Sec. Investor Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, Adv. Pro. No. 08-01789 (SMB) SIPA LIQUIDATION (Substantively Consolidated)

• Decision Date: 07 February 2019
• Docket Number: 18 Civ. 5430 (PAE),Adv. Pro. No. 10-04350,18 Civ. 5453 (PAE) ,Adv. Pro. No. 10-04488 (SMB),18 Civ. 5381 (PAE),Adv. Pro. No. 08-01789 (SMB) SIPA LIQUIDATION (Substantively Consolidated),Adv. Pro. No. 10-04387 (SMB),18 Civ. 5452 (PAE),Adv. Pro. No. 10-05110 (SMB)
• Citation: 596 B.R. 451
• Parties: SECURITIES INVESTOR PROTECTION CORPORATION, Plaintiff-Applicant, 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. James Lowrey, et al., Defendants. Irving H. Picard, Trustee for the Liquidation of Bernard L. Madoff Investment Securities, LLC, Plaintiff, v. South Ferry Building Company, et al., Defendants. Irving H. Picard, Trustee for the Liquidation of Bernard L. Madoff Investment Securities, LLC, Plaintiff, v. South Ferry #2 LP, et al., Defendants. Irving H. Picard, Trustee for the Liquidation of Bernard L. Madoff Investment Securities, LLC, Plaintiff, v. United Congregations Mesora, Defendant.
• Court: U.S. District Court — Southern District of New York

596 B.R. 451

SECURITIES INVESTOR PROTECTION CORPORATION, Plaintiff-Applicant,

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.James Lowrey, et al., Defendants.

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

v.South Ferry Building Company, et al., Defendants.

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

v.South Ferry #2 LP, et al., Defendants.

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

v.United Congregations Mesora, Defendant.

Adv. Pro. No. 08-01789 (SMB) SIPA LIQUIDATION (Substantively Consolidated)

18 Civ. 5381 (PAE)

Adv. Pro. No. 10-04387 (SMB)

18 Civ. 5430 (PAE)

Adv. Pro. No. 10-04488 (SMB)

18 Civ. 5452 (PAE)

Adv. Pro. No. 10-04350

18 Civ. 5453 (PAE)

Adv. Pro. No. 10-05110 (SMB)

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

Signed February 7, 2019

David J. Sheehan, Keith R. Murphy, Nicholas J. Cremona, Anat Maytal, Baker & Hostetler LLP, New York, NY, for Plaintiff.

Richard A. Kirby, Fisherbroyles LLP, Richard Allen Kirby, K & L Gates LLP, Josephine Wang, Kevin H. Bell, Nathanael Stephen Kelley, Securities Investor Protection Corporation, Washington, DC, for Defendant.

OPINION & ORDER

Paul A. Engelmayer, United States District Judge

This litigation arises out of the infamous Ponzi scheme carried out by Bernard L. Madoff Plaintiff Irving H. Picard ("Picard" or the "Trustee"), as trustee for the liquidation of the Bernard L. Madoff Investment Securities LLC ("BLMIS") under the Securities Investor Protection Act ("SIPA"), 15 U.S.C. §§ 78aaa et seq. , and the substantively consolidated estate of Bernard L. Madoff under Chapter 7 of the United States Bankruptcy Code, moves for summary judgment on claims to avoid and recover certain transfers. He argues that such transfers are subject to avoidance under 11 U.S.C. § 548(a)(1)(A) because Madoff made them with the intent to "hinder, delay or defraud," id. , its creditors. Defendants, recipients of those transfers, are various brokerage customers of BLMIS. Each, without knowledge of Madoff's scheme, invested money and withdrew in transfers more than he, she, or it invested. They cross-move for summary judgment and assert that they are entitled to retain the money transferred to them. On cross-motions for summary judgment, the Bankruptcy Court entered a Report and Recommendation (the "Report"). It set forth various proposed conclusions of law and recommended that the Court grant the Trustee's motion for judgment and deny defendants' cross-motion for judgment.

Defendants object to the Report. They request that the Court grant summary judgment to them and deny the Trustee's motion for summary judgment. The Trustee asks that the Court adopt the Report in full and enter a final judgment in his favor. For the reasons that follow, the Court, on de novo review, adopts the Bankruptcy Court's recommendation, grants summary judgment to the Trustee, and denies summary judgment to defendants.

I. Background¹

A. Factual Background to the Bankruptcy Court's Report

The Madoff Ponzi scheme has been the subject of numerous decisions by courts in this Circuit. See, e.g., In re BLMIS , 424 B.R. 122, 125–32 (Bankr. S.D.N.Y. 2010), aff'd , 654 F.3d 229 (2d Cir. 2011) (" Net Equity Decision "); Picard v. Ida Fishman Revocable Trust (In re BLMIS) , 773 F.3d 411, 415–17 (2d Cir. 2014) (" Ida Fishman "), cert. denied , ––– U.S. ––––, 135 S.Ct. 2858 & 2859, 192 L.Ed.2d 910 (2015) ; SIPC v. BLMIS (In re BLMIS) , 499 B.R. 416, 419 (S.D.N.Y. 2013) (" Antecedent Debt Decision "), certification for interlocutory appeal denied , 987 F.Supp.2d 309 (S.D.N.Y. 2013) ; see also In re Bernard L. Madoff Inv. Secs., LLC , No. 15 Civ. 1151 (PAE), 2016 WL 183492 (S.D.N.Y. Jan. 14, 2016) (" Inter-Account Transfer Decision "). The Court assumes familiarity with those decisions and sets out here only those facts relevant to the instant dispute.

1. The Madoff Ponzi Scheme

For many years, Madoff operated a fraudulent investment business, BLMIS, initially as BLMIS's sole member and later as its chairman and chief executive. Lowrey Stip. ¶ 1. BLMIS was an investment firm that collected brokerage customers' funds and purported to invest those funds on behalf of the customers. But Madoff never invested that money. Instead, he used principal infused by "new and existing customers to fund withdrawals of principal and supposed profit made by other customers." Net Equity Decision , 654 F.3d at 232. This Ponzi scheme did not generate legitimate profits for BLMIS's customers. When BLMIS's customers "withdrew money from their accounts ... they did not actually receive returns on successful investments, but instead only the very money that they and others had deposited ... for the purpose of purchasing securities." Picard v. Greiff , 476 B.R. 715, 718 (S.D.N.Y. 2012) (" Greiff "). To conceal Madoff's fraud, BLMIS "generated fictitious paper account statements and trading records." Net Equity Decision at 231–32.

Madoff's scheme was exposed in 2008, when the infusion of new capital was unable to support the withdrawals sought by customers. In the end, "the final customer statements issued by BLMIS falsely recorded nearly $ 64.8 billion of net investments and related fictitious gains." Id. at 232.

2. The SIPA Trustee and the Statutory Framework

On December 11, 2008, Madoff was arrested on federal criminal charges. Lowrey Stip. ¶ 2. The same day, the Securities and Exchange Commission ("SEC") initiated proceedings against BLMIS and Madoff in this District. See SEC v. Bernard L. Madoff Inv. Secs. LLC et al. , No. 08 Civ. 10791. After Madoff's arrest, a court in this District granted an application by the Securities Investor Protection Corporation ("SIPC"), filed pursuant to SIPA § 78eee(a)(4)(B) and based on BLMIS's inability to meet its obligations to securities customers as they came due. Lowrey Stip. ¶ 5. That court issued a protective order under SIPA and appointed Irving Picard as Trustee for BLMIS's liquidation. Net Equity Decision , 654 F.3d at 233. On December 15, 2008, the SEC consented to combine its own action with SIPC's application pursuant to SIPA § 78eee(a)(4)(A). Lowrey Stip. ¶ 4.

A brief primer on SIPA is useful here. SIPA liquidations are distinct from ordinary bankruptcy actions. "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. The customer property fund consists of cash and securities received or held by the broker-dealer on behalf of customers, except securities registered in the name of individual customers." Id. at 233 (citing 15 U.S.C. § 78lll (4) ) (emphasis added). Under SIPA, customers of the failed broker-dealer are 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).

The term "net equity," in turn, is defined as

the dollar amount of the account or accounts of a customer, to be determined by—(A) calculating the sum which would have been owed by the debtor to such customer if the debtor had liquidated, by sale or purchase on the filing date—(i) all securities positions of such customer ... ; minus (B) any indebtedness of such customer to the debtor on the filing date ....

Id. § 78lll (11). Often, in SIPA liquidations, "the assets in the customer property fund are insufficient to satisfy every customer's ‘net equity’ claim." Net Equity Decision , 654 F.3d at 233. In those cases, the "SIPC advances money to the SIPA trustee to satisfy promptly each customer's valid ‘net equity’ claim," up to a maximum of $ 500,000 per customer for claims for securities, and up to $ 250,000 per customer for claims of cash. Id.

SIPA trustees are assigned specific duties, but also enjoy "the general powers of a bankruptcy trustee." Net Equity Decision , 654 F.3d at 231 (citing 15 U.S.C. § 78fff–1 ). Relevant here, under the Bankruptcy Code, SIPA trustees may

avoid any transfer ... of an interest of the debtor in property, or any obligation ... incurred by the debtor, that was made or incurred on or within 2 years before the date of the filing of the petition, if the debtor voluntarily or involuntarily [ ] made such transfer or incurred such obligation with actual intent to hinder, delay, or defraud any entity to which the debtor was or became ... indebted."

11 U.S.C. § 548(a)(1)(A) ; see also Ida Fishman , 773 F.3d at 414 (citing 15 U.S.C. § 78fff–2(c)(3) ); Net Equity Decision , 654 F.3d at 242 & n.10. This authority is limited in two relevant ways. First, the transferee may prevent the Trustee from avoiding fraudulent transfers if the transferee "takes for value and in good faith." 11 U.S.C. § 548(c). Second, avoidance actions may be taken only to recover funds transferred within two years of the date of the filing of the petition (the "reach-back period"). 11 U.S.C. § 548(a)(1).

3. The Transfers to Defendants

By the time Madoff's Ponzi scheme was exposed in 2008, some brokerage customers had withdrawn from their accounts more money than they initially invested, while others had not withdrawn even the amount of the principal initially invested. A customer who deposited more than he or she withdrew has a "net equity" claim for the difference. Those customers who withdrew more than they deposited would have a net equity of zero. See Inter-Account Transfer Decision , 2016 WL 183492, at *1. Other courts have described customer withdrawals in excess of that customer's initial investment as "fictitious profits," Antecedent Debt Decision , 499 B.R. at 421, because such proceeds were not based on legitimate securities transactions.

Defendants are among those investors who withdrew more money than they deposited in...