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

Filing 164

MEMORANDUM OF LAW in Opposition re: 150 SECOND MOTION in Limine To Exclude All Evidence And Arguments Relating To The Inaction And/Or Failures Of The United States Securities And Exchange Commission.. 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. (Wise, Robert)

UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
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:
IRVING H. PICARD,
:
:
Plaintiff,
:
:
11-CV-03605 (JSR) (HBP)
- against :
:
SAUL B. KATZ, et al.,
:
:
Defendants.
:
:
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MEMORANDUM OF LAW IN OPPOSITION TO TRUSTEE’S MOTION IN
LIMINE NO. 2 TO EXCLUDE ALL EVIDENCE AND ARGUMENTS RELATING
TO THE INACTION AND/OR FAILURES OF THE UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

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

TABLE OF CONTENTS
PAGE
PRELIMINARY STATEMENT .........................................................................................1
ARGUMENT.......................................................................................................................3
I.

DEFENDANTS BELIEVED MADOFF SECURITIES
WAS REGULATED, AND THE ABSENCE OF SANCTIONS
WAS A “GREEN FLAG” ...................................................................................4

II.

THE ABSENCE OF ANY REGULATORY ACTION
AGAINST MADOFF SECURITIES IS RELEVANT
TO DEFENDANTS’ GOOD FAITH ..................................................................6

CONCLUSION....................................................................................................................9

TABLE OF AUTHORITIES
PAGE
CASES
George v. Celotex Corp., 914 F.2d 26 (2d Cir. 1990) ........................................................ 3
Global-Tech Appliances, Inc. v. SEB, S.A., 131 S. Ct. 2060 (2011)................................... 1
Highland Capital Mgmt., L.P. v. Schneider, 551 F. Supp. 2d 173 (S.D.N.Y. 2008)...... 3, 8
In re Bayou Grp., LLC, No. 09 Civ. 2340 (S.D.N.Y. May 2, 2011)................................... 8
In re Blech Sec. Litig., No. 94 Civ. 7696,
2003 U.S. Dist. LEXIS 4650 (S.D.N.Y. Mar. 26, 2003) .............................................. 3
In re Sept. 11 Litig., 621 F. Supp. 2d 131 (S.D.N.Y. 2009) .............................................. 8
United States v. Kaplan, 490 F.3d 110 (2d Cir. 2007)........................................................ 3
United States v. Khan, 787 F.2d 28 (2d Cir. 1986)......................................................... 3, 7
Vinieris v. Byzantine Mar. Corp., 731 F.2d 1061 (2d Cir. 1984) ....................................... 7
STATUTES AND RULES
Fed. R. Evid. 401 ................................................................................................................ 3
OTHER AUTHORITIES
Report of Investigation, U.S. SEC Office of Inspector Gen.,
Case No. OIG-509, Investigation of Failure of the SEC
To Uncover Bernard Madoff’s Ponzi Scheme (2009),
at http://www.sec.gov/news/studies/2009/oig-509.pdf........................................ passim

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Defendants respectfully submit this memorandum of law in opposition to the
Trustee’s motion in limine to exclude all evidence and arguments relating to the inaction
and failures of the United States Securities and Exchange Commission (“SEC”).
PRELIMINARY STATEMENT
The central issue for trial is whether Defendants were “willfully blind” when they
deposited funds into their brokerage accounts at Bernard L. Madoff Investment Securities
LLC (“Madoff Securities”) during the relevant two-year period. Defendants’ knowledge
of the SEC’s investigations and oversight of Madoff Securities is relevant to the first
prong of the willful blindness standard set forth in Global-Tech Appliances, Inc. v. SEB,
S.A., 131 S. Ct. 2060, 2070 (2011)—what Defendants actually believed. The Trustee
intends to introduce evidence of what he calls “red flags” that supposedly should have
alerted Defendants to the massive Ponzi scheme perpetrated by Bernard L. Madoff
(“Madoff”). Through this and other motions in limine, however, the Trustee seeks to
exclude evidence of the many “green flags” on which Defendants relied in forming and
maintaining their trust in Madoff up until the day his fraud was revealed, including
evidence related to SEC investigations of Madoff Securities that failed to unearth his
wrongdoing. In assessing Defendants’ state of mind, what they actually believed about
Madoff and his firm, the jury must be allowed to hear all the information about Madoff
that Defendants were aware of and took into consideration when they invested.
Evidence concerning the SEC investigations and examinations is also relevant to
the second prong of the willful blindness standard—whether there was readily accessible
information about the fraud to which Defendants turned a blind eye. As set forth in the
report entitled “Investigation of Failure of the SEC To Uncover Bernard Madoff’s Ponzi

Scheme,” issued by the Office of the Inspector General of the SEC (“SEC OIG Report”),
available at http://www.sec.gov/news/studies/2009/oig-509.pdf, Madoff and Madoff
Securities were investigated several times by the SEC and cleared every time. This is
circumstantial evidence that the Madoff scheme was complex and well hidden, which
makes it far less probable, if not entirely implausible, that Defendants had ready access to,
and deliberately turned away from, information that they feared would confirm a scheme
in which no securities were being purchased for their securities accounts. It is also
evidence that Defendants’ trust in Madoff was well founded. Indeed, the SEC itself has
recognized that Madoff Securities customers relied on the absence of any regulatory
action.
“We also found that investors who may have been uncertain about
whether to invest with Madoff were reassured by the fact that the SEC had
investigated and/or examined Madoff, or entities that did business with
Madoff, and found no evidence of fraud. Moreover, we found that Madoff
proactively informed potential investors that the SEC had examined his
operations. When potential investors expressed hesitation about investing
with Madoff, he cited the prior SEC examinations to establish credibility
and allay suspicions or investor doubts that may have arisen while due
diligence was being conducted. Thus, the fact the SEC had conducted
examinations and investigations and did not detect the fraud, lent
credibility to Madoff’s operations and had the effect of encouraging
additional individuals and entities to invest with him.” (SEC OIG Report
at 25.)
The Trustee’s attempt to block this evidence must be denied. While customers,
Defendants knew that Madoff Securities was regulated by the SEC and relied on that
regulatory regime. Defendants’ Madoff Securities trade confirmations reflected on their
face the regulatory and self-regulatory bodies they believed were part of the overall
regulatory scheme. And, as the Trustee himself recognizes, they were aware of at least
one SEC investigation of Madoff Securities in which they understood Madoff Securities
and Madoff to have been deemed completely clean—an investigation portrayed by the
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Trustee’s fraud expert as a turning point in Madoff’s fraud. Defendants’ understanding
of that investigation, and the absence of any regulatory action against Madoff Securities
for almost fifty years, provided critical support for their trust in Madoff and is directly
relevant to their state of mind—the principal issue for trial, not, as the Trustee contends,
what “Defendants did or did not do.” (Tr. Limine Mot. No. 2 at 1.) Defendants had no
duty to do anything, and their reliance on the regulatory scheme they believed was
ongoing is relevant evidence of their lack of willful blindness.
ARGUMENT
Relevant evidence is evidence having “any tendency to make a fact more or less
probable than it would be without the evidence.” Fed. R. Evid. 401. The “any tendency”
admissibility threshold of Rule 401 is “minimal.” See United States v. Khan, 787 F.2d 28,
34 (2d Cir. 1986). Exclusion under Rule 403 is only appropriate where the risk of
prejudice is significant. See Highland Capital Mgmt., L.P. v. Schneider, 551 F. Supp. 2d
173, 177 (S.D.N.Y. 2008) (“Because Rule 403 excludes relevant evidence, ‘it is an
extraordinary remedy that must be used sparingly.’” (quoting George v. Celotex Corp.,
914 F.2d 26, 31 (2d Cir. 1990))); United States v. Kaplan, 490 F.3d 110, 122 (2d Cir.
2007) (“[R]elevant evidence is always prejudicial to one side . . . .”); In re Blech Sec.
Litig., No. 94 Civ. 7696, 2003 U.S. Dist. LEXIS 4650, at *68 (S.D.N.Y. Mar. 26, 2003)
(“In conducting this balancing test, the general rule is that the balance should be struck in
favor of admissi[bility].” (internal quotation marks omitted)).
Defendants’ belief that Madoff Securities was regulated and never sanctioned and
their knowledge of at least one SEC investigation in which Madoff Securities was
completely cleared satisfies the minimal relevancy requirement. No serious concern that

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the jury would draw improper inferences, let alone a sufficient likelihood of unfair
prejudice, provides a basis for exclusion.
I.

DEFENDANTS BELIEVED MADOFF SECURITIES WAS REGULATED,
AND THE ABSENCE OF SANCTIONS WAS A “GREEN FLAG”
Madoff Securities was—and Defendants understood it to be—a registered broker

dealer operating in one of the most highly regulated areas of the economy.1 It was
subject to oversight by many federal, state, and non-governmental entities, each of whom
were, and are, responsible for protecting the interests of individual investors. Trade
confirmations sent by Madoff Securities to Defendants listed the many regulatory bodies
with which it was affiliated, including the Financial Industry Regulatory Authority
(FINRA), the National Stock Exchange (NSX), the Securities Investor Protection
Corporation (SIPC), the National Securities Clearing Corporation (NSCC), and the
Depository Trust Corporation (DTC)—each, in whole or in part, overseen and/or regulated
by the SEC. (Seshens Opp’n Decl., Ex. D.)
Defendants believed that these bodies were responsible for protecting them. For
example, Fred Wilpon testified that he understood that Madoff Securities was regularly
monitored by regulatory bodies, including NASDAQ and the SEC. (F. Wilpon Tr. 206:8207:10 (Seshens Opp’n Decl., Ex. B).) Defendants were also aware that Madoff Securities
had registered as an investment advisor in 2006, which subjected Madoff Securities to
increased SEC oversight. (See id. 76:4-18.)

1

(See Deposition Transcript of Saul Katz (“S. Katz Tr.”), Jan. 13, 2012, 78:17-79:9
(Seshens Opp’n Decl., Ex. A); Deposition Transcript of Fred Wilpon (“F. Wilpon Tr.”), Jan.
10, 2012, 46:2-5 (Seshens Opp’n Decl., Ex. B); Deposition Transcript of David Katz, Dec.
28, 2011, 221:16-23; 369:7-370:4 (Seshens Opp’n Decl., Ex. C).)
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Additionally, Defendants were aware of a specific investigation conducted by the
SEC in 1992 that Defendants understood to be a significant mark of Madoff’s probity
based on a report they received directly from Ira Sorkin, an experienced securities lawyer
whom they knew at the time had been the former head of the SEC’s New York office.2
Far from a “hazy recollection,” Fred Wilpon, for example, explained in detail his
understanding that Madoff Securities had been given “a clean bill of health” by the SEC:
“What I recall is that just by coincidence I happened to be in Howard
Squadron’s office, or the offices of Squadron. And my recollection is that
Mr. Sorkin was there. He was a—he was a partner of—of Squadron. I
don’t know how this came about, but he—I think he was representing Mr.
Madoff at the time. And the issue—there was some publicity about it, I
know, about the two accountants. And the publicity then was that they
were going to sanction—the SEC were going to sanction the accountants,
but they did not find anything wrong at all with Mr. Madoff, or Mr.
Madoff’s firm. And Ike Sorkin told me that. He said something, he used
some words, clean bill of health or something like that, with respect to that.
And I remember that the newspapers reported and—that they had sent the
money back.” (Id. 205:12-206:4.)
In his limine motion the Trustee attempts to minimize the significance of this
investigation by describing it as “brief” and “limited.” (Tr. Limine Mot. No. 2 at 3.) But
the Trustee’s fraud expert, Mr. Dubinsky, himself has testified that the investigation was
extremely consequential. According to Mr. Dubinsky, as a result of the SEC sanctioning
the Florida accountants’ operation, all of the customers who had been pooled, and thus
indirect investors with Madoff Securities through the accountants, flooded in to be direct

2

(See F. Wilpon Tr. at 143:18-145:1; 204:18-206:7 (Seshens Opp’n Decl., Ex. B);
S. Katz Tr., 249:16-250:20 (Seshens Opp’n Decl., Ex. A); Deposition Transcript of
Michael Katz, Dec. 9, 2011, 321:7-23 (Seshens Opp’n Decl., Ex. E); Bankruptcy Rule
2004 Deposition Transcript of Saul Katz, Aug. 4, 2010, 52:3-53:6 (Seshens Opp’n Decl.,
Ex. F); see also Declaration of Fred Wilpon, Jan. 26, 2012, ¶ 7 (doc. no. 94); Declaration
of Saul Katz, Jan. 26, 2012, ¶ 6 (doc. no. 91); Declaration of Michael Katz, Jan. 26, 2012,
¶ 6 (doc. no. 99); Declaration of David Katz, Jan. 26, 2012, ¶ 6 (doc. no. 95).)
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customers, which in turn caused Madoff Securities to create a more sophisticated,
scalable scheme for its greatly expanded customer base. (See Deposition Transcript of
Bruce G. Dubinsky, Jan. 11, 2012, 42:3-43:10 (Seshens Opp’n Decl., Ex. G).) This was
likely the real launch of the scheme, precipitated, ironically, by the sanctioning of the
Florida accountants.
Further, the Trustee’s argument that the SEC investigations are not relevant because
they did not focus on Madoff Securities’ investment advisory business is specious. Madoff
Securities was, and was perceived to be, a single corporate entity and a registered broker.
There is no evidence that any Defendant perceived it otherwise. To the extent Madoff
Securities had legitimate operations, they likely helped to fool the SEC just as they helped
to fool its customers, as Mr. Dubinsky recognized. (Id. 84:13-85:23.) And the portions of
the SEC OIG Report cited by the Trustee describe investigations addressed to front-running
allegations that Madoff was using his market-making activities to subsidize the returns of
his investment advisory customers. (See Tr. Limine Mot. No. 2 at 2 (citing SEC OIG
Report at 93-94, 160-64, 167-74).)
Finally, the Trustee contends that the SEC’s 1992 investigation occurred “a
decade before any of the red flags appeared in this case” (id. at 3-4), thereby abandoning
reliance on any supposed evidence of willful blindness prior to 2002.
II.

THE ABSENCE OF ANY REGULATORY ACTION AGAINST MADOFF
SECURITIES IS RELEVANT TO DEFENDANTS’ GOOD FAITH
The principal issue in the case is willful blindness. This requires the Trustee to

prove that each Defendant held a subjective belief that there was a high probability that
Madoff was engaged in a Ponzi scheme and that each such Defendant took deliberate
action to turn away from easily accessible information for fear that it would have confirmed
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his, her, or its suspicion. Evidence of Defendants’ state of mind when they invested in
Madoff Securities is, therefore, highly relevant. In fact, the Trustee’s willful blindness
case is composed entirely of circumstantial evidence of “red flags” that supposedly speak
to Defendants’ state of mind. Plainly, Defendants are equally entitled to put forward
circumstantial evidence of a state of mind that was utterly inconsistent with willful
blindness, including their reliance on the lack of any regulatory sanctions against Madoff
Securities. See Vinieris v. Byzantine Mar. Corp., 731 F.2d 1061, 1064 (2d Cir. 1984)
(where “good faith” is at issue, the trial court should “follow[ ] a liberal policy in
admitting evidence directed towards establishing . . . subjective state of mind”).
Evidence concerning the many failed SEC investigations of Madoff Securities
also is relevant to the second prong of the willful blindness test. Unlike Defendants, the
SEC had readily accessible information that could have confirmed Madoff’s fraud,
including access to the inner workings of Madoff Securities’ operations and Madoff
Securities’ trading records, and, even though the SEC affirmatively was looking for
possible fraud, the SEC never saw it. Defendants, by contrast, had no such information,
nor were they presented with any. How then is it possible, let alone probable, that
Defendants deliberately turned away from confirmatory information when Defendants
never had such information to begin with? It is not, and evidence concerning the SEC’s
many failures is relevant to that determination.
Accordingly, the SEC OIG Report and other evidence of Defendants’ reliance on
their understanding that Madoff Securities was regulated easily clears the minimal
relevancy threshold. See Khan, 787 F.2d at 34. The concerns of prejudice or confusion
articulated by the Trustee are superficial at best and do not outweigh the high probative

7

value of this evidence. See Highland Capital Mgmt., 551 F. Supp. 2d at 177. Indeed, as
noted above, the SEC itself has recognized that Madoff Securities customers relied on the
absence of any regulatory action. (See SEC OIG Report at 25.)
The Trustee’s arguments against the admissibility of the SEC OIG Report are
inapposite. The Trustee’s reliance on a ruling in Bayou Group is misplaced, as the court
in that case explicitly rejected testimony regarding the government’s failure to uncover a
Ponzi scheme on the basis that “Bayou Hedge Funds were not regulated by the NASD or
the SEC.” Transcript of Oral Argument at 41:16-17, In re Bayou Grp., LLC, No. 09 Civ.
2340 (S.D.N.Y. May 2, 2011) (doc. no. 38) (emphasis added). By contrast, Madoff
Securities was regulated by both. And In re Sept. 11 Litigation is similarly inapposite, as
that decision found that “[w]hat the [defendants] learned from the governmental and
agency sources is relevant.” 621 F. Supp. 2d 131, 146 (S.D.N.Y. 2009).

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CONCLUSION
For the reasons set forth above, Defendants respectfully request that the Court
deny the Trustee’s motion to exclude all evidence and arguments relating to the inaction
and failures of the SEC.
Dated: New York, New York
March 12, 2012
DAVIS POLK & WARDWELL LLP
By: /s/ Robert F. Wise, Jr.
Robert F. Wise, Jr
Karen E. Wagner
Dana M. Seshens
450 Lexington Avenue
New York, New York 10017
Telephone:
[phone]
Facsimile:
[phone]
Attorneys for Defendants

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