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

Filing 32

MEMORANDUM OF LAW in Opposition re: 20 MOTION to Dismiss THE AMENDED COMPLAINT OR, IN THE ALTERNATIVE, FOR SUMMARY JUDGMENT.. Document filed by Securities Investor Protection Corporation. (Attachments: # 1 Certificate of Service)(Bell, Kevin)

UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF NEW YORK
-------------------------------------------------------------- :
SECURITIES INVESTOR PROTECTION
:
CORPORATION,
:
:
Plaintiff-Applicant,
:
:
v.
:
:
BERNARD L. MADOFF INVESTMENT
:
SECURITIES LLC,
:
:
Defendant.
:
-------------------------------------------------------------- :
In re:
:
BERNARD L. MADOFF,
:
:
Debtor.
:
-------------------------------------------------------------- :
IRVING H. PICARD, Trustee for the Liquidation :
of Bernard L. Madoff Investment Securities LLC, :
:
Plaintiff,
:
:
v.
:
:
SAUL B. KATZ, et al.,
:
:
Defendants.
:
-------------------------------------------------------------- :

Adv. Pro. No. 08-01789 (BRL)
SIPA LIQUIDATION
(Substantively Consolidated)

Adv. Pro. No. 10-05287 (BRL)

MEMORANDUM OF LAW OF THE
SECURITIES INVESTOR PROTECTION CORPORATION
IN OPPOSITION TO STERLING DEFENDANTS’ MOTION
TO DISMISS THE AMENDED COMPLAINT OR, IN
THE ALTERNATIVE, FOR SUMMARY JUDGMENT
SECURITIES INVESTOR PROTECTION CORPORATION
805 15th Street, N.W., Suite 800
Washington, D.C. 20005
Telephone: [phone]
JOSEPHINE WANG
General Counsel
KEVIN H. BELL
Senior Associate General Counsel for Dispute Resolution
LAUREN T. ATTARD
Staff Attorney

TABLE OF CONTENTS
PAGE
TABLE OF AUTHORITIES ......................................................................................................... iii
STATEMENT OF THE ISSUES.....................................................................................................1
STATEMENT OF FACTS ..............................................................................................................2
1.

The Case...................................................................................................................2

2.

The Defenses ............................................................................................................4

SUMMARY OF THE ARGUMENT ..............................................................................................5
STANDARD OF REVIEW .............................................................................................................7
ARGUMENT ...................................................................................................................................8
OVERVIEW OF SIPA ....................................................................................................................8
I.

A SIPA TRUSTEE CAN BRING FRAUDULENT
CONVEYANCE ACTIONS ....................................................................................9
1.

Defendant‟s Interpretation of SIPA Limiting a Trustee‟s Capacity
to Sue In Avoidance Is Inconsistent With the Provisions and Purposes
of SIPA.....................................................................................................................9

2.

“Customers” Are Not Immune From Fraudulent Transfer Actions.......................11

3.

The Trustee Is Not Limited to Preference Actions ................................................14

II.

BECAUSE IT DOES NOT APPLY UNDER THE FACTS OF THIS CASE,
SECTION 546(e) DOES NOT BAR THE TRUSTEE‟S ACTION ......................16
1.

Defendants‟ Construction of Section 546(e) of the Bankruptcy Code
Undermines, Rather Than Effectuates, the Purposes of that Provision .................17

2.

Relevant Factors in Determining Whether Section 546(d) Applies ......................18
DEFENDANTS ARE INCORRECT THAT “ANTECEDENT DEBT”
IS TO BE MEASURED ACCORDING TO THE FICTITIOUS ACCOUNT
STATEMENTS.....................................................................................................20

III.

1.

The Uniform Commercial Code ............................................................................21

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TABLE OF CONTENTS
(cont.)
PAGE

2.
IV.

Federal Securities Law Decisions ..........................................................................22
THE PONZI SCHEME PRESUMPTION APPLIES TO THIS CASE .................25

CONCLUSION .............................................................................................................................27

-ii-

TABLE OF AUTHORITIES
CASES:

PAGE

In re Adler, Coleman Clearing Corp., 263 B.R. 406 (S.D.N.Y. 2001) ...................................17, 20
American Sur. Co. of N.Y. v. Sampsell, 327 U.S. 269 (1946) ........................................................22
American Tissue, Inc. v. Donaldson, Lufkin & Jenrette Sec. Corp.,
351 F.Supp.2d 79 (S.D.N.Y. 2004).............................................................................................19
Anderson v. Liberty Lobby, Inc., 477 U.S. 242 (1986)....................................................................7
Ashcroft v. Iqbal, ___ U. S. ___, 129 S.Ct. 1937 (2009) .................................................................7
In re Bayou Group, LLC, 362 B.R. 624 (S.D.N.Y. 2007) .............................................................27
In re Bayou Group, LLC, 439 B.R. 284 (S.D.N.Y. 2010) .............................................................25
Bear Stearns Sec. Corp. v. Gredd (In re Manhattan Inv. Fund Ltd).,
397 B.R. 1 (S.D.N.Y. 2007). .................................................................................................25, 26
Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007)……………...……………………………..7
In re Bell & Beckwith, 937 F.2d 1104 (6th Cir. 1991).....................................................................8
In re Bell & Beckwith, 104 B.R. 842 (Bankr. N. D. Ohio 1989),
aff’d, 937 F.2d 1104 (6th Cir. 1991) ...........................................................................................21
In re Bernard L. Madoff Investment Securities LLC, 424 B.R. 122
(Bankr. S.D.N.Y. 2010), appeal docketed, No. 10-2378-BK(L) (2d Cir.) .................................20
In re Bevill, Bresler & Schulman, Inc., 59 B.R. 353 (D.N.J.),
appeal dismissed, 802 F.2d 445 (3rd Cir. 1986)……………………..…………………………21
Bevill, Bresler & Schulman v. Spencer Sav. & Loan Ass’n,
878 F.2d 742 (3d Cir. 1989)...................................................................................................17, 18
Bondy v. Chemical Bank, [1975-76 Transfer Binder] Fed. Sec. L. Rep.
(CCH) ¶95,360 (S.D.N.Y. 1975) ..........................................................................................10,11
Celotex Corp. v. Catrett, 477 U.S. 317 (1986)…………………………………………..……......7
In re Chase & Sanborn Corp., 813 F.2d 1177 (11th Cir. 1987) ....................................................11
In re the Drexel Burnham Lambert Group, 123 B.R. 702 (Bankr. S.D.N.Y. 1991)......................16

-iii-

TABLE OF AUTHORITIES
(cont.)
CASES:

PAGE

Enron Corp. v. Bear, Stearns Int’l Ltd. (In re Enron Corp.),
323 B.R. 857 (Bankr. S.D.N.Y. 2005) .........................................................................................18
In re Enron Creditors Recovery Corp., 422 B.R. 423 (S.D.N.Y. 2009) .......................................19
Exchange National Bank of Chicago v. Wyatt, 517 F.2d 453 (2d Cir. 1975 ...................................8
Executive Securities Corp. v. Doe, 702 F.2d 406 (2d Cir.),
cert. den., 464 U. S. 818 (1983) ....................................................................................................9
Focht v. Athens (In re Old Naples Securities, Inc.), 311 B. R. 607 (M. D. Fla. 2002) ..................24
Focht v. McDermott (In re Old Naples Securities, Inc.), 343 B.R. 310
(Bankr. M.D. Fla. 2006)..............................................................................................................13
Freeman v. Seligson, 405 F.2d 1326 (D.C. Cir. 1968) ..................................................................16
Gindes v. United States, 740 F.2d 947 (Fed. Cir. 1984) ................................................................21
Gold v. Hyman, [1974-75 Transfer Binder] Fed. Sec. L. Rep. (CCH)
¶95,043 (S.D.N.Y. 1975) ..............................................................................................9, 10
Gredd v. Bear Stearns Sec. Corp. (In re Manhattan Inv. Fund Ltd.),
359 B.R. 510 (Bankr. S.D.N.Y. 2007), aff=d., in part, and rev=d,
in part, on other grounds, 397 B. R. 1 (S.D.N.Y. 2007) ...........................................................25
Jackson v. Mishkin (In re Adler, Coleman Clearing Corp.), 263 B.R. 406
(S.D.N.Y. 2001) .........................................................................................................................13
Kelly v. Robinson, 479 U.S. 36 (1986) ..........................................................................................17
In re Klein, Maus & Shire, Inc., 301 B. R. 408 (Bankr. S.D.N.Y. 2003) ........................................6
Klein v. Tabatchnick, 418 F.Supp. 1368 (S.D.N.Y. 1976), affirmed in part
and reversed in part, 610 F.2d 1043 (2d Cir. 1979) ..................................................................11
In the Matter of Lewellyn, 26 B.R. 246 (Bankr. S.D. Iowa 1982) .............................................9, 10
In re Lloyd Securities, Inc., 75 F.3d 853 (3d Cir. 1996) ..................................................................8

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TABLE OF AUTHORITIES
(cont.)
CASES:

PAGE

Massachusetts v. Morash, 490 U.S. 107 (1989) ............................................................................17
Matsushita Electric Industrial Co., Ltd. v. Zenith Radio Corp.,
475 U.S. 574 (1986) ......................................................................................................................7
McMahan & Co. v. Wherehouse Entertainment Inc., 65 F.3d 1044
(2d Cir. 1995), cert. den., 517 U. S. 1190 (1996) .......................................................................23
Mishkin v. Ensminger (In re Adler Coleman Clearing Corp.),
218 B.R. 689 (Bankr. S.D.N.Y. 1998) ........................................................................................11
In re New Times Securities Services, Inc., 371 F.3d 68 (2d Cir. 2004) .........................................22
In re New Times Secs. Servs., Inc., 463 F.3d 125 (2d Cir. 2006) ....................................................8
Offshore Logistics, Inc. v. Tallentire, 477 U.S. 207 (1986) ...........................................................17
Osofsky v. Zipf, 645 F.2d 107 (2d Cir. 1981) .................................................................................22
Panos v. Island Gem Enterprises, Ltd., N. V., 880 F.Supp. 169 (S.D.N.Y. 1995) ........................23
Picard v. Chais (In re Bernard L. Madoff Investment Securities LLC),
445 B.R. 206 (Bankr. S.D.N.Y. 2011) ........................................................................................13
Picard v. Merkin (In re Bernard L. Madoff Investment Securities LLC),
440 B.R. 243 (Bankr. S.D.N.Y. 2010) ....................................................................................13, 20
Picard v. Taylor (In re Park South Securities, LLC), 326 B.R. 505
(Bankr. S.D.N.Y. 2005................................................................................................................12
Samantar v. Yousef, ___ U. S. ___, 130 S. Ct. 2278 (2010) ..........................................................14
S.E.C. v. Albert & Maguire Sec. Co., 378 F.Supp. 906 (E.D. Pa. 1974) .......................................21
SEC v. Albert & Maguire Sec. Co., 560 F.2d 569 (3d Cir. 1977)..................................................10
SEC v. North American Planning Corp., [1975-76 Transfer Binder]
Fed. Sec. L. Rep. (CCH) ¶95,326 (S.D.N.Y. 1975)..............................................................11, 15
In re Sharp International Corp., 403 F.3d 43 (2d Cir. 2005) ........................................................25
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TABLE OF AUTHORITIES
(cont.)
CASES:

PAGE

SIPC v. Ambassador Church Finance/Development Group, Inc.,
788 F.2d 1208 (6th Cir.), cert. den. sub nom., Pine Street Baptist
Church v. SIPC, 479 U.S. 850 (1986)............................................................................................8
SIPC v. Charisma Securities Corp., 506 F.2d 1191 (2d Cir. 1974)...............................................15
SIPC v. Christian-Paine & Co., 755 F.2d 359 (3d Cir. 1985) .........................................................9
SIPC v. Securities Northwest, Inc., 573 F.2d 622 (9th Cir. 1978). .................................................15
SIPC v. S.J. Salmon, No. 72 Civ. 560, 1973 U. S. Dist. LEXIS
15606 (S.D.N.Y. Aug. 8, 1973) .................................................................................................. 12
Springer v. Philippine Islands, 277 U.S. 189 (1928) .....................................................................16
Young v. Hibee Co., 324 U.S. 204 (1945)......................................................................................13
STATUTES AND RULES:
Securities Investor Protection Act, as amended, 15 U.S.C. '
78eee(d)............................................................................................................................................1
78fff(a) .............................................................................................................................................8
78fff(a)(4) ..................................................................................................................................9, 16
78fff(b) .........................................................................................................................................8, 9
78fff-1 ............................................................................................................................................16
78fff-1(a) ..........................................................................................................................4, 9, 14, 16
78fff-2(a)(3) .................................................................................................................................8, 9
78fff-2(b)..........................................................................................................................................8
78fff-2(c)(1) .................................................................................................................................8, 9
78fff-2(c)(3) ...................................................................................................................................15
78fff-(3)(a) .......................................................................................................................................8
78lll(11)..........................................................................................................................................20
Securities Exchange Act of 1934, 15 U.S.C. '
78j(b) ..............................................................................................................................................23

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TABLE OF AUTHORITIES
(cont.)
STATUTES AND RULES:

PAGE

United States Bankruptcy Code, 11 U.S.C. §
102(3) .............................................................................................................................................14
105(a) ...............................................................................................................................................4
510(c)(1) ..........................................................................................................................................4
544…................................................................................................................................................3
546(e) ..................................................................................................................... 2, 5, 7, 17-20, 25
547…............................................................................................................................................4, 5
547(b) ...............................................................................................................................................4
547(b)(2) ..........................................................................................................................................4
548…..........................................................................................................................................9, 16
548(a)(1)(A) ...........................................................................................................................3, 5, 25
548(a)(1)(B) .................................................................................................................................3, 5
548(c) ...............................................................................................................................................4
548(d)(2)(A) .....................................................................................................................................4
550(a) ...........................................................................................................................................3, 4
551………………………………………………………………………………………………3, 4
704(1) .............................................................................................................................................16
Federal Rules of Civil Procedure §
9(b) ................................................................................................................................................7
56(a) ................................................................................................................................................7
Federal Rules of Bankruptcy Procedure §
7009(b) .............................................................................................................................................7
7012(b)(6) ........................................................................................................................................1
7012(d) .............................................................................................................................................1
7056..................................................................................................................................................1
Securities Exchange Commission Rule, 17 C.F.R. §240.
15c3-3(b) ........................................................................................................................................24
15c3-3(e) ........................................................................................................................................24
Securities Investor Protection Corporation Series 500 Rules, 17 C.F.R. §300.
503(a) .............................................................................................................................................13

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TABLE OF AUTHORITIES
(cont.)
OTHER AUTHORITY:

PAGE

U.S. Constitution,
Art. VI, cl. 2 ...................................................................................................................................21
LEGISLATIVE MATERIALS:
H.R. Rep. No. 97-420, reprinted in
1982 U.S.C.C.A.N. 583 .......................................................................................................17
H.R. Rep. No. 109-648, reprinted in
2006 U.S.C.C.A.N. 1585 .....................................................................................................18
Pub. L. No. 109-390, 109 Stat. 2693 (2006) ..................................................................................17
TREATISES:
3 Collier on Bankruptcy ¶60.85 (14th ed. 1977)………………………………………………...10
6 Collier on Bankruptcy ¶741.07 (16th ed. 2010) .........................................................................19
2A Sutherland Statutory Construction §47.07 (7th ed. 2010) .......................................................14

-viii-

Pursuant to Rule 7012(b)(6) of the Federal Rules of Bankruptcy Procedure (“Bankruptcy
Rules”), the defendants in this case (“Defendants”) have moved to dismiss the amended
complaint (“Complaint”) filed against them by Irving H. Picard (“Trustee”), trustee for the
substantively consolidated liquidation proceeding of Bernard L. Madoff, under the Securities
Investor Protection Act, 15 U.S.C. §78aaa et seq. (“SIPA”), and of Bernard L. Madoff
Investment Securities LLC (“BLMIS” or “Debtor”).1 Alternatively, and pursuant to Bankruptcy
Rules 7012(d) and 7056, Defendants have moved for summary judgment.

The Securities

Investor Protection Corporation (“SIPC”) submits this memorandum of law in opposition to
Defendants‟ motion (“Motion”).2 While SIPC supports the position of the Trustee in opposing
the Motion, SIPC limits its response herein to issues raised by the Defendants that involve an
interpretation of SIPA.
STATEMENT OF THE ISSUES
The issues presented by the Motion and addressed herein by SIPC are:
(1) Whether the only avoidance actions that a SIPA trustee can
bring against customers are preference actions where SIPA
a) vests in the trustee all of the powers of a bankruptcy trustee
“including the same rights to avoid preferences;”
b) bankruptcy trustees can bring, among others, fraudulent
conveyance actions as well as preference actions; c) the word
“including” is a word of enlargement and not limitation; and
d) limiting the trustee to preference actions would deprive the
trustee of a significant means of collecting property in
contravention of his duty to maximize the estate for the benefit
of customers and creditors of the debtor;
1

See Notice of Motion to Dismiss the Amended Complaint or, In the Alternative, for
Summary Judgment, filed herein (Doc. No. 35).
For convenience, references herein to provisions of SIPA shall omit “15 U.S.C.”
2

Under SIPA section 78eee(d), SIPC is a party in interest as to all matters arising in a
SIPA proceeding, with the right to be heard on all such matters.

(2) Where the purpose of section 546(e) of Title 11 of the United
States Code (the “Bankruptcy Code”) is to ensure the stability
of the financial system by exempting from avoidance certain
transfers associated with ordinary market transactions, whether
section 546(e) exempts from avoidance transfers associated
with phantom trades that never occurred whose avoidance
therefore could not have the adverse effects on the markets
that section 546(e) was designed to prevent;
(3) Whether in a SIPA proceeding the indebtedness of a broker to
a customer, that is, the customer‟s “net equity,” is to be
determined under SIPA which is a federal law, or according to
state law that is inconsistent with SIPA or inapplicable federal
securities case law; and
(4) Whether the Ponzi scheme presumption that transfers in a
Ponzi scheme are made with the intent to hinder, delay and
defraud creditors applies in SIPA cases where the presumption
is well-established in non-SIPA bankruptcy cases, is applied in
SIPA cases, and a failure to apply the presumption would
unfairly disadvantage customers and creditors in a SIPA case
versus those in non-SIPA bankruptcy cases.
SIPC respectfully submits that the SIPA Trustee is not limited to preference actions,
section 546(e) does not apply to this case, the customer‟s net equity is to be determined
according to SIPA, and the Ponzi scheme presumption applies.
STATEMENT OF FACTS
1. The Case
This is a suit by the Trustee to recapture for the benefit of BLMIS customers stolen
BLMIS customer funds transferred to Defendants, including but not limited to amounts by which
Defendants profited from the fraud, and for other relief.

2

The Defendants include Sterling Equities partners,3 their family members, their related
trusts, and various entities they own, operate, and control. The Trustee alleges that over their 25plus year relationship with BLMIS, Defendants received hundreds of millions of dollars in
fictitious profits from BLMIS. In total, Defendants received $300,000,000 in fictitious profits
and over $700,000,000 in principal (together, the “Transfers”) from BLMIS.

The Trustee

contends that Defendants were among the largest beneficiaries of the BLMIS Ponzi scheme. All
of the funds that they received were customer funds converted by Bernard Madoff. Complaint at
¶ 1105.
The Sterling Partners opened and administered 483 accounts at BLMIS, approximately
300 of which were accounts for themselves, their families, their trusts and entities. Id. at ¶ 4.
The Trustee alleges that the Sterling Partners relied on Madoff‟s consistent and steady returns as
a source of liquidity to develop and sustain their businesses, and that because the BLMIS money
was so deeply entrenched within Defendants‟ businesses, the Defendants willfully turned a blind
eye to the fraud at BLMIS. The Complaint details the various indicia of fraud that should have
triggered the Defendants to investigate BLMIS but which they failed to do because it would not
have financially benefitted them. Id. at Section IX.
The Trustee seeks to avoid the Transfers as (i) actual fraudulent transfers under
Bankruptcy Code sections 544, 548(a)(1)(A), 550(a), and 551 and New York Debtor and
Creditor Law; (ii) constructive fraudulent transfers under Bankruptcy Code sections 544,
548(a)(1)(B), 550(a), and 551 and New York Debtor and Creditor Law; and (iii) preferential
3

The general partners of Sterling include: Saul B. Katz, Fred Wilpon, Michael Katz,
Richard Wilpon, David Katz, Thomas Osterman, Jeffrey Wilpon, Arthur Friedman, Gregory
Katz, Marvin B. Tepper, and the late Leonard Schreier, whose BLMIS account interests after his
death through the Filing Date were held by his estate (collectively, the “Sterling Partners”).
Amended Complaint (Doc. No. 34) (“Complaint”) at Section V.B.
3

transfers under Bankruptcy Code sections 547(b), 550(a), and 551. In addition, the Trustee seeks
to disallow the Defendants‟ customer claims, or, to the extent any Defendant‟s claim is allowed,
equitably to subordinate the allowed customer claim pursuant to Bankruptcy Code sections
510(c)(1) and 105(a).
2. The Defenses
The Defendants assert that they were “customers” of BLMIS and that the amounts that
they received essentially were paid in the ordinary course of the Debtor‟s business as a
brokerage. Defendants make several arguments in support of their position that the Trustee‟s
suit therefore is improper and subject to dismissal. Among other things, they contend that:
1. SIPA limits avoidance suits by a trustee under SIPA section 78fff-1(a) to preferences;
2. fraudulent conveyance suits cannot be brought against customers because such suits
allegedly run counter to the goal of customer protection under SIPA;
3. the fictitious account statements issued by BLMIS allegedly reflected what the
Defendants were owed and therefore, payments received by them purportedly were on account of
antecedent debts owed to them by the Debtor. Recovery by the Trustee would at best be limited
to the recovery of preferences under section 547 of the Bankruptcy Code which allows avoidance
of transfers made on account of an antecedent debt owed by the Debtor before the transfer. 11
U.S.C. §547(b)(2). No fraudulent conveyance action, however, could be brought because such
actions would be barred under section 548(c). Transfers in satisfaction of antecedent debts of the
Debtor would have been for “value” as defined in section 548(d)(2)(A) of Title 11. A fraudulent
conveyance action is subject to the defense that under 11 U.S.C. section 548(c), a transferee can
retain a transfer that is taken for value and in good faith;

4

4. each payment that Defendants received from BLMIS was allegedly received in
connection with a securities contract. Section 546(e) would bar any action by the Trustee to
avoid preferences under section 547 of the Bankruptcy Code and fraudulent conveyances under
548(a)(1)(B) of the Bankruptcy Code. Section 546(e) does not apply to fraudulent conveyance
suits under section 548(a)(1)(A) of Title 11, but Defendants assert that even if such an action
could be brought, it would be limited to transfers that occurred within two years prior to the date
BLMIS was placed in liquidation. See Bankruptcy Code §548(a)(1)(A); and
5. the Ponzi scheme presumption, namely, that transfers out of a Ponzi scheme are made
with the actual intent to hinder, delay and defraud creditors, applied in connection with the
Trustee‟s action under section 548(a)(1)(A), has no role in a SIPA case.
Def. Mem. at 57-58.4
On these grounds, among others, the Defendants assert that they are entitled to keep the
funds that they received from BLMIS even though the monies belong to other customers.
SUMMARY OF THE ARGUMENT
In an effort to circumvent the law on fraudulent and preferential transfers, Defendants
repeatedly mischaracterize SIPA and misstate the law. Among other things, Defendants are
incorrect that a SIPA trustee can only bring preference actions. They are incorrect that a SIPA
trustee cannot sue customers for fraudulent transfers. And they are incorrect that the Ponzi
scheme presumption is unavailable in a SIPA case.

4

Memorandum of Law In Support of Sterling Defendants‟ Motion to Dismiss the
Amended Complaint Or, In the Alternative, for Summary Judgment (Doc. No. 37) (“Def.
Mem.”)
5

The Trustee is vested with the power to avoid fraudulent transfers, just as he is vested
with the power to avoid preferential transfers. At its core, a SIPA proceeding is a bankruptcy
proceeding that incorporates provisions of the Bankruptcy Code specifically made applicable to
it under SIPA. Those provisions include the power of a bankruptcy trustee to avoid preferences,
as well as fraudulent transfers.

Just as fraudulent transfers ensure equitable treatment of

creditors under the Bankruptcy Code, fraudulent transfers are pivotal to ensure equal treatment of
creditors, including customers, in a SIPA case. Allowing one customer to keep fraudulent
transfers – particularly in the amounts at issue here – provides a windfall to that customer at the
expense of all others.
Defendants are no exception to this rule. Defendants assert that they should be immune
from fraudulent transfer suits because they were customers of BLMIS and SIPA‟s purpose is to
protect customers. Defendants‟ simplistic argument is flawed in two major respects. First, it
contravenes the purpose of customer protection under SIPA. SIPA is designed to protect all
customers, and not just the select few. In order to protect all customers, a Trustee must be able
to pursue the same avoidance actions against customers as he can against general creditors and
third party transferees. Second, Defendants‟ makeshift rationale has no basis in SIPA, the
Bankruptcy Code, or in case law. “Customer” status does not entitle Defendants to special
treatment, particularly at the expense of other customers.5
Defendants also fail to recognize that the liquidation of BLMIS requires the application
of established case law specific to Ponzi schemes. Contrary to Defendants‟ assertions, transfers
5

It bears noting that the Defendants would be customers only as to amounts deposited by
them with the broker and custodied with it. To the extent their claims were for fictitious profits,
such claims are claims for damages, and the Defendants‟ status would be that of general
unsecured creditors. See In re Klein, Maus & Shire, Inc., 301 B. R. 408, 421 (Bankr. S.D.N.Y.
2003).
6

made by the Ponzi scheme perpetrator necessarily were made with the actual intent to hinder,
delay and defraud creditors. In addition, Defendants are not immune from fraudulent transfer
law by virtue of the settlement payment exception in Bankruptcy Code section 546(e). Indeed,
this Court has concluded that section 546(e) is not a valid defense in adversary proceedings
related to the BLMIS liquidation and on similar facts. Defendants‟ repeated misstatements of the
law cannot support the relief Defendants seek.
STANDARD OF REVIEW
On a motion to dismiss, all factual allegations in the Complaint are to be taken as true.
See Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 555-56 (2007). A motion to dismiss should
be denied when the complaint contains sufficient facts to “draw the reasonable inference that the
defendant is liable for the misconduct alleged.” Ashcroft v. Iqbal, ___ U. S. ___, 129 S.Ct. 1937,
1949 (2009). For allegations of fraud, Federal Rule of Civil Procedure 9(b) requires that a
complaint “state with particularity the circumstances constituting fraud.” See Bankruptcy Rule
7009(b).
Rule 56, made applicable here by Bankruptcy Rule 7056, provides that summary
judgment is proper only if a movant “shows that there is no genuine dispute as to any material
fact and that the movant is entitled to judgment as a matter of law.” Fed. R. Civ. P. 56(a); see
also Celotex Corp. v. Catrett, 477 U.S. 317, 322 (1986). All inferences to be drawn from the
underlying facts must be viewed in the light most favorable to the Trustee. Matsushita Electric
Industrial Co., Ltd. v. Zenith Radio Corp., 475 U.S. 574, 587 (1986). Summary judgment is
inappropriate if a reasonable fact-finder could return a verdict for the non-moving party.
Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986).

7

ARGUMENT
OVERVIEW OF SIPA
A SIPA proceeding is essentially a bankruptcy liquidation remodeled to achieve the
special purposes of SIPA. See §78fff(a). See, e.g., Exchange National Bank of Chicago v.
Wyatt, 517 F.2d 453, 457-459 (2d Cir. 1975); In re Lloyd Securities, Inc., 75 F.3d 853, 857 (3d
Cir. 1996); SIPC v. Ambassador Church Finance/Development Group, Inc., 788 F.2d 1208, 1210
(6th Cir.), cert. den. sub nom., Pine Street Baptist Church v. SIPC, 479 U.S. 850 (1986). Unless
SIPA mandates a different result, a SIPA proceeding is to “be conducted in accordance with and
as though it were being conducted under chapters 1, 3, and 5 and subchapters I and II of chapter
7” of the Bankruptcy Code. SIPA §78fff(b).
The provisions that modify traditional bankruptcy law are principally related to SIPA‟s
“customer” provisions. Pursuant to those provisions, claimants who qualify as “customers”
receive preferred treatment. They share ratably in the fund of “customer property” – consisting
generally of the cash and securities custodied with the broker-dealer for customers – on the basis
and to the extent of their respective “net equities,” and to the exclusion of general creditors. See
SIPA §78fff-2(b) and (c)(1). See also In re New Times Secs. Servs., Inc., 463 F.3d 125, 128-29
(2d Cir. 2006); In re Bell & Beckwith, 937 F.2d 1104, 1106-08 (6th Cir. 1991). To the extent of
a shortfall in customer property, within certain limits, “customers” may have their claims
satisfied out of funds advanced by SIPC. SIPA §78fff-3(a).
While customer protection is a highly significant objective of SIPA, SIPA also makes the
trustee responsible to the entire bankruptcy estate. Accordingly, both customers and general
creditors may file claims against the estate in a SIPA liquidation, and general creditors are
subject to the same claims filing deadline as customers. SIPA §78fff-2(a)(3). Cf., In the Matter

8

of Lewellyn, 26 B.R. 246, 253-254 (Bankr. S.D. Iowa 1982); Gold v. Hyman, [1974-75 Transfer
Binder] Fed. Sec. L. Rep. (CCH) ¶ 95,043, at 97, 657-58 (S.D.N.Y. 1975). Any general estate is
distributed in the order of priority established in Section 726 of the Bankruptcy Code. SIPA
§78fff(e). To the extent customers are not fully satisfied from customer property and any SIPC
advance, they share pari passu with general creditors in any general estate. SIPA §78fff-2(c)(1).
I. A SIPA TRUSTEE CAN BRING FRAUDULENT CONVEYANCE ACTIONS
1. Defendant’s Interpretation of SIPA Limiting a Trustee’s Capacity to Sue In
Avoidance Is Inconsistent With the Provisions and Purposes of SIPA
As previously mentioned, a SIPA liquidation is conducted not only in accordance with,
but as though it were being conducted under, specified chapters and subchapters of the
Bankruptcy Code, to the extent consistent with SIPA. §78fff(b). One of the chapters is chapter
5. Chapter 5 of the Bankruptcy Code includes section 548, the fraudulent conveyance section.
Contrary to the Defendants‟ assertion, there is no provision in SIPA that makes section 548
unavailable in any respect to a SIPA trustee. To limit the Trustee in his ability to recover assets
in avoidance would be inconsistent with his obligation to liquidate the Debtor and in the process,
to resolve all claims against the Debtor by satisfying claimants to the maximum extent possible.
A liquidation under SIPA contemplates satisfaction of certain customer claims, the
liquidation of the debtor‟s business, and the satisfaction of claims filed by general creditors. See
§§78fff(a)(4) and 78fff-2(a)(3). To accomplish those ends, the trustee has the same powers as a
Chapter 7 bankruptcy trustee, and additional powers that enable him to perform the special
functions of a SIPA liquidation. See SIPA §78fff-1(a). See also Executive Securities Corp. v.
Doe, 702 F.2d 406, 407 (2d Cir.), cert. den., 464 U. S. 818 (1983); SIPC v. Christian-Paine &
Co., 755 F.2d 359, 361 (3d Cir. 1985); SEC v. Albert & Maguire Sec. Co., 560 F.2d 569, 574 (3d

9

Cir. 1977). As the District Court for this District has remarked, practical reasons support the
expansive powers given to the trustee:
A SIPA trustee was undoubtedly intended by Congress to
completely liquidate a brokerage business which had failed –
including processing all creditor claims as well as customer claims.
Indeed, a SIPA trustee has even more powers in some
circumstances than a trustee in bankruptcy. For Congress to have
provided otherwise would have been unwise and inefficient. A
SIPA trustee knows the situation well by the time customer claims
are processed and is obviously the proper person to complete
liquidation.
Gold v. Hyman, [974-75 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶95,043 at pp. 97,65797,658 (S.D.N.Y. 1975).
Because the Trustee‟s responsibilities extend not only to stockbroker customers but to the
entire bankruptcy estate, In the Matter of Lewellyn, 26 B.R. 246, 253-254 (S.D. Iowa 1982), the
Trustee may sue to recover assets to satisfy general creditors, unpaid customers and SIPC. See
Gold v. Hyman, supra, at p. 97,657; Bondy v. Chemical Bank, [1975-76 Transfer Binder] Fed.
Sec. L. Rep. (CCH) ¶95,360 at pp. 98,784, 98,785-98- 786 (S.D.N.Y. 1975). Toward that end,
among other things, since enactment, SIPA has conferred upon the SIPA trustee the powers of a
bankruptcy trustee to avoid transfers. As succinctly stated in 3 Collier on Bankruptcy ¶60.85 at
p. 1246 (14th ed. 1977):
The trustee, therefore, has all the powers conferred by the
Bankruptcy Act upon an ordinary bankruptcy trustee to avoid or
set aside transfers of property or other transactions occurring prior
to institution of the proceedings, to recover property and collect the
assets of the estate or to assert any right or defenses the debtor
might have against the claims of others …. In short, whenever an
ordinary bankruptcy trustee could under the Bankruptcy Act
invalidate a transaction or transfer, the SIPA trustee can do the
same, and the fact that he was appointed under SIPA does not
suggest a different rule.

10

See 1 Collier on Bankruptcy ¶12.14[3] at p. 12-70 (16th ed. 2011).

See also Mishkin v.

Ensminger (In re Adler Coleman Clearing Corp.), 218 B.R. 689, 702 (Bankr. S.D.N.Y.1998)
(holding that a SIPA trustee may bring fraudulent transfer claims under the Bankruptcy Code);
Klein v. Tabatchnick, 418 F.Supp. 1368 (S.D.N.Y. 1976), affirmed in part and reversed in part,
610 F.2d 1043 (2d Cir. 1979) (unresolved factual questions making summary judgment
improper); Bondy v. Chemical Bank, supra, at p. 98,786; SEC v. North American Planning
Corp., [1975-76 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶95,326 at p. 98,640 (S.D.N.Y. 1975)
(„[SIPA] Trustee alone has the power to recover property which has been fraudulently,
preferentially or otherwise voidably transferred.”)
2. “Customers” Are Not Immune From Fraudulent Transfer Actions
With regard to fraudulent transfer laws, customers in a SIPA liquidation are not afforded
special treatment, and Defendants are no exception.

The purpose of fraudulent transfer

provisions is to benefit all customers as a class. Indeed, Defendants specifically concede as
much. See Def. Mem. at 59, quoting In re Chase & Sanborn Corp., 813 F.2d 1177, 1191 (11th
Cir. 1987) (“Fraudulent transfers are avoidable because they diminish the assets of the debtor to
the detriment of all creditors.”). Here, Defendants received transfers of funds that belonged to all
customers, not Defendants alone. Recovery of these fraudulent transfers is necessary for the
equitable treatment of all customers. Thus, instead of bolstering their own position, Defendants‟
argument actually supports the Trustee‟s own position.
Defendants are also wrong on the law: “customer” status does not prevent a trustee from
bringing a fraudulent transfer action against a transferee. Courts uniformly have held that a
trustee has standing to avoid fraudulent transfers against customers. As a Referee in Bankruptcy
for the United States District Court for the Southern District of New York remarked in SIPC v.

11

S.J. Salmon, No. 72 Civ. 560, 1973 U. S. Dist. LEXIS 15606 (S.D.N.Y. Aug. 8, 1973)
(“Salmon”), just a little more than two years after the enactment of SIPA:
...[I]t is argued that the trustee=s position in seeking to reverse
the February 2d transactions is contrary to the purpose of SIPA.
There is no validity to this point of view. It is true that SIPA
was intended to afford greater protection to customers than they
enjoyed under §60e of the Bankruptcy Act, essentially by
providing a limited form of insurance for customer claims for
cash and securities. But SIPA was not intended to make the
fraudulent transfer provisions of the Bankruptcy Act inoperative
as to stockbroker-debtors in SIPA proceedings. While SIPA
was intended to protect customers there is nothing in its
provisions to indicate that less preferred creditors are to be
denied the protection of the provisions which bar a debtor from
making fraudulent transfers at their expense.
Id. at *31.
At issue in Salmon were “trades” that the SIPA trustee alleged were neither bona fide nor
the result of arm=s length transactions in the open market, but recorded only on the books and
records of the brokerage in order to improve the eligibility for SIPA protection of certain
preferred customers in the face of the imminent liquidation of the firm. The trustee sued the
preferred customers, seeking to avoid the transactions as fraudulent and void under avoidance
provisions of the former Bankruptcy Act and New York Debtor and Creditor Law. In ruling in
favor of the trustee, the Court concluded that the Atrades@ were transfers made with actual intent
to defraud creditors, a deliberate attempt to defraud SIPC under SIPA, and done without “fair
consideration.@ Id. at *31-32.
That a SIPA trustee may sue customers for fraudulent transfers has been recognized in other
cases as well. See, e.g., Picard v. Taylor (In re Park South Securities, LLC), 326 B.R. 505, 51213 (Bankr. S.D.N.Y. 2005) (holding that the trustee had standing to bring fraudulent transfer
claims against customers); Jackson v. Mishkin (In re Adler, Coleman Clearing Corp.), 263 B.R.

12

406, 496 (S.D.N.Y. 2001) (affirming this Court‟s judgment that fraudulent transfers to customers
were avoidable); see also Focht v. McDermott (In re Old Naples Securities, Inc.), 343 B.R. 310,
320-21 (Bankr. M.D. Fla. 2006) (finding that fraudulent transfers to introducing broker were
avoidable). Moreover, in adversary proceedings related to the Debtor‟s liquidation, this Court
has held that the Trustee has standing to avoid fraudulent transfers against customers and noncustomers alike. Picard v. Chais (In re Bernard L. Madoff Investment Securities LLC), 445 B.R.
206, 219-228 (Bankr. S.D.N.Y. 2011) (“Chais”) (holding that the Trustee adequately pled claims
for recovery of fraudulent transfers to customers); see also Picard v. Merkin (In re Bernard L.
Madoff Investment Securities LLC), 440 B.R. 243, 251 n.6 (Bankr. S.D.N.Y. 2010) (“Merkin”).
Sound reasoning underscores the decisions reached in these cases. A SIPA trustee‟s ability
to recover fraudulent transfers is necessary for the equitable treatment of customers and other
creditors alike. As stated in Jackson v. Mishkin (In re Adler, Coleman Clearing Corp.), 263 B.R.
406, 479 (S.D.N.Y. 2001) (“Adler Coleman”), citing Young v. Higbee Co., 324 U.S. 204, 210
(1945):
“[T]he spirit that infuses the whole of SIPA and the Bankruptcy
Code is Congress‟s determination, reflected in a trustee‟s
avoidance powers under [Bankruptcy Code] § 548 as well as SIPC
Rule 300.503, that „a few individuals should not be allowed to
benefit from transfers by an insolvent entity at the expense of the
many.‟”6
Thus, there can be no dispute that a SIPA Trustee has the power to avoid fraudulent transfers,
whether made to a “customer” under SIPA, a general creditor, or a third party transferee.

6

SIPC Rule 503(a), 17 C.F.R. §300.503(a), specifies that “[n]othing in these Series 500
Rules shall be construed as limiting the rights of a trustee in a liquidation proceeding under
[SIPA] to avoid any securities transaction as fraudulent, preferential, or otherwise voidable under
applicable law.”

13

3. The Trustee Is Not Limited to Preference Actions
The express language of SIPA lends no support to the Defendants‟ position that a SIPA
trustee may only avoid preferences.

Pursuant to SIPA section 78fff-1(a), the trustee is

specifically “vested with the same powers and title with respect to the debtor and the property of
the debtor, including the same rights to avoid preferences, as a trustee in a case under Title 11.”
The fact that section 78fff-1(a) vests in a SIPA trustee the powers of a title 11 trustee, including
the right to avoid preferences, does not limit the trustee to recovery of estate assets only on that
basis.
In the first instance, the Defendants‟ attempt to construe the words “including the same
right to avoid preferences” (SIPA §78fff-1(a)), as words of limitation, is inconsistent with
general principles of statutory construction. Thus,
[a] term whose statutory definition declares what it “includes” is
more susceptible to extension of meaning by construction than
where the definition declares what a term “means.” It has been
said “the word „includes‟ is usually a term of enlargement, and not
of limitation…. It, therefore, conveys the conclusion that there are
other items includable, though not specifically enumerated…”
2A Sutherland Statutory Construction §47.07 at p. 305 (7th ed. 2010). See Samantar v. Yousuf,
___ U. S. ___, 130 S. Ct. 2278, 2288 n.10 (2010). The Bankruptcy Code‟s rules of construction
provide that the terms “include” and “including” are not limiting. See 11 U.S.C. §102(3).
Second, the Defendants‟ restrictive interpretation is contrary to SIPA. One the one hand,
Congress would not impose on the SIPA trustee the dual functions of resolving the claims of
both customers and general creditors while, on the other hand, withdrawing or restricting the
means for satisfying their claims in an adequate manner. Furthermore, as stated above, section
548 is contained in chapter 5 of the Bankruptcy Code which is specifically incorporated into
SIPA, to the extent consistent with SIPA. A Bankruptcy Code provision is inconsistent with
14

SIPA and not made a part of SIPA only if it “conflicts with an explicit provision” or if its
“application would substantially impede the fair and effective operation of SIPA without
providing significant countervailing benefits.” SIPC v. Charisma Securities Corp., 506 F.2d
1191, 1195 (2d Cir. 1974). See SIPC v. Securities Northwest, Inc., 573 F.2d 622, 625 (9th Cir.
1978). Cf., id. at 628. That test is not met here.
Third, Congress has expressed elsewhere in the statute its intent that the SIPA trustee
have the full range of avoidance powers available in a bankruptcy liquidation. Thus, SIPA
section 78fff-2(c)(3) authorizes the trustee to recover customer property transferred by the debtor
if and to the extent the “transfer is voidable or void under the provisions of title 11.” The
recovered property becomes “customer property” and is subject to the order of distribution in
SIPA. Section 78fff-2(c)(3) is an express provision with respect to customer property. 7 As to
general estate property, the bankruptcy provisions control, including section 548. See SEC v.
North American Planning Corp., [1975-76 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶95,326 at
98,640 (S.D.N.Y. 1975) (the trustee‟s avoidance powers derive from the “overall statutory
framework created by SIPA and the correlative provisions of the Bankruptcy Act [now
Bankruptcy Code].”
“Where a statute contains a grant of power enumerating certain things which may be
done and also a general grant of power which standing alone would include these things and
more, the general grant may be given full effect if the context shows that the enumeration was

7

Undoubtedly, Congress believed it necessary to include SIPA section 78fff-2(c)(3)
because in some states, “customer property” is not considered as property of the debtor and
customers are not considered creditors. Therefore, in SIPA, Congress expressly stated that such
property would be subject to recovery by the Debtor and that, state law to the contrary
notwithstanding, customer property would be deemed to be property of the debtor and customers
would be deemed to be creditors.
15

not intended to be exclusive.” Springer v. Philippine Islands, 277 U.S. 189, 206 (1928). When
read in conjunction with other provisions of SIPA interpreted as a whole, the term “including” in
SIPA section 78fff-1 is merely illustrative and not exhaustive. It confers upon the SIPA trustee
the same powers as a title 11 trustee including, among others, the right to avoid preferences,
whether the transferee is a customer or otherwise.
Finally, that Congress did not intend to limit the trustee‟s avoidance powers to preference
actions is supported by the fact that the trustee would have no means of recovering property if
the elements of a preference could not be shown. Thus, absent authority to sue under section 548
or other avoidance provisions, recovery for the benefit of customers and other creditors would be
extremely limited and possibly nil if a preference could not be shown. This would unjustifiably
disadvantage customers and creditors in a SIPA case versus ordinary bankruptcy, and plainly
would not comport with SIPA. Under SIPA section 78fff(a)(4) thereof, the trustee must liquidate
the estate. Being subject to the same duties as a bankruptcy trustee, the SIPA trustee likewise
must maximize the amounts realized from the liquidation and toward that end must institute all
necessary litigation. See 11 U.S.C. §704(1). See also In re the Drexel Burnham Lambert Group,
123 B.R. 702, 708 (Bankr. S.D.N.Y. 1991) (“A trustee in bankruptcy, under the Act and the
Code, is under a duty to maximize the realization of estate liquidation. To that end a trustee must
marshal the estate‟s assets and, if necessary to achieve that end, institute all necessary
litigation.”); Freeman v. Seligson, 405 F.2d 1326, 1333 (D.C. Cir. 1968). The intention of
Congress was not to deprive a SIPA trustee of a significant means of fulfilling his duty. The
Defendants‟ limited interpretation of SIPA section 78fff-1(a) simply is wrong.
II. BECAUSE IT DOES NOT APPLY UNDER THE FACTS OF THIS CASE,
SECTION 546(e) DOES NOT BAR THE TRUSTEE’S ACTION

16

1. Defendants’ Construction of Section 546(e) of the Bankruptcy Code Undermines,
Rather Than Effectuates, the Purposes of That Provision
Section 546(e) of the Bankruptcy Code, the Astockbroker defense,@ provides a Asafe
harbor@ by exempting from avoidance certain types of payments commonly made in connection
with transactions in the securities markets. Defendants rely upon that portion of section 546(e)
that provides that notwithstanding specified provisions under the Code,
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.
Defendants contend that the sums paid to them by BLMIS were “transfers” that the Trustee may
not now seek to avoid.
In determining whether section 546(e) applies, a court must Alook to the provisions of the
whole law, and to its object and policy,@ and not just its literal language. Bevill, Bresler &
Schulman v. Spencer Sav. & Loan Ass’n, 878 F.2d 742, 750 (3d Cir. 1989) (“Bevill, Bresler”)
(citing Massachusetts v. Morash, 490 U.S. 107, 115 (1989)). See Kelly v. Robinson, 479 U.S.
36, 43 (1986), quoting Offshore Logistics, Inc. v. Tallentire, 477 U.S. 207, 222 (1986) (“In
expounding a statute, we must not be guided by a single sentence or member of a sentence, but
look to the provisions of the whole law, and to its object and policy.”); In re Adler, Coleman
Clearing Corp., 263 B.R. 406, 478-479 (S.D.N.Y. 2001) (“Adler Coleman”). The legislative
history of section 546(e) explains that the provision was intended Ato minimize the displacement
caused in the commodities and securities markets in the event of a major bankruptcy affecting
those industries.@ H. R. Rep. No. 97-420, at 1 (1982), reprinted in 1982 U.S.C.C.A.N. 583.8

8

Section 546(e) was amended under the Financial Netting Improvements Act of 2006, to
include the language relied upon by the Defendants. See Pub. L. No. 109-390, §5(b)(1), 120
17

Thus, Congress sought to prevent the Aripple effect@ created by Athe insolvency of one
commodity or security firm from spreading to other firms and possibly threatening the collapse
of the affected market.@ Bevill, Bresler, 878 F.2d at 747. See Enron Corp. v. Bear, Stearns Int’l
Ltd. (In re Enron Corp.), 323 B.R. 857, 864 (Bankr. S.D.N.Y. 2005) (AThe purpose of section
546 is „to protect the nation=s financial markets from the instability caused by the reversal of
settled securities transactions.‟@), citing Kaiser Steel Corp. v. Charles Schwab & Co., Inc. (In re
Kaiser Steel Corp.), 913 F.2d 846, 848 (10th Cir. 1990).
2. Relevant Factors in Determining Whether Section 546(e) Applies
Five factors are significant to a consideration of whether section 546(e) applies. These
include whether:
(1) the transactions have long settled by means of actual transfers of
consideration, so that subsequent reversal of the trade may result in disruption
of the securities industry, creating a potential chain reaction that could
threaten collapse of the affected market;
(2) consideration was paid out in exchange for the securities or property interest
as part of settlement of the transaction;
(3) the transfer of cash or securities effected contemplates consummation of a
securities transaction;
(4) the transfers were made to financial intermediaries involved in the national
clearance and settlement system;
(5) the transaction implicated participants in the system of intermediaries and
guarantees which characterize the clearing and settlement process of public
markets and therefore would create the potential for adverse impacts on the
functioning of the securities market if any of those guarantees in the chain
were invoked.

Stat. 2693, 2697-2698 (2006). The amendment did not alter the fundamental purpose of the
section, namely, to address the risk that the failure of one financial entity would disrupt or
endanger the financial markets. H. R. Rep. No. 109-648 (part 1) at 3 (2006), reprinted in 2006
U.S.S.C.A.N. 1585, 1587.
18

In re Enron Creditors Recovery Corp., 422 B. R. 423, 439 (S.D.N.Y. 2009), citing Adler
Coleman, 263 B.R. at 479-80. See American Tissue, Inc. v. Donaldson, Lufkin & Jenrette Sec.
Corp., 351 F.Supp.2d 79, 107 (S.D.N.Y. 2004).9
A review of the factors in the context of this case makes clear that section 546(e) cannot
apply. Defendants contend that the transfers in question represent the payment of funds owed to
them as shown in their fictitious account statements. As an initial matter, section 546(e) is
inapplicable because customer withdrawals are not the type of transactions within the ambit of
the section. The section was intended to enable brokers to protect themselves in the event of the
insolvency of one of their customers or a financial counterparty. See, e.g., 6 Collier on
Bankruptcy &741.07 (16th ed. 2010). It has no application to customer account withdrawals.
Moreover, section 546(e) obviously can apply only to payments made in connection with real
Asecurities contracts.@ Phantom trades that have never occurred cannot have the kind of ripple
effect threatening the liquidity of the markets or the operation of the national securities clearance
and settlement system targeted by Congress under section 546(e). Indeed, the application of
section 546(e) to shield the withdrawals would have the effect of sanctioning fictitious trades at
fabricated prices which would undermine, and not strengthen, the financial markets. Not only
are the kinds of market participants and transactions at which section 546(e) is directed not
present here, but there also was no consideration paid for the fake securities trades. Thus, bogus
trades in the BLMIS operation consistently were Apaid for@ out of fictitious profits and transfers
were payments of false profit. Payments made by the broker to Asettle@ phony transactions
cannot be regarded as part of the normal settlement process, which section 546(e) seeks to
9

Although section 546(e) was amended in 2006 to include transfers pursuant to securities
contracts, see supra, the factors still apply in evaluating the applicability of the section. See In re
Enron Creditors Recovery Corp., 422 B. R. at 439.

19

protect. See Adler Coleman, 263 B.R. at 481 (phantom transactions Acould not be considered as
contemplating a normal completion of a securities transaction as commonly understood in the
securities industry@). See also Merkin, 440 B.R. at 266-268. Thus, there would be no basis under
section 546(e) to limit any avoidance action brought by the Trustee in this case.
III. DEFENDANTS ARE INCORRECT THAT “ANTECEDENT DEBT”
IS TO BE MEASURED ACCORDING TO THE
FICTITIOUS ACCOUNT STATEMENTS
The Defendants contend that the amounts that they received can only be avoided, if at all,
as preferences, and not fraudulent conveyances, because each transfer, in their view, was on
account of an antecedent debt. Def. Mem. at 60-64. They argue that the “antecedent debt” arose
from BLMIS‟s obligation to pay them what appeared on their account statements.

These

statements were fictitious, reflecting non-existent trades and equally non-existent profits.
Nevertheless, in support of their position that the measure of what they are owed is the last
account statement, Defendants cite to the Uniform Commercial Code and decisions under the
federal securities laws. Although their arguments are made in the context of a SIPA proceeding,
and SIPA defines how a broker‟s indebtedness to a customer is to be measured, they effectively
ignore SIPA, no doubt because it runs counter to their position.
What customers are owed in a SIPA proceeding is their net equity, as defined in SIPA
section 78lll(11). As this Court has held, the net equity of the Defendants and other customers of
BLMIS is the difference between the amounts deposited by them with the brokerage and the
amounts withdrawn. In re Bernard L. Madoff Investment Securities LLC, 424 B. R. 122 (Bankr.
S.D.N.Y. 2010), appeal docketed, No. 10-2378-BK(L) (2d Cir.). Defendants‟ Motion is an
improper attempt to have this Court revisit its decision on net equity notwithstanding that unless
reversed, the decision is the law of the case by which the parties to this adversary proceeding are

20

bound. See Gindes v. United States, 740 F.2d 947, 950 (Fed. Cir.1984) (“[T]he law of the case
[is] the rule that „a decision by the court on a point in a case becomes the law of the case unless
or until it is reversed or modified by a higher court.‟”). This Court properly construed the
definition of net equity and what BLMIS investors are owed. The Defendants‟ assertions
notwithstanding, neither the Uniform Commercial Code nor the securities laws provisions upon
which they rely, change that.
1. The Uniform Commercial Code
Defendants argue that the New York Uniform Commercial Code (“UCC”), instead of
SIPA, governs what a customer is entitled to receive. See Def. Mem. at 60-64. The argument
fails on at least two grounds.
First, to the extent that state law is inconsistent with SIPA which is a federal law, the
state law is preempted under the Supremacy Clause of the United States Constitution. See U.S.
Const., Art. VI, cl. 2; In re Bevill, Bresler & Schulman, Inc., 59 B.R. 353, 378 (D.N.J.), appeal
dismissed, 802 F.2d 445 (3rd Cir. 1986) (holding that state law that is inconsistent with SIPA is
preempted). It is particularly appropriate that state law not override federal law where the
federal law, as in SIPA, is supported both by the Bankruptcy Clause of the United States
Constitution and the Commerce Clause. See S.E.C. v. Albert & Maguire Sec. Co., 378 F.Supp.
906, 911 (E.D. Pa. 1974). See also In re Bell & Beckwith, 104 B. R. 842, 859 (Bankr. N. D.
Ohio 1989), aff’d, 937 F.2d 1104 (6th Cir. 1991) (“[I]nconsistent state laws must give way to
SIPA, a federal statute.”) Here, to the extent that any state law would provide a different form of
relief for the customer than under SIPA, SIPA controls.
Second, the Official Comment to the UCC itself, expressly citing SIPA as an example,
provides that SIPA overrides the UCC if the entity‟s affairs are being administered in an
insolvency proceeding. See U.C.C. [Rev.] § 8-503, Official Comment 1 (2009) (“applicable
21

insolvency law governs how the various parties having claims against the firm are treated. For
example, the distributional rules for stockbroker liquidation proceedings under the Bankruptcy
Code and Securities Investor Protection Act ….”). See also American Sur. Co. of N.Y. v.
Sampsell, 327 U.S. 269, 272 (1946) (“[F]ederal bankruptcy law, not state law, governs the
distribution of a bankrupt‟s assets to his creditors.”).
2. Federal Securities Law Decisions
Like the provisions of the UCC, the federal securities law decisions cited by the
Defendants are inapplicable and the Defendants‟ reliance upon them does not withstand scrutiny.
Effectively, Defendants‟ position that any antecedent debt is based on the fictitious account
statement would create an entitlement to fake profits where there is none. See In re New Times
Securities Services, Inc., 371 F.3d 68, 88 (2d Cir. 2004) (court will defer to persuasive analysis
of “potential absurdities created by reliance on the entirely artificial numbers contained in
fictitious account statements.”) None of the cases cited by the Defendants alter that fact. While
investors duped by BLMIS and Bernard Madoff may have claims for damages as general
creditors, Defendants cite to no authority establishing that the damages are to be the fake
“profits” in the amounts randomly invented by Bernard Madoff.
In support of their contention that their damages are to be measured according to a
benefit-of-the-bargain approach, namely, the difference between their actual loss and what they
were promised, the Defendants rely upon the decision in Osofsky v. Zipf, 645 F.2d 107, 114 (2d
Cir. 1981) (“Osofsky”). See Def. Mem. at 63. But there, the court held that “the benefit-of-thebargain rule should be applied under the Securities Exchange Act of 1934 (“1934 Act”) to the
limited situation involved in this case, where misrepresentation is made in the tender offer and
proxy solicitation materials as to the consideration to be forthcoming upon an intended merger.”
Id. at 114 (emphasis supplied). In McMahan & Co. v. Wherehouse Entertainment Inc., 65 F.3d
22

1044 (2d Cir. 1995), cert. den., 517 U. S. 1190 (1996) (“McMahan”), another case relied upon
by the Defendants, Def. Mem. at 63, the Second Circuit remarked in discussing Osofsky that:
[in Osofsky,] Plaintiffs tendered their stock, but received a lesser
amount than they originally had been offered. *** We held that
benefit-of-the-bargain damages, under [Securities and Exchange
Commission] Rule 10b-5, were particularly appropriate in the
context of tender offers where, despite the fraud, the shareholders
normally will receive an amount in excess of market value. ***
We noted that the key to awarding benefit-of-the-bargain damages
is the degree of certainty to which they can be established.
[citations omitted]
Id. at 1050. In McMahan, the court acknowledged the possibility of awarding benefit-of-thebargain damages in a Rule 10b-5 case but stressed that it had and would decline to do so where
the claims were speculative. Ultimately, the court reversed the lower court‟s award of benefitof-the-bargain damages in the case, holding that they were unavailable under the section of the
1934 Act under review.
In Panos v. Island Gem Enterprises, Ltd., N. V., 880 F.Supp. 169 (S.D.N.Y. 1995), also
relied upon by the Defendants, Def. Mem. at 63-64, and involving a dispute over the sale of
apartment leases, the court granted a motion to bar plaintiffs‟ benefit-of-the-bargain damage
recovery under section 10(b) of the 1934 Act, 15 U.S.C. §78j(b).

In that case, the court

remarked that under Second Circuit precedent, there was no single measure of damages applying
to all securities fraud damage cases and that it would be for the district court, “after becoming
aware of the nature of the case, to determine the appropriate measure of damages in the first
instance.” Panos, 880 F.Supp. at 175 (citation omitted). The court also observed that in section
10(b) claims, courts had endorsed a wide variety of theories of recovery, “[p]ossibly due to the
wide variety of factual predicates to §10(b) claims.” Id., 880 F.Supp. at 176. The court went on
to note that in most cases under the 1934 Act, defrauded buyers recovered only their out-of-

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pocket losses, mainly because “under most circumstances benefit-of-the-bargain damages are
highly speculative.” Id.
That damages measured according to fictitious account statements are surely speculative
is illustrated by the case at hand where the prices at which BLMIS purported to trade on behalf
of customers were pulled out of thin air, randomly selected by Bernard Madoff to yield returns
pre-determined by him.

No judgment awarding the Defendants the benefit-of-the-bargain

damages existed at the time BLMIS made the transfers to them. Benefit-of-the-bargain has not
been shown to be the applicable measure of damages and antecedent debt is not measured by the
last account statement. Defendants‟ assertion that not measuring antecedent debt by the last
account statement undermines SIPA‟s goal of customer protection is incorrect. Def. Mem. at 8487.10 As the court stated in Focht v. Athens (In re Old Naples Securities, Inc.), 311 B. R. 607,
616-617 (M. D. Fla. 2002):
Especially where the payments to claimants will be made out of
the quasi-public SIPA fund, permitting claimants to recover not
only their initial capital investment but also the phony “interest”
payments they received and rolled into another transaction is
illogical. No one disputes that the interest payments were not in
fact interest at all, but were merely portions of other victims‟
capital investments. If the Court were to agree with the ...
claimants, the fund would likely end up paying out more money
than was invested in [the] ... Ponzi scheme. This result is not
consistent with the goals of SIPA, which does not purport to make
all victimized investors whole but only to partially ameliorate the
10

Defendants‟ contention that when a customer purchases securities through a broker, the
broker becomes obligated to the customer for securities reflected on the customer‟s statement,
but can then “deploy the customer‟s funds in its business – including to pay other customers” is
sheer error. Def. Mem. at 85-86. Rather, the broker-dealer must maintain physical possession or
control of customers‟ fully paid securities and excess margin securities, and establish a special
reserve bank account for the exclusive benefit of customers. Such funds are for the exclusive
benefit of customers and cannot be deployed by the brokerage in its business. See SEC Rule
15c3-3(b) and (e), 17 C.F.R. 240.15c3-3(b) and (e).

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losses of certain classes of investors. See Packer, Wilbur, [498
F.2d 978, 983 (2d Cir. 1974)].
IV. THE PONZI SCHEME PRESUMPTION APPLIES TO THIS CASE
Defendants recognize that section 546(e), by its terms, is no defense to the Trustee‟s
fraudulent conveyance action under section 548(a)(1)(A) of the Bankruptcy Code.

They

therefore argue that the “Ponzi scheme presumption” that automatically establishes the “actual
intent to hinder, delay, or defraud any entity” criterion of section 548(a)(1)(A) does not apply.
The Defendants rely largely for that proposition on In re Sharp International Corp., 403 F.3d 43
(2d Cir. 2005) (ASharp@).
Contrary to Defendants‟ assertions, where a debtor was engaged in a Ponzi scheme,
consideration of the Abadges of fraud,@ that is, circumstances commonly associated with fraud
such that their existence gives rise to an inference of fraudulent intent, is unnecessary. Bear
Stearns Sec. Corp. v. Gredd (In re Manhattan Inv. Fund Ltd)., 397 B.R. 1, 10 n.13 (S.D.N.Y.
2007) (AManhattan Investment@), citing Securities Investor Protection Corp. v. Old Naples Sec.,
Inc. (In re Old Naples Sec., Inc.), 343 B.R. 310, 319 (Bankr. M.D. Fla. 2006) (“Old Naples”).
Actual intent to hinder, delay or defraud creditors is established as a matter of law in cases
involving a Ponzi scheme because transfers made in the course of such an operation can only be
made to hinder, delay or defraud. Gredd v. Bear Stearns Sec. Corp. (In re Manhattan Inv. Fund
Ltd.), 359 B.R. 510, 517-518 (Bankr. S.D.N.Y. 2007), aff=d., in part, and rev=d, in part, on other
grounds, 397 B. R. 1 (S.D.N.Y. 2007). Courts have long recognized that the existence of a Ponzi
scheme is sufficient to prove a Debtor‟s actual intent to defraud. See Manhattan Investment, 397
B.R. at 10-11, and cases cited therein. The Ponzi scheme presumption is well established in nonSIPA cases. See, e.g., In re Bayou Group, LLC, 439 B.R. 284, 306 n.19 (S.D.N.Y. 2010)
(“Bayou”) (“Where a Ponzi scheme exists, there is a presumption that transfers were made with
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the intent to hinder, delay and defraud creditors.”). Notwithstanding that Defendants seem to
imply that customer status under SIPA somehow renders the Ponzi scheme presumption
inapplicable, to the contrary, the Ponzi scheme presumption applies, with equal force, in SIPA
cases. See, e.g., Old Naples, 343 B.R. at 320-21 (“[I]nnocence in the underlying Ponzi scheme is
not a defense to liability under the fraudulent transfer provisions.”) See also Chais, 445 B.R. at
220; Merkin, 440 B.R. at 255. As this Court stated in Chais, “[i]t is now well recognized that the
existence of a Ponzi scheme establishes that transfers were made with the intent to hinder, delay
and defraud creditors.”

445 B.R. at 220, citing Bayou, 439 B.R. at 306 n.19; Manhattan

Investment, 397 B.R. at 8-14.
The Sharp decision relied by the Defendants requires no different outcome. As noted by
the Court in Manhattan Investment, Sharp did not involve a Ponzi scheme and the Second
Circuit did not discuss in that case the Ponzi scheme presumption. 397 B.R. at 10. As observed
by the Court:
In Sharp, the transfer at issue was the repayment of a debt that was
antecedent to the company=s fraud. See [Sharp, 403 F.3d] at 55
(finding that Ano ground exists therefore to >collapse= that loan with
other (non-contemporaneous) bad-faith maneuvers@). In contrast,
in a Ponzi scheme, the transfers sought to be avoided occur as part
of the fraud. They are not made to repay loans or services that
preceded the fraud and were unrelated to it. For this reason, the
transfer in Sharp is factually distinguishable from the typical
transfers in a Ponzi scheme case.
Manhattan Investment, 397 B.R. at 11.
That the transfers were part of a massive Ponzi scheme is palpable here. Fictitious trades
were reflected on fake account statements generating fake profits used to “invest” in more
fictitious securities positions. The transfers of funds to the Defendants were in furtherance of the
fraud, with the money of other investors used to pay the Defendants their fake profits.

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Calculated as the amounts were based on predetermined returns and the Areinvestment@ of false
profits, and comprised as they were of other investors‟ money, the transfers shown on the
fictitious account statements were themselves inherently fraudulent and intrinsically a part of the
Ponzi scheme. Necessarily, their purpose was to hinder, delay or defraud other investors. See In
re Bayou Group, LLC, 362 B.R. 624, 636-38 (S.D.N.Y. 2007).
Defendants‟ contentions about the inapplicability of the Ponzi scheme presumption are
without merit.
CONCLUSION
For all of the aforementioned reasons, the Defendants‟ Motion should be denied.
Dated: May 19, 2011
Washington, D.C.
Respectfully submitted,

_/s/ Josephine Wang___
JOSEPHINE WANG
General Counsel
KEVIN H. BELL
Senior Associate General Counsel
for Dispute Resolution
LAUREN T. ATTARD
Staff Attorney
SECURITIES INVESTOR
PROTECTION CORPORATION
805 15th Street, N.W.
Suite 800
Washington, D.C. 20005
Telephone: [phone]
Email: [e-mail]
Email: [e-mail]
Email: [e-mail]

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