In re Bernard L. Madoff Inv. Sec. Llc

• Citation: 440 B.R. 243
• Decision Date: 17 November 2010
• Docket Number: Bankruptcy No. 08-01789 (BRL),Adversary No. 09-1182 (BRL)
• Parties: In re BERNARD L. MADOFF INVESTMENT SECURITIES LLC, Debtor. Irving H. Picard, Trustee for the Liquidation of Bernard L. Madoff Investment Securities LLC, Plaintiff, v. J. Ezra Merkin, Gabriel Capital, L.P., Ariel Fund Ltd., Ascot Partners, L.P., Gabriel Capital Corporation, Defendants.
• Court: United States Bankruptcy Courts. Second Circuit. U.S. Bankruptcy Court — Southern District of New York

440 B.R. 243

In re BERNARD L. MADOFF INVESTMENT SECURITIES LLC, Debtor.Irving H. Picard, Trustee for the Liquidation of Bernard L. Madoff Investment Securities LLC, Plaintiff,

v.J. Ezra Merkin, Gabriel Capital, L.P., Ariel Fund Ltd., Ascot Partners, L.P., Gabriel Capital Corporation, Defendants.

Bankruptcy No. 08-01789 (BRL).

Adversary No. 09-1182 (BRL).

United States Bankruptcy Court, S.D. New York.

Nov. 17, 2010.

Baker & Hostetler LLP, New York, NY, by David J. Sheehan, Marc E. Hirschfield, Marc D. Powers, for Irving H. Picard, Trustee for the Substantively Consolidated SIPA Liquidation of Bernard L. Madoff Investment Securities LLC and Bernard L. Madoff.

Dechert LLP, New York, NY, by Andrew J. Levander, Neil A. Steiner, Dechert LLP, Washington, D.C., by Steven A. Engel, for J. Ezra Merkin and Gabriel Capital Corporation.

Reed Smith LLP, New York, NY, by James C. McCarroll, Lance Gotthoffer, for Bart M. Schwartz, Receiver of Gabriel Capital, L.P. and Ariel Fund Limited.

MEMORANDUM DECISION AND ORDER GRANTING IN PART AND DENYING IN PART DEFENDANTS' MOTIONS TO DISMISS TRUSTEE'S COMPLAINT

BURTON R. LIFLAND, Bankruptcy Judge.

Before this Court are the motions (the "Motions to Dismiss") of (1) J. Ezra Merkin("Merkin") and Gabriel Capital Corporation ("GCC," and together with Merkin, the "Merkin Defendants"), and (2) Ariel Fund Limited ("Ariel") and Gabriel Capital, L.P. ("Gabriel," and together with Ariel, the "Fund Defendants" or the "Funds") (collectively, the "Moving Defendants") seeking to dismiss the second amended complaint (the "Complaint") of Irving H. Picard, Esq. (the "Trustee" or "Plaintiff"), trustee for the substantively consolidated Securities Investor Protection Act ¹ ("SIPA") liquidation of Bernard L. Madoff Investment Securities LLC ("BLMIS") and Bernard L. Madoff ("Madoff"), filed pursuant to SIPA sections 78fff(b) and 78fff-2(c)(3), sections 105(a), 502(d), 542, 544, 547, 548(a), 550(a) and 551 of the Bankruptcy Code (the "Code"), various sections of New York Debtor and Creditor Law ² (the "NYDCL") and other applicable law for turnover, accounting, preferences, fraudulent conveyances, damages, and objections to SIPA claims.

The Moving Defendants assert that the Complaint fails to state a claim upon which relief can be granted pursuant to Federal Rule of Civil Procedure ("Rule") 12(b)(6), made applicable herein by Federal Rule of Bankruptcy Procedure ("Bankruptcy Rule") 7012, and should be dismissed in its entirety.

For the reasons set forth below and at oral argument, the Motions to Dismiss are GRANTED in part and DENIED in part. Specifically, the Motions to Dismiss are GRANTED with respect to Counts One and Two of the Complaint, seeking immediate turnover under section 542 of the Code and avoidance of preferential transfers under section 547(b) of the Code, respectively. The Motions to Dismiss all remaining counts of the Complaint are DENIED.

BACKGROUND ³

The Complaint arises in connection with the infamous Ponzi scheme perpetrated by Bernard L. Madoff for decades through his investment company, BLMIS. As recognized by the Securities Investor Protection Corporation ("SIPC"), "this is not a typical SIPC proceeding in which securities or cash were on hand at the time of the failure of the brokerage house." Letter from Stephen P. Harbeck, President of SIPC to the Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises at p. 6 (dated Sept. 7, 2010) [hereinafter "SIPC Letter"]. Rather, it was a fraud of unparalleled magnitude "in which the only assets were other people's money or assets derived from such funds." Id. During the course of this fraud, there were approximately 90,000 disbursements of fictitious profits to Madoff investors totaling $18.5 billion. Id. at p. 5. Due to the longstanding nature of the Ponzi scheme, many of the customer accounts presented multiple generational investments, requiring the Trustee to conduct a full forensic analysis of all of BLMIS's books and records, dating back to at least the early 1980s. Id. at p. 7. As of November 12, 2010, the Trustee has determined 14,769 claims, denied 2,752 claims, and allowed 2,291 claims in the amount of $5,739,853,405.38. Moreover,SIPC has committed $743,928,341.68 in SIPC advances to these claimants. See http:// www. madofftrustee. com (last visited Nov. 16, 2010). The Trustee has reviewed, and continues to review, millions of documents to determine the thousands of customer claims filed in this SIPA liquidation. SIPC Letter at p. 7.

The Trustee has filed 19 complaints thus far, seeking to recover, in the aggregate, approximately $15 billion. Id. at p. 5. In the instant Complaint, the Trustee is seeking to recover transfers in the collective amount of over $490 million.

I. Events Preceding the Complaint

On December 11, 2008 (the "Filing Date"),⁴ Madoff was arrested by federal agents and charged with securities fraud in violation of SIPA sections 78j(b) and 78ff, and 17 C.F.R. section 240.10b-5 in the United States District Court for the Southern District of New York (the "District Court"). United States v. Madoff, No. 08-MJ-02735, 2008 WL 5197082 (S.D.N.Y. filed Dec. 11, 2008). That same day, the Securities and Exchange Commission (the "SEC") filed a civil complaint in the District Court, alleging, inter alia, that Madoff and BLMIS were operating a Ponzi scheme through BLMIS's investment advisor activities. S.E.C. v. Madoff, et al., No. 08-CV-10791 (S.D.N.Y. filed Dec. 11, 2008) (the "Civil Action").

On December 15, 2008, SIPC filed an application in the Civil Action seeking a decree that the customers of BLMIS are in need of the protections afforded under SIPA. The District Court granted SIPC's application and entered an order on December 15, 2008, placing BLMIS's customers under the protections of SIPA (the "Protective Order"). The Protective Order appointed Plaintiff as trustee for the liquidation of the business of BLMIS and removed the SIPA liquidation proceeding to this Court pursuant to SIPA section 78eee(b)(3) and (b)(4), respectively.

On March 12, 2009, Madoff pled guilty to an 11-count criminal indictment filed against him and admitted that he "operated a Ponzi scheme through the investment advisory side of [BLMIS]." Transcript of Plea Hearing at 23:14-17, United States v. Madoff, No. 09-CR-213 (DC) (Dkt. No. 57). On June 29, 2009, Madoff was sentenced to 150 years in prison.

II. The Ponzi Scheme

BLMIS was a New York limited liability company registered with the SEC as a securities broker-dealer under section 15(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78 o (b). It was run by its founder, chairman and chief executive officer, Madoff, with several family members and a number of additional employees. BLMIS had three business units: investment advisory (the "IA Business"), market making, and proprietary trading.

Madoff's fraudulent activity was perpetrated though BLMIS's IA Business. To facilitate his fraud, Madoff would generate customer account statements purportedly showing securities that either were held or had been traded, as well as the gains and losses in those accounts. However, as Madoff admitted at his plea hearing, none of the purported purchases of securities in the BLMIS customer accounts had actually occurred, and the reported gains were entirely fictitious. This has been confirmed by the Trustee's investigation, which reveals that with the exception of isolated individual trades, there is no record of BLMIS having cleared any purchase or sale of securities in the Depository Trust & Clearing Corporation.Accordingly, the money Madoff received from his investors was not used to buy any securities; rather, it was used to pay other investors when requests for distribution of "profits" were made. Thus, any payment of "profit" to a BLMIS customer came from another BLMIS customer's initial investment. Ultimately, the requests for payments exceeded the inflow of new investments, resulting in the eventual collapse of the Ponzi scheme.

III. The Defendants

Merkin is a sophisticated investment manager who, individually or through his company, GCC, managed several investment funds, which, from at least 1995 through 2008, collectively withdrew more than $500 million from BLMIS prior to the collapse of Madoff's scheme. In connection with the management of these investments, Merkin, either individually or through GCC, earned substantial commissions and performance fees. Merkin is the sole shareholder and sole director of GCC, a corporation organized under the laws of Delaware with a principal place of business at 450 Park Avenue, # 3201, New York, New York 10022. The Trustee alleges that Merkin completely dominated GCC in dealing with BLMIS, using GCC as a mere instrument to facilitate Merkin's personal interests, rather than any corporate ends. As a result, GCC functioned as the alter ego of Merkin, such that no corporate veil could be maintained between them.

Merkin was also the sole general partner of Gabriel, a limited partnership organized under the laws of Delaware with a principal place of business at 450 Park Avenue, # 3201, New York, New York 10022. At all relevant times, Merkin's company, GCC, was the investment advisor to Ariel, a mutual fund organized under the Mutual Funds Law of the Cayman Islands with a principal place of business in New York, New York. Ariel and Gabriel executed a Customer Agreement, an Option Agreement and a Trading Authorization Limited to Purchases and Sales of Securities and Options (the "Account Agreements") in opening their BLMIS accounts.

Merkin was also the sole general partner of Ascot Partners, L.P. ("Ascot," and together with the Moving Defendants, the "Defendants"), a limited partnership organized under the laws of Delaware with a principal place of business at 450 Park Avenue, # 3201, New York, New York 10022. Ascot includes the former Ascot Fund, Ltd., which was merged into Ascot in early 2003. Like Ariel and Gabriel, Ascot also executed the...