawed reasoning: beyond putting the burden on the Trustee to prove the absence of the affirmative defense of good faith, by also putting the burden on the Trustee to prove the absence of the affirmative defense of lack of knowledge of voidability of subsequent transfers to Khronos.
That holding fails for the same reasons as the holding on good faith.
III. Even if the standards announced by the district court were correct, the bankruptcy court erred in applying them. The Amended
Complaint is replete with facts showing willful blindness. Instead of accepting the pleaded facts, the bankruptcy court made contrary factual determinations. That is impermissible at the pleading stage. The
17 Case 20-1334, Document 73, 08/06/2020, 2902485, Page29 of 180
bankruptcy court also erred in holding that the Trustee did not sufficiently allege subsequent transferee Khronos’ lack of good faith.
And the Court improperly raised the pleading burden with respect to the level of specificity required for the transfers Khronos received. The
Amended Complaint contains plausible allegations to support both claims.
STANDARD OF REVIEW
Rulings on motions to dismiss under Federal Rule of Civil
Procedure 12(b)(6) are reviewed de novo. City of New York v. Beretta
U.S.A. Corp., 524 F.3d 384, 392 (2d Cir. 2008). The bankruptcy and district courts’ interpretation of federal statutes, including SIPA and
the Bankruptcy Code, also is reviewed de novo. E.g., In re BLMIS LLC,
654 F.3d 229, 234 (2d Cir. 2011) (“Net Equity Decision”).
ARGUMENT
Transferees On Inquiry Notice Of A Broker-Dealer’s Fraud Do Not Take Funds In Good Faith Even If Their Inaction Does Not Amount To Willful Blindness
In bankruptcy cases, the trustee of a debtor’s estate can recover a
debtor’s fraudulent transfers from initial and subsequent transferees
that obtained funds other than “in good faith.” Every court of appeals
to have addressed the question has held that transferees that were on
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inquiry notice of the fraud—that is, who had reason to suspect fraud but did not investigate—cannot establish that good faith defense.
The same bankruptcy statutes, subject to the same good faith defense, are applied in broker-dealer liquidations under SIPA. Yet the
district court held that, in SIPA cases, transferees’ inquiry notice of
fraud does not defeat their good faith defense to a trustee’s recovery of a
fraudulent transfer. Rather, in SIPA liquidations, the court held, the
good faith defense absolves transferees who were on inquiry notice of
fraud so long as they were not willfully blind to it. “[I]n a SIPA
proceeding,” the court concluded, “a lack of ‘good faith’” means only that
a transferee “‘intentionally chose to blind himself to the “red flags” that
suggest a high probability of fraud.’” SPA4 (emphasis added).
That was legal error. Congress expressly provided that a SIPA
liquidation “shall be conducted in accordance with, and as though it
were being conducted under,” the Bankruptcy Code’s fraudulent
transfer statutes—their “good faith” defenses included. 15 U.S.C.
§ 78fff(b). SIPA also states that SIPA trustees may recover fraudulent
transfers “to the extent” that bankruptcy trustees can. Id. Those
provisions unambiguously grant SIPA trustees an authority to recover
19 Case 20-1334, Document 73, 08/06/2020, 2902485, Page31 of 180
fraudulent transfers coextensive with bankruptcy trustees’. They thus require that the inquiry notice standard of good faith applied in bankruptcy cases also be applied in SIPA liquidations.
The district court based its contrary conclusion on the mistaken premise that SIPA dictates that “the federal securities laws” trump anything inconsistent in the bankruptcy laws that SIPA incorporates.
SPA6. It held that, in SIPA cases, “where the Bankruptcy Code and the securities laws conflict, the Bankruptcy Code must yield.” Id.
That holding is unmoored from SIPA’s text. SIPA expressly states
one and only one trigger for departure from the Bankruptcy Code:
inconsistent provisions in SIPA itself (not in the panoply of federal
securities laws). Fraudulent transfer claims should proceed “in
accordance with, and as though . . . being conducted under,” the
relevant provisions of the Bankruptcy Code, “to the extent consistent
with the provisions of this chapter,” i.e., SIPA. 15 U.S.C. § 78fff(b)
(emphasis added); see also id. § 78fff-2(c)(3) (allowing recovery “to the
extent that such transfer is void or voidable under the provisions of title
11 [i.e., the Bankruptcy Code]” and “deem[ing]” transferred property to
have been that of the debtor and customer to have been a creditor). In
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all but one of SIPA’s relevant provisions, including its statutory cross- references and its explicit statements about what it takes to trump a provision of the Bankruptcy Code, there is no reference to the securities laws. And the one relevant provision that does refer to a securities law
(§ 78bbb) undercuts rather than supports the district court’s holding.
Those statutory directives resolve this appeal.
In any event, and independently requiring reversal, securities-law
concepts would not require expanding transferees’ good faith defenses
to cover all but their “willful blindness” even if those concepts did bear
on the question (which, again, they do not).
A. Broker-Dealer Liquidations Are Conducted In Accordance With The Bankruptcy Code Except As Otherwise Stated By SIPA
SIPA was Congress’s response to a spate of broker-dealer liquidations that had imperiled and tied up customer property in the failed broker-dealers’ custody. See SIPC v. Barbour, 421 U.S. 412, 415
(1975). SIPA established specialized procedures for liquidating broker- dealers and provided special protections for their customers. See id. at
415-17.
21 Case 20-1334, Document 73, 08/06/2020, 2902485, Page33 of 180
In a broker-dealer liquidation, SIPA creates “a fund of ‘customer property’ separate from the general estate of the failed broker-dealer.”
Net Equity Decision, 654 F.3d at 233 (quoting SIPA § 78lll(4)). That customer property fund is available for priority distribution to the broker-dealer’s customers, who share ratably in it to the extent of their net equity. Id. at 233. When there is not enough customer property to pay all customer claims, “SIPA trustees administer what is in effect a
‘bankruptcy within a bankruptcy’ for investors who had property on account with the broker-dealer.” CarVal UK Ltd. v. Giddens (In re
Lehman Bros., Inc.), 791 F.3d 277, 281 (2d Cir. 2015) (citing SIPA
§ 78fff-2(c)(3)).
The resulting SIPA liquidation, this Court has explained, is “a hybrid proceeding” overlaying Bankruptcy Code provisions onto SIPA’s unique customer-protection provisions and liquidation procedures. Net
Equity Decision, 654 F.3d at 242 n.10. SIPA provides for the appointment of a trustee to manage a broker-dealer’s liquidation. SIPA
§ 78eee(b)(3). A SIPA trustee is “vested with the same powers and title with respect to the debtor and the property of the debtor” that a bankruptcy trustee has. Id. § 78fff-1(a). And a SIPA trustee is “subject
22 Case 20-1334, Document 73, 08/06/2020, 2902485, Page34 of 180
to the same duties” as a trustee under chapter 7 of the Bankruptcy
Code (which covers liquidations), except as otherwise provided by SIPA or court order. Id. § 78fff-1(b).
Congress provided that, except as otherwise stated in SIPA, the
entirety of a SIPA liquidation “shall be conducted in accordance with,
and as though it were being conducted under chapters 1, 3, and 5 and
subchapters I and II of chapter 7” of the Bankruptcy Code. Id.
§ 78fff(b). As a result, a “SIPA trustee’s authority to bring claims in
administering a SIPA liquidation is coextensive with the powers of a
[bankruptcy trustee].” Marshall v. Picard (In re BLMIS LLC), 740 F.3d
81, 88 n.8 (2d Cir. 2014) (emphasis added).
B. The Bankruptcy Code’s Fraudulent Transfer Statutes Apply In SIPA Liquidations
Sections 548 and 550 of the Bankruptcy Code, 11 U.S.C. §§ 548,
550, are among the “chapter 5” bankruptcy laws that SIPA liquidations
must be “conducted in accordance with.” SIPA § 78fff(b). Those
statutes authorize trustees to avoid—that is, to rescind—a debtor’s
fraudulent transfer of property made within two years of filing a
bankruptcy petition, 11 U.S.C. § 548(a)(1), and to recover the property
from its initial and subsequent transferees, id. § 550. Those provisions
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thus “protect creditors from last-minute diminutions of the pool of assets in which they have interests” that otherwise would reduce “the net return to creditors as a group.” Bonded Fin. Servs., Inc. v. Eur. Am.
Bank, 838 F.2d 890, 897-98 (7th Cir. 1988).
The elements of a trustee’s claim to avoid a transfer the debtor
made with the actual intent to defraud its creditors are that (i) there was a transfer of an interest of the debtor in property (ii) made within two years of the petition date (iii) with “actual intent to hinder, delay, or defraud” a creditor. 11 U.S.C. § 548(a)(1)(A); see also Adelphia
Recovery Tr. v. Bank of Am., N.A., No. 05 Civ. 9050 (LMM), 2011 WL
1419617, at *2 (S.D.N.Y. Apr. 7, 2011), aff’d, 748 F.3d 110 (2d Cir.
2014).
When a debtor runs a Ponzi scheme, courts presume its actual intent to defraud “because transfers made in the course of a Ponzi operation could have been made for no purpose other than to hinder, delay or defraud creditors.” Gredd v. Bear, Stearns Sec. Corp. (In re
Manhattan Inv. Fund Ltd.), 359 B.R. 510, 517-18 (Bankr. S.D.N.Y.
2007); see also Christian Bros. High Sch. Endowment v. Bayou No
Leverage Fund, LLC (In re Bayou Grp. LLC), 439 B.R. 284, 304–05
24 Case 20-1334, Document 73, 08/06/2020, 2902485, Page36 of 180
(S.D.N.Y. 2010) (“Bayou IV”) (addressing the “Ponzi scheme presumption”). Here, “it is patent that all of Madoff Securities’ transfers during the two-year period [before filing] were made with actual intent to defraud present and future creditors, i.e., those left holding the bag when the scheme was uncovered.” Picard v. Katz, 462
B.R. 447, 453 (S.D.N.Y. 2011).
Once a debtor’s actual fraudulent intent is established, a trustee can recover transferred funds from any initial transferee as well as any subsequent transferees—i.e., the “immediate or mediate transferee of such initial transferee.” 11 U.S.C. § 550(a)(1)-(2). To plead such claims, the trustee must allege only the debtor’s fraudulent intent, not the transferee’s. Bayou IV, 439 B.R. at 304–05.
Congress expressly authorized SIPA trustees to make full use of
these avoidance powers to recover customer property. The statute
empowers SIPA trustees to recover any transferred property that
“would have been customer property if and to the extent that such
transfer is voidable or void under [the Bankruptcy Code].” SIPA § 78fff-
2(c)(3). This Court has recognized that “SIPA and the [Bankruptcy]
Code” therefore “intersect to . . . grant a SIPA trustee the power to
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avoid fraudulent transfers for the benefit of customers.” Net Equity
Decision, 654 F.3d at 242 n.10.
C. Transferees On Inquiry Notice Of A Debtor’s Fraud Cannot Establish, As A Defense To A Trustee’s Avoidance And Recovery Of A Fraudulent Transfer, That They Received Funds “In Good Faith”
Once a trustee establishes that a debtor transferred funds with actual fraudulent intent, those funds are recoverable from initial and subsequent transferees unless they obtained the funds “for value” and
“in good faith.” 11 U.S.C. § 548(c) (initial transferees); id. § 550(b)(1)
(subsequent transferees).
This Court has explained, in another case arising out of the
Madoff liquidation, that “[t]he presence of ‘good faith’ depends upon, inter alia, ‘whether the transferee had information that put it on inquiry notice that the transferor was insolvent or that the transfer might be made with a fraudulent purpose.’” Marshall, 740 F.3d at 90 n.11 (quoting Bayou IV, 439 B.R. at 310) (emphasis added); see also
Banner v. Kassow, No. 96-5040, 1996 WL 680760, at *3 (2d Cir. Nov. 22,
1996) (unpublished) (“A transferee does not act in good faith when he has sufficient knowledge to place him on inquiry notice of the debtor’s
26 Case 20-1334, Document 73, 08/06/2020, 2902485, Page38 of 180
possible insolvency”) (citing Brown v. Third Nat’l Bank (In re Sherman),
67 F.3d 1348, 1355 (8th Cir. 1995)).
That inquiry notice standard for determining whether transferees received funds in good faith is well established in bankruptcy law. The district court labeled this Court’s invocation of that standard in
Marshall as “pure dictum” but acknowledged “some precedent” for assessing good faith on an inquiry notice standard “in ordinary bankruptcies.” SPA5, 6 n.2. In fact, that precedent is legion and reflects how numerous courts of appeals have understood good faith in
Sections 548(c) and 550(b).4
4 See Goldman v. Capital City Mortg. Corp (In re Nieves), 648 F.3d 232, 238 (4th Cir. 2011) (“[A] transferee does not act in good faith when he has sufficient [actual] knowledge to place him on inquiry notice.”); Templeton v. O’Cheskey (In re Am. Hous. Found.), 785 F.3d 143, 164 (5th Cir. 2015) (“Once a transferee has been put on inquiry notice . . . of the possibly fraudulent purpose of the transfer, the transferee must satisfy a ‘diligent investigation’ requirement.”); Bonded Fin. Servs., Inc., 838 F.2d at 897-98 (“Venerable authority has it that the recipient of a voidable transfer may lack good faith if he possessed enough knowledge of the events to induce a reasonable person to investigate.”); In re Sherman, 67 F.3d at 1355 (“[A] transferee does not act in good faith when he has sufficient knowledge to place him on inquiry notice.”); Hayes v. Palm Seedlings Partners (In re Agric. Rsch. & Tech Grp., Inc.), 916 F.2d 528, 535-36 (9th Cir. 1990) (“[C]ourts look to what the transferee objectively ‘knew or should have known’ in questions of good faith” and whether “circumstances would place a reasonable person on
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The inquiry notice that defeats a transferee’s good faith defense is
one that “signifies awareness of suspicious facts that would have led a
reasonable firm, acting diligently, to investigate further and by doing so
discover wrongdoing.” Grede v. Bank of N.Y. Mellon Corp. (In re
Sentinel Mgmt. Grp., Inc.), 809 F.3d 958, 961 (7th Cir. 2016). Courts
applying that standard consider (i) whether what the transferee knew
or should have known triggered a duty to investigate; and (ii) if so,
whether the transferee conducted a diligent investigation of the facts.
See Bayou IV, 439 B.R. at 312-13 (collecting cases).
That “reasonable firm” standard, moreover, takes into account the
norms of the relevant industry. Courts evaluating whether a transferee
acted reasonably on learning suspicious information undertake a
“specific focus” on the “standards, norms, practices, sophistication, and
experience generally possessed by participants in the transferee’s
industry or class.” Id. at 313, 315 n.29; see also Gold v. First Tenn.
inquiry of a debtor’s fraudulent purpose.”); Jobin v. McKay (In re M & L Bus. Mach. Co.), 84 F.3d 1330, 1338 (10th Cir. 1996) (“[G]ood faith under § 548(c) should be measured objectively” and is not present “if the circumstances would place a reasonable person on inquiry of a debtor’s fraudulent purpose”).
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Bank Nat’l Assoc. (In re Taneja), 743 F.3d 423, 430 (4th Cir. 2014)
(evaluating good faith based on “the customary practices of the industry in which the transferee operates”).
D. The District Court Erred By Expanding Transferees’ Good Faith Defenses In SIPA Liquidations
The district court expanded transferees’ good faith defenses under
Sections 548(c) and 550(b) when SIPA trustees (instead of bankruptcy
trustees) use those statutes. It “rejected” the inquiry notice standard
applied in “ordinary bankruptcies,” and replaced it with a “willful
blindness” standard in SIPA liquidations. SPA4–5. “[I]n a SIPA
proceeding,” the court held, “a lack of ‘good faith’” means only that a
transferee “‘intentionally [chose] to blind himself to the “red flags” that
suggest a high probability of fraud.’” SPA4 (quoting the court’s prior
opinion in Katz, 462 B.R. at 455).
The district court believed that SIPA requires that substantial
expansion of the “good faith” defense. It held that, in SIPA cases,
“where the Bankruptcy Code and the securities laws conflict, the
Bankruptcy Code must yield.” SPA6. And those securities laws,
according to the district court, dictate that “good faith” means anything
short of a transferee’s “fraudulent intent.” Id.
29 Case 20-1334, Document 73, 08/06/2020, 2902485, Page41 of 180
The district court was twice wrong. First, SIPA’s incorporation of
Sections 548 and 550 of the Bankruptcy Code is not made subject to any
inconsistent securities laws. Second, and in any event, the securities
laws are not inconsistent with denying a good faith defense to
transferees on inquiry notice of the fraud.
1. SIPA Incorporates The Full Extent Of The Bankruptcy Code’s Fraudulent Transfer Statutes, Including Their Good Faith Defenses
The district court adopted the mistaken premise that, in SIPA liquidations, “the federal securities laws” trump anything inconsistent in the Bankruptcy Code’s fraudulent transfer statutes. It held that,
“[a]though SIPA expressly incorporates the Bankruptcy Code’s avoidance and recovery provisions, see 15 U.S.C. § [78]fff-2(c)(3), SIPA nonetheless is part of the securities laws and expressly provides that the Bankruptcy Code applies only ‘[t]o the extent consistent with the provisions of this chapter [of the federal securities laws],’ 15 U.S.C.
§ 78fff(b).” SPA6 (alteration in original).
That misstates SIPA. Section 78fff(b) states that a SIPA
“liquidation proceeding shall be conducted in accordance with, and as though it were being conducted under chapters 1, 3, and 5 and
30 Case 20-1334, Document 73, 08/06/2020, 2902485, Page42 of 180
subchapters I and II of chapter 7 of [the Bankruptcy Code].” Sections
548 and 550 are in “chapter 5” of the Bankruptcy Code, and so SIPA puts no daylight between how SIPA liquidations and bankruptcy cases are conducted under those fraudulent transfer statutes.
The district court went astray, furthermore, in how it understood
the one caveat in Section 78fff(b): It incorporates Sections 548 and 550
of the Bankruptcy Code, and other bankruptcy statutes, “[t]o the extent
consistent with the provisions of this chapter.” SIPA § 78fff(b)
(emphasis added).
In the codified version of SIPA, there is no ambiguity about what
“this chapter” means. SIPA constitutes chapter 2B-1 of title 15 of the
U.S. Code. The very first codified provision of SIPA states, “This
chapter may be cited as the ‘Securities Investor Protection Act of 1970.’”
SIPA § 78aaa (emphasis added). The original Act passed by Congress
states, “This Act may be cited as the ‘Securities Investor Protection Act
of 1970.’” Pub. L. No. 95-283, § 1(a), 84 Stat. 1636, 1636 (1970)
(emphasis added).
The codified version of the section on which Judge Rakoff relied
states, “To the extent consistent with the provisions of this chapter, a
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liquidation proceeding shall be conducted in accordance with, and as though it were being conducted under,” specified provisions of the
Bankruptcy Code. SIPA § 78fff(b) (emphasis added). The original Act passed by Congress stated, “Except as inconsistent with the provisions of this Act and except that in no event shall a plan of reorganization be formulated, a liquidation proceeding shall be conducted in accordance with, and as though it were being conducted under,” specified provisions of the Bankruptcy Act, which preceded the Bankruptcy Code. Pub. L.
No. 95-283, § 6(c), 84 Stat. 1636, 1647 (1970) (emphasis added).
In the Securities Investor Protection Act Amendments of 1978,
Congress replaced Section 6(c) of the original Act with a new Section
6(b), again applying bankruptcy law “[t]o the extent consistent with the provisions of this Act.” Pub. L. No. 95-283 § 8, 92 Stat. 249, 259 (1978)
(emphasis added). Later the same year, as part of the Act that created the Bankruptcy Code, Congress further amended Section 6(b) but made no change to the language requiring consistency with “this Act” and only “this Act.” Pub. L. No. 95-598, § 308(g), 92 Stat. 2549, 2675 (1978).
At no point did Congress, the codifiers, or anyone else other than the
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court below make SIPA’s application of the Bankruptcy Code dependent on consistency with any “securities laws” other than SIPA itself.
SIPA does contain a reference to the Securities Exchange Act of
1934. Specifically, “Except as otherwise provided in this chapter, the provisions of the Securities Exchange Act of 1934 [15 U.S.C. 78aaa-lll]
(hereinafter referred to as the ‘1934 Act’) apply as if this chapter constituted an amendment to, and was included as a section of, such
Act.” § 78bbb (emphasis added); see also Pub. L. No. 91-598, § 2, 94
Stat. 1636, 1637 (1970) (same, except that both references to “this chapter” are to “this Act”). No provision of the 1934 Act is incorporated into SIPA. Rather, SIPA is incorporated into the 1934 Act “except as otherwise provided in this chapter”—again, meaning SIPA.
The rule as to what statute trumps what other statute is straightforward—SIPA trumps the Bankruptcy Code if inconsistent and
SIPA trumps the securities laws if inconsistent. Nothing in SIPA allows any “securities law” other than SIPA itself to trump the
Bankruptcy Code. And no one contends that anything in the text of
SIPA itself changes the Bankruptcy Code’s “good faith” defense to fraudulent transfer actions.
33 Case 20-1334, Document 73, 08/06/2020, 2902485, Page45 of 180
To the contrary, SIPA provides that a SIPA “trustee may recover
any property transferred by the debtor which, except for the transfer,
would have been customer property if and to the extent that such
transfer is voidable or void under the provisions of [the Bankruptcy
Code].” SIPA § 78fff-2(c)(3) (emphasis added). The district court made only a passing reference to that SIPA provision. SPA6. But it is dispositive. This case indisputably concerns funds that, if BLMIS had not fraudulently transferred them, would have been customer property available for distribution. The SIPA trustee is therefore authorized under Section 550 of the Bankruptcy Code to recover those funds from transferees “to the extent” that the transfer from the debtor is “voidable or void” under Section 548 of the Bankruptcy Code. SIPA § 78fff-
2(c)(3). Because bankruptcy trustees can recover funds from transferees that were on inquiry notice of fraud, so too can SIPA trustees.
Nothing about SIPA’s overarching purposes requires any different reading of the statutory text. The district court believed that putting any “burden of investigation on investors” would be “totally at odds with
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the investor confidence and securities market stability that SIPA is designed to enhance.” SPA7. Not so.
Purporting to find an overarching statutory “purpose” and then effectuate it without a textual basis is the antithesis of proper statutory interpretation. “[I]t frustrates rather than effectuates legislative intent simplistically to assume that whatever furthers the statute’s primary
objective must be the law.” Rodriguez v. United States, 480 U.S. 522,
526 (1987) (per curiam). “Only the written word is the law.” Bostock v.
Clayton Cnty., Ga., 140 S. Ct. 1731, 1737 (2020).
Even if free-floating purpose without text were the law, however,
the district court still would be wrong. SIPA’s customer protection
provisions and liquidation procedures, including the statute’s wholesale
incorporation of Sections 548 and 550, provide the confidence and
stability that Congress sought. Investors need not worry that more
sophisticated investors will catch wind of their broker-dealer’s fraud
and use that knowledge to their benefit. An inquiry notice standard
allows SIPA trustees to recover withdrawn sums—taken for no value or
without good faith—back into the customer property fund for the
35 Case 20-1334, Document 73, 08/06/2020, 2902485, Page47 of 180
benefit of all customers. Contrary to the decision below (SPA8), there is nothing “unfair and unworkable” about that.
By contrast, willful blindness is a state of mind “tantamount to knowledge.” Tiffany (NJ) Inc. v. eBay, Inc., 600 F.3d 93, 110 n.16 (2d
Cir. 2010); see also Intel Corp. Inv. Pol’y. Comm. v. Sulyma, 140 S. Ct.
768, 779 (2020) (evidence of “willful blindness” might support a finding of “actual knowledge”). As the district court explained, it would require a transferee to have “intentionally” decided to blind itself to “red flags” that point to a “high probability of fraud.” SPA8. That is a standard for having fraudulent intent, not merely for lacking good faith. “Knowing or turning a blind eye (refusing to look because of what you fear to see) would have made the [transferee] guilty of fraud,” the Seventh Circuit has explained, but is not required to establish that it received funds in other than good faith. Sentinel, 809 F.3d at 962.
In fact, it is a willful blindness standard that would invite securities market instability and shake investor confidence. Under that standard, investors who should have known something was amiss, and knew enough to turn consciously away from the red flags of fraud they were aware of, are permitted to keep their fraudulent transfers, to the
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detriment of all creditors of the estate who were likewise harmed by a debtor’s scheme. That is no recipe for market stability and investor confidence.
Nor does retaining the inquiry notice standard in SIPA cases impose on a securities investor any “inherent duty to inquire about his stockbroker.” SPA7 (quoting the district court’s prior decision in Katz,
462 B.R. at 455). The inquiry notice standard simply requires investors to act reasonably in response to suspicious information that they do encounter. The reasonableness of investor conduct, moreover, is determined based on the standards of that industry. As the Fourth
Circuit has explained, the inquiry notice rule “looks to routine business practices to set the objective good faith standard,” which “gives an industry wide latitude in which to operate, so long as it follows the very customs the industry itself has created.” Nieves, 648 F.3d at 239 n.4.
In any event, these are policy disputes that Congress has already
resolved. It answered these questions in SIPA’s text by making SIPA
trustees’ and bankruptcy trustees’ avoidance and recovery authority
coextensive. The district court had no authority to reform SIPA into
something it believed—debatably at best—to be more fair or workable.
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2. The Federal Securities Laws, If They Apply At All, Do Not Require Equating “Good Faith” With A “Lack Of Fraudulent Intent”
Even if federal securities laws “inform[]” (SPA6) the extent of a
SIPA trustee’s reach under Sections 548 and 550—and they do not—the district court was wrong that those laws impose a willful blindness standard for assessing transferees’ lack of good faith.
The district court believed that, “[j]ust as fraud, in the context of federal securities law, demands proof of scienter, so too ‘good faith’ in this context implies a lack of fraudulent intent.” SPA5 (quoting the district court’s prior decision in Katz, 462 B.R. at 455). The federal securities laws do not, however, uniformly require defendants to have scienter. And, even when they do, they allow it to be established by defendants’ reckless disregard and not only their willful blindness.
First, the district court relied only selectively on the securities laws. A number of those laws do not require defendants’ scienter and make negligent conduct culpable. For example, Section 17(a)(2) of the
Securities Act of 1933, 15 U.S.C. § 78q(a)(2) (the “’33 Act”), which
“prohibits any person from obtaining money or property ‘by means of any untrue statement of a material fact or any omission to state a
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material fact,’ is devoid of any suggestion whatsoever of a scienter requirement.” Aaron v. SEC, 446 U.S. 680, 696-97 (1980). To be liable, persons covered by that statute who “obtain[ed] money or property” need only to have negligently done so by means of a material misstatement. Id. Sections 11 and 12(a)(2) of the ’33 Act, 15 U.S.C.
§§ 77k, 77l(a)(2), which prohibit certain misstatements of material fact in connection with securities offerings, likewise do not require proof of a defendant’s scienter. Rombach v. Chang, 355 F.3d 164, 169 n.4 (2d Cir.
2004).
The district court gave no reason for not applying those securities laws when determining whether the Bankruptcy Code’s inquiry notice good faith standard must “yield” to supposedly conflicting securities laws. SPA6. Given a court’s duty to construe complementary statutes not “to preclude the operation of [each] other,” POM Wonderful, LLC v.
Coca-Cola Co., 573 U.S. 102, 115 (2014), the district court was wrong to search for a securities-law provision to which the Bankruptcy Code must “yield” instead of one in harmony with its ordinary operation.
Second, even if the district court correctly fixated only on the scienter element of a securities fraud claim under Section 10(b) of the
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1934 Act, 15 U.S.C. § 78j(b), it still missed the mark. In securities fraud cases, reckless disregard for the truth—not only willful blindness to it—
satisfies the scienter requirement. See, e.g., Rothman v. Gregor, 220
F.3d 81, 90 (2d Cir. 2000) (“[T]o plead scienter in a securities fraud claim, a complaint may . . . allege facts that constitute strong circumstantial evidence of conscious misbehavior or recklessness”)
(emphasis added); accord Dekalb Cnty. Pension Fund v. Transocean
Ltd., 817 F.3d 393, 407 (2d Cir. 2016) (holding that the good faith defense to claims under Securities Exchange Act Section 18(a), 15
U.S.C. § 78r, is not available “where a defendant acted, at a minimum, recklessly”) (emphasis added). As the Supreme Court has held, “willful blindness . . . surpasses recklessness.” Glob.-Tech Appliances, Inc. v.
SEB S.A., 563 U.S. 754, 769 (2011). Thus, it was error for the district court to impose a willful blindness standard even if Section 10(b) of the
1934 Act defines the good faith defense in SIPA cases, which it does not.
Good Faith Is An Affirmative Defense That Transferee- Defendants Must Plead With Their Answer, And For Which Trustee-Plaintiffs Have No Pleading Burden
The district court correctly recognized that the text and structure
of Sections 548 and 550 of the Bankruptcy Code, 11 U.S.C. §§ 548, 550,
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make transferees’ good faith “an affirmative defense that must in the first instance be pleaded by the defendants.” SPA9. The court erred by nevertheless holding that “SIPA or other considerations” shift that pleading burden to plaintiff SIPA trustees. The district court mistakenly concluded that SIPA’s “twin goals,” and the Iqbal/Twombly line of cases, require that burden shift. SPA11. They do not. The district court thus lacked any legal basis for altering a pleading burden set by statute and rule.
A. Good Faith Is An Affirmative Defense That Transferee-Defendants Have The Burden To Plead
We begin on common ground with the district court: It correctly
acknowledged that, “simply in terms of the Bankruptcy Code,” “good
faith” is an affirmative defense under Sections 548 and 550 that
defendant-transferees must plead, not plaintiff-trustees. SPA9; see also
SPA11 (holding that, in “ordinary bankruptcies,” Sections 548(c) and
550(b)(1) “both provide an affirmative defense that must be raised by
defendants in the first instance”). The “structure” of the statutory text,
41 Case 20-1334, Document 73, 08/06/2020, 2902485, Page53 of 180
the court recognized, dictates that conclusion. SPA10.5
Section 548(a)(1)(A) “permits a trustee to ‘avoid any transfer’ made within two years of the debtor’s filing of a bankruptcy petition, if the debtor (here Madoff Securities) ‘made such transfer . . . with the actual intent to . . . defraud any entity to which the debtor was . . . indebted.” SPA9–10 (quoting 11 U.S.C. § 548(a)(1)(A)). Then, in
subsection (c), the statute states an exception that “allows a transferee
to retain ‘any interest transferred’ to the extent he [gave] value for the
transfer and if he can show that he took the transfer in good faith.”
SPA10 (quoting 11 U.S.C. § 548(c)).
5 Numerous courts of appeals have held that Section 548’s and Section 550’s “good faith” exceptions are affirmative defenses. See, e.g., Smith v. SIPI, LLC (In re Smith), 811 F.3d 228, 246 (7th Cir. 2016) (§ 550(b)); Taneja, 743 F.3d at 429-30 (§ 548(c)); Williams v. FDIC (In re Positive Health Mgmt.), 769 F.3d 899, 902-04 (5th Cir. 2014) (§ 548(c)); Mano- Y&M, Ltd. v. Field (In re Mortg. Store, Inc.), 773 F.3d 990, 994-95 (9th Cir. 2014) (§ 550(b)); Nieves, 648 F.3d at 237 (§ 550(b)); Perkins v. Haines, 661 F.3d 623, 626 (11th Cir. 2011) (§ 548(c)); IRS v. Nordic Vill., Inc. (In re Nordic Vill., Inc.), 915 F.2d 1049 (6th Cir. 1990) (§ 550(b)), rev’d on other grounds, United States v. Nordic Vill., Inc., 503 U.S. 30 (1992). As the Sixth Circuit explained, discussing Section 550(b), “[t]he language of the statute clearly places the burden of showing . . . good faith . . . on the transferee as a defense.” In re Nordic Vill., Inc., 915 F.2d at 1055.
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The “structure of the relevant provisions” in Section 550, the district court explained, is “largely analogous.” SPA10. Where a debtor’s fraudulent transfer is avoided, Section 550(a) states that a trustee “may recover, for the benefit of the estate, the property transferred” from initial or subsequent transferees “[e]xcept as otherwise provided by this section.” 11 U.S.C. § 550(a). Then, in subsection (b), the statute provides an exception that “‘[t]he trustee may not recover” from a subsequent transferee who ‘takes for value . . . in good faith and without knowledge of the voidability of the transfer avoided.’” SPA10 (quoting 11 U.S.C. § 550(b)(1)).
Sections 548 and 550 are thus examples of “the familiar principle that when Congress ‘carves an exception out of the body of a statute . . . those who set up such exception must prove it.’” Meacham v. Knolls
Atomic Power Lab’y, 554 U.S. 84, 91 (2008) (quoting Javierre v. Cent.
Altagracia, 217 U.S. 502, 508 (1910) (Holmes, J.)). A century ago, it was already “a settled rule” that a “pleading founded on a general provision defining the elements of . . . a right conferred[] need not negative the matter of an exception made by a proviso or other distinct clause . . . and that it is incumbent on one who relies on such an
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exception to set it up and establish it.” McKelvey v. United States, 260
U.S. 353, 356-57 (1922); see also FTC v. Morton Salt Co., 334 U.S. 37,
44-45 (1948) (it is a “general rule of statutory construction” that “the
burden of proving . . . exemption under a special exception to the
prohibitions of a statute generally rests on one who claims its benefits”).
Federal Rule of Civil Procedure 8(c)(1) carries forward that long-
settled understanding: “In responding to a pleading, a party must
affirmatively state any avoidance or affirmative defense . . . .” As the
Supreme Court has reaffirmed recently (and often), an “affirmative
defense to a plaintiff’s claim for relief [is] not something the plaintiff
must anticipate in her pleading.” Perry v. Merit Sys. Prot. Bd., 137
S. Ct. 1975, 1987 n.9 (2017) (citing Rule 8(c)(1)); accord United States ex
rel. Mari. Admin. v. Cont’l Ill. Nat’l Bank & Tr. Co. of Chicago, 889 F.2d
1248, 1254 (2d Cir. 1989) (plaintiff was not required to plead
affirmative defense because Federal Rule of Civil Procedure 8(c)
“imposed upon [the defendant] the burden of pleading it”). This Court
has therefore (again, recently and often) reversed dismissals that were
premised on a plaintiff’s failure to plead facts negating an affirmative
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defense. See, e.g., Hardaway v. Hartford Pub. Works Dep’t, 879 F.3d
486, 489-91 (2d Cir. 2018) (Title VII exhaustion).
B. Neither SIPA Nor Other Considerations Require The Trustee To Plead A Transferee’s Lack Of Good Faith
The analysis could and should have ended once the district court
recognized that the text of Sections 548 and 550 make good faith an
affirmative defense. See Fed. R. Civ. P. 8(c)(1); Abbas v. Dixon, 480
F.3d 636, 640 (2d Cir. 2007) (“The pleading requirements in the Federal
Rules of Civil Procedure . . . do not compel a litigant to anticipate
potential affirmative defenses, such as the statute of limitations, and to
affirmatively plead facts in avoidance of such defenses.”). Yet the court
went on to hold that SIPA trustees asserting claims under those
statutes are required to plead particularized allegations that a
defendant lacked good faith. SPA11–12. The district court gave three reasons for altering the pleading burden, but none justifies its departure from the Federal Rules and statutory text.
1. The district court believed that adhering to the statutory text in SIPA liquidations “would totally undercut SIPA’s twin goals of maintaining marketplace stability and encouraging investor confidence if a trustee could seek to recover the investors’ investments while
45 Case 20-1334, Document 73, 08/06/2020, 2902485, Page57 of 180
alleging no more than that they withdrew proceeds from their facially innocent securities accounts.” SPA11. That ad hoc policy judgment cannot justify the court’s departure from the Federal Rules and statutory text, and in any event it’s wrong.
In Jones v. Bock, 549 U.S. 199, 212-13 (2007), the Supreme Court reversed a court of appeals (in a context much more compelling than this one) for placing the burden on the plaintiff (a prisoner) to negate an affirmative defense (lack of exhaustion). Rather than indulge in a policy analysis of where the pleading burden should lie, the Supreme
Court simply determined that exhaustion is an affirmative defense and reiterated that “courts should generally not depart from the usual practice under the Federal Rules on the basis of perceived policy concerns.” Id. at 212. Changing what plaintiffs must plead to state a claim “is a result which must be obtained by the process of amending the Federal Rules, and not by judicial interpretation.” Id. at 213.
Allowing trustees who are liquidating failed broker-dealers to state fraudulent transfer claims expeditiously based on the statutory elements, and without extra pleading burdens, is in any event consistent with providing investor confidence and market stability.
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SIPA encourages trustees to recover customer property and “promptly” make payments to the customers. SIPA §§ 78fff-2(b), (c)(3). Requiring
SIPA trustees to allege particularized facts about a transferee’s state of mind at the pleading stage risks causing the early defeat of potentially meritorious claims, and a corresponding reduction in the amount of customer property made available for equitable distribution.
Moreover, the law routinely places the burden of pleading on the party with greater access to information. Nat’l Commc’ns Ass’n Inc. v.
AT & T Corp., 238 F.3d 124, 130–31 (2d Cir. 2001). Putting the burden on the defendant-transferee also avoids requiring trustees to plead a transferee’s lack of good faith. As this Court has explained, “courts should avoid requiring a party to shoulder the more difficult task of proving a negative.” Id. at 131.
In the qualified-immunity context, for example, the Supreme
Court has held that the government-official defendant “must plead good
faith as an affirmative defense,” rather than requiring a plaintiff “to
allege that the official has acted in bad faith.” Gomez v. Toledo, 446
U.S. 635, 635-36 (1980). As the Court explained, “[t]he existence of a
subjective belief will frequently turn on factors which a plaintiff cannot
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reasonably be expected to know.” Id. at 641. To “impose the pleading burden on the plaintiff would ignore this elementary fact and be contrary to the established practice in analogous areas of the law.” Id.
2. The district court also held that keeping the burden of pleading good faith on transferees would, in SIPA cases, “not accord with the Supreme Court’s requirement that, on a motion to dismiss for failure to state a claim, a court must assess whether the complaint
‘contain[s] sufficient factual matter, accepted as true, to “state a claim to relief that is plausible on its face.”’” SPA11 (quoting Iqbal, 556 U.S. at 678 (quoting Twombly, 550 U.S. at 570)).
That reasoning begs rather than answers the question of what
elements of a fraudulent transfer claim must be pleaded to make the
claim plausible on its face. The rule that affirmative defenses must be
pleaded by the defendant, not negated by the plaintiff, has been stated
by the Supreme Court and this Court consistently after Iqbal and
Twombly. E.g., Perry, 137 S. Ct. at 1987 n.9; Hardaway, 879 F.3d at
486, 489-91. Until the decision below, no court that we are aware of has
ever thought (in the multitude of cases raising the issue) that Iqbal and
Twombly had anything to do with the settled rule that affirmative
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defenses must be pleaded by the defendant, not negated by the plaintiff.
Cf. GEOMC Co., Ltd. v. Calmare Therapeutics Inc., 918 F.3d 92, 97-98
(2d Cir. 2019) (resolving a deep split of authority about whether Iqbal
and Twombly raise the hurdle a defendant must surmount to plead an
affirmative defense). They do not change the settled rule.
3. The district court added, in a footnote, that it was “not
unreasonable” to require SIPA trustees to plead transferees’ lack of
good faith because trustees have “extensive discovery powers” under
Federal Rule of Bankruptcy Procedure 2004. SPA12 n.5. That is
mistaken for three reasons.
First, at the risk of beating a dead horse, that call was not the
district court’s to make. For reasons already stated, Congress or a
Rules Committee (operating under the supervision of the Supreme
Court) would have to act for that policy concern to become law.
Second, the district court’s observation does not distinguish SIPA
cases from bankruptcy cases. Bankruptcy trustees have the same
discovery powers under Rule 2004 that SIPA trustees have. Yet, to our
knowledge, no court has ever held that bankruptcy trustees therefore
must shoulder the burden to plead a transferee’s lack of good faith.
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Third, Rule 2004 discovery is no substitute for Rule 26 discovery in litigation. Rule 2004 discovery is a non-adversarial tool affording trustees the opportunity to gather information on matters that “may affect the administration of the estate.” Fed. R. Bankr. P. 2004(b). It is often only a “quick factual fix,” In re Good Hope Refineries, Inc., 9 B.R.
421, 423 (Bankr. D. Mass. 1981), for trustees who were previously strangers to the debtor’s affairs. See also In re Handy Andy Home
Improvement Ctrs., Inc., 199 B.R. 376, 386 (Bankr. N.D. Ill. 1996) (Rule
2004 and Rule 26 discovery “are actually quite different”). Here, moreover, the bankruptcy court denied the Trustee any new discovery, after the Good Faith Decision, in large part because it held that the
Trustee was not entitled to pre-complaint discovery under the Federal
Rules of Civil Procedure. See supra at 7–9. None of the district court’s rationales provide a basis for shifting the pleading burden to the
Trustee.
C. The Trustee Has No Burden To Plead A Subsequent Transferee’s Knowledge Of The Transfer’s Voidability
Section 550(b)(1) of the Bankruptcy Code provides a defense to a
Trustee’s recovery claim when a subsequent transferee “takes for value
. . . in good faith, and without knowledge of the voidability of the
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transfer avoided.” 11 U.S.C. § 550(b)(1). In this case, the bankruptcy court extended the district court’s Good Faith Decision to hold that, just as SIPA trustees must plead subsequent transferees’ lack of good faith, so too must trustees plead transferees’ lack of knowledge of the voidability of the transfer avoided. SPA50.
That was error for the same reasons that the Good Faith Decision misstates the Trustee’s burden of pleading a transferee’s good faith. As the bankruptcy court acknowledged, Section 550(b)(1) provides “an affirmative defense that the subsequent transferee must ordinarily plead and prove.” SPA49. Although the bankruptcy court logically extended the Good Faith’s Decision’s error, its holding is no less mistaken. Under Section 550(b)(1)’s controlling text, subsequent transferees have the burden of pleading that they took for value, in good faith, and without knowledge of the voidability of the transfer avoided.
The Amended Complaint Alleges Facts From Which Appellees’ Willful Blindness And Knowledge Of Voidability Can Plausibly Be Inferred At The Pleading Stage
If this Court disagrees with the district court’s Good Faith
Decision on either one of the two grounds addressed above, then it need not proceed any further and should vacate or reverse the judgment
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below.6 If, however, this Court agrees with the Good Faith Decision on the legal standard for good faith, and about which party must plead it, then the Court should nevertheless reverse the judgment because the
Trustee’s Amended Complaint satisfied that standard and burden.
A. The Amended Complaint Plausibly Alleges Legacy Capital’s Willful Blindness To Fraud
Legacy Capital is the initial transferee of more than $213 million that BLMIS fraudulently transferred to it (and to BNP for Legacy
Capital’s account) before collapsing. A123 ¶142.
If the Trustee was required to allege Legacy Capital’s willful blindness to state a claim to recover the fraudulently transferred $213 million from Legacy, the Amended Complaint did so. Willful blindness consists of two elements: (1) “the defendant must subjectively believe
6 If the Court agrees (only) that lack of good faith does not require willful blindness, then logically the Court would vacate the judgment below and remand for application of the proper standard. If the Court agrees (only) that the burden rests with defendants to plead good faith, not the Trustee to negate it, then logically the Court would reverse the judgment below because the complaint was dismissed for failure to plead something the Trustee need not plead at all. In the interest of judicial economy, however, we urge this Court to reach both issues. Both will arise in this and many other cases in this very long-running liquidation, and all parties would benefit from knowing both the meaning of “good faith” and who bears the pleading burden.
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that there is a high probability that a fact exists” and (2) “the defendant must take deliberate actions to avoid learning of that fact.” Glob.-Tech
Appliances, Inc., 563 U.S. at 769. Willful blindness does not require
taking any “affirmative act.” State of N.Y. v. United Parcel Serv., Inc.,
253 F. Supp. 3d 583, 667 (S.D.N.Y. 2017). Rather, it consists of any
“conscious choice” by the defendant to ignore “incriminating facts.”
United States v. Fofanah, 765 F.3d 141, 150 (2d Cir. 2014) (Leval, J.,
concurring).
Willful blindness need not be as specific as being subjectively
aware of a Ponzi scheme. It suffices that transferees were willfully
blind to fraud as a general matter, or that BLMIS was engaged in other
types of fraud. “[T]he culpability of the willfully blind defendant lies in
his averting his eyes to what he thinks he sees, not in the objective
accuracy of his vision.” United States v. Nektalov, 461 F.3d 309, 315 (2d
Cir. 2006); see also United States v. Chu, 183 F. App’x 94, 98 (2d Cir.
2006) (affirming defendant’s conviction and willful blindness jury
instruction where he “claimed to lack knowledge of the true nature” of
the fraudulent scheme in which he participated); United States v. Joly,
493 F.2d 672, 674 (2d Cir. 1974) (upholding conscious-avoidance
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conviction in a drug courier case based on defendant’s belief that he
“was doing something wrong,” not that he was transporting drugs). But see, e.g., Picard v. ABN AMRO Bank N.A., No. 10-05354 (SMB), 2020
WL 1584491, at *10 n.14 (Bankr. S.D.N.Y. Mar. 31, 2020) (construing the willful blindness standard as requiring knowledge of the “critical facts” and erroneously deeming the Ponzi scheme the critical fact).
Federal Rule of Civil Procedure 8(a) requires, in relevant part, only that the Trustee’s complaint contain “a short and plain statement of the claim showing that the pleader is entitled to relief.” It “does not need detailed factual allegations,” Arista Recs. LLC v. Doe 3, 604 F.3d
110, 120 (2d Cir. 2010), but simply “sufficient factual matter, accepted as true, to state a claim to relief that is plausible on its face,” Iqbal, 556
U.S. at 678 (quoting Twombly, 550 U.S. at 556).
To present a “plausible” claim to relief, then, the complaint needs only enough “factual content” to “allow the court to draw the reasonable inference that the defendant is liable for the misconduct alleged.” Id.
The Trustee’s complaint is not required to convince a court that it is probable he will succeed. “[P]lausibility is a standard lower than
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probability.” Anderson News, L.L.C. v. Am. Media, Inc., 680 F.3d 162,
185 (2d Cir. 2012).
Moreover, “a given set of actions may well be subject to diverging interpretations, each of which is plausible.” Id. And so “[t]he choice between two plausible inferences that may be drawn from factual allegations is not a choice to be made by the court on a Rule 12(b)(6) motion.” Id.; see also Cohen v. S.A.C. Trading Corp., 711 F.3d 353, 360
(2d Cir. 2013) (“Iqbal requires that the complaint assert facts that plausibly support the inference of fraud. It does not require that all other conceivable possibilities be excluded.”). In fact, the district court denied interlocutory review of its Good Faith Decision in part because it understood that the Trustee could survive dismissal motions based on pleading just “modest evidence” of defendants’ willful blindness.
Order, SIPC v. BLMIS (In re Madoff Sec.), No. 12-mc-115 (JSR)
(S.D.N.Y. July 21, 2014), ECF No. 555.
The Amended Complaint states a plausible claim under Section
548 of the Bankruptcy Code to recover from Legacy Capital, for the benefit of all BLMIS customers, the $213 million in fraudulently transferred BLMIS customer property. More specifically, the Amended
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Complaint alleges facts that create a plausible inference that Legacy
Capital was willfully blind to ongoing fraud at BLMIS.
These factual allegations must, of course, be accepted as true at
the pleading stage. See Lynch v. City of New York, 952 F.3d 67, 74–75
(2d Cir. 2020). What is more, the Trustee is entitled to every reasonable inference from the allegations. Id. On those well-settled
principles, the following allegations demonstrably provide sufficient
“factual content” to create a reasonable inference of Legacy Capital’s
willful blindness that is “plausible on its face,” Iqbal, 556 U.S. at 678:
• Through Rafael Mayer, Appellees knew and understood the BLMIS trading impossibilities identified by the Renaissance Proposal, which found that BLMIS’ options trading volume would need to exceed the total market volume of those trades, that BLMIS claimed to buy and sell equities at impossible prices, and that BLMIS purported to execute billions of dollars of equity and options trading without leaving any market “footprint.” A100–01 ¶¶ 45–47, A108 ¶ 75, A108–09 ¶¶ 77–78.
• Rafael Mayer exchanged emails with other Meritage Oversight Committee members who knew “it wasn’t possible” that Madoff was trading the securities that he claimed to be trading, A108– 09 ¶ 78, who joked about asking Madoff non-serious questions about a strategy they already knew was fictitious, A103–04 ¶¶ 59–60, who called BLMIS’ fraud risk the kind of “background radiation” that doesn’t go away, A101¶ 49, and who saw Madoff’s head as a future trophy for the New York Attorney General once Madoff’s fraud collapsed. Id. ¶ 50.
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• After identifying BLMIS as a fraud, Meritage decided (over Rafael Mayer’s lonely objection) to redeem its investment. A122 ¶¶ 138–39. Legacy Capital, however, was a single- purpose vehicle invested exclusively in BLMIS and was not nearly ready to hop off that gravy train. So Legacy Capital bought out half of Meritage’s position to continue collecting management fees on that money (fees that Madoff inexplicably declined to charge himself). A122–23 ¶¶ 138–41.
• Rather than hire an independent third party to evaluate its BLMIS investment, Legacy Capital hired Khronos, which was controlled by the same people that controlled Legacy. A98 ¶¶ 30–34, A101–02 ¶ 52. Khronos, through Rafael Mayer, already knew what the Renaissance Proposal had uncovered. But this agreement allowed the Mayers to siphon off additional fees.
• Khronos—contrary to its standard investment monitoring process—restricted its employees’ access to Legacy Capital and its BLMIS account statements so that Rafael and David Mayer were the only ones who saw Legacy Capital’s fictitious account information. A101–02 ¶ 52.
• Khronos performed specific quantitative and qualitative analyses that confirmed—repeatedly—the trading impossibilities demonstrated by Legacy Capital’s account statements. A98 ¶ 31, A103–04 ¶ 59, A108 ¶ 75, A109 ¶ 80, A112–14 ¶¶ 94–101, A115 ¶ 104, A116 ¶ 111.
The bankruptcy court held that those and other allegations in the
Amended Complaint sufficiently “allege[] the first prong of willful blindness—Legacy strongly suspected that, at a minimum, BLMIS’ option trades were not real.” SPA48 (emphasis added). It is clear from
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the Amended Complaint’s detailed allegations that Legacy Capital was
“highly suspicious of Madoff’s options trades.” SPA41.
That is demonstrably correct. Appellees knew it was impossible that BLMIS was trading the securities it claimed to be trading. They knew that their account statements were false, reported impossible prices, and reflected statistically improbable trade execution. The bankruptcy court thus correctly held that, at the pleading stage, the
Amended Complaint plausibly alleges Legacy Capital’s subjective belief in a high probability that BLMIS was a fraud. See id.
The court nevertheless concluded that the Amended Complaint does not plausibly state the second prong of willful blindness—“that
Legacy turned a blind eye to its suspicions”—because “it alleges that
Legacy hired Khronos to conduct due diligence regarding Madoff’s trades for Legacy’s account.” SPA48. Retaining an entity to conduct more diligence, the court concluded, is not consistent with an allegation of willful blindness.
That conclusion ignores the reality of Legacy Capital’s relationship with Khronos. Khronos was controlled by Rafael and
David Mayer. It was not an independent third party that might
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actually have blown the whistle on the BLMIS fraud and Legacy
Capital’s profit from it. The Amended Complaint alleges that the
Mayers restricted other Khronos employees’ access to Legacy Capital and its BLMIS account statements precisely so that they would retain exclusive access to that information even within Khronos. A101–02
¶ 52. In short, the Mayers hired the Mayers to perform analyses that the Mayers then kept as closely guarded secrets. Those allegations of the intentional steps taken to make sure the wrong people didn’t start asking the right questions more than plausibly allege Legacy Capital’s deliberate actions to avoid confirming the truth.
The bankruptcy court also discounted the plausibility of
allegations that Legacy Capital turned a blind eye to BLMIS’ fraud by
concluding that no entity would ever invest money on that basis. “While
greed may cloud judgment,” the court opined, “it is not plausible that
the average financial professional owing fiduciary duties to its own
clients and investors would knowingly invest their money in a Ponzi
scheme that is doomed to collapse.” SPA42.
That holding is replete with problems. To begin with, not every
member of a group is the average member of that group. If the
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allegation were that a particular financial professional owing fiduciary duties committed fraud, it would be no answer that “the average financial professional” does not do so. The bankruptcy court made a simple error of logic.
And the Amended Complaint alleges that these Appellees
knowingly invested in a Ponzi scheme for the same reason that various
other feeder funds and money managers did—the lucrative fees they
could charge investors while providing them impossibly consistent
returns. The Amended Complaint alleges in detail how Madoff’s
scheme was set up to make it incredibly lucrative for feeder funds to
stay in the game. A97 ¶ 27, A109–10 ¶¶ 81–87. An investment manager like BLMIS typically charges investors a management fee (as a percentage of the total sum invested) and a performance fee (as a percentage of the fund’s gains). “Two and twenty” refers to top managers’ common practice of charging a 2% management fee and 20% performance fee, although fees can be as low as 1% and 10%. A109
¶ 82. But BLMIS charged neither a management fee nor a performance fee. Rather, it charged only modest commissions on its fictitious trades—and sometimes even forgot to charge that much. A109–10 ¶ 83.
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Madoff thus left hundreds of millions of dollars on the table. Why?
Because that left room for Legacy Capital and other feeder funds to rake in big fees in exchange for providing BLMIS the investor cash it needed to keep its Ponzi scheme going. Legacy Capital and other feeder funds therefore earned exorbitant fees without having to execute an investment strategy any more complicated than “send Madoff money; wait for checks in the mail.”
Other decisions about BLMIS recognize the logic behind well-
pleaded allegations that fees and other incentives caused defendants to
look the other way when BLMIS’ fraud became apparent to them. In
Anwar v. Fairfield Greenwich Ltd., the court held that a complaint
sufficiently pleaded that defendants waved off “two decades” of “red
flags” about Madoff’s fraud because their “finer faculties were overcome
by the fees they earned and . . . they turned a blind eye to obvious signs
of fraud.” 728 F. Supp. 2d 372, 410 (S.D.N.Y. 2010). In Katz, moreover,
the district court held that the complaint plausibly alleged that
defendants had invested while willfully blind to Madoff’s fraud “because
they felt they could realize substantial short-term profits while
protecting themselves against the long-term risk.” 462 B.R. at 454-55.
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And in Picard v. Merkin (In re BLMIS) (“Merkin II”), the bankruptcy court likewise held that the defendants’ “substantial management and incentive fees . . . can explain why they would turn a blind eye to fraud.”
515 B.R. 117, 143 (Bankr. S.D.N.Y. 2014). It cannot be the law that
some feeder funds logically could have been motivated by fees to invest
in BLMIS despite knowing that it was not trading securities as
advertised, but it is implausible that other feeder funds were.
In other cases, moreover, courts have recognized the plausibility of
assertions that sophisticated market participants might bury their head
in the sand for profit. In one case, for example, a court credited a
trustee’s allegation that “Credit Suisse’s motivation in keeping quiet” about its borrower’s fraud “was to protect the incoming stream of millions of dollars of fees that Credit Suisse received.” Unencumbered
Assets, Tr. v. JP Morgan Chase Bank, 604 F. Supp. 2d 1128, 1151 (S.D.
Ohio 2009); see also Bash v. Textron Fin. Co. (In re Fair Fin.), 834 F.3d
651, 676 (6th Cir. 2016) (trustee’s complaint plausibly alleged willful blindness where bank loaned $22 million in exchange for hundreds of thousands of dollars in fees and interest); Gowan v. Westford Asset
Mgm’t (In re Dreier LLP) 462 B.R. 474, 493 (Bankr. S.D.N.Y. 2011)
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(defendants invested clients’ money in Ponzi scheme for fees). Indeed, even when a defendant’s alleged conduct appears irrational to a judge, that is a determination for a jury to make. In re Nat’l Cen. Fin. Enters.,
846 F. Supp. 2d 828, 873 (S.D. Ohio 2012).
The bankruptcy court’s contrary conclusion relied on Buchwald
Capital Advisors LLC v. JP Morgan Chase Bank, N.A. (In re M.
Fabrikant & Sons, Inc.), 480 B.R. 480, 489 (S.D.N.Y. 2012), aff’d, 541 F.
App’x 55 (2d Cir. 2013) (“Fabrikant”) as support for its skepticism that
defendants could plausibly have ignored a fraud while putting their own
money on the table. Fabrikant did not involve a Ponzi scheme, but
rather an allegation that banks had lent money to two companies
despite knowing that those companies were insolvent, that they would
funnel the money to pay short-term obligations of their insolvent
affiliates, and therefore that the companies would be left unable to
repay the banks. Id. at 489. There were “no facts to support” the
complaint’s “wholly conclusory” allegations that the banks knew about
that fraudulent scheme when they made the loans. Id. at 488. Thus,
the district court declined to infer that defendants would make loans to
an entity engaged in fraud, finding the trustee’s barebones allegations
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regarding motivation conclusory and not plausible, particularly given the modest commissions that were at issue.
Here, by contrast, the Trustee alleges details about BLMIS’ fee structure and how it was designed to benefit Appellees. Those non- conclusory allegations should not have been disregarded. Rather,
Twombly directs courts to accept, at the pleading stage, the veracity of
even factual allegations that “strike[] a savvy judge [as] . . .
improbable.” 550 U.S. at 556; see also id. (“Rule 12(b)(6) does not
countenance . . . dismissals based on a judge’s disbelief of a complaint’s
factual allegations.”) (internal quotation omitted).
B. The Amended Complaint Pleads Recoverable Subsequent Transfers To Khronos
The bankruptcy court recognized “no meaningful distinction”
between the Trustee’s allegations that Legacy Capital and Khronos
lacked good faith. SPA53. Rafael Mayer was a principal of both
Appellees, so his knowledge is imputed to both of them. Just as the
bankruptcy court held that the Amended Complaint pleads Legacy
Capital’s subjective belief in a high probability of fraud at BLMIS, so
too, therefore, it adequately pleads the same regarding Khronos. See id.
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With respect to the turning-away allegations, however, the bankruptcy court held that the allegations about the work Khronos did for Legacy did not demonstrate that Khronos took steps to avoid confirming the fraud. Id. That conclusion is legal error as to Khronos for the same reasons it is legal error as to Legacy Capital. Among other things, the Amended Complaint alleges that Khronos, contrary to its usual practices, purposefully limited employee access to Legacy Capital and its account statements to Rafael and David Mayer. A101–02 ¶ 52.
As the Amended Complaint contends, this was not a legitimate diligence exercise.
The bankruptcy court also held that the Amended Complaint does not plead facts that permit the plausible inference that Khronos knew of the voidability of BLMIS’ transfers to Legacy Capital and Montpellier
Resources from which its fees flowed. SPA53–55. The court held that this aspect of Section 550(b)(1)’s affirmative defense “essentially defines willful blindness.” Id. That is an overstatement of that defense. See, e.g., Banner, 1996 WL 680760, at *3 (“‘[i]f a transferee possesses knowledge of facts that suggest a transfer may be fraudulent,’ he has sufficient knowledge to preclude his incantation of § 550(b)’s defense.”);
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Wallach v. Altmeyer (In re Altmeyer), 268 B.R. 349, 357 (Bankr.
W.D.N.Y. 2001) (holding that “knowledge of a potential basis for the avoidance” sufficient to bar a Section 550(b) defense) (emphasis added).
But even still the Amended Complaint sufficiently pleads Khronos’ knowledge of voidability for the same reasons that it sufficiently pleads
Khronos’ lack of good faith on the willful-blindness standard the courts
below applied.
Finally, the bankruptcy erred by holding that the Amended
Complaint failed to state a claim that any of the $6.3 million in fees
Khronos received from Montpellier Resources were recoverable
subsequent transfers from BLMIS. The court held that the Amended
Complaint had to—but did not—establish that all of those fees
necessarily originated from BLMIS. SPA50–51. It contrasted the
Amended Complaint’s descriptions of Montpellier Resources and Legacy
Capital, emphasizing that only the latter is alleged to be a single-
purpose fund invested solely in BLMIS. SPA51. Without a similar
allegation that Montpellier Resources invested only in BLMIS, the court
held, the Trustee could not plead a basis to recover any of the fees
Montpellier Resources paid to Khronos.
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That conclusion confuses the Trustee’s burden of pleading with his
ultimate burden of proof at trial. To satisfy Rule 8 when pleading a
recoverable subsequent transfer under Section 550(a), the Trustee
needs to plead only the “necessary vital statistics” of the transfers—“the
who, when, and how much” to establish an entity as a subsequent
transferee of the funds in dispute. See Silverman v. K.E.R.U. Realty
Corp. (In re Allou Distribs., Inc.), 379 B.R. 5, 32 (Bankr. E.D.N.Y. 2007);
SIPC v. Stratton Oakmont, Inc., 234 B.R. 293, 318 (Bankr. S.D.N.Y.
1999). It is not necessary that a trustee’s complaint conclusively
“connect each of the subsequent transfers with an initial, voidable
transfer emanating from BLMIS, or a prior subsequent transfer
originating with the initial transfer.” Merkin II, 515 B.R. at 150; see
also Allou Distribs., 379 B.R. at 30 (the trustee’s pleading “burden is not so onerous as to require ‘dollar-for-dollar accounting’ of ‘the exact funds’
at issue.”).
Rather, it suffices, at the pleading stage, that the Amended
Complaint implies some linkage between initial transfers from BLMIS
and subsequent transfers from Montpellier Resources to Khronos. See
Merkin II, 515 B.R. at 150 (subsequent transfers adequately pleaded
67 Case 20-1334, Document 73, 08/06/2020, 2902485, Page79 of 180
because they “took place contemporaneously or shortly after an initial transfer . . . implying linkage.”). The Amended Complaint provides that linkage. Montpellier Resources invested in BLMIS through Legacy
Capital (which was solely invested in BLMIS). A99 ¶ 35, A124 ¶ 148.
For its services, Khronos received a monthly fee equal to 1.2% of
Montpellier Resources’ net asset value attributable to its Legacy
Capital investment, plus performance fees based on new net investment profits. A124 ¶ 149. All told, Montpellier Resources paid Khronos approximately $6,281,899 for its services—some or all of which is attributable to initial transfers from BLMIS. A124–22 ¶¶ 150–51.
The exact portion of Montpellier Resources’ fee payments to
Khronos that is attributable to its Legacy Capital investment will be established by discovery into Appellees’ books and records. The
Trustee’s need to conduct that discovery does not bar his recovery at the pleading stage. See Merkin, 440 B.R. at 270 (“Defendants presumably have exclusive access to more detailed information regarding the proportion of their fees attributable to their BLMIS investments, and discovery of such information is warranted on the basis of the Trustee’s allegations.”).
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CONCLUSION
The judgment of the bankruptcy court should be reversed.
Date: August 6, 2020 Respectfully submitted, New York, New York /s/Amy E. Vanderwal DAVID J. SHEEHAN SEANNA R. BROWN AMY E. VANDERWAL BAKER & HOSTETLER LLP 45 Rockefeller Plaza New York, N.Y. 10111 (212) 589-4200
Attorneys for Appellant Irving H. Picard, as Trustee for the Liquidation of Bernard L. Madoff Investment Securities LLC
ROY T. ENGLERT, JR. MATTHEW M. MADDEN LESLIE C. ESBROOK ROBBINS, RUSSELL, ENGLERT, ORSECK, UNTEREINER & SAUBER LLP 2000 K Street NW, 4th Floor Washington, D.C. 20006 (202) 775-4500
Special Counsel to the Trustee
69 Case 20-1334, Document 73, 08/06/2020, 2902485, Page81 of 180
CERTIFICATE OF COMPLIANCE
This brief complies with the type-volume limitation of Rule 32(a)(7)(B) of the Federal Rules of Appellate Procedure and Second Circuit Local Rule 32.1(a)(4)(A) because it contains 13,743 words, excluding the parts of the brief exempted by Rule 32(f).
This brief complies with the typeface requirements of Rule
32(a)(5) and the type style requirements of Rule 32(a)(6) because it has been prepared in a proportionally spaced typeface using Microsoft Word in Century Schoolbook 14-point font.
Date: August 6, 2020 Respectfully submitted, New York, New York
/s/Seanna R. Brown SEANNA R. BROWN
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SPECIAL APPENDIX Case 20-1334, Document 73, 08/06/2020, 2902485, Page83 of 180
TABLE OF CONTENTS PAGE
Opinion and Order, filed April 28, 2014 ...... SPA-1
Memorandum Decision Regarding Motions to Dismiss the Trustee’s Amended Complaint, filed March 14, 2016 ...... SPA-14
Order Granting Legacy Capital Ltd.’s and Khronos LLC’s Motions to Dismiss the Amended Complaint Under Bankruptcy Rule 7012(b) and Federal Rule of Civil Procedure 12(b)(6), filed April 12, 2016 ...... SPA-56
Errata Order Memorandum Decision Regarding Motions to Dismiss the Trustee’s Amended Complaint, filed May 5, 2016 ...... SPA-58
Memorandum Decision and Order Granting Relief Under Federal Civil Rule 56(g), filed June 25, 2019 ...... SPA-60
Order Denying the Trustee’s Motion for Summary Judgment and Granting Relief Under Federal Rule of Civil Procedure 56(g), filed July 10, 2019 ...... SPA-90
Final Judgment and Order, filed November 12, 2019 ...... SPA-93
Statutes:
11 U.S.C. §§ 548(a)(1)(A), (c) Fraudulent transfers and obligations ... SPA-95
11 U.S.C. § 550 Liability of transferee of avoided transfer ...... SPA-95
15 U.S.C. § 78bbb Application of Securities Exchange Act of 1934 ... SPA-96
15 U.S.C. § 78eee(b)(4) Removal to bankruptcy court ...... SPA-96
15 U.S.C. § 78fff(b) Application of Title 11 ...... SPA-96
15 U.S.C. § 78fff-2(c)(3) Recovery of Transfers ...... SPA-96 Case 20-1334, Document 73, 08/06/2020, 2902485, Page84 of 180 SPA-1
Case 1:12-mc-00115-JSR Document 524 Filed 04/28/14 Page 1 of 13
UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK ------x SECURITIES INVESTOR PROTECTION CORPORATION,
Plaintiff, 12 Misc. 115 (JSR) -v- OPINION AND ORDER BERNARD L. MADOFF INVESTMENT SECURITIES LLC,
Defendant. ------x In re:
MADOFF SECURITIES ------x PERTAINS TO:
Consolidated proceedings on the "Good Faith" Standard if/.srh1r·------x . j
JED S. RAKOFF, U.S.D.J.
Under section 548(a) (1) of the Bankruptcy Code, the trustee of a bankruptcy estate is empowered to, inter alia, "avoid any transfer
. of an interest of the debtor in property. . that was made .
on or within 2 years before the date of the filing of the petition, if the debtor . . made such transfer. with actual intent to hinder, delay, or defraud any entity to which the debtor was or became .. indebted." llU.S . C. § 548(a)(l)(A). However, this authority is limited by subsection (c) of the same statute, which provides that "a transferee . of such a transfer. that takes for value and in good faith has a lien on or may retain any interest transferred . to the extent that such transferee .
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gave value to the debtor in exchange for such transfer II
Id. § 548 (c) (emphasis supplied). Section 550 (a) (2) of the
Bankruptcy Code provides, in turn, that a trustee may recover avoided property or the value of such property from "any immediate or mediate transferee of such initial transferee." Id. § 550 (a) (2).
But, similarly to the restrictions on avoidance in section 548, section 550(b) (1) provides that a "trustee may not recover" under section 550(a) (2) from "a transferee that takes for value, including satisfaction or securing of a present or antecedent debt, in good faith, and without knowledge of the voidability of the transfer avoided." Id. § 550 (b) (1) (emphasis supplied). The Bankruptcy Code does not define "good faith" in the context of section 548(c) or section 550(b), and it is that definitional question to which the instant consolidated proceeding is primarily directed, along with related questions of standards of pleading. 1
In this proceeding, various defendants in actions brought against them by Irving Picard (the "Trustee") - the trustee appointed under the Securities Investor Protection Act ("SIPA"), 15
U.S.C . §§ 78aaa-78111, to administer the estate of Bernard L. Madoff
Investment Securities LLC ("Madoff Securities") - have moved to dismiss the Trustee's avoidance and recovery actions against them.
These defendants argue that the Trustee has failed to plead their lack of good faith such that they are entitled to retain the
1 For purposes of this Opinion and Order, it is assumed that the transfers at issue were made "for value."
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transfers they have received from Madoff Securities (or some portion thereof). Defendants previously moved to withdraw the reference of their actions to the Bankruptcy Court, which the Court granted with respect to the following issue: "whether SIPA and other securities laws alter the standard the Trustee must meet in order to show that a defendant did not receive transfers in 'good faith' under either
11 U.S.C. § 548(c) or 11 U.S.C. § 550(b) ." Order at 3, No. 12 Misc.
115, ECF No. 197 (S.D.N.Y. June 25, 2012). The Court received consolidated briefing and oral argument from the defendants
(including separate briefs from various subgroups of defendants who raised issues relevant to their particular situations), and responding briefing and argument from the Trustee and the Securities
Investor Protection Corporation ("SIPC"). The matter is therefore ripe for ruling.
In ruling, the Court assumes familiarity with the underlying facts of the Madoff Securities fraud and ensuing bankruptcy and recounts only those facts that are relevant to the instant proceeding. It is undisputed that Madoff Securities, a registered securities broker-dealer, engaged in a decades-long Ponzi scheme in which it accepted investments from various customers and then issued false monthly statements to those customers indicating consistent, favorable returns on securities transactions purportedly conducted by Madoff Securities on their behalf. In actuality, Madoff
Securities undertook few, if any, securities transactions, and simply used other customers' investment funds to satisfy any
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customers' withdrawals of funds. Some withdrawing customers were individuals, and others were investment funds that in turn transferred the withdrawn funds to their customers. Additionally, some of these funds transferred some of the withdrawn monies to money managers and other professionals who were owed fees in connection with these transactions. The defendants in these consolidated proceedings are drawn both from direct customers of
Madoff Securities and from these various subsequent transferees .
Underlying the complaints here in issue is the Trustee's central contention that all these defendants were sophisticated market participants who, even though they lacked actual knowledge of
Madoff Securities' fraud, failed to act in good faith because they were aware of suspicious circumstances that should have led them to investigate the possibility of such fraud. Previously, however, in
Picard v. Katz, 462 B.R. 447 (S.D.N.Y. 2011), this Court held that, in a SIPA proceeding such as this, a lack of "good faith" requires a showing that a given defendant acted with "'willful blindness' to the truth," that is, he "intentionally [chose] to blind himself to the 'red flags' that suggest a high probability of fraud." Id . at
455. In adopting this standard, this Court rejected the Trustee's alternative "inquiry notice approach," under which a transferee may be found to lack good faith "when the 'information the transferee learned would have caused a reasonable person in the transferee's position to investigate the matter further.'" Id. (brackets omitted)
(quoting In re Manhattan Inv. Fund Ltd., 397 B.R. 1, 23 (S.D.N.Y.
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2007)). The Court reasoned that, although the inquiry notice approach
is not without some precedent in ordinary bankruptcies, it has much less applicability . in a context of a SIPA trusteeship, where bankruptcy law is informed by federal securities law. Just as fraud, in the context of federal securities law, demands proof of scienter, so too "good faith" in this context implies a lack of fraudulent intent. A securities investor has no inherent duty to inquire about his stockbroker, and SIPA creates no such duty. If an investor, nonetheless, intentionally chooses to blind himself to the "red flags" that suggest a high probability of fraud, his "willful blindness" to the truth is tantamount to a lack of good faith. But if, simply confronted with suspicious circumstances, he fails to launch an investigation of his broker's internal practices - and how could he do so anyway? - his lack of due diligence cannot be equated with a lack of good faith, at least so far as section 548(c) is concerned as applied in the context of a SIPA trusteeship.
Id. (citations omitted); see also Picard v. Avellino, 469 B.R . 408,
412 (S.D.N.Y. 2012) (" [T]o establish a lack of 'good faith' on the part of securities customers under§ 548(c) in the context of a SIPA bankruptcy, the trustee must show that the customer either actually knew of the broker's fraud or 'willfully blinded' himself to it.").
Nonetheless, in a fashion that the Court has learned is typical of the Trutee's litigation strategy, the Trustee here seeks to litigate once again the issue of whether "good faith" should be judged by a subjective standard of willful blindness or by an objective standard of inquiry notice. But nothing in the intervening time has changed the analysis and conclusion that the Court reached
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in Katz and reiterated in Avellino. 2 See Katz, 462 B.R. at 455;
Avellino, 469 B.R. at 412; see also In re Dreier, 452 B.R. 391, 449-
50 (Bankr. S.D.N.Y . 2011) ("To be eligible for the good faith
defense under§ 548(c) • I a transferee should not be able to
'consciously avoid' facts within its knowledge that would suggest that the transfers were not made in good faith."). As Katz recognized, SIPA proceedings are informed by federal securities law.
Although SIPA expressly incorporates the Bankruptcy Code's avoidance and recovery provisions, see 15 U.S.C. § 782fff-2(c) (3), SIPA nonetheless is part of the securities laws and expressly provides that the Bankruptcy Code applies only" [t]o the extent consistent with the provisions of this chapter [of the federal securities laws]," 15 U.S.C . § 78fff(b). Accordingly, where the Bankruptcy Code and the securities laws conflict, the Bankruptcy Code must yield.
It is well established that "good faith" in the securities context "implies a lack of fraudulent intent." See Katz, 462 B.R at
455; see also Ernst & Ernst v. Hochfelder, 425 U.S. 185, 206 (1976 )
(suggesting that a lack of good faith requires a mental state more culpable than negligence under the securities laws). From the perspective of an investor withdrawing funds from his account, any
2 The Court is mindful that a comment in a footnote in a recent Second Circuit opinion might be read to suggest that good faith should be judged under the inquiry notice standard. See In re Bernard L. Madoff Inv. Sec. LLC, 740 F.3d 81, 90 n.11 (2d Cir. 2014). However, as its relegation to a footnote indicates, the statement in question is pure dictum, because the appeal did not raise any issue with respect to good faith or under what standard that question should be judged.
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payments from Madoff Securities merely constituted the proceeds of a securities transaction on that customer's behalf. In these ordinary circumstances, it is undisputed that a "securities investor has no inherent duty to inquire about his stockbroker," and nothing in SIPA creates such a duty. Katz, 462 B.R. at 455; see also Santa Fe
Indus., Inc. v. Green, 430 U.S. 462, 477 (1977) ("[T]he fundamental purpose of the 1934 [Securities Exchange] Act [is] 'to substitute a philosophy of full disclosure for the philosophy of caveat emptor.'"
(quoting Affiliated Ute Citizens v. United States, 406 U.S. 128, 151
(1972))); In re New Times Sec. Servs., Inc., 371 F.3d 68, 87 (2d
Cir. 2004) (rejecting "greater investor vigilance" as a goal of SIPA and noting that "the drafters' emphasis was on promoting investor confidence in the securities markets and protecting broker-dealer customers"). Absent a duty to investigate, a customer's failure to do so does not equate with a lack of good faith. See Avellino, 469
B.R. at 412 ("[B]ecause the securities laws do not ordinarily impose any duty on investors to investigate their brokers, those laws
foreclose any interpretation of 'good faith' that creates liability
for a negligent failure to so inquire."); In re Dreier, 452 B.R. at
449 (applying a conscious avoidance standard where the investors
defendants "do not appear to have owed a duty to anyone (other than perhaps their own investors) to investigate Dreier's fraud").
The Trustee's approach would impose a burden of investigation on investors totally at odds with the investor confidence and
securities market stability that SIPA is designed to enhance. This
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does not mean that an investor may purposely close her eyes to what is plainly to be seen. As stated in Katz, "[i]f an investor intentionally chooses to blind himself to the 'red flags' that suggest a high probability of fraud, his 'willful blindness' to the truth is tantamount to a lack of good faith." 462 B.R. at 455 . But, in the context of securities transactions such as those protected by
SIPA, the inquiry notice standard that the Trustee seeks to impose would be both unfair and unworkable.
Although the subsequent transferees involved in these proceedings including not only indirect investors but also individuals and entities who received fees for services provided to investment funds that were customers of Madoff Securities - were not themselves investors with Madoff Securities itself, the same
standard applies to them under both section 548(c) and section
550(b). Not only does this outcome make sense as a matter of
statutory interpretation, but it also reflects the impracticality of
imposing a heightened duty of investigation on a securities market participant even further removed from Madoff Securities itself. See
In re Schick, 223 B.R. 661, 663 (Bankr. S.D.N.Y. 1998) (finding that
subsequent transferees are somewhat more insulated from liability because initial transferees have a "greater ability to monitor [the] debtor and the assets used to pay the debt"). This subjective
standard also matches well with Congress's intent to limit the
exception to recovery from subsequent transferees to those
individuals who themselves acted in good faith. See S. Rep. No. 95-
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989, at 90 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5876 ("The phrase 'good faith' in [section 550(b) (l)] is intended to prevent a transferee from whom the transferee could recover from transferring the recoverable property to an innocent transferee, and receiving a retransfer from him, that is, 'washing' the transaction through an innocent third party . In order for the transferee to be excepted from liability under this paragraph, he himself must be a good faith transferee.") . 3 In sum, the Court finds that, in the context of this litigation and with respect to both section 548(c) and section
SSO(b) (1), "good faith" means that the transferee neither had actual knowledge of the Madoff Securities fraud nor willfully blinded himself to circumstances indicating a high probability of such fraud .
The Court turns next to the related question of which party bears the burden of pleading a defendant's good faith or lack thereof. If one looks at the question simply in terms of the
Bankruptcy Code, without reference to SIPA or other considerations,
"good faith" appears to be an affirmative defense that must in the first instance be pleaded by defendants. Accordingly, section
548 (a) (1) (A) of the Bankruptcy Code permits a trustee to "avoid any
3 The Court is unpersuaded by the Trustee's suggestion that the third phrase in section 550(b) (1) - "without knowledge of the voidability of the transfer" - implies that "good faith" in this context should be an objective test. In light of the legislative history, the most plausible reading is that this third requirement is merely one specific type of subjective knowledge required and does not preclude a subjective standard for good faith.
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transfer" made within two years of the debtor's filing of a bankruptcy petition, if the debtor (here, Madoff Securities) "made such transfer . with actual intent to . defraud any entity to which the debtor was . . indebted." 11 U.S.C. § 548 (a) (1) (A)
(emphasis supplied), while section 548(c) allows a transferee to retain "any interest transferred" to the extent he received value for the transfer and if he can show that he took the transfer in good faith, 11 U.S.C. § 548(c). The structure of this language suggests that section 548(c) provides an affirmative defense to recovery of an otherwise avoided transfer under section
548 (a) (1) (A). See, e.g., In re Actrade Fin. Techs. Ltd., 337 B.R.
791, 805 (Bankr. S.D.N.Y. 2005) (finding that section 548(c) creates an affirmative defense).
Although section 550's language differs to some degree, the structure of the relevant provisions is largely analogous to section
548. Section 550(a) provides that" [e]xcept as otherwise provided in this section, to the extent that a transfer is avoided. . , the trustee may recover, for the benefit of the estate, the property
transferred" from either an initial transferee or "any immediate or mediate transferee of such initial transferee." 11 U. S.C. § 550(a).
However, under section 550(b), "[t]he trustee may not recover" from a subsequent transferee who "takes for value, . in good faith, and without knowledge of the voidability of the transfer avoided."
11 U.S.C. § 550(b) (1). While the onus of section 550(b) (1) appears to be placed on the Trustee - contrary to section 548(c), which
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focuses on when a transferee may retain a transfer - this small difference in wording is overshadowed by the structural similarities of the two provisions. Accordingly, in the context of an ordinary bankruptcy proceeding, section 548(c) and section 550(b) (1) both provide an affirmative defense that must be raised by defendants in the first instance.
But, just as SIPA affects the meaning of "good faith 0 when a
SIPA proceeding is involved, so too it affects the burden of pleading good faith or its absence. It would totally undercut SIPA's twin goals of maintaining marketplace stability and encouraging investor confidence if a trustee could seek to recover the investors' investments while alleging no more than that they withdrew proceeds from their facially innocent securities accounts.
Put differently, this would not accord with the Supreme Court's requirement that, on a motion to dismiss for failure to state a claim, a court must assess whether the complaint "contain[s] sufficient factual matter, accepted as true, to 'state a claim to
relief that is plausible on its face.' 0 Ashcroft v . Iqbal, 556 U.S .
662, 678 (2009) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544,
570 (2007)). Without particularized allegations that the defendants
here either knew of Madoff Securities' fraud or willfully blinded
themselv es to it, the Trustee's complaints here cannot make out a plausible claim that he is entitled to recover the monies defendants
received from their securities accounts. See also Picard v. Grieff,
476 B.R. 715, 723 (S.D . N.Y. 2012) (" [D]efendants can prevail on
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their motion to dismiss . if they prove that, 'on the face of the complaint[s] ,' they can invoke the affirmative defense provided by§ 548(c) . 0 (quoting Pani v. Empire Blue Cross Blue Shield, 152
F.3d 67, 74 (2d Cir. 1998)) . 4 Accordingly, the Court concludes that, in a SIPA proceeding such as this, a defendant may succeed on a motion to dismiss by showing that the complaint does not plausibly allege that that defendant did not act in good faith. 5
Because this determination must be made on the basis of the specific allegations in the Trustee's various complaints, the Court, having set out the general framework, hereby leaves it to the
Bankruptcy Court to determine in any given instance whether the foregoing standards have been met. Accordingly, the Court directs that the following adversary proceedings be returned to the
Bankruptcy Court for further proceedings consistent with this
Opinion and Order: (1) those cases listed in Exhibit A of item number 197 on the docket of 12 Misc. 115; and (2) those cases listed
in the schedule attached to item number 468 on the docket of 12
4 As with the willful-blindness standard set forth above, the same rule applies to subsequent transferees who received transfers from customers and thus are entitled to the same presumptions arising from securities transactions.
5 The Trustee has extensive discovery powers under Rule 2004 of the Federal Rules of Bankruptcy Procedure through which he may gather information before he ever files a complaint. See In re Lehman Bros. Inc., No. 08-01420, 2008 WL 5423214, at *3 (Bankr. S.D.N.Y. Nov. 26, 0 2008) ("The broad scope of Rule 2004 is well recognized. ). It is thus not unreasonable to require that the Trustee provide a plausible basis to claim that a defendant lacked good faith in his initial complaint.
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Misc. 115 that were designated as having been added to the "good faith" consolidated briefing.
SO ORDERED.
Dated: New York, NY April .:lf 2014 ~S.D.J.
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5UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK ------X In re: : : BERNARD L. MADOFF INVESTMENT : Case No. 08-99000 (SMB) SECURITIES LLC, : Adv. Proc. No. 08-01789 (SMB) : SIPA LIQUIDATION Debtor. : ------X IRVING H. PICARD, Trustee for the Liquidation : of Bernard L. Madoff Investment Securities LLC, : : Plaintiff, : : Adv. P. No. 10-05286 (SMB) LEGACY CAPITAL LTD. and : KHRONOS LLC : : Defendants. : ------X
MEMORANDUM DECISION REGARDING MOTIONS TO DISMISS THE TRUSTEE’S AMENDED COMPLAINT
A P P E A R A N C E S:
BAKER & HOSTETLER LLP Attorneys for Plaintiff, Irving H. Picard, Trustee for the Liquidation of Bernard L. Madoff Investment Securities LLC 45 Rockefeller Plaza New York, NY 10111 David J. Sheehan, Esq. Oren J. Warshavsky, Esq. Jason S. Oliver, Esq. Of Counsel
STEVENS & LEE, P.C. Attorneys for Legacy Capital Ltd. 485 Madison Avenue New York, NY 10022 Nicholas F. Kajon, Esq. Of Counsel Case 20-1334, Document 73, 08/06/2020, 2902485, Page98 of 180 SPA-15
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BINDER & SCHWARTZ LLP Attorneys for Khronos LLP 28 West 44th Street-Suite 700 New York, NY 10036-4039 Eric B. Fisher, Esq. Lindsay S. Bush, Esq. Of Counsel
STUART M. BERNSTEIN United States Bankruptcy Judge:
Defendants Legacy Capital Ltd. (“Legacy”) and Khronos LLC (“Khronos,” and together
with Legacy, the “Defendants”) have each moved to dismiss the Amended Complaint, dated July
2, 2015 (ECF Doc. # 112) filed by Irving H. Picard (the “Trustee”), the trustee of the liquidation
of Bernard L. Madoff Investment Securities LLC (“BLMIS”) under the Securities Investor
Protection Act of 1970 (“SIPA”), 15 U.S.C. §§ 78aaa, et seq. The Amended Complaint seeks to
avoid and recover approximately $213 million in initial transfers made to Legacy and
approximately $6.6 million in subsequent transfers made to Khronos. For the reasons that
follow, Legacy’s motion to dismiss is granted except as to the portion of Count I seeking to
avoid and recover fictitious profits transferred to Legacy within two-years of the BLMIS filing
date, and Khronos’ motion to dismiss is granted in its entirety.
BACKGROUND
A. The Ponzi Scheme1
The background information is taken from the well-pleaded factual allegations of the
Amended Complaint and other information that the Court may consider on a motion to dismiss
for failure to state a claim. The allegations are sometimes at odds with the documents they
1 Some of the headings are derived from the Amended Complaint. They are descriptive only, and do not necessarily imply the Court’s views of the allegations. 2
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purport to describe, and the content of the documents is examined in more detail later in this
opinion.
Beginning in the 1990s, Madoff outwardly ascribed the consistent investment success of
BLMIS’ investment advisory business to the “split-strike conversion” (“SSC”) investment
strategy. (¶ 20.)2 Madoff generally indicated that BLMIS would invest its investors’ funds in a
basket of common stocks within the Standard & Poor’s 100 Index (“S&P 100”), which was
designed to correlate with the movement of the S&P 100. (¶ 20.) As a hedge, BLMIS would
supposedly sell call options and buy put options on the S&P 100; this was commonly referred to
as a “collar.” (¶ 20.) Madoff claimed that he would carefully time purchases and sales to
maximize value, and consequently, customer funds would intermittently be out of the market.
During those times, Madoff claimed that the funds were invested in U.S. Treasury securities or
mutual funds invested in treasury bills. (¶ 22.)
None of this actually happened. BLMIS never purchased or sold securities, and instead,
used the money invested by customers to make distributions to other BLMIS customers. (¶ 24.)
On December 11, 2008 (the “Filing Date”), Madoff was arrested for criminal violations of
federal securities laws, including securities fraud, investment adviser fraud, and mail and wire
fraud. (¶ 7.) The Securities and Exchange Commission (“SEC”) contemporaneously
commenced an action in the United States District Court for the Southern District of New York,
and that action was consolidated with an application by the Securities Investor Protection
Corporation (“SIPC”) alleging that BLMIS could not meet its obligations to securities customers
as they came due and its customers needed the protections afforded by SIPA. (¶¶ 7-8.) District
2 The parenthetical notation “(¶ _ )” refers to paragraphs in the Amended Complaint. 3
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Judge Stanton granted SIPC’s application to appoint the Trustee and his counsel and remove the
case to this Court. (¶ 9.)
At a plea hearing on March 12, 2009, Madoff pleaded guilty to an eleven count criminal
information, and admitted that he “operated a Ponzi scheme through the investment advisory side
of [BLMIS].” (¶ 12.)
B. Defendants
Legacy is a British Virgin Islands corporation that functioned as a single purpose vehicle
to invest in BLMIS. (¶¶ 32-33.) Jimmy Mayer controlled Legacy’s BLMIS account, and his
son, Rafael Mayer (“Rafael”), was an officer of Legacy. (¶ 33.)
Khronos is a New York limited liability company co-founded by Rafael and David
Mayer, both of whom serve as managing directors. (¶¶ 30-31.) Khronos provided accounting
services to Legacy, and also acted as service providers to other funds that ultimately invested in
Legacy, including Montpellier Resources Ltd. (“Montpellier”). (¶ 35.)
C. The Renaissance Report
Renaissance Technologies, LLC (“Renaissance”) is a New York hedge fund management
company, and Meritage Fund Ltd. (“Meritage”) is an investment fund under its umbrella that
invested in BLMIS through a swap agreement with HCH Capital Ltd. (“HCH”), one of Legacy’s
predecessors. (¶¶ 1, 38-39.) Meritage’s investment activities were overseen by a committee (the
“Meritage Committee”), which included Paul Broder, Peter Brown, Henry Laufer, Nathaniel
Simons and James Simons. (¶ 40.) Rafael was also a member of the Meritage Committee. (¶
41.)
4
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Renaissance became curious about BLMIS’ consistent, positive returns. In 2003, it
attempted to replicate BLMIS’ SSC strategy utilizing BLMIS account statements provided by
Legacy and publically available information. (¶¶ 45-46.) The results were presented in a
document entitled “Madoff – Proposal,” dated Oct. 6, 2003 (the “Renaissance Report”), which
was shared with the Meritage Committee, including Rafael.3 According to the Amended
Complaint, the Renaissance Report found that (i) the market could not support the options
volume Madoff purported to trade; (ii) a very high percentage of BLMIS’ purported equity trades
were bought below the daily closing price and sold above the daily trading price; (iii)
Renaissance’s simulation of Madoff’s strategy put him in the market on days the account
statements showed he was out of the market; and (iv) Madoff’s ability to trade billions of dollars
without leaving a footprint was a mystery. (¶ 47.)
The Renaissance Report’s findings sparked an email exchange among the members of the
Meritage Committee in which they expressed their disquiet regarding Meritage’s BLMIS
investment. (¶ 48.) Nathaniel Simons initiated the email chain on November 13, 2003, stating
among other things:
It’s high season on money managers, and Madoff’s head would look pretty good above Elliot Spitzer’s mantle. I propose that unless we can figure out a way to get comfortable with the regulatory tail risk in a hurry, we get out. The risk-reward on this bet is not in our favor.
(¶ 50.) Meritage Committee member Paul Broder wrote in a November 14, 2003 email, “[l]ike
background radiation my concern about Madoff has never really gone away . . . . I am in favour
of redemption.” (¶ 49.) Meritage Committee member James Simons wrote the same day,
3 A copy of the Renaissance Report is annexed as Exhibit C to the
5
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“[u]nless one of you can give a compelling reason to stay I will ask Nat[haniel Simons] to
withdraw the funds next week.” (¶ 51.)
Meanwhile, Legacy retained Khronos to value Legacy’s portfolio on a daily basis based
on “end of day pricing” and “volume statistics.”4 Khronos was also tasked with performing this
historical valuation of trades dating back to January 1992, the time of the Mayers’ original
investment with BLMIS.5 (¶ 52.)
D. The Defendants Knew of Market Impossibilities and Indicia of Fraud
1. Defendants Knew That BLMIS’ Purported Options Trading Was Impossible
The BLMIS account statements and trade confirmations showed that it traded S&P 100
call and put option contracts on the Chicago Board Options Exchange (“CBOE”), and also
included a unique identifier CUSIP number that is assigned to the options traded on the CBOE
and designated OEX options. (¶ 57.) Based on “prevailing wisdom,” Renaissance assumed that
BLMIS had $6 billion under management. Using that assumption, the Renaissance Report noted
that Madoff “would need approximately 133000 put or call contracts for the collar [and that
d]aily volume figures for the exchange traded OEX options do not support anything like this
trade size.” (¶ 58.)
In a December 11, 2003 email, Rafael identified BLMIS’ options volume as an “open
issue” that needed Madoff’s explanation. (¶ 59.) Although the confirmations sent to Legacy
4 See “Accounting Services Agreement,” a copy of which is annexed as Exhibit A to the Fisher Declaration.
5 The Amended Complaint alleges, “upon information and belief,” that only Rafael and David Mayer had access to Legacy’s account information, and their (Khronos’) employees’ access was restricted. (¶ 52.) The Trustee did not allege the source of his information and belief, and moreover, the Amended Complaint alleges that Legacy provided its monthly statements to Renaissance to conduct its investigation. (¶ 46.)
6
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indicated that trades were being made on CBOE, Rafael could only explain the volumes by
hypothesizing that BLMIS was trading options on the over-the-counter (“OTC”) market. (¶ 59.)
However, the Renaissance Report released two months earlier explained that trading OEX
options on the OTC market would be impossible because “the OTC market in OEX options is
not developed.” (¶ 61.)
Knowing that the OTC market could not support Madoff’s volume, Meritage Committee
member Paul Broder helped Rafael draft a script of questions Khronos should ask Madoff in a
future meeting to clarify Madoff’s options trading practices:
First ask [Madoff how he would hedge out the other side of the trade.] To which we strongly expect an answer that he does this OTC. Then ask (in innocent amazement!): So you can do this kind of volume on OEX OTC options?!?! … Gee, what kind of banks are big enough to [trade with you] (more animated amazement!!!)
(¶ 59.) As to Madoff’s timing of trades, Broder instructed Rafael to ask:
We have noticed that the strike on the OTC options trade we do with you always seems to be close to the closing price of the underlying – is this for convenience purposes (try to look as though this is a really serious question). Does this mean that you execute your OTC trades (assuming this was his claim earlier) towards the end of the day (I really want to hear that the OTC counterparty does $15bln trades almost at the close.)
(¶ 60.)
In a November 21, 2003 email, which was not sent to Rafael, Broder estimated that
BLMIS had between $5 and $15 billion in assets under management, but even if Madoff traded
all of the options available on the exchange on any given day, he could only hedge a $750
million investment in equities. (¶ 62.) Broder also noted that Renaissance interviewed several
7
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OTC options market makers and they confirmed that no significant S&P 100 options volume
were traded over the counter. (¶ 63.) In addition, Broder questioned how a counterparty would
enter into consistently unfavorable transactions, especially at the volumes Madoff purported to
trade. (¶ 64.) Finally, none of the options trade confirmations sent to the Defendants identified
counterparties to the options trades. (¶ 65.)
Legacy’s account statements and trade confirmations reflected that over 26% of the time,
the options volume BLMIS reported for these accounts exceeded the total number of OEX
options traded on the CBOE for contracts with the same purchase date, strike price, and
expiration date. (¶¶ 66-69.)
2. Defendants Knew That the Timing of Madoff’s Trades Was Impossible
The Amended Complaint alleges, upon information and belief, that Madoff represented
that he was time-slicing (i.e., entering the market for a particular stock at different times
throughout a trading day) and that the prices reported on the account statements reflected the
average price over the course of the day. (¶ 72.) The average price at which a security is traded
through a trading day is measured by a metric called volume weighted average price, or
“VWAP.” (¶ 73.)
The Renaissance Report examined BLMIS’ purported equities trades and found that a
high percentage of the purported equity purchases were bought below or at the daily closing
price and sold above the daily closing price. Meritage Committee member Henry Laufer, who
supervised Renaissance’s review of BLMIS, stated that Madoff’s trade timing “was statistically
almost impossible … if you were trading in an ordinary way.” (¶ 74.) Rafael also noted that
8
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Khronos had flagged “the timing of [Madoff’s] trades” as an issue that Madoff had to explain. (¶
75.)
Laufer later told the SEC that in 2003, during the time the Renaissance Report was
prepared, “if you looked at [BLMIS’] monthly statements and looked at the executions of the
stock side … the prices were just too good from any mode of execution that we were aware of
that was legitimate.” (¶¶ 76, 78.) Laufer also told the SEC that he “had no idea” how Madoff
timed the liquidation of his positions during quarters when having no position was a good
strategy. (¶ 77.)
Legacy’s account statements and trade confirmations indicated that over the life of its
BLMIS account 81.79% of 5,776 equity buys were below the VWAP and 76.27% of 5,315
equity sales were above the VWAP. (¶ 79.) The Defendants knew these trades were statistically
impossible because Khronos had developed technology to track “pricing and volume statistics”
including “VWAP”, and used this technology to analyze the trades reported on BLMIS account
statements dating back to 1992. (¶ 80.)
3. Defendants Were Aware of Madoff’s Unusual Fee Structure
BLMIS’ fee structure differed from industry standards. (¶ 81.) Instead of charging the
typical 1% to 2% management fee and a 10% to 20% performance fee, BLMIS only charged a
trading commission of $.04 per share and $1 per option contract. (¶ 82.) However, the BLMIS
trade confirmations sent to Khronos did not report BLMIS’ commissions. In December 2003,
Rafael asked: “1) How [Madoff] make[s] money from [Legacy] since he does not charge
commissions? 2) Why bother with this? Why doesn’t he go to conventional financing and keep
more upside for him?” (¶ 84.) Meritage Committee member Nathaniel Simons also asked:
9
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“[W]hy does [Madoff] let us make so much money? Why doesn’t he capture that for himself?”
(¶ 85.)6
4. Defendants Knew That BLMIS’ Enormous Trading Volume Never Impacted the Market
Based on the amount the Defendants believed BLMIS managed (between $5-15 billion),
they understood that BLMIS purported to move billions of dollars into and out of the market
over the course of a few days multiple times every year. (¶¶ 88-89.) In December 2003, Rafael
expressed concerns about BLMIS’ purported trading volume, and determined that they needed to
address with Madoff the “timing differences based on account size.” (¶ 91.) Broder urged
Rafael to “[a]sk—given the size of these trades how do you stop the market from noticing
them—doesn’t the spike in volumes alert people to your trades?”
5. Defendants Knew That BLMIS’ Rates of Return Were Impossible
Based on Madoff’s purported use of the SSC strategy, Legacy’s returns should have
correlated to the S&P 100. (¶ 94.) Khronos screened investments “on a quantitative basis to
evaluate its overall fit with the portfolio on a risk, return and market correlation basis.” (¶ 95.)
The quantitative data Khronos analyzed indicated that from October 2000 to November 2008,
Legacy’s annual returns with BLMIS averaged 11.32% with only four months of negative
returns during the ninety-eight month period, while the S&P 100 experienced forty-six months of
negative returns. (¶ 96.) Legacy’s BLMIS account achieved positive returns even during market
downturns such as the “dot com” bubble bursting in 2000, the 2000-2002 bear market, and the
6 Simons was similarly curious about BLMIS’ fee structure when compared to the “$100 million per year in fees” made by a BLMIS feeder fund Fairfield Sentry “for doing absolutely nothing.” (¶ 87.) 10
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recession of 2008. (¶ 97.) BLMIS evaded certain SEC reporting requirements by liquidating all
investments at the end of each quarter and year-end. (¶ 99.)
6. Defendants Knew BLMIS’ Operations Lacked Transparency and Controls
Madoff held positions at BLMIS that would normally be occupied by three separate
entities: he was the investment advisor, custodian, and the broker-dealer. (¶ 102.) Renaissance
estimated that BLMIS managed between $5 and $15 billion, but BLMIS’ regulatory filings
revealed that it lacked the number of employees needed to manage that amount. BLMIS
reported that it had between one and five employees to perform its investment advisory functions
including research. (¶ 103.) These concerns were highlighted in a November 13, 2003 email
from Nathaniel Simons to Rafael:
The point is that we don’t know why [Madoff] does what he does we have no idea if there are conflicts in his business that could come to some regulator’s attention. Throw in that his brother-in- law is his auditor and his son is also high up in the organization and you have the risk of some nasty allegations, the freezing of accounts, etc.
(¶ 105.)
7. Defendants Were Aware That BLMIS Did Not Have a Capable Auditor
Although it had billions under management, BLMIS was audited by Friehling &
Horowitz, an accounting firm with only two accountants, one of whom was semi-retired and
living in Florida, and located in a strip mall in Rockland County, New York. (¶ 106.) Nathaniel
Simons’ November 13, 2003 email, which Rafael received, reflected concerns over BLMIS’ lack
of a sufficiently independent auditor. The email restated the widespread rumor that Friehling &
Horowitz was run by Madoff’s brother-in-law. Although the rumor was wrong, the concern
11
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highlighted Renaissance’s misgivings about the auditor’s lack of qualifications and
independence. (¶ 110.)
8. Defendants Knew That BLMIS Reported Trades Outside of the Daily Range
Defendants received and reviewed BLMIS trade confirmations and account statements.
Khronos valued securities daily according to prices reported by the relevant exchange, and also
“proactively monitored [BLMIS’] investment performance, [which] consist[ed] of an ongoing
reapplication of all its qualitative and quantitative analysis.” (¶ 111.) Legacy’s BLMIS trade
confirmations reported 138 equity trades that reflected prices outside the range reported in the
market. (¶¶ 112-15.)
9. Defendants Knew That BLMIS Account Statements Showed Impossible Dividends
During periods that BLMIS investments were supposedly out of the market, BLMIS
purported to invest in U.S. treasuries and the Fidelity Spartan U.S. Treasury Money Market Fund
even though BLMIS account statements failed to account for the Fidelity fund’s name change in
August 2005. (¶ 116.)
During the period of Legacy’s investment with BLMIS, the Fidelity fund issued
dividends only once a month, while Legacy’s BLMIS account statements reported up to seven
dividend payments per month. (¶ 117.) Over 97% of the dividend payments (155 of 159)
reported on Legacy’s account statements were impossible, reporting dividends on dates that did
not match the dividend dates of the Fidelity fund. Khronos tracked the activity in Legacy’s
account which reflected these improper dividends. (¶ 118.)
10. Defendants Knew That BLMIS Purported to Engage in Speculative Options Trading That Deviated From the SSC Strategy
12
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The Defendants understood that the SSC strategy’s options “collar” was designed to
protect against volatility; the options “collar” would limit the loss if the S&P 100 fell and limit
the gain if the S&P 100 rose. (¶ 119.) Legacy’s BLMIS account statements showed, however,
that on at least ten separate occasions, purported options transactions were used solely to
generate profit and not to hedge an equity transaction. In total, these non-hedging options
transactions created $8,094,580 in profits in trading, at odds with the SSC strategy, and exposed
the Legacy BLMIS account to risk. (¶ 120.)
11. Options Confirmations Reflected Trades Inconsistent with SSC Strategy
In executing the SSC strategy, the sale of call options necessarily preceded the purchase
of put options because the proceeds of the sales purportedly funded the purchases. The BLMIS
customer statements reflected this sequence of transactions. (¶ 123.) But the BLMIS option
trade confirmations showed the purchase of call options followed by the sale of put options—
precisely the opposite of what the customer statements reported. (¶ 124.) Khronos received
copies of Legacy’s trade tickets from BLMIS and was responsible for valuing and verifying
Legacy’s portfolio based on information contained in those trade tickets. (¶ 126.)
12. Defendants Were Aware That Options Collars Purportedly Executed by BLMIS Were Not Properly Balanced With Changes to the Composition of the Equities Basket
The SSC strategy required the options “collar” to be adjusted to reflect changes in the
basket of equities if some of the underlying securities were sold before liquidation of the entire
basket. The Legacy BLMIS account statements showed changes to the basket of equities
purportedly purchased for the Legacy account but failed to show corresponding changes to the
options hedging the original trade. (¶ 127.) BLMIS’ failure to rebalance the hedges was a
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deviation from the SSC strategy that would have exposed the Legacy BLMIS account to risk. (¶
128.) Legacy’s account statements showed that on twenty-three separate occasions, BLMIS did
not change the corresponding hedge when an equity was purportedly sold before the rest of the
basket. (¶ 129.)
13. Defendants Knew That BLMIS Account Statements Showed Illegal, Unauthorized Margin Trades
On several occasions, Legacy’s BLMIS account had negative cash balances resulting
from either the purchase of equities that exceeded the value of U.S. treasuries sold to fund the
purchase, the purchase of put options prior to selling the call options they were meant to fund, or
cash being withdrawn prior to the sale of equities to fund the withdrawal. When a customer
purchases assets prior to the availability of funds in the customer’s account, the customer is
buying on “margin.” (¶ 130.) There were at least sixty-eight occasions on which cash was
withdrawn from the Legacy BLMIS account, resulting in a negative cash balance. Upon
information and belief, Legacy did not have a margin account with BLMIS and could not have
traded on margin. (¶ 131.) Moreover, and upon information and belief, Madoff never charged
Legacy any margin interest for this extension of credit or other margin fees. (¶ 132.)
14. Defendants Were Aware They Were Not Getting Real-Time Electronic Access to Accounts and Trade Confirmations
BLMIS’ marketing materials highlighted its technological capabilities, including its
ability to “customize client reports and deliver them electronically in whatever format best meets
the needs of customers.” (¶ 135.) BLMIS did not, however, provide its customers with real-time
electronic access to accounts. Instead, it only provided printed account statements and paper
trading confirmations sent via U.S. mail, three or four days after the trades occurred. (¶ 136.)
14
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E. Despite Knowledge of Fraud, Defendants Borrowed Money to Remain Invested With BLMIS When Renaissance Redeemed
When Renaissance decided to redeem its BLMIS investment in early 2004, Rafael was
the only Meritage Committee member to vote against redemption. (¶ 138.) After redeeming half
of its investment, Rafael could not persuade the Meritage Committee to delay redeeming the
remainder so that he could find a lender to buy out Meritage to avoid redeeming directly from
BLMIS. Within several months, Rafael obtained a $100 million line of credit from BNP Paribas
– Dublin Branch secured by Legacy’s BLMIS account. (¶¶ 139-40.) BLMIS transferred $87
million of customer property to BNP Paribas between September 2007 and June 2008 in partial
repayment of Legacy’s loan. (¶ 141.)
F. The Transfers
1. Transfers to Legacy
During the life of the Legacy account, BLMIS transferred at least $213,180,068 to or for
Legacy’s benefit (the “Initial Transfers”). (Amended Complaint, Ex. A.) Theses transfers
consisted of $86,505,850 in fictitious profits and $126,674,218 of principal. (¶ 142.) Of the
Initial Transfers, BLMIS transferred $212,800,000 within six years of the Filing Date (the “Six-
Year Transfers”) and $174,000,000 within two years of the Filing Date (the “Two-Year
Transfers”). (¶¶ 143-44.) The Two-Year Transfers included all $86,505,850 in fictitious profits.
(See Amended Complaint, Ex. A, at 14-17.)
2. The Subsequent Transfers
From at least 2004, Khronos served as investment manager for Montpellier, a fund that
placed investments with Legacy, and received a monthly fee equal to 1.2% of Montpellier’s net
asset value. (¶ 148.) From 2004 to 2005, Khronos also received a performance fee of 5% of
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Montpellier’s new investment profits, and between 2006 and 2008, Khronos received a
performance fee equal to 10% of Montpellier’s new investment profits. (¶ 149.)
Legacy paid Khronos an annual fee of at least $42,000, paid monthly, for performing
accounting services on behalf of Legacy. Khronos also charged a one-time set up fee and a one-
time fee to create historical data loads. By the end of 2004, Khronos had received fees from
Legacy totaling $154,690. Upon information and belief, Legacy paid a total of $319,190 to
Khronos for providing accounting services. (¶ 150.) According to the Amended Complaint, the
subsequent transfers from Legacy and Montpellier to Khronos totaled $6,601,079 (the
“Subsequent Transfers”). (¶ 151.)
G. This Adversary Proceeding
The Trustee commenced this adversary proceeding on December 6, 2010, and filed the
Amended Complaint on July 2, 2015, asserting eight claims for relief summarized in the
following table:
Count ¶¶ Defendant Description of Claim 156-61 Legacy Avoid and recover the Two-Year Transfers as actual 1 fraudulent transfers under 11 U.S.C. §§ 548(a)(1)(A), 550(a), 551, and 105(a). 162-70 Legacy Avoid and recover the Two-Year Transfers as constructive 2 fraudulent transfers under 11 U.S.C. §§ 548(a)(1)(B), 550(a), 551, and 105(a). 171-75 Legacy Avoid and recover the Six-Year Transfers as actual fraudulent transfers under New York Debtor & Creditor Law 3 (“NYDCL”) §§ 276, 276-A, 278 and/or 279, and 11 U.S.C. §§ 544(b), 550(a), 551, and 105(a). 176-81 Legacy Avoid and recover the Six-Year Transfers as constructive 4 fraudulent transfers under NYDCL §§ 273 and 278 and/or 279, and 11 U.S.C. §§ 544(b), 550(a), 551, and 105(a).
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182-87 Legacy Avoid and recover the Six-Year Transfers as constructive 5 fraudulent transfers under NYDCL §§ 274, 278 and/or 279, and 11 U.S.C. §§ 544(b), 550(a), 551, and 105(a). 188-93 Legacy Avoid and recover the Six-Year Transfers as constructive 6 fraudulent transfers under NYDCL §§ 275, 278 and/or 279, and 11 U.S.C. §§ 544(b), 550(a), 551, and 105(a). 194-200 Legacy Avoid and recover the Initial Transfers as undiscovered fraudulent transfers under N.Y. C.P.L.R. §§ 203(g) and 213 7 (8), NYDCL §§ 276, 276-a, 278 and/or 279, and 11 U.S.C. §§ 544, 550(a), 551, and 105(a). 201-205 Khronos Recover the Subsequent Transfers under 11 U.S.C. §§ 550(a) 8 and 105(a).
Legacy moved to dismiss Counts II through VII arguing that the claims were barred by
the safe harbor of Bankruptcy Code § 546(e).7 (Legacy Memo at 12-16.) Legacy also asserted
that the branch of Count I seeking the return of its principal deposits should be dismissed
because the deposits provided value for the transfers pursuant to section 548(c) of the
Bankruptcy Code. (Id. at 16-22.) Khronos separately moved to dismiss Count VIII of the
Amended Complaint asserting that the Amended Complaint failed plead that the Initial Transfers
were avoidable, or that the subsequently transferred funds originated with BLMIS.8 (Khronos
Memo at 13-16.)
The Trustee opposed the motions arguing that the Defendants were not entitled to the safe
harbor of Bankruptcy Code § 546(e) because the Amended Complaint adequately pled that the
7 See Legacy’s Memorandum of Law In Support of its Motion to Dismiss the Amended Complaint under Bankruptcy Rule 7012(b) and Federal Rule of Civil Procedure 12(b)(6), dated July 30, 2015 (“Legacy Memo”) (ECF Doc. # 118), supported by Declaration of Nicholas F. Kajon, dated July 30, 2015 (“Kajon Declaration”) (ECF Doc. # 117).
8 See Khronos’s Memorandum of Law In Support of its Motion to Dismiss the Amended Complaint under Bankruptcy Rule 7012(b) and Federal Rule of Civil Procedure 12(b)(6), dated July 30, 2015 (“Khronos Memo”) (ECF Doc. # 120-12), supported by Fisher Declaration.
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Defendants had actual knowledge of the BLMIS fraud.9 (Trustee Memo at 21-25.) In addition,
Legacy and Khronos could not rely on the good faith defenses in Bankruptcy Code §§ 548(c) and
550(b)(1), respectively, because the Amended Complaint adequately pled that they willfully
blinded themselves to Madoff’s Ponzi scheme. (Id. at 25-33.) Lastly, the Trustee asserted that
he had sufficiently pled his Subsequent Transfer claim against Khronos. (Id. at 33-38.)
The Defendants filed replies on September 18, 2015,10 and the Court heard oral argument
on October 28, 2015.
DISCUSSION
A. Standards Governing the Motions
“To survive a motion to dismiss, a complaint must contain sufficient factual matter,
accepted as true, to state a claim to relief that is plausible on its face.” Ashcroft v. Iqbal, 556
U.S. 662, 678 (2009) (citations omitted); accord Bell Atlantic Corp. v. Twombly, 550 U.S. 544,
570 (2007). “A claim has facial plausibility when the plaintiff pleads factual content that allows
the court to draw the reasonable inference that the defendant is liable for the misconduct
alleged.” Iqbal, 556 U.S. at 678; accord Twombly, 550 U.S. at 570. Courts do not decide
plausibility in a vacuum. Determining whether a claim is plausible is “a context-specific task
that requires the reviewing court to draw on its judicial experience and common sense.” Iqbal,
556 U.S. at 679. “The plausibility standard is not akin to a ‘probability requirement,’ but it asks
for more than a sheer possibility that a defendant has acted unlawfully.” Iqbal, 556 U.S. at 678;
Twombly, 550 U.S. at 556. “Where a complaint pleads facts that are ‘merely consistent with’ a
9 See Memorandum of Law In Opposition to Defendants’ Motions to Dismiss the Amended Complaint, dated Aug. 27, 2015 (“Trustee Memo”) (ECF Doc. # 122).
10 See ECF Doc. Nos. 126 & 127. 18
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defendant’s liability, it ‘stops short of the line between possibility and plausibility of ‘entitlement
to relief.’’” Iqbal, 556 U.S. at 678 (quoting Twombly, 550 U.S. at 557).
Iqbal outlined a two-step approach in deciding a motion to dismiss. First, the court
should begin by “identifying pleadings that, because they are no more than [legal] conclusions,
are not entitled to the assumption of truth.” Iqbal, 556 U.S. at 679. “Threadbare recitals of the
elements of a cause of action supported by conclusory statements” are not factual. See id. at 678.
Second, the court should assume the veracity of all “well-pleaded factual allegations,” determine
whether, together, they plausibly give rise to an entitlement of relief. Id. at 679.
In deciding the motion, “courts must consider the complaint in its entirety, as well as
other sources courts ordinarily examine when ruling on Rule 12(b)(6) motions to dismiss, in
particular, documents incorporated into the complaint by reference, and matters of which a court
may take judicial notice.” Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 322
(2007). A complaint is deemed to include any written instrument attached to it as an exhibit,
documents incorporated in it by reference, and other documents “integral” to the complaint.
Chambers v. Time Warner, Inc., 282 F.3d 147, 153 (2d Cir. 2002) (citations omitted); accord
Int’l Audiotext Network, Inc. v. Am. Tel. & Tel. Co., 62 F.3d 69, 72 (2d Cir. 1995); Cortec Indus.,
Inc. v. Sum Holding L.P., 949 F.2d 42, 47 (2d Cir. 1991), cert. denied, 503 U.S. 960 (1992). A
document is “integral” to a complaint when the plaintiff has “actual notice” of the extraneous
information and relied on in framing the complaint. DeLuca v. AccessIT Grp., Inc., 695 F. Supp.
2d 54, 60 (S.D.N.Y. 2010) (citing Chambers, 282 F.3d at 153). However, “[l]imited quotation
from or reference to documents that may constitute relevant evidence in a case is not enough to
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incorporate those documents, wholesale, into the complaint.” Sira v. Morton, 380 F.3d 57, 67
(2d Cir. 2004); accord Sahu v. Union Carbide Corp., 548 F.3d 59, 67 (2d Cir. 2008).
Here, the Amended Complaint relied on and quoted extensively from the Renaissance
Report and several emails identified above which are considered and discussed below. Those
documents were integral in framing the Amended Complaint and will be considered in
connection with the motions to dismiss. In addition, the Trustee referred to and quoted from the
testimony that Meritage Committee members Henry Laufer and Paul Broder gave to the SEC to
bolster his core contention that they knew in 2003 that that Madoff’s trades were impossible.
(See ¶¶ 76-78.) The Court will, therefore, consider the transcripts of their SEC testimony.
The Defendants’ opposition also attached and relied on the SEC testimony of Nathaniel
Simons and the 477 page report issued by the SEC Office of Investigations11 in which the emails
cited in the Amended Complaint and the testimony of members of the Meritage Committee
figured prominently. The Amended Complaint did not, however, rely on the SEC Report or
Simons’ testimony. The Trustee’s opposition did not argue that the Court could not consider the
SEC Report, and on a motion to dismiss for failure to state a claim, a court may take judicial
notice of documents, like the SEC Report, that are available on a government website. Wells
Fargo Bank, N.A. v. Wrights Mill Holdings, LLC, No. 14 Civ. 9783 (PAE), 2015 WL 5122590,
at *6-7 (S.D.N.Y. Aug. 31, 2015) (“When considering a Rule 12(b)(6) or Rule 12(c) motion, the
Court may take judicial notice of certain matters of public record without converting the motion
11 See SEC REP. NO. OIG-50, INVESTIGATION OF THE FAILURE OF THE SEC TO UNCOVER BERNARD MADOFF’S PONZI SCHEME PUBLIC VERSION, dated Aug. 31, 2009 (“SEC Report”). The report was attached to the Defendants’ motion papers. (See Kajon Declaration, Ex. F; Fisher Declaration, Ex. G.) The SEC Report is also available on the SEC website at www.sec.gov/news/studies/2009/oig-509.pdf (last visited March 11, 2016).
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into one for summary judgment [including] documents publicly filed with the SEC [and]
documents filed with governmental entities and available on their official websites”); Ross v.
Am. Express Co., 35 F. Supp. 3d 407, 435 n. 27 (S.D.N.Y. 2014). Here, the SEC concluded that
Renaissance did not believe that BLMIS was engaged in fraudulent trading. (See SEC Report at
153.) Nor did the Trustee contend that it was improper to consider Nathaniel Simons’ SEC
testimony because the Trustee did not rely on it in drafting the Amended Complaint. Instead, the
Trustee responded that the statements attributed to Laufer, Broder and Simons did not contradict
the evidence of their willful blindness, were self-serving, contradicted their contemporaneous
statements and were inadmissible hearsay.
The Court is nonetheless disinclined to draw adverse inferences against the Trustee based
on the SEC’s conclusions or Simons’ testimony. While both are plainly relevant, the Trustee did
not rely on either. Moreover, they are cumulative of the emails and Laufer’s and Broder’s SEC
testimony. The Court loath to stray so far beyond the four corners of the Amended Complaint
particularly given the Court’s disposition of the motions.
B. Counts I through VII (Avoidance Claims)
1. Introduction
Counts I and II seek to avoid the Two-Year Transfers pursuant to section 548 of the
Bankruptcy Code, Counts III through VI seek to avoid the Six-Year Transfers under New York
law, and Count VII seeks to avoid all Initial Transfers under New York law regardless of when
they occurred. The Trustee’s ability to avoid and recover transfers has been limited by several
decisions issued by the Second Circuit Court of Appeals and the United States District Court for
the Southern District of New York. In light of the safe harbor granted under 11 U.S.C. § 546(e),
the Trustee may only avoid and recover intentional fraudulent transfers under § 548(a)(1)(A) 21
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made within two years of the Filing Date, Picard v. Ida Fishman Revocable Trust (In re BLMIS),
773 F.3d 411, 423 (2d Cir. 2014), cert. denied, 135 S. Ct. 2859 (2015); Picard v. Katz, 462 B.R.
447, 452 (S.D.N.Y. 2011) (“Katz”), unless the transferee had actual knowledge of Madoff’s
Ponzi scheme, or more generally, “actual knowledge that there were no actual securities
transactions being conducted.” SIPC v. BLMIS (In re BLMIS), No. 12 MC 115 (JSR), 2013 WL
1609154, at *4 (S.D.N.Y. Apr. 15, 2013) (“Cohmad”). The safe harbor was intended, among
other things, to promote the reasonable expectations of legitimate investors. If an investor knew
that BLMIS was not actually trading securities, he had no reasonable expectation that he was
signing a contract with BLMIS for the purpose of trading securities for his account. Id. In that
event, the Trustee can avoid and recover preferences and actual and constructive fraudulent
transfers to the full extent permitted under state and federal law. See id. at *6.
Although the safe harbor does not bar the Trustee’s intentional fraudulent transfer claims
under 11 U.S.C. § 548(a)(1)(A), the transferee’s knowledge is still relevant under 11 U.S.C. §
548(c). Section 548(c) provides a defense to a fraudulent transfer claim brought under
Bankruptcy Code § 548(a) to the extent the transferee “takes for value and in good faith.” 11
U.S.C. § 548(c). Where, as here, the Trustee seeks to recover the transfer of principal in addition
to fictitious profits, he must plead the transferee’s lack of subjective good faith which, in this
SIPA case, means the transferee turned a blind eye to facts that suggested a high probability of
fraud. SIPC v. BLMIS (In re BLMIS), 516 B.R. 18, 21 (S.D.N.Y. 2014) (“Good Faith
Decision”); Katz, 462 B.R. at 454, 455-56; Picard v. Merkin (In re BLMIS), 515 B.R. 117, 138-
39 (Bankr. S.D.N.Y. 2014) (“Merkin”); Picard v. Ceretti (In re BLMIS), Adv. P. No. 09-01161
(SMB), 2015 WL 4734749, at *12 (Bankr. S.D.N.Y. Aug. 11, 2015) (“Kingate”), leave to appeal
denied, 15 Civ 7086 (JPO) (S.D.N.Y. Dec. 4, 2015). Lack of objective good faith is not enough
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“because the securities laws do not ordinarily impose any duty on investors to investigate their
brokers, [and] those laws foreclose any interpretation of ‘good faith’ that creates liability for a
negligent failure to so inquire.” Picard v. Avellino, 469 B.R. 408, 412 (S.D.N.Y. 2012); accord
Katz, 462 B.R. at 455.
In summary, in order to meet his pleading burden under Counts II through VII, the
Trustee must plead that Legacy had actual knowledge that BLMIS was not engaged in the
trading of securities. If the Amended Complaint does not plead actual knowledge, the Trustee
can still recover intentional fraudulent transfers pursuant to Bankruptcy Code § 548(a)(1)(A)
under Count I if he pleads and proves that Legacy willfully blinded itself to the fact that BLMIS
was not engaged in the actual trading of securities. If the Trustee does not plead actual
knowledge or willful blindness, his recovery under 11 U.S.C. § 548(a)(1)(A) is limited to the
fictitious profits transferred by BLMIS to Legacy.
2. Knowledge
This Court outlined what it means to have actual knowledge of, or to be willfully blind to,
a fact in Merkin and Kingate. “Knowledge” is “[a]n awareness or understanding of a fact or
circumstance; a state of mind in which a person has no substantial doubt about the existence of a
fact.” BLACK’S LAW DICTIONARY 1003 (10th ed. 2014) (“BLACK”); accord Merkin, 515 B.R. at
139; Kingate, 2015 WL 4734749, at *13. “Actual knowledge” is “direct and clear knowledge, as
distinguished from constructive knowledge.” BLACK at 1004. “Thus, ‘actual knowledge’
implies a high level of certainty and absence of any substantial doubt regarding the existence of a
fact.” Merkin, 515 B.R. at 139.
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In contrast, “willful blindness” involves two elements: “(1) the defendant must
subjectively believe that there is a high probability that a fact exists and (2) the defendant must
take deliberate actions to avoid learning of that fact.” Global-Tech Appliances, Inc. v. SEB S.A.,
131 S. Ct. 2060, 2070 (2011). If a person who is not under an independent duty to investigate
“nonetheless, intentionally chooses to blind himself to the ‘red flags’ that suggest a high
probability of fraud, his ‘willful blindness’ to the truth is tantamount to a lack of good faith.”
Katz, 462 B.R. at 455; accord Merkin, 515 B.R. at 139. “Thus, willful blindness connotes strong
suspicion but some level of doubt or uncertainty of the existence of a fact and the deliberate
failure to acquire knowledge of its existence.” Merkin, 515 B.R. at 140 (emphasis in original).
As explained below, the sufficiency of the Amended Complaint comes down to the
question of whether the information acquired by Khronos as a result of its due diligence provided
Legacy with actual knowledge that BLMIS was not engaged in trading securities. The
knowledge imputed to Legacy through Rafael, particularly the Renaissance Report and the
emails cited by the Trustee, raised strong suspicions about BLMIS’ trading but no more. As a
result of those suspicions, Legacy hired Khronos to review the entire history of its BLMIS
trades, past and future, and hence, did not turn a blind eye. Thus, the only basis for Legacy’s
actual knowledge would be what it learned through Khronos.
a. The Renaissance Report and the Emails
The Amended Complaint places great weight on the Renaissance Report. According to
the Trustee, the Renaissance Report found that BLMIS’ option trades were impossible, a high
percentage of its equity trades fell outside the daily price range, Madoff’s SSC strategy could not
be simulated without putting BLMIS in the market on days the account statements showed it was
out of the market and Madoff supposedly traded billions of dollars but inexplicably left no
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footprint. (¶ 47.) While it aroused suspicions regarding how Madoff did what he said he did, the
Renaissance Report did not conclude that Madoff’s operation was a Ponzi scheme or that BLMIS
was not actually making the trades it was reporting. Instead, it speculated that Madoff was most
likely gambling that his initial long portfolio would rise in price, and stated that “the challenge is
to see if we can find a rising market predictor based around Madoff’s trading dates.”
(Renaissance Report at 4.) The authors of the report wrote a simulator to “better understand the
Madoff strategy,” (id. at 22), and made a proposal focused on the belief that “we have a
simulator that seems to capture the essence of the scheme.” (Id. at 45.) The Renaissance Report
concluded: “We think this scheme is worth an experiment where we actually put on a small
portfolio to further investigation and research.” (Id.) In short, the Renaissance Report failed to
conclude that BLMIS was not actually engaged in trading securities, and pondered how
Renaissance could replicate his strategy.
The issuance of the Renaissance Report was followed by emails between the Meritage
Committee members, some of which were sent to Rafael, that raised concerns about BLMIS’
purported trading activities as well as the structure of BLMIS. The Amended Complaint
includes quotes from these emails but omits other portions required to understand what the
members of the Meritage Committee actually knew and believed at the time.
The first email was sent by Meritage Committee member Nathaniel Simons, dated
November 13, 2003, and Rafael was one of the recipients. (See Fisher Declaration, Ex. F at
RE00000008.) According to Simons, an ex-Madoff trader had said that Madoff “cherry
picked”12 trades, and Simons speculated that Madoff took the good trades from the hedge fund
12 “Cherry picking” describes a practice whereby a trader executes trades without immediately assigning them to a particular account and later allocates the purchased securities to the account of a favored party if the securities 25
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(presumably, Meritage). David Zierk of Renaissance heard a similar story from a consultant who
had interviewed another ex-trader and speculated that Madoff would have a serious problem
within a year. Simons’ email also expressed concern about Madoff’s fee structure; it allowed the
managers of the feeder funds to capture the fees without doing any work other than investing in
BLMIS. Simons stated that Meritage did not know how Madoff did what he claimed he did (the
email described Madoff as “pretty tight-lipped”), and had no idea if there were conflicts in his
business that could come to a regulator’s attention. In addition, Simons stated (incorrectly) that
Madoff’s brother-in-law was his accountant and his son held a high-level position in the
organization, and the situation presented “the risk of some nasty allegations, the freezing of
accounts, etc. etc.”
Simons concluded that “[p]erhaps the best reason to get out is that we really don’t expect
to make an outsized return on this investment.” Furthermore, Eliot Spitzer (then-New York
Attorney General) would prize Madoff’s head on his mantle, and unless Meritage could get
comfortable with the “regulatory tail risk” in a hurry, Meritage should get out of its BLMIS
investment because the “risk-reward on this bet is not in our favor.”
The next day, Paul Broder, another Meritage Committee member, sent an email that
compared his concerns about Madoff to “background radiation” that would not go away. (Id. at
RE00000003.) Rafael also received this email. Broder’s stated concern was that if Madoff was
cherry picking, and the funds that invested with BLMIS and the fund managers were taking the
appreciate in value. See, e.g., United States v. Motz, 652 F. Supp. 2d 284, 289 (E.D.N.Y. 2009); S.E.C. v. Slocum, Gordon, & Co., 334 F. Supp. 2d 144, 147 (D. R.I. 2004). 26
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hit. He concluded that he would not be surprised to see a link exposed to the current
SEC/Spitzer investigation, and he favored redemption.
Jim Simons, another Meritage Committee member, also favored redemption in his
November 14, 2003 email that Rafael received. (Id. at RE00000001.) Simons stated that the
BLMIS investment fell into the “who needs it” category, and absent a compelling reason to stay,
he would ask Simons to withdraw the funds next week.13
Finally, the Amended Complaint relied on a December 11, 2003 email from Broder to
Rafael, (¶¶ 59-60), which was not attached to any of the motion papers but was supplied at the
hearing. This email actually consisted of two emails: one from Rafael containing “open issues
for research we would like to address with Madoff” and a response from Broder with
“suggestions for interaction with Madoff” interwoven into Rafael’s original email. Rafael’s
email outlined areas of inquiry, including (1) the amount of assets under management, (2)
options trading (whether options are traded OTC; trade volumes; identity of counterparties), (3)
stock trading (volume; timing of stock trades); (4) monitoring by regulators/auditors, and (5)
Madoff’s unusual fee structure.
Like the Renaissance Report, Rafael’s email struck a tone of wanting to understand
Madoff’s investment strategy. Broder’s comments showed that he was more suspicious of
Madoff’s activities. For example, once Madoff confirmed he was trading options OTC (as
Broder suspected), Broder instructed Rafael to “ask (in innocent amazement!): So you can do
13 The Amended Complaint also discussed and quoted from a November 21, 2003 Broder email, (see ¶¶ 62- 64), which is attached to the Fisher Declaration as Exhibit D at RE00000240. The email discussed irregularities with respect to BLMIS’ investment (e.g. impossible options trading volume), but Rafael was not a recipient of this email, and the Amended Complaint does not allege that he saw it. Therefore, the information within that email cannot be imputed to Rafael or Legacy.
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this kind of volume on OEX OTC Options?!?!” Also, with respect to options counterparties,
Broder instructed Rafael to ask, “Gee, what kind of banks are big enough to do that (more
animated amazement!!!)”.
The Renaissance Report and the emails relied on by the Trustee confirm that the Meritage
Committee members, including Rafael, were highly suspicious of Madoff’s option trades and his
uncanny ability to time his equity trades to minimize the purchase price and maximize the sale
price. They were also troubled by Madoff’s unusual fee structure, rumors of cherry picking, the
fact that his massive trades did not impact the market, the employment of his son and the
mistaken belief that BLMIS employed his brother-in-law as BLMIS’ accountant.
But the allegations of the Amended Complaint do not plead a plausible claim that they
actually knew that Madoff was not trading securities. In fact, the Meritage Committee members’
anxiety about cherry picking showed the opposite; cherry picking involved actual, albeit
fraudulent, trading. Furthermore, their fear that regulators or Eliot Spitzer would come after
Madoff was connected not to rumors of a Ponzi scheme but to cherry picking and the
employment of his family members. Moreover, they were anxious that their accounts would be
frozen, not that the securities in the accounts were a mirage. As Broder testified before the SEC,
“if you’re asking did we come to the conclusion that there was a fraud going on, I would say we
didn’t.” (Fisher Declaration, Ex. E, at RE00000095.) Instead, Broder concluded that they did
not understand what Madoff was doing; the volume numbers that he was reporting were not
supported by evidence they could discover, and this, without more meant they should get out.
(Id., Ex. E, at RE00000096.)
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Finally, and despite James Simons’ advice to “withdraw the funds next week,”
Renaissance initially redeemed only half of its investment in BLMIS. It held on to the other half
for several months until Legacy could buy out the other half of Meritage’s position. (¶¶ 139-
40.) It is common knowledge (undoubtedly more common among sophisticated financial
professionals) that a Ponzi scheme will inevitably collapse. See Christian Bros. High Sch.
Endowment v. Bayou No Leverage Fund, LLC (In re Bayou Grp., LLC), 439 B.R. 284, 306 n. 19
(S.D.N.Y.2010) (explaining the Ponzi scheme presumption). While greed may cloud judgment,
it is not plausible that the average financial professional owing fiduciary duties to its own clients
and investors would knowingly invest their money in a Ponzi scheme that is doomed to collapse.
See Katz, 462 B.R. at 454 (“[E]ven the Trustee does not appear to undertake the dubious task of
plausibly pleading that the defendants knowingly invested in a Ponzi scheme.”); cf. Buchwald
Capital Advisors LLC v. JP Morgan Chase Bank, N.A. (In re M. Fabrikant & Sons, Inc.), 480
B.R. 480, 489 (S.D.N.Y. 2012) (concluding that it was implausible, “bordering on the absurd,”
that banks would continue to lend to the debtor despite their awareness that the debtor and its
affiliates were insolvent and merely shuffling around money to meet their short term
obligations), aff’d 541 F. App’x. 55 (2d Cir. 2013). If the Meritage Committee actually believed
that BLMIS was a Ponzi scheme, it is implausible that they would have divested only half of
Meritage’s BLMIS investment and held on to the other half for several months.
b. The Accounting Services Agreement
The execution of the Accounting Services Agreement, effective January 1, 2004, can
only be explained by the continuing uncertainty and suspicions surrounding Madoff. Khronos
had already flagged the timing of Madoff’s trades as an area of concern, (¶ 75), and Rafael had
highlighted numerous questions about Madoff’s operations in his December 11, 2003 email. In
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addition, Legacy was intent on buying the other half of Meritage’s BLMIS investment.
According to the Accounting Services Agreement, Khronos’ tasks included valuing the portfolio
daily based on end of day pricing and store price/volume statistics from IDC,14 producing daily
and monthly position, profit/loss and transaction reports, reconciling Legacy’s account to the
monthly brokerage statements provided and recording any non-trade related activity and
producing a monthly trial balance, balance sheet, income statement and statement of changes in
net asset value for Legacy. (Accounting Services Agreement at 6-7.) The scope of these services
covered Legacy’s account beginning with its inception January 1, 1992 and continuing into
the future.15
The retention of Khronos to conduct due diligence implies that Legacy did not know that
Madoff was a fraud. Elendow Fund, LLC v. Rye Select Broad Mkt. XL Fund (In re Tremont Sec.
Law, State Law and Ins. Litig.), No. 10 Civ. 9061 (TPG), 2013 WL 5179064 (S.D.N.Y. Sept. 16,
2013), aff’d 588 F. App’x 27 (2d Cir. 2014), illustrates why. There, the plaintiff charged that the
defendant Tremont had committed securities fraud when it recommended that the plaintiff invest
in one of its Madoff feeder funds. The complaint alleged that Tremont was aware of numerous
red flags, had engaged in fruitless efforts to shed light on Madoff’s opaque operations, and the
awareness of the red flags plausibly implied fraudulent intent. The District Court concluded that
the inference was implausible; if Tremont believed that Madoff was a fraud, it would not have
bothered to conduct due diligence:
14 The parties have not identified IDC.
15 The Amended Complaint also alleges that Khronos’ was responsible for evaluating the adequacy of BLMIS’ accounting and back-office processes, internal controls, adherence to and compliance with tax and legal guidelines, and potential for conflicts of interest. (¶ 104.) These services were not mentioned in the Accounting Services Agreement, and it is difficult to understand how Khronos could perform such an evaluation of “tight- lipped” Madoff.
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[I]f Tremont had known, or even strongly suspected, that Madoff was perpetrating a fraud, it would have been peculiar for Tremont to continue discussing ways of gaining greater transparency into Madoff’s operations and to continue sending Madoff due-diligence questionnaires.
Id. at *5. Similarly, it would have been “peculiar” for Legacy to commission Khronos to
conduct the type of due diligence alleged in the Amended Complaint if it already knew based on
the Renaissance Report and subsequent emails that BLMIS was a fraud.
According to the Trustee, the investigation performed by Khronos confirmed the
aforementioned red flags, revealed new ones and caused Rafael to become aware of market
impossibilities and indicia of fraud. (¶¶ 55-137.) The red flags included impossible option
trades, impossible timing of equity trades, impossible rates of return, unusual fee structure, the
lack of market impact given the large trade volume, lack of transparency and controls, lack of a
capable auditor, trades outside of the daily range, impossible dividends, trades inconsistent with
the SSC strategy, failure to balance option collars, unauthorized margin trades, and lack of
electronic access to account information.
The “red flag” theory of scienter has been rejected in the Madoff-related federal
securities law litigation because it amounts to pleading fraud by hindsight. E.g., DeLollis v.
Friedberg, Smith & Co., 600 F. App’x 792, 796 (2d Cir. 2015) (“Numerous actions brought
against auditors and investment advisors by victims of Madoff’s fraud have been dismissed
despite the presence of ‘red flags,’ which in hindsight arguably should have called attention to
Madoff’s illegal conduct.”); Meridian Horizon Fund, LP v. KPMG (Cayman), 487 F. App’x.
636, 640 (2d Cir. 2012) (describing the red flags as “an archetypical example of impermissible
‘allegations of fraud by hindsight.’”) (quoting Novak v. Kasaks, 216 F.3d 300, 309 (2d Cir. 2000)
(quotation marks omitted)). Hindsight is infallible, but connecting the dots in real time may
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require clairvoyance. In many cases, it requires a regular comparison of information in BLMIS
generated trade confirmations and monthly account reports with market information. Even if the
comparison is made, many red flags are no more than pale pink especially when they crop up
infrequently over a long period. This case provides a good example. The Legacy account
statements covered seventeen years (1992-2008) and reflected 11,091 equity trades. (See ¶ 79.)
The red flags identified in the Amended Complaint included a grand total of 138 equity trades
outside the daily price range, (¶ 115), ten occasions when the option trades generated a profit at
odds with the SSC strategy, (¶ 120), twenty-three occasions when BLMIS failed to rebalance the
options after changing the composition of the underlying basket of equities, (¶ 129), and sixty-
eight purchases on margin. (¶ 131.) When the red flags are viewed in real time, “[t]he more
compelling inference as to why Madoff’s fraud went undetected for two decades was his
proficiency in covering up his scheme and deceiving the SEC and other financial professionals.”
Meridian, 487 F. App’x. at 640 (quoting lower court’s decision); accord Ellendow Fund, LLC v.
Rye Inv. Mgmt., 588 F. App’x 27, 28-29 (2d Cir. 2014) (collecting cases); see also R.W. Grand
Lodge of Free & Accepted Masons of Pennsylvania v. Meridian Capital Partners, Inc., No. 15-
1064-CV, 2015 WL 8731547, at *2 (2d Cir. Dec. 15, 2015) (“Grand Lodge essentially makes a
‘red flag’ argument—that Appellees were aware or had the duty to become aware of red flags in
the Rye Funds’ operations and that Appellees were reckless in ignoring the red flags. This court,
along with many district courts in this circuit, has rejected similar claims based upon a failure of
due diligence to uncover Madoff’s infamous Ponzi scheme.”).
While plaintiffs in federal securities litigation must satisfy a standard of proof requiring
allegations that give rise to a “strong inference” of fraud that is “more than merely plausible or
reasonable—it must be cogent and at least as compelling as any opposing inference of
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nonfraudulent intent,” Tellabs, 551 U.S. at 314, the standard in this SIPA case is no less rigorous.
The plaintiff must plead non-conclusory allegations that support the inference that the defendants
actually knew that Madoff was not trading securities. Alleging actual knowledge based on the
existence of red flags amounts to pleading that the defendant, here Khronos and Legacy, knew or
should have known that BLMIS was not engaged in the actual trading of securities. This is the
objective standard of knowledge rejected by the District Court. Although the Trustee, the SEC
and everyone else can look back today and connect the dots with the benefit of hindsight, the
inference that Khronos did so before Madoff’s fraud was publically exposed is not as plausible
as the inference that, like mostly everyone else, Khronos missed it. MLSMK Invs. Co. v. JP
Morgan Chase & Co., 737 F. Supp. 2d 137, 145 (S.D.N.Y. 2010) (“[W]hile it might have been
possible for Defendants to determine that Madoff was committing fraud from the ‘red flags’ that
Plaintiff points out, Plaintiff alleges no facts to demonstrate that Defendants actually did make
such a discovery.”), aff’d, 431 F. App’x 17 (2d Cir. 2011); cf. Clark v. Cosmo (In re Agape
Litig.), 773 F. Supp. 2d 298, 310 (E.D.N.Y. 2011) (“[W]hile a visual representation of the
account activity and actual dollar amounts in hindsight may suggest that the fraud was obvious, .
. . the Court can only infer that this information raises an inference of BOA’s constructive
knowledge of the fraud.”).
This inference is bolstered by the actions that Legacy took. Legacy hired Khronos to
conduct due diligence of its account going back to 1992 following the revelations in the
Renaissance Report and the questions raised about Madoff in the ensuing emails. Thus, Legacy
did not turn away or willfully blind itself to its suspicions. The notion that Khronos discovered
through its diligence that Madoff was a fraud is implausible. If Khronos’ work actually
confirmed that Madoff was engaged in securities fraud, or worse, that he was running a Ponzi
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scheme, why would Legacy remain invested in BLMIS and increase its investment by buying
Meritage’s position? Did Legacy need confirmation that Madoff was running a Ponzi scheme
before it decided to invest another $100 million? As noted earlier, it is implausible that a fund
such as Legacy would entrust its own investors’ money with someone it knew was not trading
securities. The only plausible explanation is that like everyone else that Madoff fooled, Khronos
did not uncover in real time what the Trustee and everyone else discovered with the aid of
hindsight.
The Trustee’s attempt to analogize this case to the Court’s Kingate decision is
unpersuasive. There, the Trustee’s complaint included allegations beyond knowledge of red
flags. Ceretti and Grosso, the principals of the Kingate funds, actively deflected inquiries
directed at Madoff, intimidated, attacked and threatened analysts who raised questions about
Madoff and threatened their employers with the loss of business, fabricated stories about Madoff
to placate the funds’ investors, and tellingly, expressed a fear that an audit by
PricewaterhouseCoopers “might actually ‘start to ask all sort [sic] of questions next time they
visit Madoff.’” Kingate, 2015 WL 4734749, at *14. In addition, an employee had sent an email
to Grosso the day after Madoff’s arrest in which he reminded Grosso that he had previously sent
him an email with “all the details” supporting his belief that BLMIS was a “scam.” Id. The
Court held that the “totality of the allegations [against Kingate] paint a picture of sophisticated
financial professionals who knew that Madoff was reporting fictitious transactions, and took
steps to prevent any inquiry.” Id. at *15. These allegations gave rise to a strong inference of
actual knowledge in Kingate, but are missing from the Amended Complaint.16
16 After the briefing in this matter, the Court decided Picard v. Shapiro (In re BLMIS), 542 B.R. 100 (Bankr. S.D.N.Y. 2015). There, the Court concluded that the complaint alleged a plausible claim that the principal individual 34
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In conclusion, the Amended Complaint does not allege a plausible claim that Legacy had
actual knowledge that BLMIS was not engaged in trading securities. Further, while it alleges the
first prong of willful blindness Legacy strongly suspected that, at a minimum, BLMIS’ option
trades were not real it does not allege the second prong, that Legacy turned a blind eye to its
suspicions. Instead, it alleges that Legacy hired Khronos to conduct due diligence regarding
Madoff’s trades for Legacy’s account. Accordingly, Counts II through VII are dismissed, and
the motion to dismiss Count I is granted except to the extent it seeks to avoid and recover the
transfer of fictitious profits to Legacy.
C. Count VIII (Subsequent Transfer Claim)
Section 550(a)(2) of the Bankruptcy Code allows the Trustee to recover an avoidable
transfer from “any immediate or mediate transferee of” an initial transferee. To plead a
subsequent transfer claim, the Trustee must plead that the initial transfer is avoidable, and the
defendant is a subsequent transferee of that initial transfer. Rule 9(b) of the Federal Rules of
Civil Procedure governs the portion of a claim to avoid an initial intentional fraudulent transfer,
Sharp Int’l Corp. v. State Street Bank & Trust Co. (In re Sharp Int’l Corp.), 403 F.3d 43, 56 (2d
Cir. 2005); Atlanta Shipping Corp., Inc. v. Chem. Bank, 818 F.2d 240, 251 (2d Cir. 1987);
Nisselson v. Drew Indus., Inc. (In re White Metal Rolling & Stamping Corp.), 222 B.R. 417, 428
(Bankr. S.D.N.Y. 1998), but Rule 8(a) governs the portion of a claim to recover the subsequent
defendant (Stanley Shapiro) had actual knowledge that BLMIS was not engaged in trading securities. The Court’s conclusion was based primarily on Stanley Shapiro’s access to Madoff and the 17th floor which housed the investment advisory business and his collaboration with BLMIS employees “to fabricate large numbers of back-dated trades to increase the value of the Core Accounts, and thereafter, to manufacture back-dated losses to eliminate the adverse tax consequences resulting from the fictitious value.” Id. at 113 (record citations omitted). While the Amended Complaint implies that Rafael may have may have had the ability to meet with Madoff, it does not draw any conclusions from the nature of that access or the information obtained at any meeting with Madoff, and does not allege that Rafael collaborated with BLMIS personnel to manipulate and back-date trading records.
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transfer. Picard v. Madoff (In re BLMIS), 458 B.R. 87, 119 (Bankr. S.D.N.Y. 2011); Picard v.
Merkin (In re BLMIS), 440 B.R. 243, 269 (Bankr. S.D.N.Y. 2010); SIPC v. Stratton Oakmont,
Inc., 234 B.R. 293, 317-18 (Bankr. S.D.N.Y. 1999).
To satisfy his burden to recover the subsequent transfer, the complaint must allege facts
that support the inference “that the funds at issue originated with the debtor,” Silverman v.
K.E.R.U. Realty Corp. (In re Allou Distribs., Inc.), 379 B.R. 5, 30 (Bankr. E.D.N.Y. 2007);
accord Picard v. Estate of Chais (In re BLMIS), 445 B.R. 206, 235 (Bankr. S.D.N.Y. 2011), and
contain the “necessary vital statistics—the who, when, and how much” of the purported transfers
to establish an entity as a subsequent transferee of the funds. Allou Distribs., 379 B.R. at 32;
accord Gowan v. Amaranth LLC (In re Dreier LLP), 452 B.R. 451, 464 (Bankr. S.D.N.Y. 2011).
The plaintiff’s burden at the pleading stage “‘is not so onerous as to require “dollar-for-dollar
accounting” of “the exact funds” at issue.’” Picard v. Charles Ellerin Revocable Trust (In re
BLMIS), Adv. P. Nos. 10-04398 & 10-05219 (BRL), 2012 WL 892514, at *3 (Bankr. S.D.N.Y.
Mar. 14, 2012) (quoting Allou Distribs., 379 B.R. at 30 (citing IBT Int’l, Inc. v. Northern (In re
Int’l Admin. Servs., Inc.), 408 F.3d 689, 708 (11th Cir. 2005))).
A trustee may not, however, recover the avoided transfer from a subsequent transferee
that “takes for value, including satisfaction or securing of a present or antecedent debt, in good
faith, and without knowledge of the voidability of the transfer avoided.” 11 U.S.C. § 550(b)(1)
(emphasis added). Bankruptcy Code § 550(b)(1), like section 548(c), is an affirmative defense
that the subsequent transferee must ordinarily plead and prove. Official Comm. of Unsecured
Creditors v. JP Morgan Chase Bank, N.A. (In re M. Fabrikant & Sons, Inc.), 394 B.R. 721, 740
n. 20 (Bankr. S.D.N.Y. 2008); Cassirer v. Sterling Nat'l Bank & Trust Co. of N.Y. (In re Schick),
223 B.R. 661, 664–65 (Bankr.S.D.N.Y.1998). In addition, the majority approach applies an
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objective, reasonable person standard to determine the defendant’s good faith. Gowan v. Patriot
Grp. (In re Dreier LLP), 452 B.R. 391, 447 (Bankr. S.D.N.Y. 2011) (collecting cases); see
Banner v. Kassow, 104 F.3d 352, No. 96-5040, 1996 WL 680760, at *3 (2d Cir. Nov. 22, 1996)
(summary order) (“[A] transferee does not act in good faith when he has sufficient knowledge to
place him on inquiry notice of the debtor's possible insolvency.”) (quoting Brown v. Third Nat’l
Bank (In re Sherman), 67 F.3d 1348, 1355 (8th Cir. 1995)).
The District Court has concluded, however, that a subjective test governs the good faith
defense under Bankruptcy Code § 550(b)(1), and has placed the burden of pleading the lack of
good faith on the Trustee. Good Faith Decision, 516 B.R. at 24 & n. 4 (a subsequent transferee
can prevail on a motion to dismiss by showing that the complaint fails to plausibly allege that it
did not act in good faith). Given the District Court’s uniform treatment of the defenses under
Bankruptcy Code §§ 548(c) and 550(b)(1), I conclude that the Trustee must also plead that the
subsequent transferee lacked “knowledge of the voidability of the transfer avoided.”
1. The Montpellier Transfers
The Mayers, “through various Khronos companies they operated” acted as a service
provider to Montpellier, a fund that “ultimately” invested in Legacy. (¶ 35.) From at least 2004,
Khronos served as investment manager for Montpellier, and received a monthly fee equal to
1.2% of Montpellier’ net asset value, which it shared with HCH. (¶ 148.) In addition, from 2004
to 2008, Khronos received a performance fee ranging from between 5% to 10% of Montpellier’s
new net investment profits. (¶ 149.)
Although the Amended Complaint provides information pertaining to what Montpellier
paid Khronos, it fails to allege any facts supporting the inference that those funds originated with
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BLMIS. In particular, it does not allege that Legacy transferred BLMIS funds to Montpellier,
and in fact, Trustee’s counsel conceded at oral argument that the Amended Complaint did not
plead this linkage. (Transcript of Oct. 28, 2015 Hearing at 54:19-57:3.) Accordingly, any
Subsequent Transfer claims based on the payments Montpellier made to Khronos are legally
insufficient.
2. The Legacy Transfers
Legacy paid Khronos for its accounting services at the rate of $42,000 per year, paid
monthly, and made one-time payments for historical pricing services. (¶ 150; Accounting
Services Agreement at 5.) These payments totaled $154,690 as of the end of 2004, and Legacy
paid Khronos a total of $319,190 for providing accounting services. (¶ 150.) Unlike
Montpellier, the Amended Complaint describes Legacy as “a single purpose vehicle” investing
“solely with BLMIS.” (¶ 33.) This implies that Legacy had no other source of cash, and
whatever Legacy paid Khronos originated with BLMIS. See Gowan v. Amaranth Advisors
L.L.C. (In re Dreier LLP), Adv. P. No. 10-03493 (SMB), 2014 WL 47774, at *15 (Bankr.
S.D.N.Y. Jan. 3, 2014).
The allegations are also sufficient to infer that Legacy paid Khronos during the Two-Year
Period, and specifically, after September 2007, with the avoidable transfers of fictitious profits it
withdrew from BLMIS. Legacy paid $3,500 per month in arrears. (See Accounting Services
Agreement at 5.) At a minimum, the Amended Complaint implies that Legacy paid that amount
during October 2007 through November 2008, and possibly, in December 2008, for the
November services. However, the Subsequent Transfer allegations involving the payments that
Legacy made to Khronos are nevertheless deficient.
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a. Value
Even where the burden of pleading rests on the defendant, the Court may dismiss the
claim pursuant to Rule 12(b)(6) where the defense is apparent on the face of the complaint.
Official Comm. of Unsecured Creditors of Color Tile, Inc. v. Coopers & Lybrand, LLP, 322 F.3d
147, 158 (2d Cir. 2003); accord Picard v. ABN AMRO Bank (Ireland) Ltd. (In re BLMIS), 505
B.R. 135, 141 (S.D.N.Y. 2013). The Amended Complaint, in this regard, pleads that Khronos
gave value for the Subsequent Transfers. The “value” that a subsequent transferee must provide
under section 550(b)(1) is “merely consideration sufficient to support a simple contract,
analogous to the ‘value’ required under state law to achieve the status of a bona fide purchaser
for value.” 5 ALAN N. RESNICK & HENRY J. SOMMER, COLLIER ON BANKRUPTCY ¶ 550.03[1] at
550-25 (16th ed. 2015) (“COLLIER ON BANKRUPTCY”); accord Enron Corp. v. Ave. Special
Situations Fund II, LP (In re Enron Corp.), 333 B.R. 205, 236 (Bankr. S.D.N.Y. 2005); KATHY
BAZOIAN PHELPS & HON. STEVEN RHODES, THE PONZI BOOK § 4.03[2] at 4.42 (2012). The
Amended Complaint alleges that Legacy transferred the Subsequent Transfers to Khronos in
payment for accounting and historical pricing services, and therefore, pleads that Khronos gave
“value” for the subsequent transfers.
b. Good Faith
In addition, the Amended Complaint fails to satisfy the Trustee’s burden to plead that
Khronos did not act in good faith. The District Court equated lack of good faith under
Bankruptcy Code § 548(c) with willful blindness, Good Faith Decision, 516 B.R. at 21, and
stated that the same standard applies to non-investors as well as investors under sections 548(c)
and 550(b). Id. at 22-23. The Court has already concluded that the Amended Complaint fails to
allege that Legacy, through Rafael, had actual knowledge of or willfully blinded itself to
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Madoff’s fraudulent scheme. Although the Subsequent Transfer claim focuses on the good faith
of Khronos, the Trustee suggests no meaningful distinction between what Legacy knew and what
Khronos knew, and pleads that Khronos’ knowledge should be imputed to Legacy. (¶ 53.) Nor
is there any suggestion that Khronos willfully blinded itself to anything during its work for
Legacy. It developed technology to track volume and pricing statistics, (¶ 80), and actively
tracked Legacy’s trades. (¶¶ 111, 118, 126.) In fact, the Amended Complaint rests on the theory
that Khronos conducted extensive diligence, and through its diligence, acquired actual
knowledge that BLMIS was a Ponzi scheme.
c. Knowledge
For similar reasons, the Amended Complaint fails to allege that Khronos knew that it was
being paid by Legacy with the proceeds of an avoidable transfer. This requirement originated
with the § 4-609(b)(1) of the Bankruptcy Commission’s 1973 proposed bill. H. DOC. NO. 93-
137, 93D CONG., 1st Sess., pt. II (1973); 5 COLLIER ON BANKRUPTCY ¶ 550.03[3], at 550-28. It is
not defined or explained in the Bankruptcy Code, and has been interpreted to mean that “‘[i]f a
transferee possesses knowledge of facts that suggest a transfer may be fraudulent,’ he has
sufficient knowledge to preclude his incantation of § 550(b)’s defense.” Banner, 1996 WL
680760, at *3 (quoting In re Sherman, 67 F.3d at 1357). Section 550(b)(1) does not impose a
duty to investigate or monitor the chain of transfers that preceded the subsequent transfer, but
“some facts strongly suggest the presence of others; a recipient that closes its eyes to the
remaining facts may not deny knowledge.” Bonded Fin. Servs., Inc. v. European Am. Bank, 838
F.2d 890, 898 (7th Cir. 1988) (Easterbrook, J.). This essentially defines willful blindness which,
the District Court has held, is synonymous with lack of good faith.
40
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It is not surprising, therefore, that the facts relevant to this element under 11 U.S.C. §
550(b)(1) often overlap with the good faith requirement, and some Courts and commentators
have suggested that the two requirements are really only one. See Genova v. Gottlieb (In re
Orange Cnty. Sanitation Corp.), 221 B.R. 323, 328 (Bankr. S.D.N.Y. 1997) (“There is no
meaningful distinction between the two remaining requirements of § 550(b)….”) (citation
omitted); 5 COLLIER ON BANKRUPTCY ¶ 550.03[3] at 550-28 (“The language appears to be
derived from section 4-609(b)(1) of the [The Commission on the Bankruptcy Laws of the United
States]’s bill, and was included as surplusage to illustrate a transferee that could not be in good
faith.”); but see CCEC Asset Mgmt. Corp. v. Chem. Bank (In re Consol. Capital Equities Corp.),
175 B.R. 629, 637-38 (Bankr. N.D. Tex. 1994) (“This court must endeavor to give meaning to
each provision of § 550(b) without rendering a provision superfluous or insignificant. Good
faith must therefore be considered as a separate concept from ‘without knowledge of the
avoidability of the transfer.’”). Furthermore, although “[i]t is ‘a cardinal principle of statutory
construction’ that ‘a statute ought, upon the whole, to be so construed that, if it can be prevented,
no clause, sentence, or word shall be superfluous, void, or insignificant,’” TRW Inc. v. Andrews,
534 U.S. 19, 31 (2001) (quoting Duncan v. Walker-, 533 U.S. 167, 174 (2001) (internal quotation
marks omitted)), neither the Trustee nor Khronos have offered a distinction between lack of good
faith and knowledge of the avoidability of the initial transfer under Bankruptcy Code §
550(b)(1).
In short, the Amended Complaint does not plead that Khronos willfully blinded itself to
any red flags; it conducted extensive due diligence on behalf of Legacy. Nor did it possess
actual knowledge that it was receiving the proceeds of a fraudulent transfer because neither
41
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Legacy nor Khronos knew that BLMIS was not actually trading securities. Accordingly, Count
VIII is dismissed.
The Court has considered the remaining arguments by the parties that are not specifically
discussed, and concludes that they lack merit or are rendered moot by this opinion. Settle order
on notice.
Dated: New York, New York March 14, 2016
/s/Stuart M. Bernstein STUART M. BERNSTEIN United States Bankruptcy Judge
42
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UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK
SECURITIES INVESTOR PROTECTION CORPORATION, SIPA LIQUIDATION
Plaintiff-Applicant, No. 08-01789 (SMB) v. (Substantively Consolidated) BERNARD L. MADOFF INVESTMENT SECURITIES LLC,
Defendant. In re:
BERNARD L. MADOFF,
Debtor, IRVING H. PICARD, Trustee for the Liquidation of Bernard L. Madoff Investment Securities LLC, Adv. Pro. No. 10-05286 (SMB)
Plaintiff,
v.
LEGACY CAPITAL LTD. and KHRONOS LLC,
Defendants.
ORDER GRANTING LEGACY CAPITAL LTD.’S AND KHRONOS LLC’S MOTIONS TO DISMISS THE AMENDED COMPLAINT UNDER BANKRUPTCY RULE 7012(b) AND FEDERAL RULE OF CIVIL PROCEDURE 12(b)(6)
This matter coming before the Court on Legacy Capital Ltd.’s Motion to Dismiss the
Amended Complaint Under Bankruptcy Rule 7012(b) and Federal Rule of Civil Procedure
12(b)(6) and Khronos LLC’s Motion to Dismiss the Amended Complaint Under Bankruptcy Rule
7012(b) and Federal Rule of Civil Procedure 12(b)(6) (the “Motions”); and the Court having
considered the Motions, the Amended Complaint, and the statements of counsel at a hearing
before the Court on October 28, 2015 (the “Hearing”); and the Court having issued a
Memorandum Decision Regarding Motions to Dismiss the Trustee’s Amended Complaint (the Case 20-1334, Document 73, 08/06/2020, 2902485, Page140 of 180 SPA-57
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“Decision”), entered on the docket on March 14, 2016; it is accordingly
ORDERED, that, for all of the reasons set forth in the Decision, the Motions are granted
in their entirety (except as set forth below); and it is further
ORDERED, that the Amended Complaint is dismissed with prejudice as against Khronos
LLC; and it is further
ORDERED, that Count One of the Amended Complaint, except to the extent Count One
seeks to avoid and recover alleged fictitious profits transferred to or for the benefit of Legacy
within two years of the BLMIS filing date, is dismissed without prejudice as against Legacy
Capital Ltd.; and it is further
ORDERED, that Counts Two through Seven of the Amended Complaint are dismissed
without prejudice as against Legacy Capital Ltd.; and it is further
ORDERED, that the foregoing is without prejudice to the rights of any party to move
pursuant to Bankruptcy Rule 9024 and Federal Rule of Civil Procedure 60 for reconsideration for
any purpose; and it is further
ORDERED, that the Court shall retain jurisdiction to hear and determine all matters
arising from or related to the implementation of this Order.
Dated: New York, New York April 12th, 2016
/s/ STUART M. BERNSTEIN United States Bankruptcy Judge
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5UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK ------X In re: : : BERNARD L. MADOFF INVESTMENT : Case No. 08-99000 (SMB) SECURITIES LLC, : Adv. Proc. No. 08-01789 (SMB) : SIPA LIQUIDATION Debtor. : ------X IRVING H. PICARD, Trustee for the Liquidation : of Bernard L. Madoff Investment Securities LLC, : : Plaintiff, : : Adv. P. No. 10-05286 (SMB) LEGACY CAPITAL LTD. and : KHRONOS LLC : : Defendants. : ------X
ERRATA ORDER MEMORANDUM DECISION REGARDING MOTIONS TO DISMISS THE TRUSTEE’S AMENDED COMPLAINT
A P P E A R A N C E S:
BAKER & HOSTETLER LLP Attorneys for Plaintiff, Irving H. Picard, Trustee for the Liquidation of Bernard L. Madoff Investment Securities LLC 45 Rockefeller Plaza New York, NY 10111 David J. Sheehan, Esq. Oren J. Warshavsky, Esq. Jason S. Oliver, Esq. Of Counsel
STEVENS & LEE, P.C. Attorneys for Legacy Capital Ltd. 485 Madison Avenue New York, NY 10022 Nicholas F. Kajon, Esq. Of Counsel Case 20-1334, Document 73, 08/06/2020, 2902485, Page142 of 180 SPA-59
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BINDER & SCHWARTZ LLP Attorneys for Khronos LLP 28 West 44th Street-Suite 700 New York, NY 10036-4039 Eric B. Fisher, Esq. Lindsay S. Bush, Esq. Of Counsel
STUART M. BERNSTEIN United States Bankruptcy Judge:
IT IS HEREBY ORDERED that the Court’s Memorandum Decision Regarding Motions
to Dismiss the Trustee’s Amended Complaint, dated Mar. 14, 2016, is modified as follows:
Page 5, footnote 3, which reads: “A copy of the Renaissance Report is annexed as Exhibit
C to the”
should be changed to read
“A copy of the Renaissance Report is annexed as Exhibit C to the Declaration of Eric B.
Fisher in Support of Khronos LLC’s Motion to Dismiss the Amended Complaint Under
Bankruptcy Rule 7012(b) and Federal Rule of Civil Procedure 12(b)(6), dated July 30, 2015
(“Fisher Declaration”) (ECF Doc. # 120-2).)”
Dated: New York, New York May 5, 2016
/s/ Stuart M. Bernstein STUART M. BERNSTEIN United States Bankruptcy Judge
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UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK ------X In re: : : Adv. Pro. No. 08-01789 (SMB) SECURITIES INVESTOR PROTECTION : CORPORATION, : SIPA Liquidation : (Substantively Consolidated) Plaintiff-Applicant, : : against : : BERNARD L. MADOFF INVESTMENT : SECURITIES LLC, : : Defendant. : ------X In re: : : BERNARD L. MADOFF, : : Debtor. : ------X IRVING PICARD, Trustee for the Liquidation : of Bernard L. Madoff Investment Securities : LLC, : : Plaintiff, : : against : Adv. Pro. No. 10-05286 (SMB) : LEGACY CAPITAL LTD., : : Defendant. : ------X
MEMORANDUM DECISION AND ORDER GRANTING RELIEF UNDER FEDERAL CIVIL RULE 56(g)
A P P E A R A N C E S:
BAKER & HOSTETLER LLP 45 Rockefeller Plaza New York, New York 10111 David J. Sheehan, Esq. Oren J. Warshavsky, Esq. Jason S. Oliver, Esq. Case 20-1334, Document 73, 08/06/2020, 2902485, Page144 of 180 SPA-61
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Of Counsel Attorneys for Plaintiff
SECURITIES INVESTOR PROTECTION CORPORATION 1667 K St., NW, Suite 1000 Washington, D.C. 20006 Josephine Wang, Esq. General Counsel Kevin H. Bell, Esq. Senior Associate General Counsel For Dispute Resolution Nathanael S. Kelley, Esq. Associate General Counsel Of Counsel Attorneys for Securities Investor Protection Corporation
STEVENS & LEE, P.C. 485 Madison Avenue, 20th Floor New York, New York 10022 Nicholas F. Kajon, Esq. Attorneys for Defendant
STUART M. BERNSTEIN United States Bankruptcy Court:
Plaintiff Irving H. Picard, as trustee (the “Trustee”) for the liquidation of Bernard
L. Madoff Investment Securities LLC (“BLMIS”) under the Securities Investor
Protection Act, 15 U.S.C. §§ 78aaa et seq. (“SIPA”), commenced this adversary
proceeding, inter alia, to avoid and recover intentional fraudulent transfers from the
BLMIS account held by Legacy Capital Ltd. (“Legacy”) pursuant to 11 U.S.C. §§
548(a)(1)(A) and 550(a)(1). The Trustee now moves for summary judgment. For the
reasons that follow, the Trustee’s motion is denied but certain facts are deemed either
immaterial or undisputed for the purposes of this adversary proceeding.
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BACKGROUND
A. Madoff’s Arrest and the BLMIS SIPA Liquidation
On December 11, 2008 (the “Filing Date”), Bernard L. Madoff was arrested for
securities fraud, see United States v. Madoff, 586 F. Supp. 2d 240, 244 (S.D.N.Y. 2009),
and the Securities and Exchange Commission (“SEC”) commenced an action against
Madoff and BLMIS alleging various violations of the Investment Advisers Act of 1940,
the Securities Act of 1933, and the Securities Exchange Act of 1934. (See Complaint,
dated Dec. 11, 2008 (ECF Dist. Ct. No. 1:08-cv-10791-LLS Doc. # 1).) Four days later,
the Securities Investor Protection Corporation (“SIPC”) filed an application for a
protective decree pursuant to SIPA § 78eee(a)(3) maintaining that BLMIS was unable to
meet its obligations to its customers and the customers needed the protections afforded
by SIPA. (See Application of the Securities Investor Protection Corporation, dated Dec.
15, 2008 (ECF Dist. Ct. No. 1:08-cv-10791-LLS Doc. # 5).) The District Court granted
SIPC’s application, appointed the Trustee and his counsel pursuant to SIPA §
78eee(b)(3), and removed the SIPA proceeding to this Court pursuant to SIPA §
78eee(b)(4). (See Order, dated Dec. 15, 2008 (ECF Main Case1 Doc. # 1).)
On March 12, 2009, Madoff pleaded guilty to an eleven-count criminal
information including charges of securities fraud, investment adviser fraud, mail fraud,
wire fraud, money laundering, making false statements, perjury, making false filings
with the SEC, and theft from an employee benefit plan. (See Transcript of March 12,
1 “ECF Main Case Doc. # _” refers to documents filed on the electronic docket of the BLMIS SIPA proceeding, In re BLMIS, No. 08-01789 (SMB). “ECF Doc. # _” refers to documents filed on the electronic docket of this adversary proceeding, Picard v. Legacy Capital Ltd., Adv. Pro. No. 10-05286 (SMB). References to District Court dockets will include the abbreviation “Dist. Ct.,” the case number, and the document number.
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2009 Hr’g in United States v. Madoff, No. 09 CR 213 (DC) (“Madoff Allocution”)2 at
7:23-8:12.) On June 29, 2009, Madoff was sentenced to a prison term of 150 years.
(See Judgment, dated June 29, 2009 (ECF Dist. Ct. No. 1:09-cr-00213-DC-1 Doc. #
100).)
B. This Adversary Proceeding
The Trustee commenced this adversary proceeding on December 6, 2010 and
filed an Amended Complaint on July 2, 2015 (“Amended Complaint”) (ECF Doc. # 112)
asserting actual and constructive fraudulent transfer claims under the Bankruptcy Code
and New York law to avoid and recover over $213 million from Legacy as initial
transferee and $6.6 million from Khronos LLC as subsequent transferee. (See Amended
Complaint, ¶ 2.) Legacy and Khronos each moved to dismiss the Amended Complaint
for failure to state a claim under Rule 12(b)(6) of the Federal Rules of Civil Procedure.
(See ECF Doc. ## 115, 120.) As set forth in Picard v. Legacy Capital Ltd. (In re BLMIS),
548 B.R. 13 (Bankr. S.D.N.Y. 2016) (“Dismissal Decision”), the Court dismissed the
claims against Khronos and dismissed the claims against Legacy except for the actual
fraudulent transfer claim under 11 U.S.C. § 548(a)(1)(A) to avoid and recover transfers
from Legacy’s BLMIS account within two years of the Filing Date. (See Order Granting
Legacy Capital Ltd.’s and Khronos LLC’s Motions to Dismiss the Amended Complaint
under Bankruptcy Rule 7012(b) and Federal Rule of Civil Procedure 12(b)(6), dated
2 A copy of the Madoff Allocution is attached as Exhibit 1 to the Declaration of Oren J. Warshavsky in Support of Plaintiff’s Motion for Summary Judgment, dated Dec. 21, 2018 (“Warshavsky Declaration”) (ECF Doc. # 193).
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Apr. 12, 2016 (ECF Doc. # 137).) Legacy answered the Amended Complaint on May 16,
2016 (“Answer”) (ECF Doc. # 139).
The Trustee now moves for summary judgment on the remaining claim, (see
Trustee’s Memorandum of Law in Support of Motion for Summary Judgment, dated
Dec. 21, 2018 (“Trustee Brief”) (ECF Doc. # 191)), and Legacy opposes the motion. (See
Memorandum of Law in Opposition to Trustee’s Motion for Summary Judgment,
dated Mar. 1, 2019 (“Legacy Brief”) (ECF Doc. # 199).)
DISCUSSION
Rule 56 of the Federal Rules of Civil Procedure, made applicable to this adversary
proceeding pursuant to Rule 7056 of the Federal Rules of Bankruptcy Procedure,
governs motions for summary judgment. The moving party bears the initial burden of
showing that no genuine factual issue exists and that the undisputed facts establish its
right to judgment as a matter of law. Rodriguez v. City of N.Y., 72 F.3d 1051, 1060-61
(2d Cir. 1995); accord Celotex Corp. v. Catrett, 477 U.S. 317, 323 (1986). In making that
determination, a court must view the evidence “in the light most favorable to the
opposing party.” Tolan v. Cotton, 572 U.S. 650, 657 (2014) (quoting Adickes v. S.H.
Kress & Co., 398 U.S. 144, 157 (1970)). If the movant carries his initial burden, the
nonmoving party “must do more than simply show that there is some metaphysical
doubt as to the material facts.” Matsushita Elec. Indus. Co., Ltd. v. Zenith Radio Corp.,
475 U.S. 574, 586-87 (1986). “Where the record taken as a whole could not lead a
rational trier of fact to find for the non-moving party, there is no genuine issue for trial.”
Id. at 587 (citation and internal quotation marks omitted); accord Scott v. Harris, 550
U.S. 372, 380 (2007). The court’s function at the summary judgment stage is not to
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resolve disputed issues of fact, but only to determine whether there is a genuine issue to
be tried. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 249 (1986). Where the Court
does not grant all the relief sought by the movant, it may nonetheless enter an order
stating any material fact, including any item of damages or other relief, not in genuine
dispute and treat that fact as established in the case. FED.R.CIV. P. 56(g); see 11 JAMES
WM.MOORE ET AL., MOORE’S FEDERAL PRACTICE § 56.123 (3d ed. 2018).
A. The Trustee’s Prima Facie Case
Under section 548(a)(1)(A) of the Bankruptcy Code, a bankruptcy trustee “may
avoid any transfer . . . of an interest of the debtor in property . . . that was made . . . on or
within 2 years before the date of the filing of the petition, if the debtor voluntarily or
involuntarily . . . made such transfer . . . with actual intent to hinder, delay, or defraud
any [creditor].”3 Thus, the elements of an intentional fraudulent transfer claim under
section 548(a)(1)(A) are: (i) a transfer of an interest of the debtor in property;4 (ii) made
within two years of the petition date;5 (iii) with “actual intent to hinder, delay, or
defraud” a creditor. Adelphia Recovery Tr. v. Bank of Am., N.A., No. 05 Civ. 9050
(LMM), 2011 WL 1419617, at *2 (S.D.N.Y. Apr. 7, 2011), aff’d, 748 F.3d 110 (2d Cir.
3 To the extent consistent with SIPA, a liquidation of a broker or dealer is “conducted in accordance with, and as though it were being conducted under chapters 1, 3, and 5 and subchapters I and II of chapter 7” of the Bankruptcy Code. SIPA § 78fff(b).
4 Money held by a broker on behalf of its customers is not the broker’s property under state law. SIPA § 78fff-2(c)(3) circumvents this problem by treating customer property as though it were the debtor’s property in an ordinary bankruptcy. See Picard v. Fairfield Greenwich Ltd., 762 F.3d 199, 213 (2d Cir. 2014) (SIPA creates a “legal fiction that confers standing on a SIPA trustee by treating customer property as though it were ‘property of the debtor’”). Thus, customer deposits are deemed to be BLMIS’s property for the purposes of this adversary proceeding.
5 In this SIPA proceeding, the relevant “petition date” is the Filing Date of December 11, 2008, the date the SIPA proceeding is deemed to have been commenced. See SIPA § 78lll(7)(B).
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2014); McHale v. Boulder Capital LLC (In re 1031 Tax Grp., LLC), 439 B.R. 47, 68
(Bankr. S.D.N.Y. 2010), supplemented by 439 B.R. 78 (Bankr. S.D.N.Y. 2010).
1. The Transfers
Legacy has admitted that BLMIS transferred $174 million from its BLMIS
account within two years of the Filing Date (the “Two-Tear Transfers”). (Legacy Capital
Ltd.’s Response to Trustee’s Statement of Material Facts Pursuant to Local Bankruptcy
Rule 7056-1, dated Mar. 1, 2019 (“Legacy 7056-1 Statement”), ¶ 35 (ECF Doc. # 199-
47); see Amended Complaint, ¶ 37 and Answer, ¶ 37; see also Stipulation and Order as
to Undisputed Transfers, dated Jan. 12, 2017 (“Transfers Stipulation”), ¶ 4 (“Exhibit A
to this stipulation accurately sets forth the cash deposits and cash withdrawals from the
. . . BLMIS accounts.”) (ECF Doc. # 155).)6 Legacy argues that the aggregate of $87
million was actually transferred from its BLMIS account to BNP Paribas – Dublin
Branch, a registered branch of BNP Paribas S.A. (together, “BNP Paribas”) as repayment
for a $100 million line of credit. (Amended Complaint, ¶¶ 139, 140; Answer, ¶¶ 139,
140, 142.) It suggests that the Court should ignore these transfers in computing its
liability. (Legacy Brief at 16-17.)
The argument lacks merit. The payment to BNP Paribas does not affect the
amount of the transfers. At most, it makes BNP Paribas rather than Legacy the initial
transferee of transfers that are otherwise fraudulent. Liability is not, however, limited to
recovery from the initial transferee. A trustee may also recover an avoided fraudulent
6 Legacy now contends that the Trustee has not established the source of the transfers. (Legacy Brief at 13.) Its new argument ignores its earlier admissions that the transfers were made by BLMIS. It matters not which BLMIS bank account was the source of the transfers.
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transfer from the entity for whose benefit the transfer was made, 11 U.S.C. § 550(a)(1),
and any subsequent transferee. 11 U.S.C. § 550(a)(2). Since the transfers made to BNP
Paribas satisfied Legacy’s obligations to BNP Paribas, Legacy was the entity for whose
benefit those transfers were made within the meaning of 11 U.S.C. § 550(a)(1). See Ames
Merch. Corp. v. Nikko Am., Inc. (In re Ames Dep’t Stores, Inc.), No. 01-42217 (REG),
2011 WL 1239804, at *5 (Bankr. S.D.N.Y. Mar. 28, 2011) (“The ‘paradigm’ transfer
beneficiary is a party . . . whose debts are extinguished or reduced by the transfer: that is
someone who receives the benefit but not the money.”) (footnote, alteration and internal
quotation marks omitted).
2. Intent
To prove intent to deceive, the Trustee relies on the “Ponzi scheme presumption”
under which the intent to hinder, delay, or defraud creditors is presumed if the
transferor operated a Ponzi scheme and the transfers are made in furtherance of the
Ponzi scheme. See Moran v. Goldfarb, No. 09 Civ. 7667 (RJS), 2012 WL 2930210, at *4
(S.D.N.Y. July 16, 2012) (“an actual intent to defraud is presumed because the transfers
made in the course of a Ponzi scheme could have been made for no purpose other than
to hinder, delay, or defraud creditors”) (citation, internal quotation marks and
alteration omitted); Bear, Stearns Sec. Corp. v. Gredd (In re Manhattan Inv. Fund
Ltd.), 397 B.R. 1, 11 (S.D.N.Y. 2007) (“if a transfer serves to further a Ponzi scheme, then
the presumption applies and ‘actual intent’ under § 548(a)(1)(A) is present”); Geltzer v.
Barish (In re Starr), 502 B.R. 760, 770 (Bankr. S.D.N.Y. 2013) (“In order to apply the
Ponzi scheme presumption, the transfers must be made in furtherance of the fraud.”);
see Christian Bros. High Sch. Endowment v. Bayou No Leverage Fund, LLC (In re
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Bayou Grp., LLC), 439 B.R. 284, 294, 307-08 (S.D.N.Y. 2010). “A ‘Ponzi scheme’
typically describes a pyramid scheme where earlier investors are paid from the
investments of more recent investors, rather than from any underlying business
concern, until the scheme ceases to attract new investors and the pyramid collapses.”
Eberhard v. Marcu, 530 F.3d 122, 132 n. 7 (2d Cir. 2008); accord Hirsch v. Arthur
Andersen & Co., 72 F.3d 1085, 1088 n. 3 (2d Cir. 1995) (quoting McHale v. Huff (In re
Huff), 109 B.R. 506, 512 (Bankr. S.D. Fla. 1989)). The presumption is based on a
recognition that a Ponzi scheme operator knows that the scheme will eventually collapse
when the pool of investors runs dry and the remaining investors will lose their money.
Bayou, 439 B.R. at 306 n. 19 (“Knowledge to a substantial certainty constitutes intent in
the eyes of the law, and awareness that some investors will not be paid is sufficient to
establish actual intent to defraud.”) (citation and internal quotation marks omitted).
Some courts have used the following four-factor test to determine the existence of
a Ponzi scheme:
1) deposits were made by investors; 2) the Debtor conducted little or no legitimate business operations as represented to investors; 3) the purported business operation of the Debtor produced little or no profits or earnings; and 4) the source of payments to investors was from cash infused by new investors.
Armstrong v. Collins, No. 01 Civ. 2437 (PAC), 2010 WL 1141158, at *22 (S.D.N.Y. Mar.
24, 2010), reconsideration denied, No. 01 Civ. 2437 (PAC), 2011 WL 308260 (S.D.N.Y.
Jan. 31, 2011); accord Wiand v. Waxenberg, 611 F. Supp. 2d 1299, 1312 (M.D. Fla.
2009); Forman v. Salzano (In re Norvergence, Inc.), 405 B.R. 709, 730 (Bankr. D. N.J.
2009); Rieser v. Hayslip (In re Canyon Sys. Corp.), 343 B.R. 615, 630 (Bankr. S.D.
Ohio 2006). Ultimately, however, the Ponzi scheme label applies “to any sort of
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inherently fraudulent arrangement under which the debtor-transferor must utilize after-
acquired investment funds to pay off previous investors in order to forestall disclosure
of the fraud.” Manhattan Inv. Fund, 397 B.R. at 12; accord Gowan v. Amaranth
Advisors L.L.C. (In re Dreier LLP), Adv. Proc. Nos. 10-03493, 10-05447 (SMB), 2014
WL 47774, at *9 (Bankr. S.D.N.Y. Jan. 3, 2014); Bayou Superfund, LLC v. WAM
Long/Short Fund II, L.P. (In re Bayou Grp., LLC), 362 B.R. 624, 633 (Bankr. S.D.N.Y.
2007).
The Trustee relies primarily on the plea allocutions of Madoff and another former
BLMIS employee, Frank DiPascali,7 to prove that BLMIS was operated as a Ponzi
scheme.8 Madoff admitted that “for many years up until my arrest on December 11,
2008, I operated a Ponzi scheme through the investment advisory side of [BLMIS],”
(Madoff Allocution at 23:14-17), and described how he misrepresented to investment
advisory (“IA”) clients that he would invest their funds using the so-called split-strike-
conversion (“SSC”) strategy:
Through the [SSC strategy] I promised to clients and prospective clients that client funds would be invested in a basket of common stocks within the Standard & Poors 100 index, a collection of the 100 largest publicly- traded companies in terms of their market capitalization. I promised that I would select a basket of stocks that would closely mimic the price
7 See Transcript of Aug. 11, 2009 Hr’g in United States v. DiPascali, No. 09 CR 764 (RJS) (“DiPascali Allocution”), a copy of which is attached to the Warshavsky Declaration as Exhibit 3.
8 The Trustee also relies on the plea allocutions of David Kugel, Irwin Lipkin, Eric Lipkin and Enrica Cotellessa-Pitz, long time BLMIS employees. The Court may rely on a plea allocution as evidence to support a fact. Am. Int’l Specialty Lines Ins. Co. v. Towers Fin. Corp., No. 94Civ.2727 (WK)(AJP), 1997 WL 906427, at *4 n. 7 (S.D.N.Y. Sept. 12, 1997) (“plea allocutions are admissible pursuant to Fed. R. Evid. 803(22)”) (citing authorities); Bayou Accredited Fund, LLC v. Redwood Growth Partners, L.P. (In re Bayou Grp., LLC), 396 B.R. 810, 834-35 (Bankr. S.D.N.Y. 2008) (“Guilty pleas and plea allocutions in criminal cases are admissible evidence in subsequent civil proceedings. See Fed. R. Evid. 803(22) and 807.”) (citing authorities), aff’d in part and rev’d in part on other grounds, 439 B.R. 284 (S.D.N.Y. 2010); accord Johnson v. Neilson (In re Slatkin), 525 F.3d 805, 812 (9th Cir. 2008) (“the plea agreement is admissible under Federal Rule of Evidence 807”).
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movements of the Standard & Poors index. I promised that I would opportunistically time those purchases and would be out of the market intermittently, investing client funds during these periods in United States Government-issued securities, such as United States Treasury bills. In addition, I promised that as part of the [SSC strategy], I would hedge the investments I made in the basket of common stocks by using client funds to buy and sell option contracts related to those stocks, thereby limiting potential client losses caused by unpredictable changes in stock prices. In fact, I never made those investments I promised to clients, who believed they were invested with me in the [SSC strategy].
(Madoff Allocution at 25:25-26:18.)
As Madoff never invested in securities on behalf of his IA clients (which included
Legacy), the securities positions listed on the BLMIS account statements were fictitious,
and redemptions were paid from a commingled bank account containing the deposits of
all IA customers:
The essence of my scheme was that I represented to clients and prospective clients who wished to open investment advisory and individual trading accounts with me that I would invest their money in shares of common stock, options, and other securities of large well-known corporations, and upon request, would return to them their profits and principal. Those representations were false for many years. Up until I was arrested on December 11, 2008, I never invested these funds in the securities, as I had promised. Instead, those funds were deposited in a bank account at Chase Manhattan Bank. When clients wished to receive the profits they believed they had earned with me or to redeem their principal, I used the money in the Chase Manhattan bank account that belonged to them or other clients to pay the requested funds.
(Id. at 24:9-22.) DiPascali similarly admitted that BLMIS made no actual trades for its
IA customers:
THE DEFENDANT: From at least the early 1990s through December of 2008, there was one simple fact that Bernie Madoff knew, that I knew, and that other people knew but that we never told the clients nor did we tell the regulators like the SEC. No purchases of [sic] sales of securities were actually taking place in their accounts. It was all fake. It was all fictitious. It was wrong and I knew it was wrong at the time, sir.
THE COURT: When did you realize that?
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THE DEFENDANT: In the late '80s or early '90s.
. . .
From our office in Manhattan at Bernie Madoff’s direction, and together with others, I represented to hundreds, if not thousands, of clients that security trades were being placed in their accounts when in fact no trades were taking place at all.
(DiPascali Allocution at 46:9-25.) To cover up the fraud, Madoff and BLMIS generated
trade confirmations and account statements containing “bogus transactions and
positions.” (Madoff Allocution at 27:9-13; see also DiPascali Allocution at 47:16-22 (“On
a regular basis I used hindsight to file historical prices on stocks then I used those prices
to post purchase of [sic] sales to customer accounts as if they had been executed in
realtime. On a regular basis I added fictitious trade data to account statements of
certain clients to reflect the specific rate of . . . return that Bernie Madoff had directed
for that client.”).)
The allocutions establish prima facie that Madoff ran BLMIS as a Ponzi scheme.
Madoff admitted to operating a Ponzi scheme, (Madoff Allocution at 23:15-16), failing to
invest customer funds as promised, (id. at 24:9-17), paying redemption requests with
customer deposits, (id. at 24:18-22) and issuing bogus customer statements and trade
confirmations to conceal the fraud. (Id. at 27:9-19.) DiPascali also admitted that
BLMIS performed no securities trades as promised to customers, (DiPascali Allocution
at 46:9-25) and posted fictitious “gains” in customer accounts and statements. (Id. at
47:16-22.)
Legacy nonetheless challenges this conclusion. During the course of its
operations, BLMIS also purchased U.S. Treasury Bills (“T-Bills”) from third-party
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brokers such as Morgan Stanley and Lehman Brothers with customer deposits not
needed to pay redemptions, (Transcript of Deposition of Bernard L. Madoff, dated Dec.
20, 2016 (“Madoff 12/20/16 Dep. Tr.”)9 at 161:11-25), in order to earn more interest
than its Chase bank accounts paid. (Transcript of United States v. Bonventre, No. 10 Cr
228 (LTS), dated Dec. 5, 2013 (“Criminal Trial 12/5/13 Tr.”)10 at 4931:16-23.) Legacy
argues that BLMIS was not a Ponzi scheme because it engaged in these legitimate
transactions. (Legacy Brief at 8-10.)
The purchase of T-Bills did not transform BLMIS into a legitimate enterprise or
prohibit the Trustee’s reliance on the Ponzi scheme presumption. Ponzi scheme
operators often engage in some legitimate transactions but if the legitimate transactions
further the scheme or are funded by the scheme they are part of the scheme. For
example, in Wing v. Layton, 957 F. Supp. 2d 1307 (D. Utah 2013), VesCor ostensibly
operated as a real estate development enterprise promising substantial returns to its
investors. The business was never profitable and VesCor actively concealed its losses by
paying earlier investors with money raised from later investors. Id. at 1309-10. VesCor
was eventually placed into receivership and the receiver sued a former officer of VesCor
(“Layton”) seeking the return of funds he received from VesCor as intentional fraudulent
transfers under state law. Id. at 1313.
9 A copy of Madoff 12/20/16 Dep. Tr. is attached as Exhibit 2 to the Warshavsky Declaration.
10 A copy of the Criminal Trial 12/5/13 Tr. is attached as Exhibit 2 to the Reply Declaration of Oren J. Warshavsky in Support of the Trustee’s Motion for Summary Judgment, dated Mar. 22, 2019 (“Warshavsky Reply Declaration”) (ECF Doc. # 202).
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The receiver invoked the Ponzi scheme presumption because “VesCor as a whole
operated as a Ponzi scheme.” Id. at 1314. Layton countered that even if VesCor was a
Ponzi scheme, the Ponzi scheme presumption did not apply to the relevant transfers
because the two real estate projects with which he was most involved (KOJO and Siena
Office Park) were profitable and independent of any Ponzi scheme which may have
existed. Id. at 1314. The District Court rejected Layton’s effort to disaggregate the
legitimate transactions from the Ponzi scheme:
[T]he fact that the KOJO and Siena Office Park projects might have been profitable—which the Receiver strongly disputes—misses the point. The Receiver appears to not dispute that development activity occurred with the VesCor enterprise. Even so, seemingly legitimate business activity does not insulate companies from a finding that they were operated as part of a Ponzi scheme. As the Receiver points out, ponzi schemes sometimes use legitimate operations to attract investors, but this does not insulate those operations from the taint of the Ponzi scheme. See, e.g., Jobin v. McKay, 84 F.3d 1330, 1332 (10th Cir.1996) (Ponzi scheme existed where its perpetrator used the company’s legitimate operations as a computer sales and leasing company as a front); Sender v. Simon, 84 F.3d 1299, 1302 (10th Cir.1996) (Ponzi scheme existed in partnership hedge fund where “trading resulted in net profits in a few years,” though “in most years the Hedged Investments operation realized net trading losses”).
Id. at 1315 (record citations omitted). Regardless of their profitability, the KOJO and
Sienna Office Park projects were part of the larger VesCor scheme and the money that
funded those projects came from VesCor’s commingled funds. Id.
Gredd v. Bear, Stearns Sec. Corp. (In re Manhattan Inv. Fund Ltd.), 310 B.R.
500, 510-11 (Bankr. S.D.N.Y. 2002), leave to appeal denied, 288 B.R. 52 (S.D.N.Y.
2002), is to the same effect. There, Berger ran a Fund that engaged in the business of
short-selling securities. Bear Stearns served as the prime broker and financed all the
Fund’s short sales with loans of securities to cover the short sales. Id. at 502-03. As
losses mounted, Berger hid the losses, distributed false account statements to investors
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and service providers and paid off earlier investors with funds acquired from later
investors, a classic Ponzi scheme much like BLMIS. Id. at 503.
Gredd, the Fund’s chapter 11 trustee, sued Bear Stearns under 11 U.S.C. §
548(a)(1)(A) to avoid and recover the margin payments as intentional fraudulent
transfers and relied on the Ponzi scheme presumption to establish the Fund’s actual
intent to defraud. Bear Stearns moved to dismiss, countering that even if the Fund was
operated as a Ponzi scheme, the presumption was inapplicable to the transfers at issue
because the practice of short selling stocks was a legitimate business separate from the
Ponzi scheme. Id. at 506.
Judge Lifland made quick work of Bear Stearns’ argument:
Bear Stearns’ argument that actual fraudulent intent cannot be presumed in this case because the margin payments at issue were made in connection with a legitimate business outside of the Ponzi scheme— namely, the short selling of securities—is ludicrous.
Id. at 510-11. Noting that Berger had pled guilty to criminal charges of securities fraud
while working for the Fund, Judge Lifland concluded:
[I]t is impossible for this Court to understand how Bear Stearns attempts to characterize Berger’s continued short selling activities as a legitimate business enterprise. Moreover, “a guilty plea or criminal conviction of the perpetrator of the Ponzi scheme provides evidence of actual fraudulent intent.” In re C.F. Foods, 280 B.R. at 111 (citing Floyd v. Dunson, (In re Ramirez), 209 B.R. 424, 433 (Bankr.S.D.Tex.1997)). Accordingly, I find that by citing to Berger’s guilty plea and conviction, coupled with the fact that the margin payments were made in connection with a massive Ponzi scheme, the Trustee has sufficiently alleged facts pursuant to Bankruptcy Rules 7009(b) and 7012(b) to withstand Bear Stearns’ Motion to Dismiss.
Id. at 511.
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Madoff operated the largest, longest running Ponzi scheme in history. He had to
pay redemptions and profits to or for the benefit of customers like Legacy to further the
scheme. If BLMIS did not pay redemptions or profits on request, its aura of success
would evaporate, new investments would dry up and the scheme would collapse. The
use of the funds he stole from BLMIS’s customers to purchase T-Bills was an integral
part of the scheme; it enabled BLMIS to earn more interest to pay more redemptions for
a longer time and keep the scheme running. In fact, Madoff allocuted that he told his
investors, albeit falsely, that the timed purchase of T-Bills was a component of the SSC
strategy. (Madoff Allocution at 26:7-11.)
Accordingly, the Trustee has established that there is no genuine disputed issue
of fact that BLMIS was a Ponzi scheme and that it transferred its interest in $174 million
to or for the benefit of Legacy in furtherance of the Ponzi scheme within two years of the
Filing Date. Furthermore, although the start date of the Ponzi scheme is disputed for
the reasons discussed in the next section, Legacy does not dispute that the Ponzi scheme
was ongoing during the period of the Two-Year Transfers or that the Two-Year Transfers
were made in connection with the Ponzi scheme in large part from the property of other
customers. The Trustee is, therefore, entitled to rely on the Ponzi scheme presumption,
and has established as a matter of law that the Two-Year Transfers were made with the
actual intent to defraud.
B. Legacy’s Value Defenses
Section 548(c) of the Bankruptcy Code provides a defense to a fraudulent transfer
claim to the extent the transferee took “for value and in good faith.” The Trustee has the
burden of proving lack of good faith, SIPC v. BLMIS (In re BLMIS), 516 B.R. 18, 23-24
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(S.D.N.Y. 2014), and Legacy has the burden of proving value. Bayou, 439 B.R. at 308
(burden of proving “value” under 11 U.S.C. § 548(c) is on the transferee); cf. Picard v.
BNP Paribas S.A. (In re BLMIS), 594 B.R. 167, 206 (Bankr. S.D.N.Y. 2018) (subsequent
transferee must demonstrate that it gave value to prevail on defense under Bankruptcy
Code § 550(b)(1)); Dismissal Decision, 548 B.R. at 37 (same). The Court previously
ruled that the Trustee failed to adequately allege Legacy’s bad faith, see Dismissal
Decision, 548 B.R. at 28-35, and the remaining issue under section 548(c) is whether
Legacy received some or all of the Two-Year Transfers for value.
The parties agreed in the Transfers Stipulation that $126,674,219.00 in principal
was deposited into Legacy’s BLMIS account and $212,800,000 was withdrawn, leaving
a negative balance of $86,125,781.00. The Trustee’s expert computed the fictitious
profits in the slightly higher amount of $86,505,850.00. (See Expert Report of
Matthew B. Greenblatt, CPA/CFF, CFE, Senior Managing Director FTI Consulting,
Inc., Principal Balance Calculation as Applied to Legacy Capital Ltd., dated Feb. 20,
2017, ¶ 45.)11 The difference appears to relate to additional reductions based on
withholding taxes. (See id, Ex. 4D.) I leave to trial the determination of the correct
amount.
Legacy makes three arguments in support of its contention that the amount of
fictitious profits should be lower or even zero: (1) the Ponzi scheme started later than
11 A copy of Mr. Greenblatt’s report is attached to the Warshavsky Declaration as Exhibit 9.
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the Trustee argues; (2) Legacy earned profits from legitimate T-Bill trades in its account
that the Trustee ignores; and (3) the Two-Year Transfers satisfied antecedent debts.12
1. Ponzi Scheme Start Date
To determine a customer’s net equity in its BLMIS account, the Second Circuit
has endorsed the Trustee’s Net Investment methodology of subtracting cash
withdrawals from cash deposits and ignoring the fictitious securities and trading profits
that appeared on the customers’ monthly statements. In re BLMIS, 654 F.3d 229, 234-
40 (2d Cir. 2011), cert. denied, 567 U.S. 934 (2012). “Value” under section 548(c) is
computed in the same way. Picard v. Greiff (In re BLMIS), 476 B.R. 715, 725 (S.D.N.Y.
2012) (“transfers from [BLMIS] to defendants that exceeded the return of defendants’
principal, i.e., that constituted profits, were not ‘for value’”), aff’d on other grounds by
773 F.3d 411 (2d Cir. 2014), cert. denied, 135 S. Ct. 2859 (2015).
In some cases, a BLMIS account received a deposit through an inter-account
transfer from another BLMIS account. In determining the amount of the deposit to be
credited to the transferee account, the Trustee followed the same methodology. First, he
computed the actual balance in the transferor account under the Net Investment
method. Second, he gave the transferee account a credit up to the amount of the actual
balance and ignored the amount of any purported transfer to the extent it exceeded the
12 Arguably, the first two points, the Ponzi scheme start date and the profits from T-Bill trades, are foreclosed by the Transfers Stipulation. If correct, the cash deposits were greater than the stipulated amounts. Legacy raised these contentions in its opposition papers. The Trustee did not argue in his reply or at oral argument that these arguments were foreclosed by the Transfers Stipulation.
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actual balance. See Sagor v. Picard (In re BLMIS), 697 F. App’x 708, 710-11 (2d Cir.
2017).
In October 2000, Montpellier International LDC (“Montpellier”) transferred the
balance in its BLMIS account to Legacy’s BLMIS account.13 Utilizing the inter-account
methodology, the Trustee credited the Legacy account in the amount of $13,706,225.
(See Transfers Stipulation, Ex. A, at 7.) In computing the balance at the time of the
transfer, the Trustee assumed that the Ponzi scheme was in full force throughout the life
of the Montpellier account. Hence, he ignored trading profits appearing on
Montpellier’s monthly statements. If, however, the Ponzi scheme began after the
Montpellier account was opened, pre-scheme trading profits would have been real
instead of fictitious. In that case, the balance in the Montpellier BLMIS account at the
time of the transfer to Legacy would have been greater, the amount of the transfer to
Legacy would have been greater and the amount of Legacy’s liability for fictitious profits
would be smaller.
The Montpellier BLMIS account was opened on March 16, 1992, (id.), which may
have been before the Ponzi scheme began. The evidence submitted on this issue is
confusing. Madoff stated in his allocution that “[t]o the best of my recollection, my
fraud began in the early 1990s.” (Madoff Allocution at 25:12-13.) At his December 2016
deposition, Madoff for the most part stuck with 1992 as the year that the Ponzi scheme
began, (Madoff 12/20/16 Dep. Tr. at 19:14-17; 26:20-23), but added that 1992 was a
13 Legacy also received inter-account transfers from two other accounts held by Olympus Assets LDC and HCH Management Company Limited, but those accounts were opened in 1997 and 1999, respectively, (see Transfers Stipulation, Ex. A, at 8-9), well after the latest date suggested as the onset of the Ponzi scheme.
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“ballpark number” and the Ponzi scheme began “during the Gulf War situation.”14 (Id.
at 20:1-4.) During his April 2017 deposition, Madoff declared that although his Ponzi
scheme “began in 92,” BLMIS performed “some transactions” for its IA customers
“through 1993.” (Transcript of Deposition of Bernard L. Madoff, dated April 26, 2017
(“Madoff 4/26/17 Dep. Tr.”)15 at 91:7-12; accord id. at 12:1-4.) Moreover, while Madoff
never said that trades occurred in 1994, he answered in the affirmative to a question
that referenced 1994 as a timeframe for when BLMIS was still performing some trades.
(See id. at 92:9-12 (“Q. . . . [Y]ou testified earlier today that you were doing the split
strike trades until late 1993 or early 1994?16 A. Right.”); see also id. at 17:20-18:2.)
Other former BLMIS employees, however, fixed the onset of the Ponzi scheme to a much
earlier date. DiPascali stated that he realized that BLMIS was not trading securities in
the “late ‘80s or early ‘90s,” (DiPascali Allocution at 46:9-17), and David Kugel allocuted
that, “beginning in the early 70s,” he helped create “fake, backdated trades based on
historical stock prices” that were “executed only on paper.” (Transcript of Nov. 21, 2011
Hr’g in United States v. Kugel, No. 10 Cr. 228 (LTS) (“Kugel Allocution”) at 32:4-14.)17
14 Although not part of the record for purposes of this summary judgment motion, the Gulf War began and ended in the early part of 1991. See War in the Gulf: The White House; Transcript of President’s Address on the Gulf War, N.Y. TIMES, Feb. 28, 1991, available at https://www.nytimes.com/1991/02/28/world/war-gulf-white-house-transcript-president-s-address-gulf- war.html?searchResultPosition=11.
15 A copy of Madoff 4/26/17 Dep. Tr. is attached as Exhibit B to the Declaration of Nicholas F. Kajon in Opposition to the Trustee’s Motion for Summary Judgment, dated Mar. 1, 2019 (“Kajon Declaration”) (ECF Doc. # 199-1).
16 Counsel did not object to this question at the deposition.
17 A copy of the Kugel Allocution is attached to the Warshavsky Declaration as Exhibit 4.
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Viewing the evidence in the light most favorable to Legacy, it is possible that the
Ponzi scheme did not begin until sometime in 1994 and any prior trades and profits
derived from those trades in the Montpellier account were real. The Court cannot
determine as a matter of law the date when the Ponzi scheme began and hence, the
actual balance transferred from Montpellier to Legacy is a genuine issue of disputed
fact.
2. T-Bills Allocated to Customers
Although BLMIS’ purchase of T-Bills does not affect the conclusion that BLMIS
was operated as a Ponzi scheme for the purposes of the Ponzi scheme presumption, a
related but separate question is whether the profits made by a BLMIS customer such as
Legacy from actual T-Bill purchases allocated to its BLMIS account during the Ponzi
scheme were real rather than fictitious and, therefore, increased the account balance
and decreased the amount of fictitious profits. Legacy matched five such transactions to
its own BLMIS account,18 but a discussion of just one illustrates its point. On May 9,
2002, BLMIS purchased approximately $100 million worth of T-Bills, due July 25,
2002, from Morgan Stanley. (Mayer Declaration, Ex. 2.) According to BLMIS’s
records, a corresponding trade confirmation sent to Legacy showed that BLMIS sold
Legacy approximately $12.4 million worth of the same T-Bills on May 20, 2002, (id., Ex.
3), and the transaction also appeared on Legacy’s May 2002 BLMIS account statement.
18 The actual matching was performed by Rafael Mayer, the managing member of Khronos LLC, which provided accounting and financial services to Legacy. (Declaration of Rafael Mayer in Opposition to the Trustee’s Motion for Summary Judgment, dated Feb. 28, 2019 (“Mayer Declaration”), at ¶ 1 (ECF Doc. # 199-11).) The records he matched are admissible, and the Court can perform the same task. As Mayer lacked personal knowledge of the five sets of trades he discussed in his declaration, I discount his declaration, including his speculation that there are more than five sets of matching trades, in its entirety.
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(Id., Ex. 4.) BLMIS’s records then indicated that Legacy sold the same T-Bills back to
BLMIS on July 19, 2002, (id., Exs. 5, 6), and BLMIS sold the original $100 million of T-
Bills back to Morgan Stanley on July 25, 2002. (Id., Ex. 7.) According to Legacy’s
monthly customer statements, it earned approximately $35,000.00 in profit from that
buy-sell transaction. Legacy argues as a factual matter that BLMIS allocated actual T-
Bill purchases to its account, and as a legal matter, the profits from the T-Bill
transactions reduced its potential liability for fictitious profits.
The parties dispute whether the T-Bills that appeared in the trade confirmations
and monthly statements were real or, alternatively, were fictitious like the equity
securities in the same statements and unrelated to the actual T-Bills purchases by
BLMIS from third-party brokers. The proof offered by the parties was mixed. During
his allocution, Madoff described the SSC strategy, which included the timed purchases
of T-Bills, and said that none of the transactions took place in the customers’ accounts.
At his deposition, however, he answered a series of questions indicating that he
purchased the T-Bills for the customers and those purchases were reflected on the
BLMIS customer statements:
Q. So you basically took the money that went into the 703 account?
A. Correct.
Q. Which was the investment advisory customers’ money?
A. Correct.
Q. And you purchased Treasury bills with that?
A. Correct.
Q. And in the early '90s the Treasury bills were bearing an interest rate of about six percent; isn’t that true?
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A. No. . . . [T]hey were short-term T bills, so they were probably . . . closer to three to four percent.
Q. Okay. And that three to four percent was money that was earned by the customers . . . whose money you were using?
A. Correct.
Q. And, in fact, the statements reflected the ownership of those Treasury securities?
A. Correct. And they . . . also . . . reflected the ownership of the securities that I wasn’t buying.
(Madoff 4/26/17 Dep. Tr. at 19:3-20:1; accord id. at 44:16-22.) However, in the same
deposition, Madoff stated that the T-Bills were purchased to benefit his brokerage firm:
Q. And [the T-Bills] would have been held for the benefit of the investment advisory customers?
A. It would have been . . . held at the firm for the benefit of the firm. We didn’t segregate . . . these securities.
(Id. at 40:2-6.)
In contrast, DiPascali testified during the criminal trial against multiple, former
BLMIS employees, United States v. Bonventre, No. 10 Cr. 228 (LTS), that although T-
Bills were purchased using customer property to earn additional interest, those
purchases were not reflected on the IA customer statements, and the T-Bills trades on
the IA customer statements were entirely fake:
Q. From time to time did you get real treasury bills?
A. Yes.
Q. And what were those real treasury bills for?
A. To invest the excess cash in the IA checking account.
Q. And when you say to invest the excess cash in the IA checking account, for what reason did you get a treasury bill to do that?
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A. So as to provide safety and an enhanced yield to what the checking account interest rate was.
Q. So it would be fair to say it would be a way of getting interest on the checking account?
A. More or less, yes.
. . .
Q. Now, for . . . the IA side . . . when you would provide the fake information, what would you do there?
A. I’d look at a pricing service of historical prices of treasury bills, ascertain the price on the date that I needed and write a ticket and put it into the AS/400.
. . .
Q. Now, what was your understanding of what Ms. Bongiorno would do with the treasury information that you gave to her?
A. She would put through a buy ticket that was approximately equal to the cash credit balance reflected in the account she was working on, and it would produce a confirmation and an entry on the customer statement that . . . now - - owned treasuries.
Q. And as with the other trading that was on those accounts, was any of it real?
A. No.
(Criminal Trial 12/5/13 Tr. at 4931:12-4933:13; accord Transcript of United States v.
Bonventre, No. 10 Cr 228 (LTS), dated Dec. 4, 2013 at 4804:6-12.)19
Much of the Trustee’s reply dealt with the five sets of T-Bill trades that Mayer had
identified and pointed to inconsistencies in the evidence. These discrepancies and the
relationship, if any, between BLMIS’s purchase of T-Bills from brokers and the apparent
19 A copy of the December 4 trial transcript is attached as Exhibit 1 to the Warshavsky Reply Declaration. Legacy did not object to the use of DiPascali’s trial testimony.
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resale of a portion of those purchases to customers like Legacy raise factual issues that
the Court cannot resolve on this motion.
This does not necessarily mean that the disputed factual issue regarding the
allocation of actual T-Bill purchases to Legacy’s account is material. The Court in Wing
v. Layton referred to the oft-cited opinion of Circuit Judge Posner in Scholes v.
Lehmann, 56 F.3d 750 (7th Cir.), cert. denied, 516 U.S. 1028 (1995). There, the Ponzi-
scheme fraudster (“Douglas”) promised investors returns from commodities trading.
Id. at 752. Although Douglas engaged in some commodities trades, most of the money
raised from investors was used to pay the returns promised to earlier investors. Id.
Douglas’s scheme lasted two years, he was arrested for fraud, and a receiver was
appointed. Id. The receiver commenced fraudulent conveyance actions under state law
against Phillips, a net winner investor in Douglas’s Ponzi scheme. Id. at 753, 755.
Like the defendant in Wing v. Layton, Phillips argued that he was entitled to
keep the profits derived from legitimate trades. Rejecting Phillips’s argument, Judge
Posner opined that profits earned with other people’s money are not legitimate:
It is no answer that some or for that matter all of Phillips’s profit may have come from “legitimate” trades made by the corporations. They are not legitimate. The money used for the trades came from investors gulled by fraudulent representations. Phillips was one of those investors, and it may seem “only fair” that he should be entitled to the profits on trades made with his money. That would be true as between him and Douglas or Douglas’s corporations. It is not true as between him and either the creditors of or the other investors in the corporations. He should not be permitted to benefit from a fraud at their expense merely because he was not himself to blame for the fraud.
Id. at 757; accord Slatkin, 525 F.3d at 815 (“Although the Johnsons argue that there is a
question of fact as to whether the purported profits they received were from ‘legitimate’
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investments made by Slatkin, in truth none of the trades made by Slatkin were
‘legitimate’ because the money used for the trades came from investors gulled by
Slatkin’s fraudulent representations.”).
This case illustrates Judge Posner’s point. Legacy was a substantial net winner.
Its withdrawals exceeded its deposits by over $86 million. Even if Legacy received the
benefits of Montpellier’s early trades and the T-Bill profits realized from purchases
made with its own principal deposits, it still received tens of millions of dollars of
fictitious profits resulting from imaginary equity trades paid with other customers’
funds. Once Legacy exhausted the net equity in its account, BLMIS necessarily used
other investors’ property to make the profitable T-Bill trades for which Legacy demands
credit. I question the logic of this argument, but the parties did not address it and I do
not decide it.
3. Antecedent Debt
Finally, Legacy argues that it provided “value” within the meaning of section
548(c) because the transfers from BLMIS satisfied antecedent debts. See 11 U.S.C. §
548(d)(2)(A) (“value” includes the satisfaction of an antecedent debt of the debtor). As
a victim of the fraud, Legacy had numerous statutory and common law claims against
BLMIS and Madoff. Legacy maintains that the withdrawals from its BLMIS account
satisfied BLMIS’s liability to Legacy arising from BLMIS’s fraud, breach of fiduciary
duty and breach of contract claims under state law, and because Legacy was entitled to
the securities that appeared on its customer statements under the New York Uniform
Commercial Code. (Legacy Brief at 20-24; see also Sur-Reply of Legacy Capital Ltd. in
Response to Reply Memorandum of the Securities Investor Protection Corporation in
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Support of the Trustee’s Motion for Summary Judgment, dated Apr. 4, 2019 (“Legacy
Sur-Reply”) (ECF Doc. # 212).)
These arguments have been rejected on multiple occasions by the District Court
and this Court in other fraudulent transfer actions brought by the Trustee. See Picard v.
Lowrey (In re BLMIS), 596 B.R. 451, 464 (S.D.N.Y. 2019) (“Lowrey II”) (Engelmayer,
J), appeal docketed, No. 19-429(L) (2d Cir. Feb. 20, 2019); SIPC v. BLMIS (In re
BLMIS), 499 B.R. 416, 422-26 (S.D.N.Y. 2013) (“Antecedent Debt Decision”) (Rakoff, J),
certification for interlocutory appeal denied, 987 F. Supp. 2d 309 (S.D.N.Y. 2013);
Picard v. Greiff, 476 B.R. at 724-26; Picard v. Goldenberg (In re BLMIS), No. 10-
04946(SMB), 2018 WL 3078149, at *4-5 (Bankr. S.D.N.Y. June 19, 2018) (report and
recommendation); Picard v. Cohen (In re BLMIS), 2016 WL 1695296, at *6-13 (Bankr.
S.D.N.Y. Apr. 25, 2016) (report and recommendation), adopted by No. 16 Civ. 5513
(LTS), slip op. (S.D.N.Y. Feb. 24, 2016); SIPC v. BLMIS (In re BLMIS), 531 B.R. 439,
461-63 (Bankr. S.D.N.Y. 2015) (“Omnibus Good Faith Decision”).
These decisions have established that a transferee in a Ponzi scheme does not
give value beyond his deposit of principal. See, e.g., Lowrey II, 596 B.R. at 464 (“where
defendants seek rescission and have received full repayment on the principal
investment, they have no freestanding interest claim”) (quoting Antecedent Debt
Decision, 499 B.R. at 422); Antecedent Debt Decision, 499 B.R. at 421 n. 4; Greiff, 476
B.R. at 725 (ruling that transfers in excess of principal were not “for value” and noting
that “every circuit court to address this issue has concluded that an investor’s profits
from a Ponzi scheme, whether paper profits or actual transfers, are not ‘for value’”);
Omnibus Good Faith Decision, 531 B.R. at 462-63 (citing authorities); see also
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Silverman v. Cullin (In re Agape World, Inc.), 633 F. App’x 16, 17 (2d Cir.) (noting that
the “prevailing view” among district and bankruptcy courts in the Second Circuit is to
treat the payment of interest in Ponzi schemes as fraudulent transfers because “fair
consideration” is not present in the context of such schemes) (summary order), cert.
denied, 137 S. Ct. 160 (2016). In addition, a broker cannot use customer property to
satisfy his personal liability. Hence, a transferee of the broker cannot defend against a
SIPA trustee’s claim for the return of customer property by arguing that the earlier
transfer of customer property satisfied the transferee’s statutory and common law
claims against the broker. See, e.g., Lowrey II, 596 B.R. at 464 (quoting Antecedent
Debt Decision, 499 B.R. at 424) (alteration omitted); accord Cohen, 2016 WL 1695296,
at *11.20
Legacy argues, (see Legacy Brief at 21-22; Legacy Sur-Reply at 2-4), that the
above precedent was overruled by the Second Circuit’s decision in Picard v. Ida
Fishman Revocable Tr. (In re BLMIS), 773 F.3d 411 (2d Cir. 2014), cert. denied, 135 S.
Ct. 2859 (2015), but this argument has also been rejected on numerous occasions by this
Court and the District Court. See Lowrey II, 596 B.R. at 466-67 (“the Second Circuit did
not, in Ida Fishman or elsewhere, upset ‘the general rule in Ponzi scheme cases limiting
value to principal deposits’”) (quoting Lowrey I, 2018 WL 1442312, at *13); Cohen, 2016
WL 1695296, at *12-13; Omnibus Good Faith Decision, 531 B.R. at 469-70.
20 Non-bankruptcy law similarly prohibits a broker from using customer property held by the broker to discharge the broker’s personal debts. See Picard v. Lowrey (In re BLMIS), No. 10-04387 (SMB), 2018 WL 1442312, at *10-11 (Bankr. S.D.N.Y. Mar. 22, 2018) (report and recommendation) (“Lowrey I”), adopted by 596 B.R. 451 (S.D.N.Y. 2019), appeal docketed, No. 19-429(L) (2d Cir. Feb. 20, 2019).
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Last, Legacy argues, (see Legacy Brief at 18-20), that the Trustee’s method for
calculating its fraudulent transfer exposure violates the two-year-reach-back period set
forth in 11 U.S.C. § 548(a)(1), citing to the Supreme Court decision in Cal. Pub.
Employees’ Ret. Sys. v. ANZ Sec., Inc., 137 S. Ct. 2042 (2017). Like the other
arguments, this specific argument has also failed. See Lowrey II, 596 B.R. at 470-72;
Lowrey I, 2018 WL 1442312, at *14; accord Antecedent Debt Decision, 499 B.R. at 427-
28.
These rulings constitute law of the case, see In re Motors Liquidation Co., 590
B.R. 39, 62 (S.D.N.Y. 2018) (law of the case doctrine applies across adversary
proceedings within the same bankruptcy case), appeal docketed, No. 18-1939 (2d Cir.
June 28, 2018); accord Moise v. Ocwen Loan Servicing LLC (In re Moise), 575 B.R. 191,
205 (Bankr. E.D.N.Y. 2017), and the Court declines Legacy’s invitation to revisit these
prior decisions. But even if they did not establish the law of the case, the Court would
follow the earlier precedent for the reasons they explained.
CONCLUSION
The Trustee has shown that there is no genuine material issue of fact regarding
his prima facie case and those facts are deemed established for the purposes of this
adversary proceeding. The Trustee’s motion for summary judgment is otherwise
denied. The Court has considered the parties’ other arguments and concludes that they
lack merit or are mooted by the disposition of the motion. The Trustee is directed to
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settle an order on notice that sets forth the established facts. The parties are also
directed to schedule a conference with chambers to fix a trial date.
Dated: New York, New York June 25, 2019
/s/ Stuart M. Bernstein STUART M. BERNSTEIN United States Bankruptcy Judge
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UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK
SECURITIES INVESTOR PROTECTION No. 08-01789 (SMB) CORPORATION, Plaintiff,
v. SIPA Liquidation BERNARD L. MADOFF INVESTMENT SECURITIES LLC, (Substantively Consolidated) Defendant.
In re:
BERNARD L. MADOFF,
Debtor.
IRVING H. PICARD, Trustee for the Liquidation of Bernard L. Madoff Investment Securities LLC,
Plaintiff, Adv. Pro. No. 10-05286 (SMB) v.
LEGACY CAPITAL LTD.,
Defendant.
ORDER DENYING THE TRUSTEE’S MOTION FOR SUMMARY JUDGMENT AND GRANTING RELIEF UNDER FEDERAL RULE OF CIVIL PROCEDURE 56(g)
The Court has considered the motion of Irving H. Picard (the “Trustee”), as Trustee for the
liquidation of the business of Bernard L. Madoff Investment Securities LLC (“BLMIS”) under the
Securities Investor Protection Act, 15 U.S.C. §§ 78aaa-lll, and the substantively consolidated chapter
7 estate of Bernard L. Madoff (“Madoff”), seeking summary judgment pursuant to Federal Rule of
Civil Procedure 56, as incorporated in this proceeding by Federal Rule of Bankruptcy Procedure
7056 (the “Motion”) (ECF Nos. 190-193); Defendant Legacy Capital, Ltd. (“Legacy”)’s
memorandum of law in opposition to the Motion and its accompanying documents (ECF No. 199); Case 20-1334, Document 73, 08/06/2020, 2902485, Page174 of 180 SPA-91
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the Trustee’s submissions in further support of the Motion (ECF Nos. 201-02); Legacy’s sur-reply in
further opposition to the Motion (ECF No. 212); the arguments of counsel at the hearing on April 9,
2019, and the record in the case.
Accordingly, for the reasons set forth in the Memorandum Decision and Order Granting
Relief Under Federal Rule of Civil Procedure 56(g) dated June 25, 2019 (ECF No. 221), IT IS
HEREBY ORDERED that:
(1) The Trustee has established that there is no genuine disputed issue of fact that: (a)
BLMIS was a Ponzi scheme and that it transferred its interest in $174 million to or for the benefit
of Legacy, within the meaning of 11 U.S.C. § 550(a)(1), in furtherance of the Ponzi scheme
within two years of December 11, 2008 (the “Two-Year Transfers”); (b) the BLMIS Ponzi
scheme was ongoing during the period of the Two-Year Transfers; and (c) the Two-Year
Transfers were made in connection with the Ponzi scheme in large part from the property of
other customers;
(2) The criminal allocutions of Madoff, Frank DiPascali, David Kugel, Irwin Lipkin, Eric
Lipkin and Enrica Cotellessa-Pitz establish prima facie that Madoff ran BLMIS as a Ponzi
scheme;
(3) The Trustee is entitled to rely on the Ponzi scheme presumption, and has established
as a matter of law that the Two-Year Transfers were made with the transferor’s actual intent to
defraud;
(4) With respect to the value defense asserted by Legacy under Section 548(c) of the
Bankruptcy Code (the “Value Defense”), Legacy bears the burden of proof;
(5) The Court will hold a trial to determine, with respect to Legacy’s Value Defense: (i)
the start date of the BLMIS Ponzi scheme; and (ii) whether the profits reported on Legacy’s
BLMIS account statements arising from BLMIS’s purported U.S. Treasury Bill trades were real
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and resulted from BLMIS’s purchase of those U.S. Treasury Bills from third party brokers for
Legacy’s benefit;
(6) The Two-Year Transfers did not satisfy antecedent debts, based on the law of the
case and established case precedent that a transferee in a Ponzi scheme does not give value
beyond his deposit of principal;
(7) The Trustee and Legacy will confer and schedule a conference with this Court’s
chambers to fix a trial date on issues identified in paragraph 5 above; and
(8) The Trustee’s Motion is otherwise denied.
Dated: July 9th, 2019
/s/ STUART M. BERNSTEIN______HONORABLE STUART M. BERNSTEIN UNITED STATES BANKRUPTCY JUDGE
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UNITED STATES BANKRUPTCY COURT SOUTHERN DISTRICT OF NEW YORK
SECURITIES INVESTOR PROTECTION CORPORATION, No. 08-01789 (SMB) Plaintiff-Applicant, SIPA LIQUIDATION v. (Substantively Consolidated)
BERNARD L. MADOFF INVESTMENT SECURITIES LLC,
Defendant.
In re:
BERNARD L. MADOFF,
Debtor.
IRVING H. PICARD, Trustee for the Liquidation of Bernard L. Madoff Investment Securities LLC,
Plaintiff, Adv. Pro. No. 10-05286 (SMB) v.
LEGACY CAPITAL LTD., %& Defendant.
FINAL JUDGMENT AND ORDER
Plaintiff Irving H. Picard (the “Trustee”) commenced this adversary proceeding on
December 6, 2010 seeking to avoid and recover fraudulent transfers allegedly received by Legacy
Capital Ltd. (“Legacy”) in connection with BLMIS account 1FR071.
IT IS HEREBY ORDERED AND ADJUDGED THAT: 1. Pursuant to the terms of the Stipulation and Order for Entry of Final Judgment dated
November 8, 2019, judgment is hereby entered in favor of the Trustee and against Legacy in the amount of $79,125,781.00. The Clerk is instructed to enter judgment for the Trustee in such Case 20-1334, Document 73, 08/06/2020, 2902485, Page177 of 180 SPA-94
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amount; and
2. The Clerk shall enter judgment and close the case.
Dated: November 12, 2019_
IT IS SO ORDERED: /s/ STUART M. BERNSTEIN ______HON. STUART M. BERNSTEIN United States Bankruptcy Judge
- 2 - Case 20-1334, Document 73, 08/06/2020, 2902485, Page178 of 180 SPA-95
TITLE 11 – UNITED STATES BANKRUPTCY CODE
11 U.S.C. § 548(a)(1)(A), (c)
(a)(1) The trustee may avoid any transfer (including any transfer to or for the benefit of an insider under an employment contract) of an interest of the debtor in property, or any obligation (including any obligation to or for the benefit of an insider under an employment contract) incurred by the debtor, that was made or incurred on or within 2 years before the date of the filing of the petition, if the debtor voluntarily or involuntarily—
(A) made such transfer or incurred such obligation with actual intent to hinder, delay, or defraud any entity to which the debtor was or became, on or after the date that such transfer was made or such obligation was incurred, indebted; or
(c) Except to the extent that a transfer or obligation voidable under this section is voidable under section 544, 545, or 547 of this title, a transferee or obligee of such a transfer or obligation that takes for value and in good faith has a lien on or may retain any interest transferred or may enforce any obligation incurred, as the case may be, to the extent that such transferee or obligee gave value to the debtor in exchange for such transfer or obligation.
11 U.S.C. § 550
(a) Except as otherwise provided in this section, to the extent that a transfer is avoided under section 544, 545, 547, 548, 549, 553(b), or 724(a) of this title, the trustee may recover, for the benefit of the estate, the property transferred, or, if the court so orders, the value of such property, from—
(1) the initial transferee of such transfer or the entity for whose benefit such transfer was made; or
(2) any immediate or mediate transferee of such initial transferee.
(b) The trustee may not recover under section1 (a)(2) of this section from—
(1) a transferee that takes for value, including satisfaction or securing of a present or antecedent debt, in good faith, and without knowledge of the voidability of the transfer avoided; or
(2) any immediate or mediate good faith transferee of such transferee. Case 20-1334, Document 73, 08/06/2020, 2902485, Page179 of 180 SPA-96
TITLE 15 – SECURITIES INVESTOR PROTECTION ACT
15 U.S.C. § 78bbb
Except as otherwise provided in this chapter, the provisions of the Securities Exchange Act of 1934 [15 U.S.C. 78a et seq.] (hereinafter referred to as the 1934 Act) apply as if this chapter constituted an amendment to, and was included as a section of, such Act.
15 U.S.C. § 78eee(b)(4)
(b) Court action
(4) Removal to bankruptcy court
Upon the issuance of a protective decree and appointment of a trustee, or a trustee and counsel, under this section, the court shall forthwith order the removal of the entire liquidation proceeding to the court of the United States in the same judicial district having jurisdiction over cases under Title 11. The latter court shall thereupon have all of the jurisdiction, powers, and duties conferred by this chapter upon the court to which application for the issuance of the protective decree was made.
15 U.S.C. § 78fff(b)
(b) Application of Title 11
To the extent consistent with the provisions of this chapter, a liquidation proceeding shall be conducted in accordance with, and as though it were being conducted under chapters 1, 3, and 5 and subchapters I and II of chapter 7 of Title 11. For the purposes of applying such title in carrying out this section, a reference in such title to the date of the filing of the petition shall be deemed to be a reference to the filing date under this chapter.
15 U.S.C. § 78fff-2(c)(3)
(c) Customer related property
(3) Recovery of transfers
Whenever customer property is not sufficient to pay in full the claims set forth in subparagraphs (A) through (D) of paragraph (1), the trustee may recover any property transferred by the debtor which, except for such transfer, would have been customer property if and to the extent that such transfer is voidable or void under the provisions of Case 20-1334, Document 73, 08/06/2020, 2902485, Page180 of 180 SPA-97
Title 11. Such recovered property shall be treated as customer property. For purposes of such recovery, the property so transferred shall be deemed to have been the property of the debtor and, if such transfer was made to a customer or for his benefit, such customer shall be deemed to have been a creditor, the laws of any State to the contrary notwithstanding.