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

Filing 13

DECLARATION of Fernando A. Bohorquez Jr. in Opposition re: 1 MOTION TO WITHDRAW THE BANKRUPTCY REFERENCE. Bankruptcy Court Case Numbers: 10-5287A, 08-1789 (BRL).MOTION TO WITHDRAW THE BANKRUPTCY REFERENCE. Bankruptcy Court Case Numbers: 10-5287A, 08-1789 (BRL).MOTION TO WITHDRAW THE BANKRUPTCY REFERENCE. Bankruptcy Court Case Numbers: 10-5287A, 08-1789 (BRL).MOTION TO WITHDRAW THE BANKRUPTCY REFERENCE. Bankruptcy Court Case Numbers: 10-5287A, 08-1789 (BRL).MOTION TO WITHDRAW THE BANKRUPTCY REFERENCE. Bankruptcy Court Case Numbers: 10-5287A, 08-1789 (BRL).MOTION TO WITHDRAW THE BANKRUPTCY REFERENCE. Bankruptcy Court Case Numbers: 10-5287A, 08-1789 (BRL).MOTION TO WITHDRAW THE BANKRUPTCY REFERENCE. Bankruptcy Court Case Numbers: 10-5287A, 08-1789 (BRL).MOTION TO WITHDRAW THE BANKRUPTCY REFERENCE. Bankruptcy Court Case Numbers: 10-5287A, 08-1789 (BRL).MOTION TO WITHDRAW THE BANKRUPTCY REFERENCE. Bankruptcy Court Case Numbers: 10-5287A, 08-1789 (BRL).MOTION TO WITHDRAW THE BANKRUPTCY REFERENCE. Bankruptcy Court Case Numbers: 10-5287A, 08-1789 (BRL).. Document filed by Irving H. Picard. (Attachments: # 1 Exhibit A, # 2 Exhibit B, # 3 Exhibit C, # 4 Exhibit D, # 5 Exhibit E, # 6 Exhibit F, # 7 Exhibit G, # 8 Exhibit H, # 9 Exhibit I, # 10 Exhibit J, # 11 Exhibit K, # 12 Exhibit L, # 13 Exhibit M)(Bohorquez, Fernando)

Exhibit G

Case: 10-2378

Document: 185

Page: 1

08/09/2010

84657

42

(L)
10-2378-bk

10-2676, 10-2677, 10-2679, 10-2684, 10-2685, 10-2687,
10-2691, 10-2693, 10-2694, 10-2718, 10-2737
IN THE

United States Court of Appeals
FOR THE SECOND CIRCUIT

IN

RE :

d

BERNARD L. MADOFF INVESTMENT SECURITIES LLC

ON APPEAL FROM THE UNITED STATES BANKRUPTCY COURT
FOR THE SOUTHERN DISTRICT OF NEW YORK

BRIEF FOR APPELLANTS
STERLING EQUITIES ASSOCIATES, ARTHUR FRIEDMAN,
DAVID KATZ, GREGORY KATZ, MICHAEL KATZ, SAUL KATZ,
L. THOMAS OSTERMAN, MARVIN TEPPER, FRED WILPON, JEFF
WILPON, RICHARD WILPON, AND METS LIMITED PARTNERSHIP
KAREN E. WAGNER, ESQ.
BRIAN S. WEINSTEIN, ESQ.
JONATHAN D. MARTIN, ESQ.
DAVIS POLK & WARDWELL LLP
450 Lexington Avenue
New York, New York 10017
[phone]
Attorneys for Appellants Sterling
Equities Associates, Arthur
Friedman, David Katz, Gregory
Katz, Michael Katz, Saul Katz,
L. Thomas Osterman, Marvin
Tepper, Fred Wilpon, Jeff Wilpon,
Richard Wilpon, and
Mets Limited Partnership

Case: 10-2378

Document: 185

Page: 2

08/09/2010

84657

42

CORPORATE DISCLOSURE STATEMENT
In accordance with Rule 26.1 of the Federal Rules of Appellate Procedure,
appellant Sterling Equities Associates states that it has no parent corporation and
that no publicly held corporation owns 10% or more of its stock. Appellant Mets
Limited Partnership states that it has no parent corporation, that its general partner
is C.D.S. Corp., a private corporation, and that no publicly held corporation owns
10% or more of its stock.
Dated: New York, New York
August 6, 2010
DAVIS POLK & WARDWELL LLP
By: /s/ Karen E. Wagner
Karen E. Wagner
Brian S. Weinstein
Jonathan D. Martin
450 Lexington Avenue
New York, New York 10017
[phone]
[e-mail]
[e-mail]
[e-mail]
Attorneys for
Sterling Equities Associates,
Arthur Friedman, David Katz,
Gregory Katz, Michael Katz,
Saul Katz, L. Thomas Osterman,
Marvin Tepper, Fred Wilpon,
Jeff Wilpon, Richard Wilpon, and
Mets Limited Partnership
i

Case: 10-2378

Document: 185

Page: 3

08/09/2010

84657

42

TABLE OF CONTENTS
PAGE
TABLE OF AUTHORITIES ................................................................................ iii
JURISDICTIONAL STATEMENT.......................................................................1
STATEMENT OF THE ISSUE ON APPEAL......................................................1
STATEMENT OF THE CASE...............................................................................2
STATEMENT OF FACTS......................................................................................6
SUMMARY OF THE ARGUMENT .....................................................................7
STANDARD OF REVIEW .....................................................................................7
ARGUMENT ............................................................................................................8
POINT I. SIPA’S DEFINITION OF “NET EQUITY” CONTROLS ................8
POINT II. “NET EQUITY” CONTROLS EVEN WHERE NO
SECURITIES WERE PURCHASED..........................................................9
POINT III. THE DECISION MISINTERPRETS NEW TIMES I ...................15
POINT IV. SECTION 78fff-2(b) DOES NOT SUPPORT
THE DECISION ..........................................................................................18
POINT V. THE DECISION ALTERS SIPA’S
DISTRIBUTION SCHEME .......................................................................21
POINT VI. AVOIDANCE POWERS ARE IRRELEVANT .............................23
CONCLUSION.......................................................................................................31

ii

Case: 10-2378

Document: 185

Page: 4

08/09/2010

84657

42

TABLE OF AUTHORITIES
PAGE
In re Bayou Group, LLC, 362 B.R. 624 (Bankr. S.D.N.Y. 2007) ...........................27
In re Bernard L. Madoff Investment Sec. LLC, 424 B.R. 122
(Bankr. S.D.N.Y. 2010) ...............................................................................passim
In re Bevill, Bresler & Schulman, Inc., 59 B.R. 353 (D.N.J. 1986) ............ 18-19, 20
Bevill, Bresler & Schulman Asset Mgmt. Corp. v. Spencer
Savings & Loan Ass’n, 878 F.2d 742 (3d Cir. 1989)..........................................29
Boston Trading Group, Inc. v. Burnazos, 835 F.2d 1504
(1st Cir. 1987) .....................................................................................................25
Butner v. United States, 440 U.S. 48 (1979)............................................................21
In re Carrozzella & Richardson, 286 B.R. 480 (D. Conn. 2002)............................26
Clark v. Martinez, 543 U.S. 371 (2005) ..................................................................15
Coder v. Arts, 213 U.S. 223 (1909) .........................................................................28
Colautti v. Franklin, 439 U.S. 379 (1979)...............................................................20
Conn. Nat’l Bank v. Germain, 503 U.S. 249 (1992) .................................................8
In re Flanagan, 503 F.3d 171 (2d Cir. 2007) ............................................................7
Flickinger v. Harold C. Brown & Co., 947 F.2d 595 (2d Cir. 1991) ......................11
Fuentes v. Shevin, 407 U.S. 67 (1972).....................................................................24
Grippo v. Perazzo, 357 F.3d 1218 (11th Cir. 2004) ................................................13
Groman v. Comm’r of Internal Revenue, 302 U.S. 82 (1937).................................20
Harwood v. Int’l Estate Planners, 33 F. App’x 903 (9th Cir. 2002).......................11
HBE Leasing Corp. v. Frank, 48 F.3d 623 (2d Cir. 1995) ......................................25
iii

Case: 10-2378

Document: 185

Page: 5

08/09/2010

84657

42

In re Highland Superstores Inc., 154 F.3d 573 (6th Cir. 1998) ..............................22
In re Indep. Clearing House Co., 77 B.R. 843 (D. Utah 1987)...............................28
In re Lapiana, 909 F.2d 221 (7th Cir. 1990) ...........................................................22
Lee v. Bankers Trust Co., 166 F.3d 540 (2d Cir. 1999).............................................8
Louisville Joint Stock Land Bank v. Radford, 295 U.S. 555 (1935)........................24
Lowenbraun v. L.F. Rothschild, 685 F. Supp. 336 (S.D.N.Y. 1988) ......................11
Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit,
547 U.S. 71 (2006)..............................................................................................13
Mullane v. Cent. Hanover Bank & Trust Co., 339 U.S. 306 (1950) .......................24
In re New Times Sec. Servs., Inc., 371 F.3d 68 (2d Cir. 2004).........................passim
In re New Times Sec. Servs., Inc., 463 F.3d 125 (2d Cir. 2006)..............................16
In re Old Naples Sec., Inc., 311 B.R. 607 (M.D. Fla. 2002) ............................. 17-18
Osofsky v. Zipf, 645 F.2d 107 (2d Cir. 1981)...........................................................13
Raleigh v. Ill. Dep’t of Revenue, 530 U.S. 15 (2000) ..............................................22
Saboundijian v. Bank Audi, 157 A.D.2d 278,
556 N.Y.S.2d 258 (1st Dep’t 1990)....................................................................11
Scalp & Blade, Inc. v. Advest, Inc., 309 A.D.2d 219,
765 N.Y.S.2d 92 (4th Dep’t 2003) .....................................................................11
SEC v. Zandford, 535 U.S. 813 (2002) ....................................................................13
In re Sharp Int’l Corp., 403 F.3d 43 (2d Cir. 2005) .......................................... 25-27
Ultramar Energy Ltd. v. Chase Manhattan Bank, N.A.,
191 A.D.2d 86, 599 N.Y.S.2d 816 (1st Dep’t 1993) ..........................................26
In re Unified Commercial Capital, 260 B.R. 343
(Bankr. W.D.N.Y. 2001).....................................................................................27
iv

Case: 10-2378

Document: 185

Page: 6

08/09/2010

84657

42

In re Unified Commercial Capital, Nos. 01-MBK-6004L,
01-MBK-6005L, 2002 WL 32500567 (W.D.N.Y. 2002)...................................26
United States v. Noland, 517 U.S. 535 (1996)...................................................21, 22
United States v. Reorganized CF & I Fabricators of Utah, Inc.,
518 U.S. 213 (1996)............................................................................................22
United States v. Sec. Indus. Bank, 459 U.S. 70 (1982)............................................24
Visconsi v. Lehman Bros., 244 F. App’x 708 (6th Cir. 2007) .................................11
In re W. World Funding, 54 B.R. 470......................................................................28
Wright v. Union Cent. Life Ins., 304 U.S. 502 (1938) .............................................24
Statutes & Rules
11 U.S.C. § 362(b)(6)...............................................................................................29
11 U.S.C. § 362(b)(7)...............................................................................................29
11 U.S.C. § 362(b)(17).............................................................................................29
11 U.S.C. § 362(b)(27).............................................................................................29
11 U.S.C. § 362(o) ...................................................................................................29
11 U.S.C. § 510(c) ...................................................................................................22
11 U.S.C. § 544........................................................................................................25
11 U.S.C. § 546(e) ...................................................................................................29
11 U.S.C. § 546(f)....................................................................................................29
11 U.S.C. § 546(g) ...................................................................................................29
11 U.S.C. § 546(j) ....................................................................................................29
11 U.S.C. § 547........................................................................................................28
v

Case: 10-2378

Document: 185

Page: 7

08/09/2010

84657

42

11 U.S.C. § 548(a)(1)(A) .........................................................................................25
11 U.S.C. § 548(a)(1)(B) .........................................................................................25
11 U.S.C. § 548(d)(2)(A) .........................................................................................25
11 U.S.C. § 555........................................................................................................29
11 U.S.C. § 556........................................................................................................29
11 U.S.C. § 559........................................................................................................29
11 U.S.C. § 560........................................................................................................29
11 U.S.C. § 561........................................................................................................29
11 U.S.C. § 562........................................................................................................29
11 U.S.C. § 741 et seq........................................................................................13, 20
11 U.S.C. § 741(6) ...................................................................................................20
11 U.S.C. § 749(b) ...................................................................................................29
11 U.S.C. § 753........................................................................................................29
11 U.S.C. § 764(b) ...................................................................................................29
11 U.S.C. § 767........................................................................................................29
15 U.S.C. § 78aaa et seq. ...........................................................................................1
15 U.S.C. § 78eee(b)(4) .............................................................................................1
15 U.S.C. § 78fff-2(b)........................................................................................ 18-20
15 U.S.C. § 78fff-2(c)(1) .........................................................................................18
15 U.S.C. § 78fff-2(c)(1)(B) ................................................................................3, 22
15 U.S.C. § 78fff-3(a) ................................................................................................3

vi

Case: 10-2378

Document: 185

Page: 8

08/09/2010

84657

42

15 U.S.C. § 78lll(11).........................................................................................passim
17 C.F.R. § 240.10b-10 (2010) ................................................................................12
28 U.S.C. § 158(d)(2)(A) ...........................................................................................1
Fed. R. Bankr. P. 7001(1) ........................................................................................24
Fed. R. Bankr. P. 7004(a) ........................................................................................24
Fed. R. Bankr. P. 7012 .............................................................................................24
Fed. R. Bankr. P. 7013 .............................................................................................24
N.Y. Debt. & Cred. Law § 272 ................................................................................25
N.Y. Debt. & Cred. Law § 273 ................................................................................25
NASD Rule 2340 .....................................................................................................12
NYSE Rule 409........................................................................................................12
NYUCC Art. 8 Historical and Statutory Notes (McKinney 2002)..........................10
NYUCC § 8-102(a)(9)(i) .........................................................................................10
NYUCC § 8-102(a)(14) ...........................................................................................10
NYUCC § 8-102(a)(17) ...........................................................................................10
NYUCC § 8-112(c)..................................................................................................11
NYUCC § 8-501 cmt. 2 ...........................................................................................11
NYUCC § 8-501 cmt. 3 ...........................................................................................12
NYUCC § 8-501 et seq. ...........................................................................................10
NYUCC § 8-501(b)..................................................................................................10
NYUCC § 8-501(c)..................................................................................................11

vii

Case: 10-2378

Document: 185

Page: 9

08/09/2010

84657

42

Other Authorities
5 Collier on Bankruptcy § 547.01
(Alan N. Resnick & Henry J. Sommer eds., 15th ed. rev. 2010) .......................27
5 Collier on Bankruptcy § 548.01[1][a]
(Alan N. Resnick & Henry J. Sommer eds., 16th ed. 2010) ..............................24
Confirmation of Transactions, 59 Fed. Reg. 59,612 (Nov. 17, 1994).....................12
FINRA, If a Brokerage Firm Closes Its Doors ........................................................14
H.R. Rep. No. 95-746 (1977)...................................................................................14
Nat’l Ass’n of Sec. Dealers, Notice 92-30:
Proposed Amendment to Rules of Fair Practice to
Require Members to Send Periodic Statements of
Account to Customers (July 22, 1992) ...............................................................13
S. Rep. No. 95-763 (1978) .......................................................................................14
SIPC, SIFMA & NASAA,
Understanding Your Brokerage Account Statements ...................................12, 14
SIPC, SIPC Exposes Phony “Look-Alike” Web Site Targeting
Madoff Victims (Mar. 9, 2010) ..........................................................................14

viii

Case: 10-2378

Document: 185

Page: 10

08/09/2010

84657

42

JURISDICTIONAL STATEMENT
The United States Bankruptcy Court for the Southern District of New York
(the “Bankruptcy Court”) has jurisdiction over this proceeding pursuant to
15 U.S.C. § 78eee(b)(4). This Court has jurisdiction over this direct appeal
pursuant to 28 U.S.C. § 158(d)(2)(A).
On March 19, 2010, Appellants Sterling Equities Associates, Arthur
Friedman, David Katz, Gregory Katz, Michael Katz, Saul Katz, L. Thomas
Osterman, Marvin Tepper, Fred Wilpon, Jeff Wilpon, Richard Wilpon, and Mets
Limited Partnership (together, the “Sterling Customers” (Docket No. 10-2693))
timely filed a notice of appeal from a final order of the Bankruptcy Court dated
March 8, 2010. On April 7, 2010, the Sterling Customers timely transmitted a
Joint Petition for Permission to Appeal, and this Court granted the petition on
June 16, 2010.
STATEMENT OF THE ISSUE ON APPEAL
Under the Securities Investor Protection Act, 15 U.S.C. § 78aaa et seq.
(“SIPA”), customer “net equity” claims against a failed broker are 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, all securities positions of such customer . . . ; minus
(B) any indebtedness of such customer to the debtor on the filing
date[.]” 15 U.S.C. § 78lll(11).

1

Case: 10-2378

Document: 185

Page: 11

08/09/2010

84657

42

Did the Bankruptcy Court err when it ruled that SIPA’s “net equity” definition may
be ignored in a SIPA proceeding precipitated by a massive fraud in which the
broker failed to purchase securities shown on customer account statements?
STATEMENT OF THE CASE
This is an appeal from an order of the United States Bankruptcy Court for
the Southern District of New York (Hon. Burton R. Lifland) dated March 8, 2010
(the “Order”), based upon a Memorandum Decision issued on March 1, 2010 (the
“Decision”). The Decision holds that, in this case, which involves “astounding
sums” and an “incogitable scheme,” the broker’s failure to purchase customer
securities warranted departure from the statutory “net equity” definition in favor of
an ad hoc “Net Investment Method” that disregards the broker’s obligation to the
customer on the filing date. See In re Bernard L. Madoff Investment Sec. LLC, 424
B.R. 122 (Bankr. S.D.N.Y. 2010) (“In re BLMIS”).
Nature of the Case
This case arises out of the substantively consolidated SIPA liquidation of
Bernard L. Madoff Investment Securities LLC (“BLMIS”) and Bernard L. Madoff
(“Madoff”). BLMIS was a broker registered with the United States Securities and
Exchange Commission (the “SEC”) and a member of the Securities Investor
Protection Corporation (“SIPC”).

2

Case: 10-2378

Document: 185

Page: 12

08/09/2010

84657

42

On December 11, 2008, the SEC filed a civil complaint in the United States
District Court for the Southern District of New York alleging that BLMIS and
Madoff operated a fraudulent scheme through BLMIS’s investment advisory
business. See In re BLMIS, 424 B.R. at 126. On December 15, 2008, the District
Court granted SIPC’s application for an order commencing a proceeding under
SIPA, appointing a trustee (the “Trustee”) and removing the proceeding to the
Bankruptcy Court. See id.
SIPC is an independent, nonprofit membership corporation created by SIPA.
SIPC is required to support a fund (the “SIPC Fund”) to be used to advance money
to a SIPA trustee. After a registered broker’s failure, “customer property” is to be
distributed ratably to customers “on the basis and to the extent of their respective net
equities.” 15 U.S.C. § 78fff-2(c)(1)(B). If a customer’s “net equity” exceeds its
ratable share of customer property, the customer is entitled to an advance from the
SIPC Fund, and the SIPC trustee is directed to advance money from the SIPC Fund
“[i]n order to provide for prompt payment and satisfaction of net equity claims of
customers.” See 15 U.S.C. § 78fff-3(a); see also In re BLMIS, 424 B.R. at 133.
The parties agree that BLMIS customers are “customers” within the
meaning of SIPA and that they have “claims for securities” entitling each account
to an advance of up to $500,000 from the SIPC Fund against their net equity claim.
In re BLMIS, 424 B.R. at 135 and n.28.
3

Case: 10-2378

Document: 185

Page: 13

08/09/2010

84657

42

SIPA defines “net equity” as “the dollar amount of the account or accounts
of a customer, to be determined by 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, all securities positions of such customer,” less “any
indebtedness of such customer to the debtor on the filing date.” 15 U.S.C.
§ 78lll(11).
Procedural History
On December 23, 2008, the Bankruptcy Court entered a claims procedure
order governing the filing, determination, and adjudication of claims in the BLMIS
liquidation proceeding. In re BLMIS, 424 B.R. at 126. The order required that
customers submit written statements of claim to the Trustee. The Trustee was then
to determine their treatment, and customers were permitted to object and seek
judicial review. Id.
Based on SIPA’s definition of “net equity,” the Sterling Customers filed
written statements of claim for the market value of the securities reflected on their
last account statements, which were dated November 30, 2008. The Trustee
rejected the claims, ruling that the Sterling Customers were entitled to nothing.
His determination was based not on the statutory “net equity” definition but upon
the Trustee’s so-called “Net Investment Method” – a calculation of the difference

4

Case: 10-2378

Document: 185

Page: 14

08/09/2010

84657

42

over the life of each account between the total sum the customer deposited with
BLMIS and the total sum withdrawn.
The Sterling Customers filed timely objections to the Trustee’s
determinations.
The Bankruptcy Court’s Decision
On September 16, 2009, the Bankruptcy Court entered an order establishing
a briefing schedule limited to the legal issue of “the proper interpretation of ‘net
equity.’” Joint Appendix (“J.A.”) Vol. I at 267. All rights were reserved as to
other issues, and no fact-finding process was anticipated in the order or undertaken
by the parties or the Court.
After briefing and argument, the Bankruptcy Court issued the Decision on
March 1, 2010, and the Order on March 8. Special Appendix (“S.A.”) 7; S.A. 60.
Citing this Court’s decision in New Times Sec. Servs., Inc., 371 F.3d 68 (2d
Cir. 2004) (“New Times I”), the Bankruptcy Court asserted that “net equity” may
be “susceptible to differing formulations” depending upon the “underlying factual
disparities” of a broker’s fraud. In re BLMIS, 424 B.R. at 137. Concluding that
“[t]he BLMIS books and records expose a Ponzi scheme where no securities were
ever ordered, paid for or acquired,” id. at 135, the Court decided that departure
from the “net equity” definition was warranted in this case.

5

Case: 10-2378

Document: 185

Page: 15

08/09/2010

84657

42

The Bankruptcy Court further held that the Net Investment Method was
“consistent with the Trustee’s statutory avoidance powers,” id., even though no
avoidance action was before the Court. In effect, the Bankruptcy Court supported
the Trustee’s unilateral determination, without recourse to any process, that
transfers by BLMIS to its customers before the filing were broadly void, and
therefore the statutory “net equity” definition should be displaced. The Court
dismissed as “hypothetical” and “irrelevant” the existence of defenses to avoidance
claims. Id. at 136.
STATEMENT OF FACTS
The only facts relevant to the issue before the Court are not in dispute.
Each of the Sterling Customers executed a Customer Agreement, a Trading
Authorization, and an Option Agreement with BLMIS. The agreements gave
Madoff investment discretion. J.A. Vol. I. at 547, 549.
BLMIS brokerage account 1KW300 held by Sterling Equities Associates
(“SEA”) is an example. SEA regularly deposited funds for the purpose of
purchasing securities, usually by sending a check drawn on a bank to BLMIS, and
withdrew funds when its statement reflected available cash proceeds of sales. SEA
received confirmations of deposits and transactions, and monthly account statements
that reflected transactions, securities held, and available cash. The last account
statement SEA received states that, as of November 30, 2008, SEA’s account was
6

Case: 10-2378

Document: 185

Page: 16

08/09/2010

84657

42

credited with ownership of stock in numerous real companies – including Wal-Mart,
Exxon Mobil, Coca-Cola, Intel, and Pfizer. J.A. Vol. I at 552-56.
SUMMARY OF THE ARGUMENT
Under SIPA, a customer’s “net equity” claim is determined by reference to
the sum which would have been owed by the broker to the customer on the filing
date. That sum is established by the customer’s last account statement, the primary
document upon which customers rely to establish their ownership of securities.
The Bankruptcy Court erred when it substituted the “Net Investment Method,”
which disregards customer statements, based on its conclusion that no securities
were ever purchased in this Ponzi scheme. Under SIPA, as under other laws
regulating the securities markets, customer statements are the foundation by which
a broker’s obligation to its customer is established. Claims based on such
statements are entitled to SIPA protection, regardless of either the broker’s
purchase of securities or the nature and extent of the broker’s fraud.
The Decision and Order should be reversed.
STANDARD OF REVIEW
This Court reviews de novo the Bankruptcy Court’s legal conclusions,
including its interpretation of SIPA. See In re Flanagan, 503 F.3d 171, 179 (2d
Cir. 2007); New Times I, 371 F.3d at 75.

7

Case: 10-2378

Document: 185

Page: 17

08/09/2010

84657

42

ARGUMENT
POINT I.
SIPA’S DEFINITION OF “NET EQUITY” CONTROLS
The interpretation of “net equity” starts and ends with the plain language of
the statute. “[C]ourts must presume that a legislature says in a statute what it
means and means in a statute what it says there. When the words of a statute are
unambiguous, then, this first canon is also the last: ‘judicial inquiry is complete.’”
Conn. Nat’l Bank v. Germain, 503 U.S. 249, 253-54 (1992) (internal citations
omitted); see also Lee v. Bankers Trust Co., 166 F.3d 540, 544 (2d Cir. 1999) (“It
is axiomatic that the plain meaning of a statute controls its interpretation . . . and
that judicial review must end at the statute’s unambiguous terms.”).
The definition of “net equity” in SIPA is unambiguous:
“The term ‘net equity’ means 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, all securities positions of such customer . . . ; minus
(B) any indebtedness of such customer to the debtor on the filing
date[.]” 15 U.S.C. § 78lll(11).
The definition of “net equity” requires that a customer’s claim against a
failed broker be calculated by valuing the securities “owed” to the customer on the
filing date, deducting only indebtedness of the customer to the broker as of that

8

Case: 10-2378

Document: 185

Page: 18

08/09/2010

84657

42

date. It imposes no obligation that the customer prove the actual purchase of
securities listed on the customer’s statement.
The Sterling Customers’ November 30, 2008 account statements – the last
account statements that BLMIS issued before the December 11, 2008 filing date –
reflect the securities positions that BLMIS owed them as of that date. None of the
Sterling Customers was indebted to BLMIS. Accordingly, the Sterling Customers’
“net equity” under SIPA is the dollar amount that BLMIS would have owed the
Sterling Customers if the securities positions reflected on their account statements
had been liquidated on December 11, 2008.
POINT II.
“NET EQUITY” CONTROLS EVEN WHERE
NO SECURITIES WERE PURCHASED
The Trustee ignored the statutory definition. Instead, he devised the Net
Investment Method, and determined that BLMIS – and the SIPC Fund – owed the
Sterling Customers nothing. The Bankruptcy Court sustained his methodology
because “[t]he BLMIS books and records expose a Ponzi scheme where no securities
were ever ordered, paid for or acquired.” See In re BLMIS, 424 B.R. at 135.
But there is no statutory support – and the Bankruptcy Court cited none – for
the proposition that the broker’s failure to buy securities owed to the customer, as
established by the customer’s statements, somehow means the broker is no longer
obligated for those securities. Rather, SIPA reflects the rules that govern the
9

Case: 10-2378

Document: 185

Page: 19

08/09/2010

84657

42

operation of the securities markets, under which a broker is obligated to the
customer for the securities listed on the customer’s statements and confirmations –
whether or not the broker actually buys them.
In New York, Article 8 of the New York Uniform Commercial Code
(“NYUCC”) governs the obligations of a broker to its customer, and the rights of
the customer against the broker. See NYUCC § 8-501 et seq.1 Under Article 8, the
broker’s obligation to the customer is created by the issuance of a statement.
Section 8-501(b) of the NYUCC provides that “a person acquires a security
entitlement2 if a securities intermediary3 . . . (1) indicates by book entry that a
financial asset has been credited to the person’s security account.” It is therefore
“a basic operating assumption of the indirect holding system that once a [broker]
has acknowledged that it is carrying a position in a financial asset for the customer

1

Article 8 addresses the modern securities holding system, in which customers do not
hold physical certificates, but rather hold securities entitlements in an indirect holding system.
See, e.g., “Legislative Intent and Declaration” accompanying the enactment of Article 8 in
New York:
“The legislature finds and declares that a revised article eight of the uniform commercial
code is needed to provide clarity and certainty regarding the rules that govern how
interests in securities are evidenced and how they are transferred in the current securities
market. The existing law fails to clearly define such rules when an interest is held
through an intermediary, rather than by holding a certificate or by registration with the
issuer of securities.” NYUCC Art. 8 Historical and Statutory Notes (McKinney 2002).
2

A “security entitlement” means “the rights and property interest of an entitlement holder
with respect to a financial asset [including a security, see NYUCC § 8-102(a)(9)(i)] specified in
Part 5 [of Article 8].” NYUCC § 8-102(a)(17).
3

A “securities intermediary” includes a broker. See NYUCC § 8-102(a)(14).

10

Case: 10-2378

Document: 185

Page: 20

08/09/2010

84657

42

. . . the [broker] is obligated to treat the customer . . . as entitled to the financial
asset.” See NYUCC § 8-501 cmt. 2.4
Once the acknowledgment is reflected on a statement, Section 8-501(c)
provides that “a person has a securities entitlement even though the securities
intermediary does not itself hold the financial asset” – i.e., the broker owes the
customer the securities reflected on the customer’s statement regardless of whether
the broker actually purchased the securities. As the Official Comment to this
Section explains:
“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.”
* * * * *

4

A customer has an enforceable claim against its broker for the securities on its account
statements. See NYUCC § 8-112(c); Flickinger v. Harold C. Brown & Co., 947 F.2d 595, 599600 (2d Cir. 1991) (“Brown, in sum, breached its contract with Flickinger when it failed to
deliver the securities to him.”); Visconsi v. Lehman Bros., 244 F. App’x 708, 713-14 (6th Cir.
2007) (“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. . . . [T]he 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.”);
see also Harwood v. Int’l Estate Planners, 33 F. App’x 903, 906 (9th Cir. 2002); Scalp & Blade,
Inc. v. Advest, Inc., 309 A.D.2d 219, 765 N.Y.S.2d 92 (4th Dep’t 2003).
In addition, New York law provides that a “broker who has discretionary powers over an
account owes his client fiduciary duties,” Lowenbraun v. L.F. Rothschild, 685 F. Supp. 336, 343
(S.D.N.Y. 1988), breach of which gives rise to a claim for damages. See Saboundijian v. Bank
Audi, 157 A.D.2d 278, 284, 556 N.Y.S.2d 258 (1st Dep’t 1990).

11

Case: 10-2378

Document: 185

Page: 21

08/09/2010

84657

42

“The entitlement holder’s rights against the securities intermediary do
not depend on whether or when the securities intermediary acquired
its interests.” NYUCC § 8-501 cmt. 3.
Article 8 is consistent with the bedrock principle of federal broker-dealer
regulation that brokers are to issue statements, upon which customers may rely, to
evidence customer transactions and holdings.5 Thus, Rule 10b-10 under the
Securities Exchange Act of 1934 (the “1934 Act”) requires brokers to provide
customers with confirmations of securities transactions. See Rule 10b-10, 17
C.F.R. § 240.10b-10 (2010) (Confirmation of Transactions). Similarly, the rules of
the Financial Industry Regulatory Authority (“FINRA”) and the New York Stock
Exchange (“NYSE”) require brokers to provide periodic account statements.
NASD Rule 2340 (Customer Account Statements); NYSE Rule 409 (Statements of
Accounts to Customers). A customer’s account statements show, among other
things, its trading activity and current securities positions.
These customer documents are intended to “serve[] basic investor protection
functions,” by “allowing investors to verify the terms of their transactions . . . [and]
acting as a safeguard against fraud.”6 Confirmation of Transactions, 59 Fed. Reg.
5

A joint publication by SIPC, the Securities Industry and Financial Markets Association
(“SIFMA”), and the North American Securities Administrators Association (“NASAA”), titled
Understanding Your Brokerage Account Statements, tells customers of broker-dealers that
“[y]our account statement will . . . tell you the market value of securities you own – at the
beginning and end of the period covered – so you can decide whether to buy more, sell, or
simply hold your position.” J.A. Vol. II at 133.
6

Federal securities law protects customers’ claims for securities shown on their
statements, whether or not they were purchased. “[A] broker who accepts payment for securities

12

Case: 10-2378

Document: 185

Page: 22

08/09/2010

84657

42

59,612, 59,613 (Nov. 17, 1994). Account statements inform customers of “the
status of their securities positions” and provide a “safeguard against errors and
misunderstandings between [brokerage firms] and customers.” Nat’l Ass’n of Sec.
Dealers, Notice 92-30: Proposed Amendment to Rules of Fair Practice to Require
Members to Send Periodic Statements of Account to Customers (July 22, 1992).7
The primary role played by customer account statements does not change
when a broker is in a SIPA proceeding. SIPA is a key part of the same overall
system of securities regulation intended to “promot[e] investor confidence in the
securities markets and protect[] broker-dealer customers.” See New Times I, 371
F.3d at 86, 87. See generally 11 U.S.C. § 741 et seq. Customers in a SIPA case
are entitled to rely “on what the customer has been told by the debtor in written
confirmations.” New Times I, 371 F.3d at 86. Indeed, SIPC expressly advises
customers that, in the event a broker fails, they should use their account statements
to prove what the broker owed them:
“In the unlikely event your brokerage firm fails, you will need to prove
that cash and/or securities are owed to you. This is easily done with a
copy of your most recent statement and transaction records of the items
that he never intends to deliver . . . violates § 10(b) and Rule 10b-5.” SEC v. Zandford, 535 U.S.
813, 819 (2002); Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71, 85 n.10
(2006); Grippo v. Perazzo, 357 F.3d 1218, 1223-24 (11th Cir. 2004). Any violation gives rise to
damages. See, e.g., Osofsky v. Zipf, 645 F.2d 107, 114 (2d Cir. 1981) (applying benefit-of-thebargain damages under the 1934 Act).
7

Available at
http://finra.complinet.com/en/display/display_main.html?rbid=2403&element_id=1695&print=1
(last visited Aug. 6, 2010).

13

Case: 10-2378

Document: 185

Page: 23

08/09/2010

84657

42

bought or sold after the statement.” SIPC, et al., Understanding Your
Brokerage Account Statements, J.A. Vol. II at 137.
The SIPC Fund was established precisely because Congress recognized that
securities may be missing when a broker becomes insolvent. 8 SIPA’s legislative
history explains that Congress was aware that securities belonging to customers of
a defunct broker might be missing for a variety of reasons, both nefarious and not,
including the broker’s failure to purchase such securities:
“Under present law, because securities belonging to customers may
have been lost, improperly hypothecated, misappropriated, never
purchased or even stolen, it is not always possible to provide to
customers that which they expect to receive, that is, securities which
they maintained in their brokerage account. . . . By seeking to make
customer accounts whole and returning them to customers in the form
they existed on the filing date, the amendments . . . would satisfy the
customers’ legitimate expectations . . . .” J.A. Vol. III at 326
(emphasis added).
“A customer generally expects to receive what he believes is in his
account at the time the stockbroker ceases business. But because
securities may have been lost, improperly hypothecated,
misappropriated, never purchased or even stolen, this is not always
possible. Accordingly, [when this is not possible, customers] will
receive cash based on the market value as of the filing date . . . .” J.A.
Vol. I at 617 (emphasis added).

8

SIPC describes itself as “the U.S. investor’s first line of defense in the event a brokerage
firm fails, owing customer cash and securities that are missing from customer accounts.” E.g.,
SIPC, SIPC Exposes Phony “Look-Alike” Web Site Targeting Madoff Victims (Mar. 9, 2010)
(emphasis added), available at http://www.sipc.org/media/release09Mar10.cfm (last visited
Aug. 6, 2010). Similarly, FINRA’s website states that “SIPC insurance comes into play in
those rare cases of firm failure where customer assets are missing because of theft or fraud.”
FINRA, If a Brokerage Firm Closes Its Doors,
http://www.finra.org/Investors/protectyourself/investoralerts/P116996 (last visited Aug. 6, 2010)
(emphasis added).

14

Case: 10-2378

Document: 185

Page: 24

08/09/2010

84657

42

The Decision turns this entire system on its head. The Bankruptcy Court
ruled that the account statements upon which the indirect holding system depends
become useless exactly when they are most needed – when a broker fails due to
fraud. Nothing in SIPA supports that conclusion. A result less likely to reinforce
the confidence that investors have in the U.S. securities markets is hard to imagine.
POINT III.
THE DECISION MISINTERPRETS NEW TIMES I
The Bankruptcy Court decided that different rules should apply in this case
because of the nature and scope of Madoff’s fraud, finding that “underlying factual
disparities make the definition of Net Equity susceptible to differing formulations,”
citing this Court’s decision in New Times I. See In re BLMIS, 424 B.R. at 137.
But New Times I does not stand for “the dangerous principle that judges can give
the same statutory text different meanings in different cases.” Clark v. Martinez,
543 U.S. 371, 386 (2005). Such an approach “would render every statute a
chameleon,” id. at 382, and has never been the law of this Circuit.
In any event, New Times I supports the application of “net equity” in this
case. New Times was a broker that, like BLMIS, engaged in a Ponzi scheme in
which no securities were acquired. Most New Times customers received account
statements showing investments in real securities. New Times I, 371 F.3d at 71-72.
In the subsequent SIPA liquidation of New Times, no one disputed that these
15

Case: 10-2378

Document: 185

Page: 25

08/09/2010

84657

42

claimants had net equity claims equal to the market value of the securities reflected
on their account statements, even though the broker never purchased them and
even though the statements reflected fictitious payments. See id. at 74.
Other New Times customers, however, received account statements showing
investments in non-existent securities – the issuers were imaginary. See id. at 7172. “To be clear – and this is the crucial fact in this case – the New Age Funds in
which the Claimants invested never existed.” Id. at 74 (emphasis in original).
Based in part upon SEC rules providing that “whether a claim is treated as one for
securities or cash depends not on what is actually in the customer’s account but on
what the customer has been told by the debtor in written confirmations, ” this
Court ruled that these customers nevertheless had claims for securities. Id. at 86
(emphasis in original).
However, it was impossible to apply the valuation required by the “net
equity” definition to these securities – not because the securities were never
purchased, as was true of all of them, but because “the securities in question did
not exist and, thus, could not be liquidated or replaced by the Trustee.” Id. at 76;
see also In re New Times Sec. Servs., Inc., 463 F.3d 125, 129-30 (2d Cir. 2006)
(“New Times II”) (noting that it was “impossible to reimburse customers with the
actual securities or their market value on the filing date (the usual remedies when
customers hold specific securities)”). Therefore, valuing these securities posed an
16

Case: 10-2378

Document: 185

Page: 26

08/09/2010

84657

42

interstitial question not addressed by SIPA. It was only in the context of a fact
pattern where the statute could not be applied as written that this Court approved a
net investment approach.
The blue chip securities found on the BLMIS customer statements – such as
Wal-Mart, Exxon Mobil, Coca-Cola, Intel and Pfizer – are real and can easily be
valued, and so do not present the same conundrum. However, the Bankruptcy Court
wrongly concluded that these securities should be likened to the imaginary New
Times securities because the positions on the BLMIS statements were “artificially
constructed” by backdating trades and were “entirely divorced from the uncertainty
and risk of actual market trading.” In re BLMIS, 424 B.R. at 139-40.9
The Bankruptcy Court’s conclusion is unsupported. In New Times I this
Court held that there is a critical difference between “non-existent transactions”
and “non-existent securities.” 371 F.3d at 86 (emphasis in original).10 The “net

9

The Bankruptcy Court cited an alleged trading price discrepancy for one security and
the fact that another – the Fidelity Spartan U.S. Treasury Money Market Fund – changed its
name. See In re BLMIS, 424 B.R. at 130, 139 n.34; J.A. Vol. I at 540. But, particularly where
the broker has discretion and is a fiduciary, SIPA does not require that a customer confirm the
status of each security on every statement. The “goal of greater investor vigilance” is not one of
SIPA’s purposes. New Times I, 371 F.3d at 87. In any event, even if a single security on a
statement full of otherwise-traded blue chips was incorrectly named, that error cannot support a
departure from the “net equity” definition and the New Times I decision.
As no evidentiary process was employed, these “findings,” like others relied upon by the
Bankruptcy Court, were improperly made, but in all events none of them affects the substance of
the legal dispute at issue – how “net equity” is determined under SIPA.
10

The Bankruptcy Court’s reliance on In re Old Naples Securities, Inc., 311 B.R. 607
(M.D. Fla. 2002), is misplaced. See In re BLMIS, 424 B.R. at 140 n.35. That case involved

17

Case: 10-2378

Document: 185

Page: 27

08/09/2010

84657

42

equity” definition can readily be applied to securities positions on customer
statements whether or not any transactions occurred; it is only where the securities
themselves do not exist that the statute provides no valuation criteria. As the
securities on the BLMIS customer statements have ascertainable market values,
New Times I – and SIPA itself – require that the statutory definition of “net equity”
be employed to determine customer claims.
POINT IV.
SECTION 78fff-2(b) DOES NOT SUPPORT THE DECISION
Instead of applying the statutory “net equity” definition, the Bankruptcy
Court adverted to an irrelevant phrase in an unrelated section to bolster its support
for the Trustee’s approach. But that phrase supports the application of the “net
equity” definition and the determination of a customer’s claim based on its account
statement.
Section 78fff-2(b) of SIPA provides that a trustee is promptly to discharge
the obligations of the defunct broker to its customers by distributing the securities
or cash owed to each customer.11 The phrase upon which the Bankruptcy Court
“claims for cash,” so the court did not have to determine whether the securities at issue could be
“liquidated by sale or purchase on the filing date.” See In re Old Naples, 311 B.R. at 616.
Moreover, just as in New Times I, the securities at issue in Old Naples were imaginary and had
no ascertainable market value on the filing date. See id. at 613.
11

The provision addresses “the qualitative distribution of customer property, that is, the
manner of payment of each customer’s share of the customer property fund.” In re Bevill,
Bresler & Schulman, Inc., 59 B.R. 353, 362-63 (D.N.J. 1986) (emphasis added). By contrast,
Section 78fff-2(c)(1), which requires a trustee to pay customers ratably “on the basis and to the

18

Case: 10-2378

Document: 185

Page: 28

08/09/2010

84657

42

relied, italicized below, requires that a customer demonstrate whether the broker
owed it securities or cash, so that the trustee can distribute the requisite form of
compensation to the customer. Section 78fff-2(b) reads, in relevant part:
“Payments to Customers. After receipt of a written statement of
claim pursuant to subsection (a)(2), the trustee shall promptly
discharge, in accordance with the provisions of this section, all
obligations of the debtor to a customer relating to, or net equity claims
based upon, securities or cash, by the delivery of securities or the
making of payments to or for the account of such customer (subject to
the provisions of subsection (d) and section 9(a) [15 U.S.C. § 78fff3(a) of this title]) insofar as such obligations are ascertainable from
the books and records of the debtor or are otherwise established to
the satisfaction of the trustee. For purposes of distributing securities
to customers, all securities shall be valued as of the close of business
on the filing date.” 15 U.S.C. § 78fff-2(b) (emphasis added).
Patently, neither the italicized phrase nor the entire section requires proof
that the broker bought the securities owed to the customer – they require proof
only of the broker’s “obligation” to the customer. Consequently, before now no
court has ever concluded that Section 78fff-2(b) requires the customer to prove that
securities were actually purchased. Indeed, the panel in New Times I, where the
calculation of certain net equity claims was directly at issue, did not even refer to
Section 78fff-2(b).
And that is not surprising, since “net equity” is defined in Section 78lll(11).
“[A] definition which declares what a term ‘means’ . . . excludes any meaning that
extent of their respective net equities,” “describes the quantitative distribution of customer
property, that is, the share of the aggregate fund of customer property to which each customer is
entitled.” Id. at 362 (emphasis added).

19

Case: 10-2378

Document: 185

Page: 29

08/09/2010

84657

42

is not stated.” Colautti v. Franklin, 439 U.S. 379, 392 n.10 (1979) (internal
quotation marks omitted); see also Groman v. Comm’r of Internal Revenue, 302
U.S. 82, 86 (1937) (“[W]hen an exclusive definition is intended the word ‘means’
is employed[.]”).
That a customer’s claim should be calculated based upon the obligation of
the broker is also confirmed by reference to Subchapter III of Chapter 7 of the
Bankruptcy Code, which governs bankruptcy of non-registered brokers. See 11
U.S.C. § 741 et seq. Under Chapter 7, unlike SIPA, no provision is made for
distribution of securities to customers, so Chapter 7 has no analogue to Section
78fff-2(b). Yet the definition of “net equity” in each statute is substantively the
same, compare 11 U.S.C. § 741(6) with 15 U.S.C. § 78lll(11), and it has been held
that Subchapter III and SIPA differ only in “the qualitative distribution of customer
property,” not the “quantitative distribution of customer property.” See In re
Bevill, Bresler & Schulman, Inc., 59 B.R. 353, 362, 369 (D.N.J. 1986).
Here, the Bankruptcy Court and the Trustee agree that the BLMIS customers
are SIPA “customers” with claims for securities, based on the customers’ account
statements. See In re BLMIS, 424 B.R. at 135 and n.28. The same statements
evidence BLMIS’s obligation to them on the filing date. No further proof is
required by Section 78fff-2(b), which does not in any event vary the statutory “net
equity” definition.
20

Case: 10-2378

Document: 185

Page: 30

08/09/2010

84657

42

POINT V.
THE DECISION ALTERS SIPA’S DISTRIBUTION SCHEME
The Net Investment Method alters the customer’s right under SIPA both to
ratably share in customer property and to receive an advance from the SIPC Fund.
To support its affirmation of the Net Investment Method, the Decision invokes
“equity and practicality.” In re BLMIS, 424 B.R. at 140. But Congress has already
decided how equity and practicality are to be resolved in the treatment of customer
claims under SIPA. When Congress has so spoken, “undefined considerations of
equity” can play no role in determining customers’ claims in bankruptcy. Butner v.
United States, 440 U.S. 48, 55-56 (1979). “Decisions about the treatment of
claims in bankruptcy proceedings . . . are not dictated or illuminated by principles
of equity . . . .” See United States v. Noland, 517 U.S. 535, 540-41 (1996) (internal
quotation marks omitted).
The Decision improperly varies SIPA’s mandate in at least two ways. First, it
redefines “net equity” by replacing it with the Net Investment Method. Once
Congress has defined how a claim in bankruptcy is to be determined, neither a
bankruptcy court nor anyone else is “authorized in the name of equity to make
wholesale substitution of underlying law controlling the validity of creditors’

21

Case: 10-2378

Document: 185

Page: 31

08/09/2010

84657

42

entitlements.”12 Raleigh v. Ill. Dep’t of Revenue, 530 U.S. 15, 24-25 (2000); see also
In re Highland Superstores, Inc., 154 F.3d 573, 579 (6th Cir. 1998) (a court may not
“sweep aside [substantive ] law – in favor of general equitable principles – in
computing [a creditor’s] claim”); In re Lapiana, 909 F.2d 221, 224 (7th Cir. 1990)
(“[B]ankruptcy judges are not empowered to dissolve rights in the name of equity.”).
Second, the Decision ignores SIPA’s mandate that a customer’s net equity
claim be calculated as of the filing date, and claims so calculated are to share
ratably in customer property. See 15 U.S.C. § 78fff-2(c)(1)(B). Under the Net
Investment Method, claims are calculated by reference to a customer’s transfers in
and out over the life of the account, in order to “bring[] the greatest number of
investors closest to their positions prior to Madoff’s scheme,” In re BLMIS, 424
B.R. at 142, resulting in each claim being calculated at a different point in time.
The Net Investment Method therefore is an improper “categorical reordering of
priorities that takes place at the legislative level.” United States v. Reorganized
CF & I Fabricators of Utah, Inc., 518 U.S. 213, 229 (1996) (holding that
bankruptcy courts may not rank claims within the class of general unsecured
creditors in the name of equity).

12

Under principles of equitable subordination, bankruptcy trustees may seek to
subordinate a particular claim based on the inequitable conduct of a specific creditor. See 11
U.S.C. § 510(c); Noland, 517 U.S. at 540. A bankruptcy trustee may not, however, subordinate a
class of claims based “on the supposedly general unfairness of satisfying [those claims].”
Noland, 517 U.S. at 541.

22

Case: 10-2378

Document: 185

Page: 32

08/09/2010

84657

42

POINT VI.
AVOIDANCE POWERS ARE IRRELEVANT
Finally, the Bankruptcy Court justified its approval of the Net Investment
Method by commenting that it was “consistent with the Trustee’s statutory
avoidance powers,” because “transfers made in furtherance of a Ponzi scheme, and
specifically transfers of fictitious profits, are avoidable.” In re BLMIS, 424 B.R. at
135-36. The existence of legal or factual defenses was found to be irrelevant.
“The fact that the Trustee may be unable to avoid a transfer in
particular circumstances . . . is irrelevant to the Court’s finding that
the power itself is inconsistent with a distribution scheme that credits
the reported products of a fraud. The Net Investment Method allows
the definition of Net Equity and the Trustee’s powers to avoid and
recover property, contained in the same statutory framework, to be
interpreted with preferred consonance.” Id. at 136-37.
But there is no “consonance.” The definition of “net equity” says nothing
about any power to avoid and recover property. The possible existence generally
of claims for avoidance against customers, and even the existence of avoidance
claims against a particular customer, are simply not criteria relevant to the
definition, which permits “net equity” to be reduced only by indebtedness to the
broker on the filing date.
And, the transfers by BLMIS to its customers are not void.
First, no avoidance power has properly been invoked in this case. To use the
avoidance provisions, a trustee must employ mandatory process, including
23

Case: 10-2378

Document: 185

Page: 33

08/09/2010

84657

42

commencement of an adversary proceeding, in part so that the target of an
avoidance action may assert defenses.13 Here, the Bankruptcy Court itself
observed that “no avoidance action is currently pending,” to explain why the Court
declined to reach the merits of any defenses to avoidance. In re BLMIS, 424 B.R.
at 136 and n.30. But that is exactly the point – in the absence of such process, the
conclusion that BLMIS transfers before the filing date may be considered void by
the Trustee on a unilateral and wholesale basis is wholly improper.
Second, transfers to valid creditors are not avoidable as fraudulent. The
purpose of fraudulent transfer law is to ensure that an insolvent debtor does not,
intentionally or otherwise, reduce the pool of assets available to creditors by
transferring assets for less than fair value.14 Therefore,

13

See Fed. R. Bankr. P. 7001(1). These rules import most of the Federal Rules of Civil
Procedure, including the requirement that summons and complaint be served, and the provisions
for asserting defenses and counterclaims. See Fed. R. Bankr. P. 7004(a), 7012, 7013.
SIPA does not permit the Trustee simply to make a unilateral determination of
voidability – and if it did SIPA would run afoul of constitutional due process protections and
takings prohibitions. See, e.g., Fuentes v. Shevin, 407 U.S. 67 (1972) (due process mandates a
hearing before property can be taken); Mullane v. Cent. Hanover Bank & Trust Co., 339 U.S.
306, 314 (1950) (“An elementary and fundamental requirement of due process” is “an
opportunity to present . . . objections.”); Wright v. Union Central Life Ins., 304 U.S. 502, 518
(1938) (“[Congress] may authorize the bankruptcy court to affect these property rights, provided
the limitations of the due process clause are observed.”); United States v. Sec. Indus. Bank, 459
U.S. 70, 75 (1982) (“The bankruptcy power is subject to the Fifth Amendment’s prohibition
against taking private property without compensation.”); Louisville Joint Stock Land Bank v.
Radford, 295 U.S. 555, 589 (1935) (“The bankruptcy power, like the other great substantive
powers of Congress, is subject to the Fifth Amendment.”).
14

Any transfer, intentional or not, that has the effect of “unfairly draining the pool of
assets available to satisfy creditors’ claims” may be avoided. 5 Collier on Bankruptcy
§ 548.01[1][a] (Alan N. Resnick & Henry J. Sommer eds., 16th ed. 2010); see also 11 U.S.C.

24

Case: 10-2378

Document: 185

Page: 34

08/09/2010

84657

42

“the preferential repayment of pre-existing debts to some creditors
does not constitute a fraudulent conveyance, whether or not it
prejudices other creditors, because ‘[t]he 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.’” HBE Leasing Corp. v. Frank, 48 F.3d 623, 634 (2d Cir.
1995) (quoting Boston Trading Group, Inc. v. Burnazos, 835 F.2d
1504, 1509 (1st Cir. 1987)).
A payment made to discharge an enforceable debt, such as BLMIS’s obligation to
its customers, is a transfer for value that is not avoidable as fraudulent.15
The Decision contends to the contrary that the payments by BLMIS over the
years were invalid because Madoff was engaged in a fraud. But this Court has
held that any such proposition is invalid. In In re Sharp International Corp., 403
F.3d 43 (2d Cir. 2005), State Street, a lender to Sharp, began to suspect Sharp of
fraud and demanded that Sharp repay its loan. Sharp fraudulently induced
investments from unsuspecting investors, which were then used to repay State
Street. See id. at 47-48. This Court ruled that Sharp’s payment to State Street
constituted a preference, but not a fraudulent conveyance. 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.’”
§§ 548(a)(1)(A) (federal intentional fraud provision), 548(a)(1)(B) (federal constructive fraud
provision), 544 (importing state law); N.Y. Debt. & Cred. Law § 273 (New York fraudulent
transfer provision).
15

See 11 U.S.C. § 548(d)(2)(A) (defining “value” to include the “satisfaction or securing
of a present or antecedent debt of the debtor”); N.Y. Debt. & Cred. Law § 272 (providing that
fair consideration is given when “an antecedent debt is satisfied”).

25

Case: 10-2378

Document: 185

Page: 35

08/09/2010

84657

42

Id. at 54 (quoting Ultramar Energy Ltd. v. Chase Manhattan Bank, N.A., 191
A.D.2d 86, 90-91, 599 N.Y.S.2d 816 (1st Dep’t 1993)).
That Sharp used funds from defrauded investors to pay State Street, just as
occurs in a Ponzi scheme, did not change the fact that the transfer to the lender
“was at most a preference between creditors and did not ‘hinder, delay, or defraud
either present or future creditors.’” Id. at 56.
“The nub of the complaint is that State Street knew that there would
likely be victims of the [Sharp principals’] fraud, and arranged not to
be among them. On the one hand, this seems repugnant; on the other
hand, [the lender’s] discovery that Sharp was rife with fraud was an
asset of State Street, and State Street had a fiduciary duty to use that
asset to protect its own shareholders, if it legally could. One could
say that State Street failed to tell someone that his coat was on fire; or
one could say that it simply grabbed a seat when it heard the music
stop. The moral analysis contributes little.” Id. at 52.
Other courts have recognized that a payment to an innocent creditor in a
Ponzi scheme cannot be avoided as fraudulent if the payment satisfied an
antecedent debt. For example, in In re Carrozzella & Richardson, 286 B.R. 480
(D. Conn. 2002), also a Ponzi scheme case, creditors had a contractual right to both
the principal and the profits that the debtor had transferred to them. The court thus
concluded that payment of profits could not be avoided as fraudulent, because “[i]n
exchange for the [profits] paid to the Defendants, the Debtor received a dollar-fordollar forgiveness of a contractual debt.” Id. at 491; see also In re Unified
Commercial Capital, Nos. 01-MBK-6004L, 01-MBK-6005L, 2002 WL 32500567,
26

Case: 10-2378

Document: 185

Page: 36

08/09/2010

84657

42

at *8 (W.D.N.Y. June 21, 2002) (rejecting trustee’s effort to claw back profits from
“an innocent investor, who has received a bargained-for, contractual interest
payment, at a commercially reasonable rate”); In re Unified Commercial Capital,
260 B.R. 343, 351 (Bankr. W.D.N.Y. 2001).
Nor can the so-called “Ponzi scheme presumption” serve as a legal foundation
for the Decision. See In re BLMIS, 424 B.R. at 136 and n.29. The facts of Sharp
were legally indistinguishable from those characterizing a Ponzi scheme.
Consequently, after Sharp no “Ponzi scheme presumption” may be the basis for
concluding that transfers on account of antecedent debt – even in the course of a Ponzi
scheme – are avoidable simply because the transferor was engaged in a fraud.16
By paying legally enforceable debts, BLMIS did not reduce the amount
available to pay creditors – it simply paid one over another. Such a payment cannot
be avoided as fraudulent, but only, if at all, as preferential. “A preference involves
payment of a debt that violates the bankruptcy principle of equal distribution among
all creditors.” 5 Collier on Bankruptcy § 547.01 (Alan N. Resnick & Henry J.
Sommer eds., 15th ed. rev. 2010). A fraudulent transfer goes further. As the

16

Such a presumption may have some relevance where a transfer is made to someone
other than a creditor, for example the redemption of an equity interest. See, e.g., In re Bayou
Group, LLC, 362 B.R. 624, 638 (Bankr. S.D.N.Y. 2007) (equity holders – as opposed to
creditors – of the fraudulent enterprise did not have contractual antecedent debt “[i]n contrast to
the lawful and disclosed payment of a valid contractual antecedent debt in Sharp”). But where a
transfer is made to discharge a valid antecedent debt, bad intent as to that transfer cannot be
presumed, and in any event is irrelevant, as the creditor body as a whole has not been harmed.

27

Case: 10-2378

Document: 185

Page: 37

08/09/2010

84657

42

Supreme Court long ago cautioned, “[a]n attempt to prefer is not to be confounded
with an attempt to defraud, nor a preferential transfer with a fraudulent one.” Coder
v. Arts, 213 U.S. 223, 241 (1909) (internal quotation marks omitted).
Third, even were these payments subject to avoidance as preferential, the
preference provision permits avoidance only of transfers made within ninety days
before a bankruptcy filing, and that period may not be enlarged. See 11 U.S.C.
§ 547; see also In re Indep. Clearing House Co., 77 B.R. 843, 855 (D. Utah 1987)
(“The equitable powers of the bankruptcy court are limited by the express terms of
the Code. . . . In the absence of any statutory or judicial precedent, . . . the court
may not invoke its equitable powers to substantively enlarge the trustee’s avoiding
powers as urged in this case.” (internal quotation marks omitted)); see also In re
W. World Funding, 54 B.R. 470, 476 n.2 (D. Nev. 1985) (“The Court’s equitable
powers are limited by the express provisions of the Code. Section 547 is intended
to promote equality of distribution, and ‘it is no reflection on the statute that it does
not do so entirely.’” (internal citation omitted)).
Since avoidance of transfers extending further back than the preference
period is barred, avoidance law cannot be the basis of any legal conclusion that any
payments by BLMIS outside of the preference period are void.
Finally, payments made by brokers in connection with securities contracts
are protected from most avoidance theories. Because Congress has recognized that
28

Case: 10-2378

Document: 185

Page: 38

08/09/2010

84657

42

the capital markets cannot function unless transfers are protected from some of the
contingencies of bankruptcy, the Bankruptcy Code excepts many types of
securities transactions from some of its rules. 17 See Bevill, Bresler & Schulman
Asset Mgmt. Corp. v. Spencer Savings & Loan Ass’n, 878 F.2d 742, 751 (3d Cir.
1989) (Section 546 is at the intersection of “two important national legislative
policies [bankruptcy and securities law] . . . on a collision course”). Section 546(e)
is one of these protective provisions.
Section 546(e) provides, in relevant part:
“Notwithstanding sections 544, 545, 547, 548(a)(1)(B), and 548(b) of
this title, the trustee may not avoid a transfer . . . that is a transfer
made by or to . . . [a] stockbroker [or] financial institution, . . . in
connection with a securities contract, as defined in section 741(7), . . .
that is made before the commencement of the case, except under
section 548(a)(1)(A) of this title.” 11 U.S.C. § 546(e).
This section shields from avoidance any transfer by a broker in connection
with a securities contract, unless the transfer is otherwise avoidable and made with
fraudulent intent, within two years of a filing. Very few transfers, if any, by a
broker to a bona fide customer will fall outside of this protection. The policy
served by this provision is entirely consistent with the laws generally regulating the
securities markets, including SIPA, which are intended to protect customers and
encourage investment.

17

See, e.g., 11 U.S.C. §§ 362(b)(6),(7),(17) & (27), 362(o), 546(e),(f),(g) & (j), 555, 556,
559, 560, 561, 562, 749(b), 753, 764(b), 767.

29

Case: 10-2378

Document: 185

Page: 39

08/09/2010

84657

42

The abandonment in the Decision of the “net equity” definition is not
supported by the assumption that vast avoidance powers exist with respect to
payments by BLMIS to its customers. Any such powers are extremely limited, and
are entirely independent of the definition of “net equity.”

30

Case: 10-2378

Document: 185

Page: 40

08/09/2010

84657

42

CONCLUSION
For the reasons stated above, the Sterling Customers respectfully request that
this Court reverse the Decision and Order and hold that the Sterling Customers’
“net equity” under SIPA is what BLMIS owed the Sterling Customers, which is the
securities on their statements, or their value, as of the filing date.
Dated: New York, New York
August 6, 2010
DAVIS POLK & WARDWELL LLP
By: /s/ Karen E. Wagner
Karen E. Wagner
Brian S. Weinstein
Jonathan D. Martin
450 Lexington Avenue
New York, New York 10017
[phone]
[e-mail]
[e-mail]
[e-mail]
Attorneys for
Sterling Equities Associates,
Arthur Friedman, David Katz,
Gregory Katz, Michael Katz,
Saul Katz, L. Thomas Osterman,
Marvin Tepper, Fred Wilpon,
Jeff Wilpon, Richard Wilpon, and
Mets Limited Partnership

31

Case: 10-2378

Document: 185

Page: 41

08/09/2010

84657

42

CERTIFICATE OF COMPLIANCE WITH TYPE-VOLUME
LIMITATION, TYPEFACE REQUIREMENTS AND TYPE STYLE
REQUIREMENTS
This brief complies with the type-volume limitation of Fed. R. App. P.
32(a)(7)(B) because it contains 7,986 words, excluding the parts of the brief
exempted by Fed. R. App. P. 32(a)(7)(B)(iii).
This brief complies with the typeface requirements of Fed. R. App. P.
32(a)(5) and the type style requirements of Fed. R. App. P. 32(a)(6) because
this brief has been prepared in a proportionally spaced typeface using
Microsoft Word 2003 in size 14 Times New Roman font.
Dated: New York, New York
August 6, 2010
DAVIS POLK & WARDWELL LLP
By: /s/ Karen E. Wagner
Karen E. Wagner
Brian S. Weinstein
Jonathan D. Martin
450 Lexington Avenue
New York, New York 10017
[phone]
[e-mail]
[e-mail]
[e-mail]
Attorneys for
Sterling Equities Associates,
Arthur Friedman, David Katz,
Gregory Katz, Michael Katz,
Saul Katz, L. Thomas Osterman,
Marvin Tepper, Fred Wilpon,

Case: 10-2378

Document: 185

Page: 42

08/09/2010

84657

Jeff Wilpon, Richard Wilpon, and
Mets Limited Partnership

42