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

• Decision Date: 24 March 2021
• Docket Number: 20 cv. 3836 (JGK)
• Citation: 528 F.Supp.3d 219
• 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 Substantively Consolidated SIPA Liquidation of Bernard L. Madoff Investment Securities LLC and Bernard L. Madoff, Plaintiff, v. Jaba Associates LP, et al., Defendants.
• Court: U.S. District Court — Southern District of New York

528 F.Supp.3d 219

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 Substantively Consolidated SIPA Liquidation of Bernard L. Madoff Investment Securities LLC and Bernard L. Madoff, Plaintiff,

v.Jaba Associates LP, et al., Defendants.

20 cv. 3836 (JGK)

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

Signed March 24, 2021

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

Helen Davis Chaitman, Chaitman LLP, New York, NY, for Defendants.

OPINION AND ORDER

JOHN G. KOELTL, District Judge:

The plaintiff, Irving H. Picard (the "Trustee"), has brought this suit in his capacity as the trustee for the substantively consolidated SIPA liquidation of Bernard L. Madoff Investment Securities LLC ("BLMIS" or the "LLC") against the defendants, JABA Associates LP ("JABA") and the general partners of JABA: Audrey Goodman, Bruce Goodman, Andrew Goodman, and the estate of James Goodman. The Trustee has sought avoidance and recovery of $2,925,000 transferred from BLMIS to the defendants in the two years prior to BLMIS's filing for bankruptcy (the "Two-Year Transfers") pursuant to the Securities Investor Protection Act of 1970, 15 U.S.C. §§ 78aaa - 78lll ("SIPA"). The Trustee has moved for summary judgment holding the defendants liable to the Trustee for the Two-Year Transfers, and the defendants have moved for summary judgment dismissing this case. For the following reasons, the Trustee's motion is granted, and the defendants’ motion is denied.

I. BACKGROUND

JABA is a limited partnership formed under the laws of New York. Pl.’s 56.1 Stmt. ¶ 107. JABA was a good faith customer of BLMIS and held BLMIS Account Number 1EM357 (the "JABA Account"). Id. ¶ 108. The Trustee brings this action to recover the allegedly fictious profits transferred from BLMIS to the defendants in the two years prior to BLMIS's filing for bankruptcy.¹

A. Operation of BLMIS

BLMIS operated as three business units: (1) a proprietary trading business; (2) a market-making business; and (3) the investment-advisory business (the "IA Business"). Dubinsky Decl., Attach. A (the "Dubinsky Report") ¶ 36. The proprietary trading business traded for its own account to make money for BLMIS. Id. ¶¶ 36, 46. The market-making business made markets in certain stocks, bonds, warrants, and rights. Id. The IA Business was advertised as trading stocks, equities, and options on behalf of its customer accounts. Id. ¶¶ 41-44. The propriety trading and market-making businesses are collectively referred to as the "Proprietary Trading Business." All three business units were part of BLMIS and were operated by Bernard L. Madoff. Id. ¶¶ 36, 48.

BLMIS told its IA Business customers that BLMIS was using investment strategies known as "convertible arbitrage" or "split-strike conversion." Id. ¶¶ 19-26. BLMIS did not actually employ either strategy. Id. Instead, BLMIS used historical trading information to create false records for the IA Business customers. Id. Section VI.A(1)(a). By 1992, BLMIS represented that its primary investment strategy was split-strike conversion, which was the strategy BLMIS claimed to use in connection with the JABA Account. Id. ¶ 155. The purported split-strike conversion strategy involved investing in a basket of common stocks from the Standard & Poor's 100 Index, buying put options and selling call options as a hedge, and purchasing United States Treasury Bills ("T-Bills") where appropriate. Id. ¶¶ 44, 156-58.

The Trustee's expert, Bruce G. Dubinsky, demonstrated that BLMIS did not actually trade on behalf of its IA Business clients. Dubinsky presented evidence of (1) fabricated trades; (2) the impossible reported volume of equity trades; (3) the impossible equity and options trades reported outside the daily price range; (4) the low volatility in BLMIS's reported daily trading performance compared to the market; (5) the consistently positive return rates that did not mirror the volatility of the market; (6) a lack of Depository Trust Corporation ("DTC") records to confirm the IA Business equity trades; and (7) a lack of Options Clearing Corporation ("OCC") records to confirm the IA Business options trades. Id. Section VI.A(1)(c)-(f). The Dubinsky Report shows that there were many instances where the volume that BLMIS claimed to have traded on behalf of its IA Business customers exceeded the volume of equities traded for the entire market. Id. ¶¶ 159-60. Moreover, Dubinsky demonstrated that the actual equity trades recorded in BLMIS's DTC account were traded by the Proprietary Trading Business, and that no IA Business trades were cleared through BLMIS's DTC account. Id. ¶¶ 209-13. Likewise, Dubinsky demonstrated that BLMIS's OCC account revealed that BLMIS did not conduct any options trading for its IA Business customers. Id. ¶ 222.

Dubinsky's analysis also demonstrated that no customer funds were invested in T-Bills for the benefit of the customer. Id. ¶¶ 224-27. Based on maturity dates, purchase and sale dates, and volume, Dubinsky determined that all of the T-Bills held by BLMIS were different from the T-Bills purportedly held by the IA Business accounts. Id. ¶¶ 232-40. T-Bills were purchased to obtain interest on the customer cash that BLMIS was holding, but those purchases did not match the T-Bills transactions that appeared on periodic customer statements that BLMIS provided to its customers. Id. ¶¶ 224-28.

Corroborating Dubinsky's analysis, Frank DiPascali, a now-deceased BLMIS employee, testified in the criminal trial of Daniel Bonventre, BLMIS's operations manager, that T-Bills purchased with IA Business money were purchased for the sake of BLMIS's own cash management strategy and were not purchased for any customer account. Cremona Decl. Ex. 3 at 4931. Several other former BLMIS employees testified or allocuted to facts establishing that BLMIS falsified records and inflated revenue. Pl.’s 56.1 Stmt. ¶¶ 100-06.

In the 10 years prior to BLMIS's collapse, the IA Business primarily used three bank accounts: JPMorgan Chase Bank, N.A. ("JPMorgan") account #xxxxx1703 (the "703 Account"); JPMorgan account #xxxxxxxxx1509 (the "509 Account", together with the 703 Account, the "JPMorgan Accounts")); and Bankers Trust account #xx-xx0-599 (the "BT Account"). Collura Decl., Attach. A (the "Collura Report") ¶ 17. BLMIS comingled the IA Business customers’ cash deposits in the 703 Account. Id. ¶¶ 20-24. The JPMorgan Accounts were linked commercial business accounts and the 509 Account was funded entirely by the 703 Account. Id. ¶ 25. IA Business customer withdrawals were made from checking accounts funded entirely by the 703 Account, typically from the 509 Account or the BT Account. Id. ¶¶ 25-30. About 97% of all cash additions into the 703 Account came from IA Business customers. Id. ¶ 24; Dubinsky Report ¶ 340 & n.285. The remaining 3% of the cash additions into the 703 Account was from income earned on short-term investment activity made directly from the 703 Account, transfers from other BLMIS or Madoff accounts, and investments of BLMIS customer funds held in the name of BLMIS or Madoff. Collura Report ¶¶ 24, 45-62; Dubinsky Report Figure 52 & n.286. There were no inflows or outflows from the 703 Account due to purchasing or selling securities for customer accounts. Collura Report ¶¶ 24, 32; Dubinsky Report ¶¶ 340, 350. Apart from two short-term loans from JPMorgan in 2005 and 2006, both of which were repaid by June 2006, the IA Business did not obtain loans from third parties or from the Proprietary Trading Business sufficient to pay the IA Business customer withdrawals. Dubinsky Report ¶¶ 342-44.

According to customer statements, the IA Business reported receiving cash dividends related to purported equity holdings and paid or credited them to the accountholders. Id. ¶¶ 247-55. Of the over 8,300 IA Business dividend transactions identified on customer account statements between 1998 to 2008, not one of them matched to a cash addition to the 703 Account, and there is no record of any dividend being received by the IA Business. Id. ¶¶ 248, 253-55. BLMIS falsely reported paying or crediting its customers with $4.3 billion in cash dividends during that period. Id. ¶¶ 247-55.

When IA Business customers sent Madoff money to purchase securities, Madoff did not reserve it, but rather comingled it into the 703 Account. Id. ¶ 340; Collura Report ¶¶ 20-24. Customer redemptions were paid with cash that other customers had deposited into the 703 Account. Dubinsky Report ¶¶ 330-37. Because the IA Business did not have any legitimate income-producing activities, the only source of cash available to pay purported profits to customers was from cash that other IA Business customers deposited into the 703 Account. Id. By 2002, BLMIS was insolvent, with approximately $1.82 billion in assets and $11.9 billion in liabilities. Id. ¶¶ 432-33. In December 2008, customer redemptions and withdrawal requests far exceeded the amount of capital BLMIS had on hand. Id. ¶¶ 40, 440-41.

B. BLMIS's Change in Organization

Madoff operated his business from 1960 to 2008. In 1960, Madoff was assigned Registrant Number 8-8132 from the Securities and Exchange Commission ("SEC") as a broker-dealer. Cremona Decl. Ex. 1, SEC Form BD. When SIPA was enacted in 1970, Madoff's business became a member of the Securities Investor Protection Corporation ("SIPC") by virtue of its previous registration with the SEC as a broker-dealer. Pl.’s 56.1 Stmt. ¶ 7; see also 15 U.S.C. § 78ccc(a)(2)(A). In 2001, Madoff reorganized his business from a sole proprietorship to a single member LLC under the name "Bernard L. Madoff Investment Securities LLC." Pl.’s 56.1 Stmt. ¶¶ 7-8. Madoff previously operated his business under the names "Bernard L. Madoff" and "Bernard L. Madoff Investment Securities." Id. When Madoff reorganized the...