In re Bernard L. Madoff Inv. Sec. LLC
| Citation | 548 B.R. 13 |
| Decision Date | 14 March 2016 |
| Docket Number | Case No. 08–99000 (SMB),Adv. P. No. 10–05286 (SMB),Adv. Proc. No. 08–01789 (SMB) |
| 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, Legacy Capital Ltd. and Khronos LLC, Defendants. |
| Court | United States Bankruptcy Courts. Second Circuit. U.S. Bankruptcy Court — Southern District of New York |
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, N.Y. 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, N.Y. 10022, Nicholas F. Kajon, Esq. Of Counsel
BINDER & SCHWARTZ LLP, Attorneys for Khronos LLP, 28 West 44th Street–Suite 700, New York, N.Y. 10036–4039, Eric B. Fisher, Esq., Lindsay S. Bush, Esq., Of Counsel
SIPA LIQUIDATION
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.
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 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 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.)
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.)
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.)
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, (¶ 49.) Meritage Committee member James Simons wrote the same day, "[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.)
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 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:
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