Irving H. Picard, Tr. for the Liquidation of Bernard L. Madoff Inv. Sec. LLC v. J. Ezra Merkin, Gabriel Capital, L.P. (In re Bernard L. Madoff Inv. Sec. LLC)

• Citation: 515 B.R. 117
• Decision Date: 12 August 2014
• Docket Number: Adv. Proc. No. 08–01789 (SMB), Adv. Proc. No. 09–01182 (SMB),Case No. 08–99000 (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, v. J. Ezra Merkin, Gabriel Capital, L.P., Ariel Fund Ltd., Ascot Partners, L.P., Ascot Fund Ltd., Gabriel Capital Corporation, Defendants.
• Court: United States Bankruptcy Courts. Second Circuit. U.S. Bankruptcy Court — Southern District of New York

515 B.R. 117

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., Ascot Fund Ltd., Gabriel Capital Corporation, Defendants.

Case No. 08–99000 (SMB)

Adv. Proc. No. 08–01789 (SMB), Adv. Proc. No. 09–01182 (SMB)

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

Signed August 12, 2014

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, Marc E. Hirschfield, Esq., Marc D. Powers, Esq., David J. Sheehan, Esq., Of Counsel.

Dechert LLP, Attorneys for Defendants J. Ezra Merkin & Gabriel Capital Corporation, 1095 Avenue of the Americas, New York, NY 10036, Andrew J. Levander, Esq., Gary J. Mennitt, Esq., Jonathan D. Perry, Esq., Neil A. Steiner, Esq., M. Katherine Stroker, Esq., Of Counsel.

Reed Smith LLP, Attorneys for Defendants Gabriel Capital, L.P. & Ariel Fund Ltd., 599 Lexington Avenue, New York, NY 10022, Casey D. Laffey, Esq., James C. McCarroll, Esq., Jordan W. Siev, Esq., Of Counsel.

Fulbright & Jaworski L.L.P., Attorneys for Defendant Ascot Partners, L.P., 666 Fifth Avenue, New York, NY 10103, Judith A. Archer, Esq., David L. Barrack, Esq., Daniel M. Glosband, Esq., Christopher R. Newcomb, Esq., David B. Schwartz, Esq., Joseph A. Schwartz, Esq., Matthew T. Tulchin, Esq., Jami Mills Vibbert, Esq., Of Counsel.

Sadis & Goldberg LLP, Attorneys for Ascot Fund Ltd., 551 Fifth Avenue, 21st Floor, New York, NY 10176, Douglas R. Hirsch, Esq., Jennifer A. Rossan, Esq., Of Counsel.

SIPA LIQUIDATION

MEMORANDUM DECISION GRANTING IN PART AND DENYING IN PART DEFENDANTS' MOTIONS TO DISMISS

STUART M. BERNSTEIN, United States Bankruptcy Judge:

Irving H. Picard, trustee (the “Trustee”) for the liquidation of the estate of Bernard L. Madoff Investment Securities LLC (“BLMIS”), commenced this adversary proceeding to avoid and recover fraudulent transfers and disallow and/or subordinate certain defendants' claims. The defendants are direct or indirect feeder funds that invested in BLMIS and the persons that managed those funds. The defendants have moved to dismiss the Trustee's thirteen count complaint.¹ For the reasonsthat follow, the motion is granted to the extent of dismissing Counts One, Three through Eight and Eleven and Twelve, but is otherwise denied.

BACKGROUND

A. Madoff and BLMIS²

The background information is derived from the well-pleaded factual allegations of the TAC and other information that the Court may consider on a motion to dismiss for failure to state a claim. Bernard L. Madoff operated a Ponzi scheme through BLMIS. Following his arrest on December 11, 2008 (the “Filing Date”), the Securities and Exchange Commission (“SEC”) initiated a fraud action against Madoff. (¶ 10.) ³ Upon application of the Securities Investor Protection Corporation (“SIPC”) made pursuant to the Securities Investor Protection Act of 1970 (“SIPA”), 15 U.S.C. §§ 78aaa, et seq., the District Court appointed Irving H. Picard, Esq. as Trustee for BLMIS, and removed the case to this Court. (¶ 13.) On March 12, 2009, Madoff pleaded guilty to an 11–count criminal information, admitting that he “operated a Ponzi scheme through the investment advisory side of [BLMIS],” and acknowledged that “[a]s I engaged in my fraud, I knew what I was doing [was] wrong, indeed criminal.” (¶ 16.) On June 29, 2009, Madoff was sentenced to 150 years in prison. (¶ 16.)

Madoff professed to engage in an investment strategy known as the “split-strike conversion strategy,” or SSC Strategy. (¶ 26.) He purported to invest in a basket of stocks within the Standard & Poor's 100 Index (“S & P 100 Index”) that was intended to mimic the S & P 100 Index. (¶ 26.) He would time the purchases and sales to maximize the strategic timing of trades, and at times, the funds would be out of the market and completely invested in U.S. Treasury securities. (¶ 26.) As a hedge, BLMIS would sell call options and buy put options on the S & P 100 Index. (¶ 26.)

None of this actually happened. Instead, BLMIS used the money invested by BLMIS customers to make distributions to other BLMIS customers. (¶¶ 32–33.) No securities were actually purchased. (¶¶ 26, 28, 30.) At the time of Madoff's arrest, BLMIS managed approximately $65 billion of mostly fictitious funds. (¶ 36.)

B. The Defendants1. Merkin and Gabriel Capital Corporation

The defendant J. Ezra Merkin is a New York resident and investment manager. He managed several funds, individually or through the defendant Gabriel Capital Corporation (“GCC”), a Delaware corporation. (¶¶ 3, 42.) Merkin was the sole director and shareholder of and decision-maker for GCC. (¶ 43.) Merkin and GCC are sometimes collectively referred to as the “Merkin Defendants.”

2. Gabriel Capital, L.P.

The defendant Gabriel Capital, L.P. (“Gabriel”) is a Delaware limited partnership with a principal place of business in New York. (¶ 44.) Merkin was the sole general partner of and sole decision-maker for Gabriel, (¶ 45), and the investors were limited partners. (¶ 46.) Gabriel maintained an account with BLMIS, and invested between 16% and 30% of its assets with BLMIS during the six years preceding the Petition Date. (¶ 247.) As of third quarter 2008, Gabriel had at least 200 investors and managed $1.4 billion. (¶ 63.)

3. Ariel Fund Ltd.

The defendant Ariel Fund Limited (“Ariel”) is a Cayman Islands exempted company with a principal place of business in New York. (¶ 47.) GCC owned all the voting shares of Ariel, and the investors owned non-voting shares. (¶ 49.) Ariel maintained an account with BLMIS, and invested between 16% and 29% of its assets with BLMIS during the six years preceding the Petition Date. (¶ 247.) As of third quarter 2008, Ariel managed $1.3 billion. (¶ 59.)

4. Ascot Partners, L.P.

The defendant Ascot Partners, L.P. (“Ascot”) is a Delaware limited partnership with a principal place of business in New York. (¶ 50.) Merkin created Ascot for the principal purpose of investing in BLMIS, and was its sole general partner and sole decision-maker. (¶¶ 51–52.) Ascot maintained an account with BLMIS, and invested between 91% and 100% of its assets with BLMIS during the six years preceding the Petition Date. (¶ 248.) As of third quarter 2008, Ascot managed $1.8 billion. (¶ 68.)

5. Ascot Fund Ltd.

The defendant Ascot Fund Ltd. (“Ascot Fund”) is a Cayman Islands corporation with a principal place of business in New York. (¶ 53.) Until 2003, Ascot Fund invested directly with BLMIS, GCC served as its sole investment advisor and Merkin its sole decision-maker. (¶¶ 53–54.) In 2003, Ascot Fund entered into a “master-feeder” relationship with Ascot and invested substantially all of its capital with Ascot. (¶ 55.) At about the same time, Ascot Fund transferred the full balance in its BLMIS account to the BLMIS account of Ascot, and ceased activity in its BLMIS account. (¶ 55.)

Gabriel, Ariel, Ascot and Ascot Fund are referred to in this opinion as the Defendant Funds.

C. The Transfers1. Initial Transfers

The following table lists the aggregate amount of initial transfers made to the Defendant Funds from their respective BLMIS accounts within two years and six years of the December 11, 2008 Petition Date. It is derived from Exhibit B attached to the TAC which specifies the amount, month and year of each transfer. Because TAC Exhibit B lists the month but not the date of most of the transfers, it is not possible to tell whether the December 2002 and December 2006 transfers fall within the six year and two year periods, respectively. Accordingly, separate columns list these transfers as “borderline” transfers.

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2. Subsequent Transfers

The following table lists the subsequent transfers among the Defendant Funds within two years and six years of the Petition Date. It is derived from Exhibit C attached to the TAC which specifies the amount, month, day and year of each transfer.

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[Editor's Note: The preceding image contains the reference for footnote ⁴].

D. Merkin and Madoff

Merkin and Madoff shared a close business and personal relationship. Madoff called Merkin “a good friend” and “a very good client.” (¶ 82.) They sat together on the board of trustees of Yeshiva University. Madoff attended the bar and bat mitzvahs of Merkin's children. (¶ 84.) Merkin had personal access to Madoff and could speak with him directly, including meeting with Madoff at BLMIS. (¶¶ 87, 90.) Merkin stated to others that he was a fiduciary to Madoff's children and had been investing with BLMIS for decades. (¶¶ 89–90.) Madoff permitted Merkin to open up new accounts with BLMIS in 2000 (for Gabriel and Ariel), even though Madoff was not accepting new accounts at that time, because Merkin had been “a good friend” and “a very good client.” (¶ 165.) Merkin subsequently deposited $74.8 million into Gabriel's BLMIS account and $84.2 million into Ariel's BLMIS account. (¶ 165.)

E. Merkin's Knowledge of the BLMIS Fraud

Merkin knew that BLMIS “could not have been legitimately engaged in the trading activity it reported,” (¶ 106), the trades were a fraud, (¶ 174), and “Madoff was running a Ponzi scheme.” (¶ 108.) Victor Teicher, a money manager, managed parts of the Ariel and Gabriel portfolios between 1988 to 1994 and between 1998 to 2000. (¶¶ 102, 104.) He told Merkin, in the presence of Jack Mayer, an employee under Teicher, that BLMIS' trading was impossible and “could be a Ponzi scheme.” (¶¶ 102–03, 105.) Teicher warned Merkin that BLMIS' “returns were too consistent,” and “just not possible.” (¶ 102.) Teicher also cautioned Merkin about BLMIS self-clearing its own trades. (¶ 103.) After the fraud was revealed, Merkin acknowledged that “what made [the fraud] possible was the fact that Madoff was the custodian” of BLMIS' trades through self-clearing. (¶ 103.)

In addition, Merkin kept a...