Picard v. Citibank, N.A. (In re Bernard L. Madoff Inv. Sec. LLC)

Decision Date30 August 2021
Docket NumberAugust Term 2020,20-1334,Docket Nos. 20-1333
Parties IN RE: BERNARD L. MADOFF INVESTMENT SECURITIES LLC Irving H. Picard, Trustee for the Liquidation of Bernard L. Madoff Investment Securities LLC, Plaintiff-appellant, and Securities Investor Protection Corporation, Appellant, v. Citibank, N.A., Citicorp North America, Inc., Defendants-Appellees. Irving H. Picard, Trustee for the Liquidation of Bernard L. Madoff Investment Securities LLC, Plaintiff-Appellant, and Securities Investor Protection Corporation, Appellant, v. Legacy Capital Ltd., Khronos LLC, Defendants-Appellees.
CourtU.S. Court of Appeals — Second Circuit

ROY T. ENGLERT, JR., Robbins, Russell, Englert, Orseck, Untereiner & Sauber LLP, Washington, D.C., Special Counsel (David J. Sheehan, Seanna R. Brown, Amy E. Vanderwal, Matthew D. Feil, Chardaie C. Charlemagne, Baker & Hostetler LLP, New York, NY; Matthew M. Madden, Leslie C. Esbrook, Robbins, Russell, Englert, Orseck, Untereiner & Sauber LLP, Washington, D.C., Special Counsel, on the brief), for Plaintiff-Appellant Irving H. Picard, Trustee for the Liquidation of Bernard L. Madoff Investment Securities LLC.

NATHANAEL S. KELLEY, Associate General Counsel (Kenneth J. Caputo, General Counsel, Kevin H. Bell, Senior Associate General Counsel, on the brief), Securities Investor Protection Corporation, Washington, D.C., for Appellant Securities Investor Protection Corporation.

CARMINE D. BOCCUZZI, JR. (E. Pascale Bibi, Ariel M. Fox, on the brief), Cleary Gottlieb Steen & Hamilton LLP, New York, NY, for Defendants-Appellees Citibank N.A., Citicorp North America, Inc.

ERIC B. FISHER (Lindsay A. Bush, on the brief), Binder & Schwartz LLP, New York, NY, for Defendants-Appellees Legacy Capital Ltd., Khronos LLC.

Before: WESLEY, SULLIVAN, MENASHI, Circuit Judges.

WESLEY, Circuit Judge:

These appeals are the latest installments in the long-running litigation arising from Bernard Madoff's Ponzi scheme. Madoff falsely claimed to invest money he received from customers of Bernard L. Madoff Investment Securities LLC ("BLMIS"). When customers wanted to withdraw money, BLMIS transferred funds directly to them, the initial transferees , some of whom then transferred the funds to their own investors, the subsequent transferees . Irving H. Picard, trustee for the liquidation of BLMIS, brought actions against initial transferee Legacy Capital Ltd. and subsequent transferees Citibank, N.A., Citicorp North America, Inc., and Khronos LLC, seeking to avoid and recover the transfers pursuant to his authority under the Securities Investor Protection Act ("SIPA"), 15 U.S.C. §§ 78aaa et seq. A SIPA liquidation is "conducted in accordance with" the Bankruptcy Code "[t]o the extent consistent with" SIPA. Id. § 78fff(b). Under the Bankruptcy Code, a transferee may retain transfers it took "for value" and "in good faith." 11 U.S.C. §§ 548(c), 550(b).

The United States District Court for the Southern District of New York (Rakoff, J .) held that in a SIPA liquidation, a lack of good faith requires a showing of at least willful blindness to the fraud on the part of the transferee and the trustee bears the burden of pleading the transferee's lack of good faith. Applying that decision, the United States Bankruptcy Court for the Southern District of New York (Bernstein, J .) dismissed Picard's actions against Appellees for failure to plead their willful blindness. We vacate both judgments of the bankruptcy court and hold that lack of good faith in a SIPA liquidation applies an inquiry notice, not willful blindness, standard, and that a SIPA trustee does not bear the burden of pleading the transferee's lack of good faith.

BACKGROUND

The details of the Madoff Ponzi scheme1 are described at length in previous opinions of this Court and others. See, e.g. , In re BLMIS , 654 F.3d 229, 231 (2d Cir. 2011) (collecting cases). Madoff operated his Ponzi scheme through his investment firm BLMIS, a securities broker-dealer. A Ponzi scheme is "an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors." Picard v. Gettinger (In re BLMIS) , 976 F.3d 184, 188 n.1 (2d Cir. 2020) (citation omitted), cert. denied , ––– U.S. ––––, ––– S.Ct. ––––, 209 L.Ed.2d 736 (2021).

Customers ranging from banks and hedge funds to individuals and charities entrusted BLMIS with their money, expecting it to make investments on their behalf. A number of the customers were "feeder funds," firms that pooled money from investors and invested directly (or indirectly) with BLMIS. When a feeder fund wanted to withdraw money, it received a transfer directly from BLMIS, making it an "initial transferee." When an investor of a feeder fund wanted to withdraw money, the feeder fund transferred money it received from BLMIS, making that investor a "subsequent transferee." See In re Picard , 917 F.3d 85, 93 (2d Cir. 2019), cert. denied sub nom HSBC Holdings PLC v. Picard , ––– U.S. ––––, 140 S. Ct. 2824, 207 L.Ed.2d 157 (2020).

BLMIS was a sham. It sent its customers account statements with fabricated returns; in actuality, it was making few, if any, trades. "At bottom, the BLMIS customer statements were bogus and reflected Madoff's fantasy world of trading activity, replete with fraud and devoid of any connection to market prices, volumes, or other realities." Sec. Inv. Prot. Corp. v. BLMIS (In re BLMIS ), 424 B.R. 122, 130 (Bankr. S.D.N.Y. 2010) (hereinafter "SIPC "), aff'd , 654 F.3d 229 (2d Cir. 2011). The customers’ funds were commingled in BLMIS's bank account. When customers withdrew their "profits" or principal, BLMIS paid them from this commingled account. As a result, each time BLMIS transferred payments to a customer, it was money stolen from other customers. See In re BLMIS , 654 F.3d at 232.

Amid the global financial crisis of 2007–08, concerned customers began to withdraw their investments, leading to BLMIS's collapse as "customer requests for payments exceeded the inflow of new investments." See SIPC , 424 B.R. at 128. Following Madoff's arrest for securities fraud on December 11, 2008,2 the Securities Investor Protection Corporation ("SIPC") requested that the United States District Court for the Southern District of New York (Stanton, J .) place BLMIS into a SIPA liquidation to recover and distribute funds to BLMIS's customers who lost their investments.3 The district court granted SIPC's petition, appointed Picard as the trustee, and referred the SIPA liquidation of BLMIS to the bankruptcy court. In this ongoing liquidation, Picard brought actions to recover approximately $343 million from subsequent transferees Citibank, N.A. and Citicorp North America, Inc. (together, "Citi"), $6.6 million from subsequent transferee Khronos LLC ("Khronos"), and $213 million from initial transferee Legacy Capital Ltd. ("Legacy").

I. The SIPA Liquidation of BLMIS

Congress enacted SIPA in 1970 to protect customers of bankrupt broker-dealers. As we have previously explained, "[a] trustee's primary duty under SIPA is to liquidate the [failed] broker-dealer and, in so doing, satisfy claims made by or on behalf of the broker-dealer's customers for cash balances." Marshall v. Picard (In re BLMIS) , 740 F.3d 81, 85 (2d Cir. 2014). "In a SIPA liquidation, a fund of ‘customer property,’ separate from the general estate of the failed broker-dealer, is established for priority distribution exclusively among customers." In re BLMIS , 654 F.3d at 233. The "customer property" fund consists of "cash and securities ... at any time received, acquired, or held by" the debtor on behalf of the customers, including "the proceeds of any such property transferred by the debtor" and "property unlawfully converted." 15 U.S.C. § 78lll(4).

Although investors of BLMIS are considered "customers" under SIPA, see In re BLMIS , 654 F.3d at 236, under certain circumstances, those who indirectly invested in BLMIS do not qualify as customers, see Kruse v. Picard (In re BLMIS) , 708 F.3d 422, 426–27 (2d Cir. 2013).4 Only BLMIS's customers with "allowed claims" are entitled to a distribution from the customer property fund. SIPA requires customers to "share ratably in such customer property on the basis and to the extent of their respective net equities." 15 U.S.C. § 78fff-2(c)(1)(B). We previously approved Picard's "Net Investment Method" to calculate each customer's "net equity," "crediting the amount of cash deposited by the customer into his or her BLMIS account, less any amounts withdrawn from it." See In re BLMIS , 654 F.3d at 233–34, 242. Accordingly, customers who withdrew less than they deposited have allowed claims.5 See id. at 233.

Picard's goal in this liquidation is to satisfy the allowed customer claims. A SIPA liquidation 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]." 15 U.S.C. § 78fff(b). As is invariably true of Ponzi schemes, due to BLMIS's transfers of commingled customer funds before the Ponzi scheme unraveled, there was insufficient money in the BLMIS customer property fund for Picard to satisfy all allowed claims. See In re Picard , 917 F.3d at 92. "Whenever customer property is not sufficient to pay in full the [customers’] claims ... 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 Title 11." 15 U.S.C. § 78fff-2(c)(3). As a result, Picard initiated actions against Appellees under Sections 548 and 550 of the Bankruptcy Code, 11 U.S.C. §§ 548, 550, to avoid and recover BLMIS's transfers to them.

II. The Instant Actions Under Bankruptcy Code Sections 548 and 550

Avoidance and recovery are related but distinct concepts. Section 548 governs the avoidance of actually and constructively fraudulent...

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