Kruse v. Sec. Investor Prot. Corp. (In re Bernard L. Madoff Inv. Sec. LLC)

• Decision Date: 22 February 2013
• Docket Number: Docket Nos. 12–410–bk(L), 12–437–bk(Con), 12–483–bk(Con), 12–529–bk(Con).
• Citation: Kruse v. Sec. Investor Prot. Corp. (In re Bernard L. Madoff Inv. Sec. LLC), 708 F.3d 422 (2nd Cir. 2013)
• Court: U.S. Court of Appeals — Second Circuit
• Parties: In re BERNARD L. MADOFF INVESTMENT SECURITIES LLC, Debtor. James L. Kruse, Henry T. DeNero, Nancy S. DeNero, Charles F. Rolecek, C. Thomas Brown, Margaret H. Brown, Sally S. Beaudette, Marshall G. Rowe, Lee F. Wood, Harvey A. Taylor, Markian D. Stecyk, Donald H. Hangen, Martha L. Wood, Robert H. Scott, Molly McNaughton, Jan Feldman, James P. Dulany, Neva Rosamilia, Nicholas Rosamilia, Upstate New York Bakery Drivers and Industry Pension Fund, Claimants–Appellants, Bricklayers and Allied Craftsman Local 2 Annuity Fund, Bricklayers and Allied Craftsworkers Local 2, Health Benefit Fund, Bricklayers & Allied Craftworkers, Local No. 2, AFL–CIO, Building Trade Employers Insurance Fund, Central New York Laborers Annuity Fund, Central New York Laborers Health and Welfare Fund, Central New York Laborers Pension Fund, Central New York Laborers Training Fund, Construction Employers Association Of CNY, Inc., Construction and General Laborers' Local No. 633, AFL–CIO, Engineers Joint Welfare Fund, Engineers Joint Training Fund, International Brotherhood of Electrical Workers Local Union No. 43 and Electrical Contractors Pension Fund, International Brotherhood of Electrical Workers Local No. 43 and Electrical Contractors Welfare Fund, I.B.E.W. Local 241 Welfare Benefits Fund, I.B.E.W. Local 910 Welfare Fund, Laborers' Local 103 Annuity Fund, Laborers' Local 103 Welfare Fund, New York State Lineman's Safety Training Fund, Oswego Laborers' Local No. 214 Pension Fund, Plumbers, Pipefitters and Apprentices Local No. 112 Health Fund, Roofers' Local 195 Annuity Fund, Roofers' Local 195 Health & Accident Fund, Syracuse Builders Exchange, Inc./CEA Pension Plan, Service Employees Benefit Fund, Service Employees Benefit Fund of Upstate New York, S.E.I.U. Local 200 United, AFL–CIO, Syrabex, Inc., Syracuse Builders Exchange, Inc., U.A. Local 73, Plumbers & Fitters, AFL–CIO, Local 73 Retirement Fund, Upstate Union Health and Welfare Fund, Claimants, v. Securities Investor Protection Corporation, Irving H. Picard, Appellees, Securities and Exchange Commission, Intervenor.

708 F.3d 422

In re BERNARD L. MADOFF INVESTMENT SECURITIES LLC, Debtor.James L. Kruse, Henry T. DeNero, Nancy S. DeNero, Charles F. Rolecek, C. Thomas Brown, Margaret H. Brown, Sally S. Beaudette, Marshall G. Rowe, Lee F. Wood, Harvey A. Taylor, Markian D. Stecyk, Donald H. Hangen, Martha L. Wood, Robert H. Scott, Molly McNaughton, Jan Feldman, James P. Dulany, Neva Rosamilia, Nicholas Rosamilia, Upstate New York Bakery Drivers and Industry Pension Fund, Claimants–Appellants,Bricklayers and Allied Craftsman Local 2 Annuity Fund, Bricklayers and Allied Craftsworkers Local 2, Health Benefit Fund, Bricklayers & Allied Craftworkers, Local No. 2, AFL–CIO, Building Trade Employers Insurance Fund, Central New York Laborers Annuity Fund, Central New York Laborers Health and Welfare Fund, Central New York Laborers Pension Fund, Central New York Laborers Training Fund, Construction Employers Association Of CNY, Inc., Construction and General Laborers' Local No. 633, AFL–CIO, Engineers Joint Welfare Fund, Engineers Joint Training Fund, International Brotherhood of Electrical Workers Local Union No. 43 and Electrical Contractors Pension Fund, International Brotherhood of Electrical Workers Local No. 43 and Electrical Contractors Welfare Fund, I.B.E.W. Local 241 Welfare Benefits Fund, I.B.E.W. Local 910 Welfare Fund, Laborers' Local 103 Annuity Fund, Laborers' Local 103 Welfare Fund, New York State Lineman's Safety Training Fund, Oswego Laborers' Local No. 214 Pension Fund, Plumbers, Pipefitters and Apprentices Local No. 112 Health Fund, Roofers' Local 195 Annuity Fund, Roofers' Local 195 Health & Accident Fund, Syracuse Builders Exchange, Inc./CEA Pension Plan, Service Employees Benefit Fund, Service Employees Benefit Fund of Upstate New York, S.E.I.U. Local 200 United, AFL–CIO, Syrabex, Inc., Syracuse Builders Exchange, Inc., U.A. Local 73, Plumbers & Fitters, AFL–CIO, Local 73 Retirement Fund, Upstate Union Health and Welfare Fund, Claimants,

v. Securities Investor Protection Corporation, Irving H. Picard, Appellees,Securities and Exchange Commission, Intervenor.^*

Docket Nos. 12–410–bk(L), 12–437–bk(Con), 12–483–bk(Con), 12–529–bk(Con).

United States Court of Appeals, Second Circuit.

Argued: Jan. 25, 2013.

Decided: Feb. 22, 2013.

William L. Chapman, Orr & Reno, P.A., Concord, New Hampshire, for Appellants James L. Kruse, Henry T. DeNero, Nancy S. DeNero, Charles F. Rolecek, C. Thomas Brown, Margaret H. Brown, Sally S. Beaudette, Marshall G. Rowe, Lee F. Wood, Harvey A. Taylor, Markian D. Stecyk, Donald H. Hangen, Martha L. Wood, Robert H. Scott, Molly McNaughton, Jan Feldman, and James P. Dulany.

Christopher H. Larosa (Josephine Wang, Kevin H. Bell, on the brief), for Appellee Securities Investor Protection Corporation, Washington, D.C.

David J. Sheehan (Jorian L. Rose, Thomas D. Warren, Wendy J. Gibson, Seanna R. Brown, Bik Cheema, on the brief), Baker & Hostetler LLP, New York, NY, for Appellee Irving H. Picard.

Michael L. Post (Mark D. Cahn, Michael A. Conley, Jacob H. Stillman, John W. Avery, on the brief), for Intervenor Securities and Exchange Commission, Washington, D.C.

Helen Davis Chaitman, Becker & Poliakoff, LLP, New York, NY, for Appellants Neva Rosamilia and Nicholas Rosamilia.

Mark I. Silberblatt, Bisceglie & De Marco, LLC, Woodland Park, NJ, for Appellant Upstate New York Bakery Drivers and Industry Pension Fund.

Before: LEVAL, RAGGI, and LIVINGSTON, Circuit Judges.

REENA RAGGI, Circuit Judge:

Appellants are investors who lost money in the multi-billion dollar Ponzi scheme perpetrated by Bernard L. Madoff Investment Securities LLC (“BLMIS”). They here appeal from a judgment of the United States District Court for the Southern District of New York (Denise L. Cote, Judge ) entered on January 6, 2012, which affirmed a June 28, 2011 order of the bankruptcy court for the same district (Burton R. Lifland, Bankruptcy Judge ), affirming Trustee Irving H. Picard's denial of appellants' claims against BLMIS under the Securities Investor Protection Act (“SIPA”), 15 U.S.C. § 78aaa et seq., based on the Trustee's determination that appellants do not qualify as BLMIS “customers” under SIPA, see id.§ 78 lll (2).¹

I. Background

The record demonstrates that none of the appellants remaining on this appeal invested directly with BLMIS.² Rather, they invested in two limited partnerships, Spectrum Select, L.P., and Spectrum Select II, L.P. (“Spectrum Funds”), which in turn invested in two hedge funds, Rye Select Broad Market Fund, L.P., and Rye Select Broad Market Prime Fund, L.P. (“Feeder Funds”), which were organized as limited partnerships under Delaware law. Through various explanatory material, including offering memoranda, the Feeder Funds advised investors who purchased interests in the funds that the investors yielded exclusive control over investment decisions to the funds. The Feeder Funds invested the pooled capital obtained from their investors with BLMIS through securities accounts maintained only in the funds' names. The Feeder Funds made deposits to and withdrawals from their BLMIS accounts, and they received account documentation, including account statements and trade confirmations, from BLMIS. As investors in the Spectrum Funds that invested in the Feeder Funds, appellants had no direct financial dealings with BLMIS, and no account information in BLMIS records identified them as BLMIS investors.

In these circumstances, the Trustee, the bankruptcy court, and the district court each concluded that appellants could not pursue SIPA claims distinct from those of the Feeder Funds because appellants were not themselves BLMIS “customers.” See SIPC v. Bernard L. Madoff Inv. Sec. LLC (In re Bernard L. Madoff), 454 B.R. 285, 295 (Bankr.S.D.N.Y.2011) (stating that, because appellants “purchased ownership interests in the Feeder Funds themselves, thereby investing in, and not through, the Feeder Funds,” they did not “have a claim on account of a securities account with BLMIS,” could not “establish that they entrusted cash or securities with BLMIS for the purpose of trading or investing in securities,” and therefore lacked “the type of fiduciary relationship with the debtor that characterizes customers in general” (emphasis in original; internal quotation marks omitted)); accord Aozora Bank Ltd. v. SIPC (In re Bernard L. Madoff Inv. Sec., LLC), 480 B.R. 117, 121–29 (S.D.N.Y.2012).

Appellants' timely appeal followed.

II. Discussion

Appellants' interest in being recognized as BLMIS “customers” distinct from the Feeder Funds is obvious. To the extent BLMIS's assets are insufficient to compensate “customers” for their investment losses, each recognized “customer” can seek to have its remaining losses compensated by the Securities Investor Protection Corporation (“SIPC”)—subject to a cap of $500,000 per “customer”—out of a special fund capitalized by the general brokerage community. See15 U.S.C. §§ 78ddd, 78fff–3; Stafford v. Giddens (In re New Times Sec. Servs., Inc.), 463 F.3d 125, 127 (2d Cir.2006). Thus, should appellants be recognized as BLMIS “customers” in their own right, each would be entitled to seek up to $500,000 in uncompensated losses. But if only the Feeder Funds are recognized as “customers,” their SIPC recovery would be capped at $500,000, from which their investors, such as the Spectrum Funds, could recover only a fraction for distribution in even smaller amounts to their own investors, such as appellants.

In considering appellants' argument that they qualify as BLMIS “customers” under SIPA, we review the bankruptcy court's contrary conclusion “independently, accepting its factual findings unless clearly erroneous but reviewing its conclusions of law de novo.” Midland Cogeneration Venture Ltd. P'ship v. Enron Corp. (In re Enron Corp.), 419 F.3d 115, 124 (2d Cir.2005). On such review, we perceive no error in the bankruptcy court's decision. SIPA defines a “customer” of a debtor as follows:

[A]ny person (including any person with whom the debtor deals as principal or agent) who has a claim on account of securities received, acquired, or held by the debtor in the ordinary course of its business as a broker or dealer from or for the securities accounts of such person for safekeeping, with a view to sale, to cover consummated sales, pursuant to purchases, as collateral, security, or for purposes of effecting transfer.

15 U.S.C. § 78 lll(2)(A). The statute explains that this definition includes, inter alia, “any person who has deposited cash with the debtor for the purposes of purchasing securities,” id. § 78 lll(2)(B)(i), and “any person who has a claim against the debtor arising out of sales or conversions of such securities,” id. § 78 lll(2)(B)(iii).

This court has ruled that “[j]udicial interpretations of ‘customer’ status support a narrow interpretation of the SIPA's provisions.” In re New Times Sec. Servs., Inc., 463 F.3d at 127 (internal quotation marks omitted). We have identified “the critical aspect of the ‘customer’ definition” to be “the entrustment of cash or securities to the broker-dealer for the purposes of trading securities.” In re Bernard L. Madoff Inv. Sec. LLC, 654 F.3d 229, 236 (2d Cir.2011) (emphasis and internal quotation marks omitted).

Appellants fail to satisfy this critical requirement. The record shows that they: (1) had no direct financial relationship with BLMIS, (2) had no property interest in the assets that the Feeder Funds invested with BLMIS, (3) had no securities accounts with BLMIS, (4) lacked control over the Feeder Funds' investments with BLMIS, and (5) were not identified or otherwise reflected in BLMIS's books and records. In SIPC v. Morgan, Kennedy & Co., 533 F.2d 1314 (2d Cir.1976), we relied on similar factors to conclude that employee-beneficiaries of a profit-sharing plan were not “customers” of a debtor under SIPA. See id. at 1318. Such analysis continues to provide the appropriate framework for identifying a SIPA debtor's “customers.” Thus, as in ...