Irving H. Picard v. Saul B. Katz et al

Filing 118

MEMORANDUM OF LAW in Opposition re: 81 MOTION for Partial Summary Judgment.. Document filed by Charles 15 Associates, Charles 15 LLC, Charles Sterling LLC, Charles Sterling Sub LLC, College Place Enterprises LLC, Coney Island Baseball Holding Company LLC, Estate of Leonard Schreier, FFB Aviation LLC, FS Company LLC, Fred Wilpon Family Trust, Arthur Friedman, Ruth Friedman, Iris J. Katz and Saul B. Katz Family Foundation, Inc., Judy and Fred Wilpon Family Foundation, Inc., Amy Beth Katz, David Katz, Dayle Katz, Gregory Katz, Howard Katz, Iris Katz, 157 J.E.S. LLC, Air Sterling LLC, BAS Aircraft LLC, Jason Bacher, Bon Mick Family Partners LP, Bon-Mick, Inc., Brooklyn Baseball Company LLC, C.D.S. Corp., Michael Katz, Saul B. Katz, Todd Katz, Katz 2002 Descendants' Trust, Heather Katz Knopf, Natalie Katz O'Brien, Mets II LLC, Mets Limited Partnership, Mets One LLC, Mets Partners, Inc., Minor 1 (REDACTED), Minor 2 (REDACTED), L. Thomas Osterman, Phyllis Rebell Osterman, Realty Associates Madoff II, Red Valley Partners, Robbinsville Park LLC, Ruskin Garden Apartments LLC, Saul B. Katz Family Trust, Michael Schreier, Deyva Schreier Arthur, See Holdco LLC, See Holdings I, See Holdings II, Sterling 10 LLC, Sterling 15C LLC, Sterling 20 LLC, Sterling Acquisitions LLC, Sterling American Advisors II LP, Sterling American Property III LP, Sterling American Property IV LP, Sterling American Property V LP, Sterling Brunswick Corporation, Sterling Brunswick Seven LLC, Sterling Dist Properties LLC, Sterling Equities, Sterling Equities Associates, Sterling Equities Investors, Sterling Heritage LLC, Sterling Internal V LLC, Sterling Jet II Ltd., Sterling Jet Ltd., Sterling Mets Associates, Sterling Mets Associates II, Sterling Mets LP, Sterling Pathogenesis Company, Sterling Third Associates, Sterling Thirty Venture LLC, Sterling Tracing LLC, Sterling Twenty Five LLC, Sterling VC IV LLC, Sterling VC V LLC, Edward M. Tepper, Elise C. Tepper, Jacqueline G. Tepper, Marvin B. Tepper, Valley Harbor Associates, Kimberly Wachtler, Philip Wachtler, Bruce N. Wilpon, Daniel Wilpon, Debra Wilpon, Fred Wilpon, Jeffrey Wilpon, Jessica Wilpon, Judith Wilpon, Richard Wilpon, Scott Wilpon, Valerie Wilpon, Wilpon 2002 Descendants' Trust, Robin Wilpon Wachtler. (Wagner, Karen)

UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
----------------------------------- x
:
IRVING H. PICARD,
:
:
Plaintiff,
:
:
- against : 11-CV-03605 (JSR) (HBP)
:
SAUL B. KATZ, et al.,
:
:
Defendants.
:
:
:
----------------------------------- x

MEMORANDUM OF LAW IN OPPOSITION TO TRUSTEE’S MOTION
FOR PARTIAL SUMMARY JUDGMENT

DAVIS POLK & WARDWELL LLP
450 Lexington Avenue
New York, New York 10017
[phone]
Attorneys for Defendants

TABLE OF CONTENTS
PAGE
PRELIMINARY STATEMENT ...................................................................................... 1
ARGUMENT.................................................................................................................... 1
I.

ALL TRANSFERS WERE “FOR VALUE”........................................................ 2
A.

Each Defendant Had Valid Claims Against BLMIS Under
Article 8 and Other State Law .................................................................. 2

B.

Each Defendant’s Claims Against BLMIS Constituted “Value”
Under 11 U.S.C. § 548(d)(2) .................................................................... 5
1.
2.

II.

BLMIS’ Obligations To Defendants Cannot Be Avoided............ 6
Creditor Claims Remain Creditor Claims in a Ponzi
Scheme Insolvency ....................................................................... 7

THE TRUSTEE CAN NEITHER STATE NOR PROVE A
FRAUDULENT TRANSFER CLAIM............................................................... 11
A.

The Trustee Cannot Establish That Any Transfer Was Fraudulent
Under Sharp and Boston Trading ........................................................... 12

B.

Defendants Have Demonstrated That All Transfers Were “For
Value” Under 11 U.S.C. § 548(c) ........................................................... 16

CONCLUSION............................................................................................................... 17

i

TABLE OF AUTHORITIES
CASES
PAGE
ABF Capital Mgmt. v. Askin Capital Mgmt., L.P., No. 96 Civ. 2978,
1997 U.S. Dist. LEXIS 8195 (S.D.N.Y. June 11, 1997) .............................................. 8
Armstrong v. Collins, No. 01 Civ. 2437, 2010 U.S. Dist. LEXIS 28075
(S.D.N.Y. Mar. 24, 2010) ........................................................................................ 9-10
Banque Worms v. BankAmerica Int’l, 77 N.Y.2d 362 (1991) .................................... 10, 11
Boston Trading Grp., Inc. v. Burnazos,
835 F.2d 1504 (1st Cir. 1987)................................................................... 12, 13, 14, 16
Butner v. United States, 440 U.S. 48 (1979)..................................................................... 17
CFTC v. Walsh, 17 N.Y.3d 162 (2011) ............................................................................ 11
CFTC v. Weintraub, 471 U.S. 343 (1985) .................................................................... 8, 10
Donell v. Kowell, 533 F.3d 762 (9th Cir. 2008) ................................................................. 9
Hatch v Fourth Nat’l Bank, 147 N.Y. 184 (1895) ............................................................ 11
HBE Leasing Corp. v. Frank, 48 F.3d 623 (2d Cir. 1995) ............................................... 12
In re Bayou Grp., LLC, 439 B.R. 284 (S.D.N.Y. 2010) ................................... 9, 14, 15, 16
In re Bernard L. Madoff Inv. Sec. LLC, 654 F.3d 229 (2d Cir. 2011) ................................ 3
In re Churchill Mortgage Inv. Corp., 256 B.R. 664 (Bankr. S.D.N.Y. 2000),
aff’d sub nom. Balaber-Strauss v. Lawrence, 264 B.R. 303 (S.D.N.Y. 2001) ........... 14
In re DBSD N. Am., Inc., 634 F.3d 79 (2d Cir. 2011)................................................... 8, 10
In re Manhattan Inv. Fund, 359 B.R. 510 (Bankr. S.D.N.Y. 2007) ........................... 14, 15
In re Manhattan Inv. Fund, 397 B.R. 1 (S.D.N.Y. 2007)................................................. 13
In re New Times Sec. Servs., Inc., 371 F.3d 68 (2d Cir. 2004)............................................7
In re Refco Inc., 461 B.R. 181 (Bankr. S.D.N.Y. 2011) ....................................................14
In re Sharp Int’l Corp., 403 F.3d 43 (2d Cir. 2005) .................................................. passim
ii

Lippe v. Bairnco Corp., 249 F. Supp. 2d 357 (S.D.N.Y. 2003),
aff’d, 99 F. App’x 274 (2d Cir. 2004)......................................................................... 12
NML Capital v. Republic of Argentina, 17 N.Y.3d 250 (2011)...........................................4
Perkins v. Haines, 661 F. 3d 623 (11th Cir. 2011) ............................................................. 9
Picard v. Katz, 11 Civ. 3605, 2011 U.S. Dist. LEXIS 109595
(S.D.N.Y. Sept. 27, 2011)................................................................................. 1, 2, 3, 7
Scholes v. Lehmann, 56 F.3d 750 (7th Cir. 1995)......................................................... 9, 13
Visconsi v. Lehman Bros., 244 F. App’x 708 (6th Cir. 2007) ............................................ 5
STATUTES AND RULES
11 U.S.C. § 101(5)(A)......................................................................................................... 5
11 U.S.C. § 101(10)(A)....................................................................................................... 5
11 U.S.C. § 101(12) ............................................................................................................ 5
11 U.S.C. § 546(e) .............................................................................................................. 7
11 U.S.C. § 548(a)(1)(A) .................................................................................................. 11
11 U.S.C. § 548(c) ...................................................................................................... 11, 16
11 U.S.C. § 548(d)(2) ............................................................................................... 1, 2, 16
11 U.S.C. § 548(d)(2)(A).................................................................................................... 5
11 U.S.C. § 749(a) .............................................................................................................. 6
15 U.S.C. § 78fff-1(a) ......................................................................................................... 6
15 U.S.C. § 78fff-2(c)(3) .................................................................................................... 6
UCC Art. 8. ................................................................................................................ passim
UCC § 8-501. ...................................................................................................................... 4
UCC § 8-501 cmt. 2 .......................................................................................................... 10
UCC § 8-501 cmt. 3 ............................................................................................................ 4
UCC § 8-504 ....................................................................................................................... 4
iii

Defendants respectfully submit this memorandum of law in opposition to the
Trustee’s motion for partial summary judgment. All transfers to Defendants were “for
value.” The Trustee’s motion must be denied.
PRELIMINARY STATEMENT
The Trustee has moved for partial summary judgment with regard to transfers of
“profits.” He argues that “Defendants cannot establish that they took the transfers of
fictitious profits ‘for value’ because the profits were not on account of a valid antecedent
debt.” But his legal argument ignores three critical factors, none of which is in dispute.
First, BLMIS was a registered broker. Second, Article 8 of the New York Uniform
Commercial Code (“UCC”) establishes that a broker is liable to a customer for the
securities reflected on the statements issued by the broker. And, third, the Trustee cannot
avoid BLMIS’ obligations to Defendants. Therefore, all payments by BLMIS to
Defendants satisfied such obligations and were, by definition, “for value,” under 11
U.S.C. § 548(d)(2). In addition, as set forth in Defendants’ motion for summary
judgment, the undisputed evidence demonstrates that no Defendant was willfully blind to
Madoff’s fraud.
ARGUMENT
BLMIS was obligated to each Defendant for the blue chip securities and
Treasuries on his, her, or its account statement pursuant to Article 8 of the UCC, and its
obligation was enforceable under several bodies of law. These obligations establish
“value” for all transfers on account of such obligations. Although this Court has
suggested that Defendants will have difficulty establishing that they took profits “for
value,” see Picard v. Katz, 11 Civ. 3605, 2011 U.S. Dist. LEXIS 109595, at *14-18 & n.6

(S.D.N.Y. Sept. 27, 2011), Defendants respectfully submit that BLMIS’ status as a broker,
Defendants’ status as creditors, and UCC Article 8 mandate that all transfers were for
value.1
The Ponzi scheme cases relied upon by the Trustee are not to the contrary. The
existence of a Ponzi scheme is used in these cases as the basis for a finding of fraudulent
intent on the part of the transferor, but this finding does not affect the recognition that
creditor claims constitute “value” for avoidance purposes. The cases cited by the Trustee
differ from this case only as to the nature of the claims at issue. Those cases afford
restitution claims to defrauded equity investors. In this case, Defendants were creditors
whose claims were not limited to restitution, requiring the conclusion that all payments to
Defendants by BLMIS were “for value” within the meaning of 11 U.S.C. § 548(d)(2).
I.

ALL TRANSFERS WERE “FOR VALUE”
A.

Each Defendant Had Valid Claims Against
BLMIS Under Article 8 and Other State Law

The Second Circuit has ruled that each claimant who deposited cash with BLMIS
“for the purpose of purchasing securities” should be “treated as a customer with claims

1

Defendants do not dispute, and have offered to stipulate to, the only facts
relevant to this motion—the dates, amounts, and account holder recipients of cash
transfers. Nevertheless, the Trustee has filed a lengthy, and largely improper, purported
statement of undisputed material facts pursuant to Rule 56.1(a) of the Local Civil Rules
(“Trustee’s Rule 56.1 Statement”). See Trustee’s Statement of Undisputed Material Facts
Pursuant to Local Rule 56.1, Picard v. Katz, 11 Civ. 3605, doc. no. 102 (S.D.N.Y. Jan. 26,
2012). The Trustee’s Rule 56.1 Statement is replete with expert opinions, legal
conclusions, and “facts” that have no bearing on this motion. Further, in their prior briefs,
Defendants have challenged the Trustee’s methodology for calculating “principal” and
“profit” and, therefore, disagree with the Trustee’s assertion that the “Two-Year Net
Winner Defendants” received, in the aggregate, $83 million of “profits.” (Trustee’s Mem.
of Law in Supp. of Mot. for Partial Summ. J. (“Tr. Mem.”) at 1 n.1, 23-25.)
2

for securities.” In re Bernard L. Madoff Inv. Sec. LLC, 654 F.3d 229, 236 (2d Cir. 2011)
(internal quotation marks omitted). This Court’s decision that transfers from BLMIS to
customers were, as a matter of law, settlement payments and/or transfers made in
connection with a securities contract implicitly reaches the same conclusion. Katz, 2011
U.S. Dist. LEXIS 109595, at *9-14. The Trustee and SIPC do not disagree.
“All BLMIS customers who filed claims—whether their net equity
customer claims were allowed or denied—are general creditors of the
BLMIS estate. The Trustee is working diligently on behalf of the entire
BLMIS estate and seeks to satisfy all creditor claims in this proceeding.”
Trustee’s Sixth Interim Report for the Period Ending September 30, 2011,
In re Bernard L. Madoff Inv. Sec. LLC, 08-1789, doc. no. 4529, at 35
(Bankr. S.D.N.Y. Nov. 15, 2011).
“[T]o the extent that the Claimants in this case have been harmed by the
Debtor by more than the net amounts deposited by them, their claims are
for damages which are general creditor, and not customer, claims. This is
the true nature of their claims, but as to such losses, investors are not
protected by SIPA.” Brief of Appellee SIPC, In re Bernard L. Madoff Inv.
Sec. LLC, 10-2378-bk, doc. no. 282, at 52 (2d Cir. Sept. 20, 2010).
These creditor claims arise under UCC Article 8 and are enforced principally
pursuant to state contract law. Under Article 8, a securities entitlement arose in favor of
each Defendant when BLMIS issued a statement or confirmation evidencing ownership
of securities. UCC § 8-501. Defendants became creditors with “claims” against BLMIS
for securities, and BLMIS owed them concomitant “debts.” At any time prior to BLMIS’
SIPA filing, a Defendant could have obtained a judgment under Article 8 enforcing those
debts. Article 8 does not distinguish between “principal” and “profits”—the amount of a
broker’s obligation to its customer is determined by reference to the account statements
delivered by the broker to the customer. And the fact that the broker may have been
engaged in fraud does not affect the customer’s legal rights.

3

“In the indirect holding system, the significant fact is that the securities
intermediary has undertaken to treat the customer as entitled to the
financial asset. It is up to the securities intermediary to take the necessary
steps to ensure that it will be able to perform its undertaking. . . . The
entitlement holder’s rights against the securities intermediary do not
depend on whether or when the securities intermediary acquired its
interests. . . . The duty of a securities intermediary to maintain sufficient
assets is governed by 8-504 and regulatory law. Subsection (c) [of Section
8-501] is included only to make it clear the question whether a person has
acquired a security entitlement does not depend on whether the
intermediary has complied with that duty.” UCC § 8-501 cmt. 3.
The word “broker” does not appear in the Trustee’s brief in support of his motion
for partial summary judgment, which also makes no mention of Article 8. But the
Trustee has recognized customer claims against BLMIS under other bodies of law.
“All BLMIS creditors, including customers whose claims were allowed,
customers whose claims were denied, and general creditors, may have
claims as general creditors against BLMIS for misrepresentation, fraud,
and breach of contract . . . .” (Mot. for an Order Approving an Initial
Allocation of Property to the Fund of Customer Property and Authorizing
an Interim Distribution to Customers, In re Bernard L. Madoff Inv. Sec.
LLC, No. 08-01789, doc. no. 4048, at 11 n.9 (Bankr. S.D.N.Y. May 4,
2011) (emphasis added).)
Thus, even the Trustee acknowledges that a broker who fails to invest funds
deposited for investment is liable for breach of contract. The remedy for breach of
contract is not limited to restitution.2 On the contrary, a customer would be entitled to

Even a restitution claim would include a recovery for the time value of money.
See NML Capital v. Republic of Argentina, 17 N.Y.3d 250, 266 (2011). (“[P]laintiffs are
entitled to be compensated for the loss of the time value of that money—which can be
accomplished only by awarding them statutory interest on the unpaid interest-only
payments.”) And the SEC has advocated for a constant dollar approach rather than a
limited restitution remedy. Brief of the SEC, Amicus Curiae, in Supp. of Appellee and
Affirmance of the Order of the Bankruptcy Court, In re Bernard L. Madoff Inv. Sec. LLC,
10-2378-bk, doc. no. 296, at 4, 17 (2d Cir. Sept. 21, 2010).
2

4

“benefit of the bargain damages”—what the customer would have owned had the
securities been acquired as promised—if his broker failed to acquire securities.
“Plaintiffs gave $21 million to [the broker], not to hide under a rock or
lock in a safe, but for the express purpose of investment, with a hope—
indeed a reasonable expectation—that it would grow. Thus, the out-ofpocket theory, which seeks to restore to Plaintiffs only the $21 million
they originally invested less their subsequent withdrawals, is a wholly
inadequate measure of damages. Had [the broker] invested Plaintiffs’
money as requested, their funds would have likely grown immensely. . . .
In fact, the fictitious statements issued by Lehman, which were designed
to track Plaintiffs’ funds as if they had been properly invested, indicate
that Plaintiffs’ accounts would have grown to more than $37.9 million. . . .
Plaintiffs thus . . . were entitled to the full $37.9 million balance shown,
regardless of the amounts of their previous deposits and withdrawals.”
Visconsi v. Lehman Bros., 244 F. App’x 708, 713-14 (6th Cir. 2007).
B.

Each Defendant’s Claims Against BLMIS
Constituted “Value” Under 11 U.S.C. § 548(d)(2)

Customer claims under Article 8 and contract law constitute “value.” “Value” is
defined in the Bankruptcy Code as “satisfaction . . . of a present or antecedent debt.” 11
U.S.C. § 548(d)(2)(A). “Debt” is defined as “liability on a claim.” Id. § 101(12).
“Claim” is defined extremely broadly as a “right to payment.” Id. § 101(5)(A). And a
creditor is an “entity that has a claim against the debtor.” Id. § 101(10)(A).
The Trustee does not dispute that a claim constitutes “value” or that Defendants
were creditors with such claims. Instead, the Trustee posits that Defendants’ claims, to
the extent they exceeded “principal,” are invalid because they arose in the context of a
Ponzi scheme and, therefore, must be treated like equity claims of defrauded investors.
The Trustee’s position cannot be sustained. The Trustee cannot avoid BLMIS’
obligations to Defendants, and Madoff’s fraud did not convert Defendants’ claims as
creditors to equity investments.

5

1.

BLMIS’ Obligations To Defendants Cannot Be Avoided

The Trustee’s Complaint does not seek to avoid BLMIS’ obligations to
Defendants.3 Indeed, the Trustee is not authorized to do so. SIPA section 78fff-2(c)(3),
which authorizes a SIPC trustee to employ the avoidance provisions of the Bankruptcy
Code, permits their use only as to transfers:
“(3) RECOVERY OF TRANSFERS
Whenever customer property is not sufficient to pay in full the claims set
forth in subparagraphs (A) through (D) of paragraph (1), 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. Such
recovered property shall be treated as customer property. For purposes of
such recovery, the property so transferred shall be deemed to have been
the property of the debtor and, if such transfer was made to a customer or
for his benefit, such customer shall be deemed to have been a creditor, the
laws of any State to the contrary notwithstanding.” 15 U.S.C. § 78fff2(c)(3) (emphasis added); see also 11 U.S.C. § 749(a) (same limitation as
to unregistered broker liquidations).
Consistent with this limitation, Section 78fff-2(c)(3) also deems customers to be
creditors, and Section 78fff-1(a) gives a SIPA trustee powers that include “the same
rights to avoid preferences, as a trustee in a case under title 11.” 15 U.S.C. § 78fff-1(a)
(emphasis added). Creditors, by definition, have valid claims. Those claims constitute
antecedent debt. Transfers on account of antecedent debt cannot be avoided as fraudulent.
They can only be avoided as preferential.4 Indeed, the Trustee’s Complaint sought to

3

The Trustee has recently commenced a wholesale amendment of complaints in
other cases to add counts for the avoidance of obligations, perhaps recognizing that those
obligations otherwise constitute valid antecedent debt. See, e.g., Am. Compl., Picard v.
Blumenthal, 11 Civ. 4293, doc. no. 24, at ¶¶ 36-38 (S.D.N.Y. Dec. 2, 2011).
4

The reason for Section 78ff-2(c)(3)’s limitation is readily apparent. Customers
must rely upon their brokerage statements as evidence of what their broker is holding for
(…continued)

6

avoid transfers within the preference period based on the allegation that each was on
account of antecedent debt. (Compl. ¶¶ 1380, 1385.) But under no circumstances can the
Trustee avoid such transfers as fraudulent, particularly where, as here, no underlying
obligation has been or can be challenged.
2.

Creditor Claims Remain Creditor
Claims in a Ponzi Scheme Insolvency

Because the Trustee cannot avoid BLMIS’ obligations to Defendants, those
obligations constitute valid antecedent debt, and transfers that satisfied those obligations
were “for value.” The Trustee has cited no case in which transfers to non-complicit
customers of a registered broker were avoided as fraudulent—because there is none.
Instead, the Trustee argues that, because BLMIS was operating a Ponzi scheme, the law
is different than in other fraud cases. But the Trustee is wrong. The law is exactly the
same. As this Court recognized, the existence of the BLMIS Ponzi scheme is a fact
relevant to a finding of fraudulent intent on the part of the debtor. Katz, 2011 U.S. Dist.
LEXIS 109595, at *14-15. That fact has no implications with respect to “value.” And
the critical difference between this case and the Ponzi scheme cases is that they address
the interests of equity holders in—not the claims of creditors against—an insolvent entity.

(continued…)

them because they have no other evidence of securities ownership. SIPA was enacted to
“promot[e] investor confidence in the securities markets and [to] protect[] broker-dealer
customers.” In re New Times Sec. Servs., Inc., 371 F.3d 68, 87 (2d Cir. 2004).
Permitting a broker’s obligations to be subject to fraudulent transfer risk, other than
where customers were complicit in a fraud or other malfeasance, would be inimical to
SIPA’s objectives. Further, by enacting Section 546(e), which eliminates preference risk
as well, Congress continued to expand protection for securities transactions.
7

The rights of creditors and equity holders are very different. Equity holders
bargain for the right to participate in the increase in a firm’s value and bear the risk of
loss if that value decreases. See ABF Capital Mgmt. v. Askin Capital Mgmt., L.P., No. 96
Civ. 2978, 1997 U.S. Dist. LEXIS 8195, at *8 (S.D.N.Y. June 11, 1997). An equity
interest can never constitute debt, and an equity interest in an insolvent entity can neither
have value nor give rise to any right to payment. By contrast, creditors bargain for
contractual protections, which do not change with a firm’s fortunes. Creditors have
claims whether or not their counterparty is solvent. The ability to collect might change,
but the claim does not.
A creditor claim constitutes antecedent debt. An equity interest does not. And
when a firm becomes insolvent, creditors recover and equity interest holders do not. See,
e.g., CFTC v. Weintraub, 471 U.S. 343, 354-55 (1985) (“One of the painful facts of
bankruptcy is that the interests of shareholders become subordinated to the interests of
creditors . . . shareholders are [the] last to recover in bankruptcy.”); In re DBSD N. Am.,
Inc., 634 F.3d 79, 95 (2d Cir. 2011) (reversing bankruptcy plan approval that provided
value to equity holders before all unsecured creditor claims were satisfied in full).
The cases cited by the Trustee for the proposition that net investment is the limit
of any claim in a Ponzi scheme case all involve holders of equity interests. None
recognizes any claim for antecedent debt, or “value,” arising from the equity interest
itself, which can have no value where a debtor is insolvent. However, they do recognize
restitution claims for defrauded equity holders, and hold that such claims constitute
“value” for avoidance purposes.

8

Thus, for example, the Trustee’s key precedent, Donell v. Kowell, 533 F.3d 762
(9th Cir. 2008)—a receivership case under California law that did not involve SIPA, a
broker, or Article 8—held that equity investors in a fraudulent scheme were entitled to
restitution claims for net cash invested and that transfers to them could not be avoided to
the extent of such claims. “Up to the amount that ‘profit’ payments return the innocent
investor’s initial outlay, these payments are settlements against the defrauded investor’s
restitution claim. Up to this amount, therefore, there is an exchange of ‘reasonably
equivalent value’ for the defrauded investor’s outlay.” Id. at 777.
The Trustee’s other Ponzi scheme cases reach similar conclusions. See, e.g.,
Perkins v. Haines, 661 F.3d 623, 629 (11th Cir. 2011) (discussing transfers to defrauded
equity investors and holding that “transfers from the Debtors up to the amount of the
investment satisfied the investor defendants’ restitution or fraud claims and provided
value to the Debtors”); Scholes v. Lehmann, 56 F.3d 750, 757 (7th Cir. 1995) (“Phillips [a
defrauded equity investor] is entitled to his profit only if the payment of that profit to him,
which reduced the net assets of the estate now administered by the receiver, was offset by
an equivalent benefit to the estate.”); In re Bayou Grp., LLC, 439 B.R. 284, 308-09
(S.D.N.Y. 2010) (addressing claims against equity investors in bankrupt hedge fund who
“gave value in the form of their initial investments, and have tort claims of rescission to
recover all of their initial investment based on fraudulent inducement”); Armstrong v.
Collins, No. 01 Civ. 2437, 2010 U.S. Dist. LEXIS 28075, at *67 (S.D.N.Y. Mar. 24,
2010) (addressing claims against equity investors and recognizing that “courts have held
that a defrauded investor in a Ponzi scheme gives ‘value’ to the debtor in the form of a

9

dollar-for-dollar reduction in the investor’s restitution claim against the Ponzi scheme”
(citations and internal quotation marks omitted)).
Under these cases, “value” exists for any valid claim against the debtor. For
equity investors in a Ponzi scheme, that claim is limited to restitution. For Defendants, as
creditors, their claims under Article 8 and the law of contract are for the value of the
securities on their statements. Recognizing that the Ponzi scheme cases support him only
if he can persuade this Court that BLMIS was not a broker, the Trustee now suggests that
only part of BLMIS was fraudulent and perhaps that part should not be considered a
broker—and perhaps Defendants should be treated as though they had been limited
partners in BLMIS. The argument is specious. The Trustee admits that BLMIS was a
registered broker (Trustee’s Rule 56.1 Statement ¶ 1) and cannot dispute that Defendants
were its customers.
Further, any suggestion that customer withdrawals constituted payments of “Other
People’s Money” is equally specious. Where an equity investor has no right to payment
from an insolvent entity, a transfer on account of an equity interest is a transfer taken
from creditors, who do have a priority right to payment. See Weintraub, 471 U.S. at 35455; DBSD, 634 F.3d at 95. And the “idea that discrete objects might be traced through
the hands of different persons has no place in the Revised Article 8 rules for the indirect
holding system.” UCC § 8-503 cmt. 2. Article 8 serves policies similar to those
supporting finality with respect to electronic fund transfers. For example, in Banque
Worms v. BankAmerica Int’l, 77 N.Y.2d 362, 372 (1991), the New York Court of
Appeals, addressing a certified question from the Second Circuit, held that an erroneous

10

funds transfer taken in good faith and for value could not be reversed, focusing on the
need for finality.
“This concern for finality in business transactions has long been a
significant policy consideration in this State. In a different but pertinent
context, we observed in Hatch v Fourth Natl. Bank (147 N.Y. 184, 192)
that ‘to permit in every case of the payment of a debt an inquiry as to the
source from which the debtor derived the money, and a recovery if shown
to have been dishonestly acquired, would disorganize all business
operations and entail an amount of risk and uncertainty which no
enterprise could bear.’” Banque Worms, 77 N.Y.2d at 372.
Banque Worms, decided in the context of a mistake, was then applied in CFTC v.
Walsh, 17 N.Y.3d 162, 172 (2011), to support the conclusion that a transfer by the
perpetrator of a Ponzi scheme to his ex-wife could, if taken in good faith and for
consideration, be protected from avoidance. “It has long been the law of this State that
‘money obtained by fraud or felony cannot be followed by the true owner into the hands
of one who has received it bona fide and for a valuable consideration in due course of
business.’” Id. at 172-73. Similarly, here, the fact that BLMIS was engaged in fraud
cannot affect the validity of a transfer that otherwise was “for value.”
II.

THE TRUSTEE CAN NEITHER STATE NOR
PROVE A FRAUDULENT TRANSFER CLAIM
As Defendants have demonstrated, their rights to the value of the securities

reflected on their account statements were not limited to restitution claims, or net cash
invested. Consequently, any transfer discharging those claims was “for value,” and either
the Trustee cannot state any claim for fraudulent transfer under Section 548(a)(1)(A) of
the Bankruptcy Code, or Defendants have established that all transfers were “for value”
as a matter of law for purposes of Section 548(c) of the Bankruptcy Code.

11

A.

The Trustee Cannot Establish That Any Transfer
Was Fraudulent Under Sharp and Boston Trading

The Trustee can state no fraudulent transfer claim. By definition, a payment to a
creditor on account of valid antecedent debt is not a fraudulent transfer—it is at most a
preference. “[A] conveyance which satisfies an antecedent debt made while the debtor is
insolvent is neither fraudulent nor otherwise improper, even if its effect is to prefer one
creditor over another.” In re Sharp Int’l Corp., 403 F.3d 43, 54 (2d Cir. 2005) (citation
omitted); see also Lippe v. Bairnco Corp., 249 F. Supp. 2d 357, 375 (S.D.N.Y. 2003),
aff’d, 99 F. App’x 274, 281 (2d Cir. 2004) (“[I]t is hornbook law that [a] conveyance
cannot be fraudulent as to creditors if . . . [it] does not deplete or otherwise diminish the
value of the assets of the debtor’s estate remaining available to creditors.” (internal
quotation marks omitted)); HBE Leasing Corp. v. Frank, 48 F.3d 623, 634 (2d Cir. 1995)
(“[T]he preferential repayment of pre-existing debts to some creditors does not constitute
a fraudulent conveyance, whether or not it prejudices other creditors, because ‘the basic
object of fraudulent conveyance law is to see that the debtor uses his limited assets to
satisfy some of his creditors; it normally does not try to choose among them.’” (quoting
Boston Trading Grp., Inc. v. Burnazos, 835 F.2d 1504, 1509 (1st Cir. 1987))).
In Sharp, the Second Circuit held that no intentional fraudulent transfer claim was
stated by a complaint that alleged fraud as to the source of the challenged payment, but
not as to the obligation being paid, even when the transferee knew that it was being paid
with fraudulently obtained funds.
“[T]he intentional fraudulent conveyance claims fails for the independent
reason that Sharp inadequately alleges fraud with respect to the
transaction that Sharp seeks to void, i.e., Sharp’s $12.25 million payment
to State Street. See Boston Trading, 835 F.2d at 1510 (“Fraudulent
conveyance law is basically concerned with transfers that ‘hinder, delay or
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defraud’ creditors; it is not ordinarily concerned with how such debts were
created.”) (emphasis omitted).
The fraud alleged in the complaint relates to the manner in which Sharp
obtained new funding from the Noteholders, not Sharp’s subsequent
payment of part of the proceeds to State Street. The $12.25 million
payment was at most a preference between creditors and did not hinder,
delay or defraud either present or future creditors.” 403 F.3d at 56
(internal quotation marks omitted).
Defendants respectfully submit that this holding, predicated on then-Judge
Breyer’s decision in Boston Trading to similar effect in the context of an actual
fraudulent conveyance, establishes that no fraudulent conveyance claim—intentional or
constructive—was stated because there was no allegation that that the obligation satisfied
by the challenged transfer was itself invalid. Other decisions have reached the same
conclusion. For example, in Scholes, 56 F.3d at 753, Judge Posner, also relying in part
on Boston Trading, observed that, under the avoidance provisions of the Uniform
Fraudulent Transfer Act (“UFTA”), which are nearly identical to those of the Bankruptcy
Code, see id. at 756, an exchange for value is not voidable as fraudulent as between a
debtor and its creditors:
“It is apparent from the wording of the statute, as well as from its purpose,
that if a transfer is made for commensurate consideration—if it is ‘fair’ in
the sense of being one side of an equal exchange—it is not voidable. For
creditors are not disturbed, delayed, hindered, or defrauded if all that
happens is the exchange of an existing asset of the debtor for a different
asset of equal value.” Id. at 753.
The Sharp court’s holding cannot be distinguished on the ground that it was not a
Ponzi scheme case, so the payment was not part of the fraud. See, e.g., In re Manhattan
Inv. Fund, 397 B.R. 1, 11 (S.D.N.Y. 2007). When an entity is engaged in fraud, all
transactions can be considered a “but for” cause of the fraud, and the repaid loan in Sharp

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is no exception.5 Rather, Sharp recognized that non-complicit creditors are entitled to
payment of antecedent debt, irrespective of the fraudulent intent of the transferor-debtor,
and held that if a valid antecedent debt is paid, the payment can constitute neither
constructive nor intentional fraud because it does not harm creditors. See In re Churchill
Mortgage Inv. Corp., 256 B.R. 664, 681 (Bankr. S.D.N.Y. 2000), aff’d sub nom. BalaberStrauss v. Lawrence, 264 B.R. 303, 308 (S.D.N.Y. 2001) (“The significance or
consequence of the . . . transaction as it relates to the Debtor’s overall Ponzi scheme is of
no relevance here.”).
“Fraudulent conveyance law, under both state and federal statutes, is
concerned with the reality of whether the transferee conferred equivalent
value on the debtor in the transaction sought to be avoided. The fact that
the debtor’s enterprise as a totality operated at a loss, or in a manner that is
fraudulent, does not render actually or constructively fraudulent a
particular transaction which in and of itself is not fraudulent in any
respect.” In re Churchill Mortgage Inv. Corp., 256 B.R. at 681.
Nonetheless, the Trustee argues that Sharp and Boston Trading are inapposite
because BLMIS was a Ponzi scheme, and it is “universally accepted that when investors
invest in a Ponzi scheme, payments by the debtor that exceed their investment (i.e.,
fictitious profits) constitute fraudulent transfers.” (Tr. Mem. at 26.) The Trustee relies
upon Bayou, 439 B.R. at 304, and In re Manhattan Investment Fund, 359 B.R. 510, 51718 (Bankr. S.D.N.Y. 2007), for the proposition that every payment in a Ponzi scheme is
in furtherance of the fraud and, therefore, any payment in excess of net cash invested can
never be “for value.” (Tr. Mem. at 22-23, 25-26.) Manhattan Investment Fund stands for
5

Cf. In re Refco Inc., 461 B.R. 181, 198 (Bankr. S.D.N.Y. 2011) (“The Second
Circuit in Sharp also made it clear that the mere existence of an underlying fraud on
creditors . . . does not transform into a constructive fraudulent transfer a payment in
satisfaction of an antecedent debt that enabled the fraudsters to further such fraud.”).
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no such proposition, as there was no dispute in that case that a creditor’s antecedent debt
created “value” for the challenged transfers. 359 B.R. at 523. And the Bayou Court,
addressing fraudulent conveyance claims against equity investors in a Ponzi scheme,
distinguishes creditor claims. 439 B.R. at 337.
In Bayou, a bankruptcy trustee sought to avoid redemptions by limited partner
equity investors in a hedge fund that turned out to be a Ponzi scheme. An investor’s
claim for equity, which has no value against an insolvent entity, gives rise to no legal
right or obligation on the part of the insolvent entity to make any payment to the investor.
On the contrary, its assets are subject to the priority claims of creditors. Consequently,
the District Court agreed with the Bankruptcy Court that:
“[T]he conclusion is inescapable that corrupt Bayou Management
authorized the fraudulently inflated redemption payments with ‘actual
intent to hinder, delay, or defraud’ because there cannot be any other
explanation for [transferors] to authorize redemption payments in amounts
to which they knew the redeeming investors were not contractually
entitled and which deepened the insolvency and damaged the remaining
investors.” Id. at 305-06 (emphasis added).
Because the Bayou court found that the debtor had no obligation to pay limited
partners and, because it was insolvent, the debtor had no right to pay them, the payments
necessarily hindered, delayed, and defrauded creditors. Id. at 305-06. The Bayou court
recognized that, even though the debtor was insolvent in Sharp, the debtor did have an
obligation to pay its creditor, and therefore its payments could not hinder, delay, or
defraud creditors.
“Because Sharp’s complaint failed to plead that the loan repayment was
made to ‘hinder, delay or defraud’ Sharp’s creditors—and instead focused
on ‘the manner in which Sharp obtained new funding’—Sharp failed to
make out a prima facie case of actual fraudulent conveyance. The Debtors
here, however, specifically pled and demonstrated that the redemption
payments hindered, delayed, and defrauded Bayou’s creditors, by inter alia,
15

forestalling disclosure of the fraudulent scheme.” Bayou, 439 B.R. at 302
(citation omitted).
Here, contrary to Bayou, but consistent with Sharp, BLMIS had contractual
obligations to its customers. Those obligations were not affected by BLMIS’ insolvency.
The Trustee has not sought to avoid those obligations. He challenges only the “manner in
which BLMIS obtained new funding” with which to pay them. The facts of this case,
therefore, align it with Sharp and Boston Trading, not with Bayou, and the law upon which
all three cases are based support Defendants, not the Trustee.
B.

Defendants Have Demonstrated That All Transfers
Were “For Value” Under 11 U.S.C. § 548(c)

Finally, even where a prima facie fraudulent transfer claim is stated, a transfer
taken “for value” and in good faith cannot be avoided under 11 U.S.C. § 548(c).
Defendants have demonstrated in their summary judgment motion that no material
factual dispute exists as to their good faith and herein have demonstrated that all
challenged transfers were “for value.”
Payments by fraudulent entities to investors on account of their valueless equity
interests in insolvent schemes are legally unsupported, but payments to unwitting
creditors on account of their enforceable obligations are legally mandated. Every
withdrawal here was supported by a valid obligation that the Trustee has acknowledged.
Under Section 548(d)(2), “value” is defined to include “antecedent debt.” Because
Defendants were creditors and not equity investors under Article 8 and other bodies of
law, BLMIS owed them more than restitution damages—BLMIS owed them the
securities on their statements. That obligation was not reduced or eliminated by BLMIS’
fraud. Nor was it eliminated by BLMIS’ SIPA filing. The onset of bankruptcy does not
16

retroactively affect the existence of antecedent debt—state law rights must be respected
both before and after bankruptcy. See Butner v. United States, 440 U.S. 48, 55 (1979).
Therefore, all transfers to Defendants were “for value.”
CONCLUSION
For the reasons set forth above and in Defendants’ memorandum of law in
support of their motion for summary judgment, the Trustee’s partial motion for summary
judgment must be denied.
Dated: New York, New York
February 9, 2012
DAVIS POLK & WARDWELL LLP
By: s/ Karen E. Wagner
Karen E. Wagner
Dana M. Seshens
450 Lexington Avenue
New York, New York 10017
Telephone: [phone]
Facsimile: [phone]
Attorneys for Defendants

Of Counsel:
Robert B. Fiske, Jr.
Robert F. Wise, Jr.

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