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

• Decision Date: 15 October 2013
• Docket Number: No. 12 MC 115(JSR).,12 MC 115(JSR).
• Citation: 499 B.R. 416
• Parties: SECURITIES INVESTOR PROTECTION CORPORATION, Plaintiff, v. BERNARD L. MADOFF INVESTMENT SECURITIES LLC, Defendant. In re Madoff Securities. Pertains to: Consolidated proceedings on antecedent debt issues.
• Court: U.S. District Court — Southern District of New York

499 B.R. 416

SECURITIES INVESTOR PROTECTION CORPORATION, Plaintiff,

v. BERNARD L. MADOFF INVESTMENT SECURITIES LLC, Defendant.In re Madoff Securities.Pertains to: Consolidated proceedings on antecedent debt issues.

No. 12 MC 115(JSR).

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

Oct. 15, 2013.

OPINION AND ORDER

JED S. RAKOFF, District Judge.

Under section 548(a)(1) of the Bankruptcy Code, the trustee of a bankruptcy estate is empowered to, inter alia, “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).¹ However, this authority is limited by subsection (c) of the same section, which provides that “a transferee or obligee of such a transfer or obligation that takes for value and in good faith has a lien on or may retain any interest transferred or may enforce any obligation incurred, as the case may be, to the extent that such transferee or obligee gave value to the debtor in exchange for such transfer or obligation.” Id. § 548(c). In other words, although a trustee in bankruptcy may avoid the entirety of an actually fraudulent transfer by the debtor, the transferee from whom that transfer is sought may retain the transfer “to the extent that [the transferee] gave value to the debtor” and acted in good faith. The question before the Court on the instant motion is whether and how this “value” limitation applies in the context of the avoidance and recovery actions brought by Irving Picard (the “Trustee”), the trustee appointed under the Securities Investor Protection Act (“SIPA”), 15 U.S.C. § 78aaa et seq., to administer the estate of Bernard L. Madoff Investment Securities LLC (“Madoff Securities”).²

The Court assumes familiarity with the underlying facts of Madoff Securities' fraud and ensuing bankruptcy and recounts here only those facts that are relevant to the instant issues. As explained in this Court's Opinion in Picard v. Greiff, 476 B.R. 715, 718 (S.D.N.Y.2012), for many years Madoff Securities, a registered securities broker-dealer, operated a fraudulent investment advisory business, through which “Madoff Securities purported to make securities investments on [its] clients' behalf” and accordingly

sent monthly or quarterly statements to each of its investment advisory clients showing the securities that Madoff Securities claimed to hold for the client and the trades that it claimed to have executed on the client's behalf during the applicable period. In reality, the investment advisory unit of Madoff Securities never, or almost never, made the trades or held the securities described in the statements it sent to investment advisory clients, at least during all years here relevant. Instead, Madoff Securities operated its investment advisory division as a Ponzi scheme. Thus, when clients withdrew money from their accounts with Madoff Securities, they did not actually receive returns on successful investments, but instead only the very money that they and others had deposited with Madoff Securities for the purpose of purchasing securities.

Id. (citations and footnotes omitted). Indeed, these payments were necessary to perpetuate Madoff Securities' fraud, as it was only by making such transfers that Bernard Madoff was able to induce new investors to continue to join his scheme. Id. at 723.

By the time that Madoff Securities was revealed to be a Ponzi scheme and entered into liquidation, some investors had withdrawn from their accounts more than they had initially invested (because of their erroneous assumption that the amounts reflected in their customer statements were in fact returns on their investment), while others had not withdrawn even the amounts they had invested. The defendants to the instant proceeding are Madoff Securities customers who received in transfers from Madoff Securities more than they had invested and against whom the Trustee has brought avoidance and recovery proceedings to reclaim that difference. Defendants now move to dismiss the Trustee's complaints, arguing that they are entitled to retain the amounts transferred from Madoff Securities under section 548(c) because the transfers constituted “satisfaction ... of a[n] ... antecedent debt of the debtor,” which is within the definition of “value” under section 548 of the Bankruptcy Code. 11 U.S.C. § 548(d)(2)(A).³

To understand the defendants' challenge to the Trustee's avoidance claims, a bit of statutory background is in order. As a general matter, a SIPA trustee is “vested with the same powers and title with respect to the debtor and the property of the debtor, including the same rights to avoid preferences, as a trustee in a case under Title 11.” 15 U.S.C. § 78fff–1(a). What makes a SIPA, bankruptcy different from an ordinary bankruptcy is, in particular, that SIPA empowers a trustee to recover and distribute to the debtor broker-dealer's customers “customer property,” defined as “cash and securities ... at any time received, acquired, or held by or for the account of a debtor from or for the securities accounts of a customer, and the proceeds of any such property transferred by the debtor, including property unlawfully converted.” 15 U.S.C. § 78 lll(4). Correspondingly, SIPA superimposes on the Bankruptcy Code a separate customer property estate that takes priority over the debtor's general estate. Customer property remaining in the possession of the debtor at the time of filing for bankruptcy is allocated to this separate customer property estate for distribution according to SIPA's statutory priorities, under which customers of the debtor “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).

To the extent that existing “customer property is not sufficient to pay in full” those statutorily identified claims, the trustee is empowered by SIPA to “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. Such recovered property shall be treated as customer property.” 15 U.S.C. § 78fff–2(c)(3). If the recovered funds “are not sufficient to pay or otherwise satisfy in full the net equity claims of customers, such customers shall be entitled, to the extent only of their respective unsatisfied net equities, to participate in the general estate as unsecured creditors.” 15 U.S.C.A. § 78fff–2(c)(1). Conversely, if any customer property remains “after allocation in accordance with” SIPA's statutory priorities, those assets “become part of the general estate of the debtor.” Id.

Thus, in addition to the ordinary recovery of the debtor's assets for distribution to creditors of the general estate, the Trustee in this SIPA proceeding must both recover customer property—which, for our purposes, has primarily been transferred to other customers in the form of fictitious “profits” as part of Madoff Securities' efforts to perpetuate its fraud—and then distributed to customers who have “net equity” claims. See15 U.S.C. § 78fff–2(b) (requiring a SIPA trustee to “promptly discharge ... all obligations of the debtor to a customer relating to, or net equity claims based upon, securities or cash ... insofar as such obligations are ascertainable from the books and records of the debtor or are otherwise established to the satisfaction of the trustee”). The Trustee has taken the position that, in this case, a customer's net equity and the amounts sought in avoidance and recovery proceedings (assuming the customer's good faith) are two sides of the same coin. That is, a “customer's ‘net equity’ [is] calculated by the ‘Net Investment Method,’ crediting the amount of cash deposited by the customer into his or her [Madoff Securities] account, less any amounts withdrawn from it,” as opposed to “the market value of the securities reflected on their last ... customer statements.” In re Bernard L. Madoff Inv. Sec. LLC, 654 F.3d 229, 233 (2d Cir.2011). A customer who withdrew less than she deposited over the course of her investment with Madoff Securitieshas a net-equity claim and may be entitled to disbursements from the customer property estate for the amount of that net equity. At the same time, the Trustee has engaged in the same “netting” process and has brought avoidance actions for the amount in excess of their deposits against those investors who withdrew more money from their accounts than they deposited, including each of the defendants party to this consolidated proceeding. These avoidance actions are limited by the two-year “reach-back period” specified in section 548(a)(1) for fraudulent-transfer actions. See11 U.S.C. § 548(a)(1).

In Greiff, this Court rejected the argument that Madoff Securities' payments of fictitious profits to its customers discharged the debtor's obligation to pay the amounts reflected on the defendants' most recent customer statements, making the entirety of Madoff Securities' transfers to its customers repayment of an antecedent debt and therefore “for value.” See Greiff, 476 B.R. at 724–25. As the Court stated, “[I]n this context, the transfers must be assessed on the basis of what they really were; and they really were artificial transfers designed to further the fraud, rather than any true return on investments.” Id. at 725. Thus, the Court held that any “transfers from Madoff Securities to defendants that exceeded the return of defendants' principal ... were not ‘for value’ ” for purposes of section 548(c).⁴Id.

In the instant action, defendants argue that Greiff's holding that “value” under 548(c) is...