Sec. Investor Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC

• Decision Date: 18 October 2019
• Docket Number: Adv. Proc. No. 08-01789 (SMB) (Substantively Consolidated) Adv. Proc. No. 10-05345 (SMB)
• Citation: 608 B.R. 181
• Parties: SECURITIES INVESTOR PROTECTION CORPORATION, Plaintiff, v. BERNARD L. MADOFF INVESTMENT SECURITIES LLC, Defendant. In re: Bernard L. Madoff, Debtor. Irving H. Picard, Trustee for the Liquidation of Bernard L. Madoff Investment Securities LLC, Plaintiff, v. Citibank, N.A., Citicorp North America, Inc., and Citigroup Global Markets Limited, Defendants.
• Court: U.S. Bankruptcy Court — Southern District of New York

608 B.R. 181

SECURITIES INVESTOR PROTECTION CORPORATION, Plaintiff,

v.BERNARD L. MADOFF INVESTMENT SECURITIES LLC, Defendant.

In re: Bernard L. Madoff, Debtor.

Irving H. Picard, Trustee for the Liquidation of Bernard L. Madoff Investment Securities LLC, Plaintiff,

v.Citibank, N.A., Citicorp North America, Inc., and Citigroup Global Markets Limited, Defendants.

Adv. Proc. No. 08-01789 (SMB) (Substantively Consolidated) Adv. Proc. No. 10-05345 (SMB)

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

Signed October 18, 2019

BAKER & HOSTETLER LLP, Attorneys for Irving H. Picard, Trustee, 45 Rockefeller Plaza, New York, NY 10111 David J. Sheehan, Esq., Seanna R. Brown, Esq., Matthew D. Feil, Esq., Andres A. Munoz, Esq., Chardaie C. Charlemagne, Esq. Of Counsel

CLEARY GOTTLIEB STEEN & HAMILTON LLP, Attorneys for the Defendants, One Liberty Plaza, New York, NY 10006, Carmine D. Boccuzzi, Jr., Esq., Pascale Bibi, Esq., Of Counsel

MEMORANDUM DECISION DENYING TRUSTEE'S MOTION FOR LEAVE TO FILE AMENDED COMPLAINT

STUART M. BERNSTEIN, United States Bankruptcy Judge

Plaintiff Irving H. Picard ("Trustee"), the trustee for the liquidation of Bernard L. Madoff Investment Securities LLC ("BLMIS") under the Securities Investor Protection Act, 15 U.S.C. §§ 78aaa, et seq . ("SIPA") seeks to recover $343,084,590 in subsequent transfers made to Defendants Citibank, N.A. ("Citibank") and Citicorp North America, Inc. ("Citicorp") made by a BLMIS feeder fund.¹ He has moved ("Motion") for leave to file and serve a Proposed Amended Complaint , dated Dec. 14, 2018 ("PAC ")² (ECF Doc. # 150-1).³ Defendants oppose the Motion. (Memorandum of Law in Opposition to Trustee's Motion for Leave to File an Amended Complaint , filed Mar. 29, 2019 ("Opposition ") (ECF Doc. # 158).) For reasons that follow, the Motion is denied.

BACKGROUND

The background information is derived from the well-pleaded factual allegations of the PAC and other information the Court may consider in determining whether the pleading is legally sufficient.

A. The Ponzi Scheme

At all relevant times, Bernard Madoff operated the investment advisory arm of BLMIS as a Ponzi scheme. (¶ 79.)⁴ Beginning in 1992, Madoff told investors that he employed the "split-strike conversion" strategy ("SSC Strategy"), under which BLMIS purported to purchase a basket of stocks intended to track the S&P 100 Index, and hedged the investments by purchasing put options and selling call options on the S&P 100 Index. (¶¶ 85, 87.) In reality, BLMIS never purchased any securities on behalf of its investors and sent monthly statements to investors containing falsified trades typically showing fictitious gains. (¶¶ 85, 86.) All investor deposits were commingled in a JPMorgan Chase Bank account held by BLMIS, and the funds were used to satisfy withdrawals by other investors, benefit Madoff and his family personally, and prop-up BLMIS's proprietary trading department. (¶ 85.)

The BLMIS Ponzi scheme collapsed when redemption requests overwhelmed the flow of new investments, (¶ 101), and Madoff was arrested by federal agents for criminal violations of federal securities laws on December 11, 2008 ("Filing Date"). (¶ 17.) 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") asserting that BLMIS's customers needed the protections afforded by SIPA. (¶¶ 17, 18.) On December 15, 2008, the District Court granted SIPC's application, appointed the Trustee and his counsel, and removed the SIPA liquidation to this Court. (¶ 19.)

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]." (¶¶ 22, 102.)

B. Defendants and Relevant Affiliates

Citibank is a commercial bank with it principal place of business in New York, and is a wholly-owned subsidiary of Citigroup, Inc. ("Citigroup"). (¶ 29.) Citicorp is a non-bank holding company registered in Delaware and an indirect subsidiary of Citigroup. (¶ 37.) Citibank uses Citicorp to book and assign capital for leveraged and bridge loans. (¶ 37.) Non-party Citigroup Global Markets, Incorporated ("CGMI") is an indirect, wholly-owned subsidiary of Citigroup whose focus and expertise relate to derivative products, including exchange-listed ("OEX") and over-the-counter ("OTC") options. (¶¶ 52, 59.) Defendants conducted their BLMIS-related business and diligence primarily through CGMI. (¶¶ 5, 107.) Non-party CAFCO, LLC ("CAFCO"), a wholly-owned subsidiary of Citigroup, is a conduit commercial lender. (¶ 58.)

C. The Fairfield Deal – Deal No. 1

On April 28, 2005, CGML entered into an offshore swap transaction with Auriga International Limited ("Auriga"), a British Virgin Islands hedge fund that invested almost all its assets with Fairfield Sentry Limited ("Fairfield Sentry"). Auriga provided CGML with $140 million in collateral in return for leverage that would allow Auriga to recover two-times the returns on a hypothetical direct investment in Fairfield Sentry ("Fairfield Deal"). (¶¶ 72, 105, 106.) To generate the returns it might have to pay Auriga, CGML invested the $140 million in collateral plus an equivalent amount of its own funds, directly in Fairfield Sentry, (¶ 106), effecting a "perfect hedge." See Picard v. ABN AMRO Bank (Ireland) Ltd. (In re BLMIS ), 505 B.R. 135, 138 (S.D.N.Y. 2013). The investment by CGML of an equal amount of its own funds provided it with protection if the Fairfield Sentry investment increased in value and required CGML to pay two times the returns. In the meantime, CGML earned fees. (¶ 106.)

CGMI's Global Hybrid Trading Desk summarized the proposed terms of the Fairfield Deal in a March 10, 2005 internal memorandum. ("March 10 Memo ").⁵ (¶ 111.) The March 10 Memo also detailed the SSC Strategy and attached a due diligence questionnaire for its investors prepared by Fairfield Sentry's operator, Fairfield Greenwich Group ("FGG"), that claimed BLMIS executed its options trades on the OTC market. (¶¶ 112, 116; see also March 10 Memo at ECF pp. 4, 7-42 of 132.)⁶

1. CGMI's Due Diligence

Diligence for the Fairfield Deal was spearheaded by CGMI, specifically Samir Mathur, a managing director, and Rajiv Sennar, an employee in the Fund and Multi-Asset Derivatives Group. (¶ 107.) CGMI could not verify BLMIS's option transactions or identify the relevant options counterparties which, together with BLMIS's lack of an independent custodian, "concerned" CGMI. (¶¶ 108, 110.) On March 11, 2005, Marc Fisher told FGG's Kim Perry that Citibank was afraid the assets in Fairfield's BLMIS account could disappear. (¶ 118.) An internal FGG email from Perry relayed Citibank's "credit concerns" that "the money [could] disappear from the account in any one day," and advised that Citibank "would feel more comfortable if there were some sort of control on money leaving the account." (¶ 118.) Citibank's main concern, according to Perry, was the lack of an independent custodian to prevent BLMIS from stealing Fairfield Sentry's assets. (¶ 119.) On or around March 22, 2005, Fisher, Mathur, Ramesh Gupta and other CGMI employees visited Fairfield's New York office for further diligence. Two days later, Fisher advised FGG (Perry) that Citibank had lingering concerns about the "theoretical fraud risk given that Madoff is the custodian of the assets," but Perry nonetheless informed his Fairfield colleagues that Citicorp's trading head agreed to assume the risk and the final "senior sign-off" was a mere formality. (¶ 120.)

CGMI asked Fairfield to arrange a meeting with BLMIS before finalizing the Fairfield Deal because "the more [Citibank] could find out more directly it's better," but Fairfield explained that a meeting was not possible. (¶ 123.) In lieu of a meeting, Mathur asked Fairfield for public information about BLMIS that he could distribute to the CGMI credit committee to help consummate the deal. (¶ 124.) But the information did not alleviate CGMI's concerns. (¶ 125.) On March 30, Mathur requested a telephone call with Amit Vijayvergiya, Fairfield's Head of Risk Management, to discuss CGMI's concerns that BLMIS was not making options trades it purported to make and that the money under Madoff's control could disappear. (¶ 126.) According to Vijayvergiya, CGMI wanted to revisit (1) whose name the stock/option positions were held in at the Depository Trust and Clearing Corporation; (2) what happens to the assets in the event of bankruptcy; (3) the name of BLMIS's accountant; and (4) the number of option counterparties. (¶ 127.)

On March 30, 2005, CGMI's Global Hybrid Trading Desk issued a memorandum ("March 30 Memo ") to the Fast Track Capital Markets Approval Committee, whose purview was reviewing structured financing products and identifying risks. (¶¶ 128-130.)⁷ The March 30 Memo stated that "[t]here should be no counterparty risk associated with this transaction. There is a fraud risk" but did not amplify the nature of the fraud or the risk. (March 30 Memo at ECF p. 8 of 28.) The memo also noted that "Madoff is both Prime Broker and Custodian of the SSC assets of Sentry." (¶ 131; March 30 Memo at ECF p. 7 of 28.)

2. CGMI's Quantitative Analysis

CGMI also performed a quantitative analysis ("Quantitative Analysis"), circulated internally with the March 10 and March 30 Memos , that compared BLMIS's stated investment returns to the returns that an SSC Strategy would be expected to yield. (¶¶ 136, 137.)⁸ The Quantitative Analysis showed that from December 1990 through January 2005 ("Sample Period"), BLMIS stated positive returns for Fairfield in 164 out of 170 months. (¶¶ 137, 142.) By contrast, the S&P 100 Index posted positive returns in only 107 months in the Sample Period. (¶ 143.) The Quantitative Analysis revealed that BLMIS outperformed the S&P 100...