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

Filing 37

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

Davis Polk & Wardwell LLP
450 Lexington Avenue
New York, New York 10017
Telephone:
[phone]
Facsimile:
[phone]
Attorneys for the Sterling Defendants
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
----------------------------------- x
:
IRVING H. PICARD,
:
:
Plaintiff,
:
:
11-CV-03605 (JSR)
- against :
:
SAUL B. KATZ, et al.,
:
:
Defendants.
:
:
----------------------------------- x

SUPPLEMENTAL MEMORANDUM OF LAW IN RESPONSE
TO SUPPLEMENTAL MEMORANDA OF THE TRUSTEE AND SIPC
AND IN FURTHER SUPPORT OF STERLING DEFENDANTS’ MOTION
TO DISMISS OR, IN THE ALTERNATIVE, FOR SUMMARY JUDGMENT

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

TRANSFERS ON ACCOUNT OF ANTECEDENT
DEBT CANNOT BE AVOIDED AS FRAUDULENT ..........................................3
A.

Under Applicable Non-Bankruptcy Law, Brokers Are Indebted
to Customers for Cash and Securities on Brokerage Statements.................3

B.

Customers Are Creditors As to Whom Payments Discharging
Valid Antecedent Debt Cannot Be Avoided As Fraudulent ........................4

C.

BLMIS’ Obligations to a Customer May Be
Invalidated Only by a Showing of Willful Blindness..................................6
1.
2.

Because a Brokerage Customer Has No Duty to
Investigate His Broker, “Willful Blindness” Cannot
Be Predicated on Breach of Any Such Duty..................................10

3.
II.

“Willful Blindness” Is Akin to Knowledge .....................................8

As a Matter of Law the Sterling Defendants Were
Not “Willfully Blind” to Madoff’s Ponzi Scheme.........................12

THE HAPPENSTANCE OF BANKRUPTCY DOES NOT
RETROACTIVELY ALTER NON-BANKRUPTCY
RIGHTS AND OBLIGATIONS OR IMPOSE NEW DUTIES ............................14
A.
B.

III.

A Bankruptcy Filing Does Not Alter
Substantive Pre-Bankruptcy Rights ...........................................................14
Nothing in SIPA Changes This Result.......................................................17

BY ITS PLAIN MEANING, SECTION 546(E) APPLIES IN THIS CASE ........20

CONCLUSION..................................................................................................................22

i

TABLE OF AUTHORITIES
CASES
PAGE
Armstrong v. McAlpin, 699 F.2d 79 (2d Cir. 1983)...........................................................11
Banque Worms v. BankAmerica Int’l, 77 N.Y.2d 362 (1991) ...........................................17
Barnhill v. Johnson, 503 U.S. 393 (1992) .........................................................................15
Bear, Stearns Sec. Corp. v. Gredd, 275 B.R. 190 (S.D.N.Y. 2002) ..................................15
In re Bernard L. Madoff Inv. Sec. LLC, 424 B.R. 122 (Bankr. S.D.N.Y. 2010) .................6
BFP v. Resolution Trust Corp., 511 U.S. 531 (1994)..................................................15, 16
Boston Trading Group, Inc. v. Burnazos, 835 F.2d 1504 (1st Cir. 1987) ...........................5
Butner v. United States, 440 U.S. 48 (1979)......................................................................15
Cohen v. Cohen,
No. 09 Civ. 10230, 2011 U.S. Dist. LEXIS 33771 (S.D.N.Y. Mar. 29, 2011)............11
Commodity Futures Trading Comm’n v. Walsh,
No. 91, 2011 N.Y. LEXIS 1704 (N.Y. June 23, 2011).......................................... 16-17
Crigger v. Fahnestock & Co., 443 F.3d 230 (2d Cir. 2006)..............................................11
Enron Creditors Recovery Corp. v. Alfa, S.A.B. de C.V.,
No. 09-5122, 2011 U.S. App. LEXIS 13177 (2d Cir. June 28, 2011).............17, 20, 21
Global-Tech Appliances, Inc. v. SEB, S.A., 131 S. Ct. 2060 (2011)....................................9
Goldman v. Capital City Mortgage Corp. (In re Nieves),
No. 08-2160, 2011 U.S. App. LEXIS 11704 (4th Cir. June 10, 2011)........................16
Granfinanciera, S.A. v. Nordberg, 492 U.S. 33 (1989) .....................................................14
HBE Leasing Corp. v. Frank, 48 F.3d 623 (2d Cir. 1995) ..................................................5
Kirschner v. Bennett, 759 F. Supp. 2d 301 (S.D.N.Y. 2010)...............................................9
Lippe v. Bairnco Corp., 249 F. Supp. 2d 357 (S.D.N.Y. 2003)...........................................5
ii

Pa. Dep’t of Pub. Welfare v. Davenport, 495 U.S. 552 (1990) ...........................................4
Picard v. HSBC Bank PLC,
No. 11 Civ. 763, 2011 U.S. Dist. LEXIS 82936 (S.D.N.Y. July 28, 2011)...........12, 17
Rosner v. Bank of China,
No. 06 CV 13562, 2008 U.S. Dist. LEXIS 105984 (S.D.N.Y. Dec. 18, 2008) .............9
Schlaifer Nance & Co. v. Estate of Warhol, 119 F.3d 91 (2d Cir. 1997) ..........................11
SEC v. Milan Capital Group, Inc.,
No. 00 Civ. 108, 2000 U.S. Dist. LEXIS 16204 (S.D.N.Y. Nov. 9, 2000) .................11
In re Sharp Int’l Corp., 403 F.3d 43 (2d Cir. 2005) ............................................................5
Stern v. Marshall, 131 S. Ct. 2594 (2011) .........................................................................14
Tiffany Inc. v. eBay, Inc., 600 F.3d 93 (2d Cir. 2010) ...................................................9, 11
United States v. Abreu, 342 F.3d 183 (2d Cir. 2003).........................................................10
United States v. Nektalov, 461 F.3d 309 (2d Cir. 2006) ....................................................10
Wood v. Carpenter, 101 U.S. 135 (1879) ..........................................................................11
STATUTES & RULES
11 U.S.C. § 101(5)(A)..........................................................................................................4
11 U.S.C. § 101(10)(A)..................................................................................................4, 18
11 U.S.C. § 101(12) .............................................................................................................4
11 U.S.C. § 544..............................................................................................................5, 18
11 U.S.C. § 546(e) ..................................................................................................... passim
11 U.S.C. § 547(b)(1) ........................................................................................................18
11 U.S.C. § 548........................................................................................................5, 15, 18
11 U.S.C. § 548(a)(1)(A) ...................................................................................................20
11 U.S.C. § 741(7) .............................................................................................................22

iii

15 U.S.C. § 78fff-1(a) ........................................................................................................19
15 U.S.C. § 78fff-2(c)(3) .......................................................................................17, 18, 19
15 U.S.C. § 78lll(11)............................................................................................................6
Fed. R. Civ. P. 12(b)(6)......................................................................................................22
Fed. R. Civ. P. 56...............................................................................................................22
N.Y.D.C.L. §§ 273-278 .......................................................................................................5
NYUCC § 8-101 (Legislative Intent) ..................................................................................8
NYUCC § 8-102(a)(1) .........................................................................................................6
NYUCC §8-105(a)...............................................................................................................7
NYUCC § 8-105(a)(2) .....................................................................................................7, 8
NYUCC § 8-105(a)(3) .......................................................................................................10
NYUCC § 8-105 cmt. 4 .......................................................................................................8
NYUCC § 8-501(b)(1).........................................................................................................3
NYUCC § 8-501(b)(3).........................................................................................................3
NYUCC § 8-501(c)..............................................................................................................4
NYUCC § 8-501 cmt. 2 .......................................................................................................4
NYUCC § 8-501 cmt. 3 .......................................................................................................4
NYUCC § 8-502 ..................................................................................................................6
NYUCC § 8-503 ..................................................................................................................7
NYUCC § 8-503(b)..............................................................................................................8
NYUCC § 8-503(e)..............................................................................................................7
NYUCC § 8-503 cmt. 2 .....................................................................................................19
NYUCC § 8-510 ..................................................................................................................6
iv

SEC Rule 10b-5 .................................................................................................................10
SEC Rule 10b-10 ...............................................................................................................10
Sec. Exch. Act § 10(b) ...............................................................................................2, 7, 10
OTHER AUTHORITIES
Confirmation of Transactions,
Exchange Act Release No. 34-34962, 59 Fed. Reg. 59,612 (Nov. 17, 1994) ...............4
Frances Facciolo, Father Knows Best: Revised Article 8 and the Individual Investor,
27 Fla. St. U. L. Rev. 615 (2000)...................................................................................6
Concept Release on the U.S. Proxy System,
Exchange Act Release No. 34-62495, 75 Fed. Reg. 42,982 (July 22, 2010).................4

v

The Sterling Defendants respectfully submit this supplemental memorandum of
law in response to the supplemental briefs of the Trustee (“Trustee Supp. Br.”) and SIPC
(“SIPC Supp. Br.”) and in further support of the Sterling Defendants’ motion to dismiss
or, in the alternative, for summary judgment dismissing the Complaint (“Motion”). 1
PRELIMINARY STATEMENT
In their fully submitted Motion, the Sterling Defendants seek dismissal of the
Trustee’s illegitimate Complaint. The Complaint seeks to avoid as fraudulent
conveyances payments that discharged valid contractual obligations of BLMIS, a
registered broker, to its customers, who were creditors. No fraudulent conveyance claim,
intentional or constructive, may be stated where a payment discharged a valid obligation
to a creditor. Under Article 8 of the NYUCC, a broker’s obligation to a customer may be
invalidated only if the customer was willfully blind, or complicit, in a broker’s fraud.
Because a customer has no duty to investigate his broker, willful blindness or complicity
cannot be premised upon any breach of such duty. Neither SIPA nor the Bankruptcy
Code retroactively changes that result. Nor does the result change because the broker’s
fraud turns out to be a Ponzi scheme.
The Complaint does not challenge the validity of BLMIS’ obligations to its
customers. Rather, the Complaint targets only the payments discharging those
obligations, contending that, by failing to investigate BLMIS’ operations, the Sterling
Defendants were “willfully blind” to BLMIS’ fraud. No duty to investigate exists, so a
supposed failure to investigate cannot constitute “willful blindness.” And the evidence
1

Defined terms used herein have the same meaning as in the prior briefs
submitted in support of the Sterling Defendants’ Motion.
1

submitted by the Sterling Defendants demonstrates that all of the Trustee’s claims of
“willful blindness” are false or immaterial.
After withdrawing the reference of this adversary proceeding, the Court allowed
supplemental briefing to consider three questions: (i) whether SIPA permits avoidance of
transfers from brokers that discharge enforceable obligations to customers; (ii) whether
SIPA or the Bankruptcy Code imposes a retroactive duty on customers to investigate
their broker; and (iii) whether the application of Section 546(e) of the Bankruptcy Code
in this case is incompatible with SIPA.
The supplemental briefs of the Trustee and SIPC essentially fail to address these
or any of the key issues in this case. Neither acknowledges the legal relevance of
BLMIS’ status as a registered broker, or that Article 8 applies at all. Instead, both
contend, implausibly, that Section 10(b) of the Exchange Act, the rules enacted
thereunder, and New York common law impose a due diligence duty on customers of
registered brokers, breach of which gives rise to massive liability. And both repeat, but
do not support, the false allegations already discredited by the evidence offered in support
of the Sterling Motion.
Finally, the Trustee argues that Section 546(e) does not apply in this SIPA case,
contending that no statutory purpose would be served by its application and that, because
no “securities transactions” took place, no “securities contracts” existed. The Trustee’s
argument is contrary to the Second Circuit’s recent Enron decision, pursuant to which the
plain meaning of Section 546(e) controls, and Section 546(e)’s objectives are served by
application in this case.

2

ARGUMENT
I.

TRANSFERS ON ACCOUNT OF ANTECEDENT
DEBT CANNOT BE AVOIDED AS FRAUDULENT
The Complaint asserts fraudulent conveyance claims. To prove such a claim in

this case, the Trustee must demonstrate that, at the time the targeted transfers were made,
a Sterling Defendant received a transfer to which he was not entitled. Here, the Sterling
Defendants had enforceable claims against BLMIS, under Article 8 of the NYUCC and
the federal securities laws, for the securities reflected on their brokerage statements.
BLMIS was legally obligated to make payments in respect of those statements. These
legal rights and obligations were not changed by SIPA or the Bankruptcy Code after
BLMIS’ insolvency filing. Previously valid debt remained valid, as did payments made
to discharge such debt. Therefore, although certain payments may be avoidable as
fraudulent after an insolvency filing, that is not because SIPA or the Bankruptcy Code
renders a valid debt invalid. It is because the debt being discharged was invalid in the
first place. That is not the case here.
A.

Under Applicable Non-Bankruptcy Law, Brokers Are Indebted
to Customers for Cash and Securities on Brokerage Statements

BLMIS issued periodic statements to its customers, reflecting that BLMIS owed
them blue-chip, Fortune 100 securities and cash. Under the NYUCC, when a broker
sends such an acknowledgement to its customer—as required under federal securities
laws—the customer acquires a securities entitlement and the broker incurs an obligation.
NYUCC § 8-501(b)(1), (3). The “most important rule” is that “once a securities
intermediary has acknowledged that it is carrying a position in a financial asset for its
customer or participant, the intermediary is obligated to treat the customer or participant
3

as entitled to the financial asset.” Id. § 8-501 cmt. 2. The broker is obligated whether or
not the broker actually acquires or holds the securities. Id. § 8-501(c); see also § 8-501
cmt. 3. These rights and obligations are recognized and enforced by the federal securities
laws. 2 (See Sterling Br. at 60-64; Sterling Reply Br. at 47.)
B.

Customers Are Creditors As to Whom Payments Discharging
Valid Antecedent Debt Cannot Be Avoided As Fraudulent

By virtue of the NYUCC, at the time of the targeted transfers the Sterling
Defendants had “claims” against BLMIS. 3 BLMIS owed “debts” to its customers. 4
Those customers were “creditors” of BLMIS. 5 Consequently, when analyzed under the
avoidance provisions of the Bankruptcy Code, the payments made by BLMIS were
payments to creditors on account of antecedent debt.

2

See, e.g., Concept Release on the U.S. Proxy System, Exchange Act Release
No. 34-62495, 75 Fed. Reg. 42,982, 42,985 n.31 (July 22, 2010) (recognizing that the
rights and interests that a customer has against a broker are created by contract and the
UCC); see also, e.g., Confirmation of Transactions, Exchange Act Release No. 34-34962,
59 Fed. Reg. 59,612, 59,614 n.29 (Nov. 17, 1994) (recognizing that the contract between
a broker and its customers is made enforceable under the UCC by the written transaction
confirmation).
3

The Bankruptcy Code defines “claim” in relevant part as a “right to payment,
whether or not such right is reduced to judgment, liquidated, unliquidated, fixed,
contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or
unsecured.” 11 U.S.C. § 101(5)(A); see also Pa. Dep’t of Pub. Welfare v. Davenport,
495 U.S. 552, 558 (1990) (citing legislative history describing definition of “claim” as
“broadest possible”).
4

The Bankruptcy Code defines “debt” very broadly to mean “liability on a
claim.” 11 U.S.C. § 101(12); see also Davenport, 495 U.S. at 558 (discussing breadth of
definition of “debt”).
5

The Bankruptcy Code defines “creditor” in relevant part as an “entity that has a
claim against the debtor that arose at the time of or before the order for relief concerning
the debtor.” 11 U.S.C. § 101(10)(A).
4

By definition, a payment to a creditor on account of valid antecedent debt is not a
fraudulent transfer—it is at most a preference. “[A] conveyance which satisfies an
antecedent debt made while the debtor is insolvent is neither fraudulent nor otherwise
improper, even if its effect is to prefer one creditor over another.” In re Sharp Int’l
Corp., 403 F.3d 43, 54 (2d Cir. 2005) (internal quotation marks omitted); see also Lippe
v. Bairnco Corp., 249 F. Supp. 2d 357, 375 (S.D.N.Y. 2003), aff’d, 99 F. App’x 274, 281
(2d Cir. 2004) (“[I]t is hornbook law that [a] conveyance cannot be fraudulent as to
creditors if . . . [it] does not deplete or otherwise diminish the value of the assets of the
debtor’s estate remaining available to creditors.”); HBE Leasing Corp. v. Frank, 48 F.3d
623, 634 (2d Cir. 1995) (“[T]he preferential repayment of pre-existing debts to some
creditors does not constitute a fraudulent conveyance, whether or not it prejudices other
creditors, because ‘the basic object of fraudulent conveyance law is to see that the debtor
uses his limited assets to satisfy some of his creditors; it normally does not try to choose
among them.’” (quoting Boston Trading Group, Inc. v. Burnazos, 835 F.2d 1504, 1509
(1st Cir. 1987))); (Sterling Br. at 58-60; Sterling Reply Br. at 50-51).
Thus, payments made by BLMIS that discharged valid debts to customers are not
avoidable as fraudulent under either federal or state law. See 11 U.S.C. §§ 544, 548;
NYDCL §§ 273-278; (see also Sterling Br. at 58-67; Sterling Reply Br. at 49-52).
Contrary to the claims of both SIPC and the Trustee, the Sterling Defendants do not argue
that the Trustee cannot assert any fraudulent transfer claim against a customer. The
Trustee could do so if a transfer were, for example, for amounts in excess of what the
broker owed according to a statement—though Section 546(e) of the Bankruptcy Code
would limit any such claim to transfers made with actual intent to defraud within two
5

years of the filing date. But the transfers here were on account of valid debt, and,
therefore, no fraudulent conveyance claim can be sustained. 6
C.

BLMIS’ Obligations to a Customer May Be
Invalidated Only by a Showing of Willful Blindness

Under the NYUCC, a customer’s securities entitlement—which establishes the
obligation of the broker—cannot be challenged under any legal theory unless the
customer was on notice of an “adverse claim.” 7
“An action based on an adverse claim to a financial asset, whether framed
in conversion, replevin, constructive trust, equitable lien, or other theory,
may not be asserted against a person who acquires a security entitlement
under Section 8-501 for value and without notice of the adverse claim.”
NYUCC § 8-502 (emphasis added). 8

6

Also contrary to the claims of SIPA and the Trustee, the validity of the
Trustee’s fraudulent conveyance claims will not be decided by the Second Circuit.
(Trustee Supp. Br. at 19; SIPC Supp. Br. at 17-18.) The Second Circuit has been asked to
interpret SIPA § 78lll(11), which defines a customer’s “net equity” claim against the
SIPC Fund and the BLMIS estate. Although the Sterling Defendants argue that the
definition must be interpreted by reference to the broker’s obligation on its last customer
account statement, the “net equity” definition has no bearing on the requisite elements of
a fraudulent conveyance claim against a customer. If the Circuit were to decide the
weight to be afforded customer statements in determining a customer’s “net equity”
claim, such guidance could be instructive, but it would not govern the legal questions at
issue in this case. Indeed, the Bankruptcy Court, in rendering its “net equity” opinion,
expressly disavowed deciding the merits of any defenses to avoidance. See In re Bernard
L. Madoff Inv. Sec. LLC, 424 B.R. 122, 137 n.30 (Bankr. S.D.N.Y. 2010).
7

An “adverse claim” is a claim to a property interest in a financial asset such that
it is a violation of the rights of the claimant for another person to hold, transfer, or deal
with the financial asset. NYUCC § 8-102(a)(1).
8

Sections 8-502 and 8-510, as revised, “require notice of the particular adverse
claim that is asserted in order for a purchaser to lose its favored status.” Frances
Facciolo, Father Knows Best: Revised Article 8 and the Individual Investor, 27 Fla. St. U.
L. Rev. 615, 654 n.218 (2000) (emphasis added).
6

A person has notice of an adverse claim if:
“(1) the person knows of the adverse claim;
(2) the person is aware of facts sufficient to indicate that there is a
significant probability that the adverse claim exists and deliberately avoids
information that would establish the existence of the adverse claim; or
(3) the person has a duty, imposed by statute or regulation, to investigate
whether an adverse claim exists, and the investigation so required would
establish the existence of the adverse claim.” NYUCC § 8-105(a).
The Complaint does not allege actual knowledge of Madoff’s Ponzi scheme, and
the Trustee’s claim that Section 10(b) of the Exchange Act and the rules enacted
thereunder imposed a duty of investigation on the Sterling Defendants is not credible.
(See infra at 10-12.) Thus, in order to invalidate BLMIS’ obligations to the Sterling
Defendants, the Trustee must offer evidence of their “willful blindness.” 9 NYUCC
§ 8-105(a)(2). As noted, he must show willful blindness not as to the source of BLMIS’
payments, but as to the validity of its obligations. (See supra at 4-6; see also Sterling Br.
at 64-70; Sterling Reply Br. at 50-53.) The Complaint does not challenge these
obligations, and the Trustee has no evidence with which to mount any such challenge. 10
9

The Trustee now claims that he uses the term “willful blindness” only as a
descriptive phrase (Trustee Supp. Br. at 2 n.1), an implicit concession that the Sterling
Defendants were not willfully blind. Whatever he may say, he must plead and prove that
the Sterling Defendants had no valid securities entitlements because they were willfully
blind to the fraud. He has done neither. (Sterling Br. at 6-47, 68-74; Sterling Reply Br.
at 3-36.)
10

If the Trustee alternatively were to attempt to invalidate the Sterling
Defendants’ securities entitlements on the ground that their creation violated the interests
of other customers in particular financial assets held by the broker, his claim would be
defeated by NYUCC Section 8-503. Under Section 8-503, the Trustee would have to
plead and prove that the Sterling Defendants were acting in collusion with BLMIS to
deprive other entitlement holders of their rights. NYUCC § 8-503(e). “Collusion”
includes “acting in concert, acting by conspiratorial arrangement,” or engaging in
transactions with a securities intermediary with “actual knowledge that the securities
7

The Trustee has failed either to plead or prove that the Sterling Defendants were willfully
blind to BLMIS’ Ponzi scheme such that the creation of their securities entitlements
violated the property rights of other brokerage customers, pursuant to their own securities
entitlements. See NYUCC § 8-503(b).
1.

“Willful Blindness” Is Akin to Knowledge

As discussed in the Sterling Motion, “willful blindness” is a culpable state of
mind approximating actual knowledge. (Sterling Br. at 69-70; Sterling Reply Br. at 54.)
NYUCC § 8-105(a)(2) codifies the “willful blindness” standard.
“The first prong of the willful blindness test of paragraph (a)(2) turns on
whether the person is aware of facts sufficient to indicate that there is a
significant probability that an adverse claim exists. The ‘awareness’
aspect necessarily turns on the actor’s state of mind. Whether facts known
to a person make the person aware of a ‘significant probability’ that an
adverse claim exists turns on facts about the world and the conclusions
that would be drawn from those facts, taking account of the experience
and position of the person in question. A particular set of facts might
indicate a significant probability of an adverse claim to a professional with
considerable experience in the usual methods and procedures by which
securities transactions are conducted, even though the same facts would
not indicate a significant probability of an adverse claim to a nonprofessional.
The second prong of the willful blindness test of paragraph (a)(2) turns on
whether the person ‘deliberately avoids information’ that would establish
the existence of the adverse claim. The test is the character of the person’s
response to the information the person has. The question is whether the
person deliberately failed to seek further information because of concern
that suspicions would be confirmed.” NYUCC § 8-105 cmt. 4.

intermediary has violated or is violating an entitlement holder’s property interest.” Id.
§ 8-101 (Legislative Intent). “Collusion” is comparable to “willful blindness” and, thus,
cannot be based on “rumors, allegations or reports of suspected wrongdoing” or on a
failure to “inquire.” Id. Therefore, even if this provision were applicable, the analysis
would be no different—the Trustee has not demonstrated either “willful blindness” or
“collusion.”
8

As the Supreme Court recently held, willful blindness requires evidence of both
guilty knowledge and evasive action: “(1) the defendant must subjectively believe that
there is a high probability that a fact exists and (2) the defendant must take deliberate
actions to avoid learning of that fact.” Global-Tech Appliances, Inc. v. SEB, S.A., 131 S.
Ct. 2060, 2070 (2011) (emphasis added).
“[T]hese requirements give willful blindness an appropriately limited
scope that surpasses recklessness and negligence. Under this formulation,
a willfully blind defendant is one who takes deliberate actions to avoid
confirming a high probability of wrongdoing and who can almost be said
to have actually known the critical facts.” Id. at 2070-71 (emphasis
added).
The Second Circuit has deemed willful blindness “tantamount to knowledge.”
Tiffany Inc. v. eBay, Inc., 600 F.3d 93, 110 n.15 (2d Cir. 2010) (collecting cases). The
standard therefore differs materially from a negligence, or “should have known,”
standard. See, e.g., Global-Tech, 131 S. Ct. at 2070-71 (contrasting willful blindness
with negligence); see also, e.g., Rosner v. Bank of China, No. 06 CV 13562, 2008 U.S.
Dist. LEXIS 105984, at *24 (S.D.N.Y. Dec. 18, 2008), aff’d, 349 F. App’x 637 (2d Cir.
2009) (“If such allegations [indicative of constructive knowledge] are insufficient to
support a claim of actual knowledge, they are necessarily insufficient to support a claim
of willful blindness; otherwise, the required element of actual knowledge would
effectively be demoted to one of constructive knowledge.”); Kirschner v. Bennett, 759 F.
Supp. 2d 301, 334 (S.D.N.Y. 2010) (“Conscious avoidance therefore involves a culpable
state of mind whereas constructive knowledge imputes a state of mind on a theory of
negligence.” (internal quotation marks omitted)).

9

Consequently, someone who is willfully blind must have actually suspected fraud
and “decided not to learn the key fact, not merely to have failed to learn it through
negligence.” United States v. Nektalov, 461 F.3d 309, 315-16 (2d Cir. 2006) (emphasis
added); see also United States v. Abreu, 342 F.3d 183, 188 (2d Cir. 2003) (rejecting
argument “premised on the common misconception that the conscious avoidance theory
allows the prosecution to establish knowledge by proving only that the defendant should
have known of a certain fact, even if he did not actually know it”).
2.

Because a Brokerage Customer Has No Duty to
Investigate His Broker, “Willful Blindness” Cannot
Be Predicated on Breach of Any Such Duty

Lacking any evidence establishing the Sterling Defendants’ “willful blindness,”
the Trustee relies instead on allegations that the Sterling Defendants failed to investigate
BLMIS. Willful blindness, however, cannot be premised upon breach of a customer’s
duty to investigate a broker. There is no such duty. Extensive research has revealed no
case finding such a duty, and no such case is cited by SIPC or the Trustee. No applicable
statute or regulation imposes such a duty. On the contrary, the duties all run the other
way—to the customer—especially where, as here, the broker is a fiduciary. (See Sterling
Br. at 76.)
Finding no legal support for their position, and perhaps hoping to come within the
ambit of NYUCC § 8-105(a)(3), SIPC and the Trustee now argue that Section 10(b) of
the Exchange Act, Rules 10b-5 and 10b-10, and New York common law impose a
supposed “duty of inquiry” upon brokerage customers. (Trustee Supp. Br. at 10-14; SIPC
Supp. Br. at 19-24.) They are wrong.

10

Every case cited by the Trustee or SIPC concerns the limits on the assertion of a
claim by the plaintiff, resulting from the plaintiff’s own delay, or pleading or evidentiary
failure. 11 See, e.g., Wood v. Carpenter, 101 U.S. 135, 140-41 (1879) (plaintiff’s fraud
claim barred by statute of limitations); Crigger v. Fahnestock & Co., 443 F.3d 230, 23436 (2d Cir. 2006) (plaintiffs’ fraud claims failed for lack of reasonable reliance on
defendant’s misrepresentations); Schlaifer Nance & Co. v. Estate of Warhol, 119 F.3d 91,
101 (2d Cir. 1997) (plaintiff’s fraud claim dismissed for failure to establish reasonable
reliance on defendants’ misrepresentations); Armstrong v. McAlpin, 699 F.2d 79, 88-89
(2d Cir. 1983) (receiver’s securities fraud claims barred by statute of limitations); Cohen
v. Cohen, No. 09 Civ. 10230, 2011 U.S. Dist. LEXIS 33771, at *47-48, 63-65 (S.D.N.Y.
Mar. 29, 2011) (plaintiff’s civil RICO and common law claims barred by applicable
statutes of limitations).
These cases address the rules under which an investor must assert his own claims.
They certainly do not suggest that, if he fails to do so, he will then be liable to someone
else. The failure to exercise reasonable diligence in making an investment or to preserve
one’s own rights—which may preclude a subsequent recovery for oneself—is not a
breach of an affirmative duty to anyone that gives rise to liability. 12 These cases provide

11

Notably, SEC v. Milan Capital Group, Inc., No. 00 Civ. 108, 2000 U.S. Dist.
LEXIS 16204 (S.D.N.Y. Nov. 9, 2000), emphasizes the duties that a broker—even an
unregistered one—owes to its customers when dispensing investment advice. See id. at
*14 (“A broker is under a duty to investigate the truth of his representations to clients,
because ‘by his position he implicitly represents he has an adequate basis for the opinions
he renders.’”).
12

Even if brokerage customers had some duty of inquiry that, if breached, could
expose them to liability to other customers—which they do not—the Trustee would lack
standing to assert such a claim against the Sterling Defendants on their behalf. See
11

no authority for the Trustee’s claim that a customer is obligated to investigate his broker
for the benefit of others.
3.

As a Matter of Law the Sterling Defendants Were
Not “Willfully Blind” to Madoff’s Ponzi Scheme

The Trustee has failed as a matter of law to meet his burden of proving “willful
blindness.” The Complaint is replete with false allegations that are entirely contradicted
by the evidence the Trustee himself adduced in unilateral discovery before filing the
Complaint. (Sterling Br. at 6-53; Sterling Reply Br. at 3-33.) In response to the Sterling
Motion, the Trustee has offered no admissible evidence to refute the Sterling Defendants’
evidence demonstrating the falsity of his allegations—instead, in his supplemental brief,
the Trustee ignores the evidence and suggests that the allegations in his Complaint
remain valid. They do not.
•
The central allegation of the Complaint is that Sterling Stamos warned one
of the Sterling Defendants that Madoff was a “scam” or a “fraud.” That
allegation, even if true, is not sufficient as a matter of law to establish “willful
blindness.” But the allegation is false, as demonstrated by the evidence the
Trustee had adduced before the allegation was made. (Sterling Br. at 6-7; Sterling
Reply Br. at 12-16.)
•
In his opposition to the Sterling Motion, the Trustee shifted to a new
central allegation—that the Sterling Defendants went on a “shopping spree” for
Ponzi scheme insurance. That allegation is also insufficient as a matter of law to
prove “willful blindness.” And it is false based upon the evidence the Trustee had
adduced before the allegation was made. (Sterling Reply Br. at 3-8.)
•
The allegation now receiving top billing in the supplemental briefs—that
the Sterling Defendants knew of industry articles in which industry professionals
questioned Madoff’s legitimacy (Trustee Supp. Br. at 8)—is immaterial. The
Picard v. HSBC Bank PLC, No. 11 Civ. 763, 2011 U.S. Dist. LEXIS 82936, at *8
(S.D.N.Y. July 28, 2011). Nor can the Trustee bolster his claim by reference to a 401(k)
plan trustee’s fiduciary duties. No brokerage customer, including a 401(k) plan trustee,
has a duty to engage in a forensic examination of a broker or investment advisor.
12

claim that these public articles were “red flags,” even for financial professionals,
has been rejected by numerous courts as insufficient to establish scienter.
(Sterling Br. at 70-73.) Consequently, this allegation cannot be sufficient as a
matter of law to demonstrate “willful blindness.”
•
None of the other allegations is sufficient to constitute “willful blindness”
as a matter of law, and none is supported by admissible evidence in any event.
Every one of the other allegations is false, irrelevant, or immaterial, or all three.
(Sterling Br. at 6-47; Sterling Reply Br. at 3-33.)
•
And the Trustee’s entire $1 billion demand is based on an unsupported and
unprecedented extension of imputation principles to impose liability on, among
others, grandchildren, charitable foundations, and family trusts. (Sterling Br. at
87-91; Sterling Reply Br. at 59-65.)
Once the false and immaterial allegations are stripped from the fully submitted
record, it is apparent that the entire willful blindness case, and the demand for $1 billion,
is based upon emails sent after Madoff’s arrest, which were sent neither to nor from a
Sterling Defendant and which do not even remotely suggest that any Sterling Defendant
was willfully blind to BLMIS’ fraud. (Sterling Reply Br. at 12-14, 34-35.) Even if the
hearsay statements in these unauthenticated emails were admissible, which they are not,
they fail, as a matter of law, to establish that the Sterling Defendants knew “facts
sufficient to indicate that there is a significant probability” of a Ponzi scheme. Nor are
they evidence of deliberate avoidance of information that would establish the existence
of a Ponzi scheme. Indeed, as the SEC’s Office of Inspector General Report
demonstrates, even when extremely detailed information was offered to a trained
regulatory body, it did not see evidence of a Ponzi scheme. (Sterling Br. at 78-79.)
The Complaint is both factually and legally without merit. It is a profound attack
on brokerage customers that has no precedent and that threatens the Sterling Defendants’
rights under important federal and state non-bankruptcy laws. Contrary to the

13

contentions of the Trustee and SIPC, this action is not “the ordinary re-ordering and
adjustment of creditor rights characteristic of bankruptcy.” (SIPC Supp. Br. at 9, 17-18;
cf. Trustee Supp. Br. at 19-20.) It is an affirmative demand for a huge sum of money to
augment the debtor’s estate, not to address “creditors’ hierarchically ordered claims to a
pro rata share of the bankruptcy res.” Granfinanciera, S.A. v. Nordberg, 492 U.S. 33, 56
(1989). The issues raised by the Complaint cannot and will not be determined through
the claims process; indeed, the Trustee’s letters rejecting the Sterling Defendants’ claims
did not even raise any of these issues. The Sterling Defendants, therefore, respectfully
submit that this case must be heard in its entirety by an Article III court. See Stern v.
Marshall, 131 S. Ct. 2594, 2616 (2011).
II.

THE HAPPENSTANCE OF BANKRUPTCY DOES NOT
RETROACTIVELY ALTER NON-BANKRUPTCY
RIGHTS AND OBLIGATIONS OR IMPOSE NEW DUTIES
Before this SIPA case was filed, the Sterling Defendants had legally enforceable

rights against BLMIS that had been discharged by valid payments from BLMIS. After
the filing of this SIPA case, the Sterling Defendants still had legally enforceable rights
against BLMIS that had been discharged by valid payments from BLMIS. Nothing in the
Bankruptcy Code or SIPA, nor the fact that this case was ostensibly triggered by a Ponzi
scheme, altered the legal status of those obligations and payments or retroactively
imposed duties that did not previously exist.
A.

A Bankruptcy Filing Does Not Alter
Substantive Pre-Bankruptcy Rights

The filing of a bankruptcy case does not alter non-bankruptcy rights, but, rather,
recognizes them as the foundation for analysis of claims and rights in a bankruptcy case.

14

The keystone of the legal architecture governing the interplay between bankruptcy law
and non-bankruptcy law is Butner v. United States, 440 U.S. 48, 54 (1979), in which the
Supreme Court unanimously held that “Congress has generally left the determination of
property rights in the assets of a bankrupt’s estate to state law.”
“Property interests are created and defined by state law. Unless some
federal interest requires a different result, there is no reason why such
interests should be analyzed differently simply because an interested party
is involved in a bankruptcy proceeding. Uniform treatment of property
interests by both state and federal courts within a State serves to reduce
uncertainty, to discourage forum shopping, and to prevent a party from
receiving ‘a windfall merely by reason of the happenstance of
bankruptcy.’” Id. at 55.
The Butner Court held that a creditor must be “afforded in federal bankruptcy
court the same protection he would have under state law if no bankruptcy had ensued”
and expressly rejected the view that the onset of bankruptcy permitted “undefined
considerations of equity” to contravene state law. Id. at 56.
Later cases confirm Butner’s ruling. See, e.g., BFP v. Resolution Trust Corp.,
511 U.S. 531, 544-45 (1994) (rejecting avoidance of state foreclosure sale as fraudulent
under 11 U.S.C. § 548 because state law precluded the Trustee’s avoidance claim and
“the Bankruptcy Code will be construed to adopt, rather than to displace, pre-existing
state law” unless Congress’s intent to the contrary is “‘clear and manifest’”); Barnhill v.
Johnson, 503 U.S. 393, 399-400 (1992) (relying upon the UCC to determine when a
“transfer” by check occurred for purposes of preference avoidance); Bear, Stearns Sec.
Corp. v. Gredd, 275 B.R. 190, 195-98 (S.D.N.Y. 2002) (dismissing billions of dollars of
intentional fraudulent conveyance claims because Regulation T of the federal securities
laws precluded the debtor from having an interest in the transferred property and

15

recognizing that “[b]ankruptcy does not provide a forum for the realignment of rights or
priorities but serves only as a forum for the recognition of rights already acquired”
(internal quotation marks omitted)). 13
A critical objective served by this framework is commercial certainty. If
bankruptcy were to change substantive legal rights, no one could be confident of the legal
status of his actions. For example, the BFP Court expressed its concern that, if the
commencement of a bankruptcy case caused the validity of a foreclosure sale to be
questioned, “[t]he title of every piece of realty purchased at foreclosure would be under a
federally created cloud.” BFP, 511 U.S. at 544. Similarly, as the New York Court of
Appeals has recognized in answering questions certified to it by the Second Circuit, “to
permit in every case of the payment of a debt an inquiry as to the source from which the
debtor derived the money, and a recovery if shown to have been dishonestly acquired,
would disorganize all business operations and entail an amount of risk and uncertainty
which no enterprise could bear.” Commodity Futures Trading Comm’n v. Walsh, No. 91,

13

To escape the “willful blindness” standard of proof, the Trustee and SIPC
argue that bankruptcy law supersedes state law and, therefore, the “good faith” standard
supersedes the “willful blindness” standard. (See Trustee Supp. Br. at 3-10; SIPC Supp.
Br. at 10-19.) But as the Complaint does not challenge, and the Trustee cannot prove,
that the Sterling Defendants’ securities entitlements were invalid, he cannot state a claim
for fraudulent conveyance, and the “good faith” defense to such a claim is irrelevant.
Further, where, as here, a specific statute sets out the standard by which a party to
a transfer is to be judged, that standard necessarily must govern. See, e.g., Goldman v.
Capital City Mortgage Corp. (In re Nieves), No. 08-2160, 2011 U.S. App. LEXIS 11704,
at *17-18 & n.4 (4th Cir. June 10, 2011) (looking to compliance with industry practice to
establish “good faith” standard). Therefore, “willful blindness” also must inform the
“good faith” test.
16

2011 N.Y. LEXIS 1704, at *13 (N.Y. June 23, 2011) (quoting Banque Worms v.
BankAmerica Int’l, 77 N.Y.2d 362, 372 (1991)).
The result would be the same if brokerage customers knew that they could not
rely on the rights established by non-bankruptcy law when they engage in transactions
with their broker. As the Second Circuit has recently remarked, “certainty and
predictability are at a premium” in the area of law governing securities transactions. See
Enron Creditors Recovery Corp. v. Alfa, S.A.B. de C.V., No. 09-5122, 2011 U.S. App.
LEXIS 13177, at *19 (2d Cir. June 28, 2011) (“Enron”).
B.

Nothing in SIPA Changes This Result

Nothing in SIPA alters the application of the Butner principles. Contending to the
contrary, the Trustee and SIPC point to SIPA § 78fff-2(c)(3) to claim that SIPA permits
fraudulent conveyance claims against customers. (Trustee Supp. Br. at 18; SIPC Supp.
Br. at 15-18.) But the Sterling Defendants do not argue that the Trustee is precluded
from asserting fraudulent conveyance claims against customers in appropriate
circumstances—only that he cannot do so in an attempt to avoid payments on account of
antecedent debt. This is so because “the powers of a SIPA trustee are still, as indicated,
cabined by Title 11.” HSBC, 2011 U.S. Dist. LEXIS 82936, at *11 (citing to SIPA
§ 78fff-2(c)(3)).
Section 78fff-2(c)(3), like the rest of SIPA, protects customers. It does not create
a platform from which the Trustee may attack their long-settled expectations. 14

14

In the case of many of the Sterling Defendants, those settled expectations reach
back more than twenty years, far outside any limitations or repose period. Although the
Trustee contends he may exceed the statutory bar to bringing his claims under New
17

“Whenever customer property is not sufficient to pay in full the claims set
forth in subparagraphs (A) through (D) of paragraph (1), the trustee may
recover any property transferred by the debtor which, except for such
transfer, would have been customer property if and to the extent that such
transfer is voidable or void under the provisions of title 11. Such
recovered property shall be treated as customer property. For purposes of
such recovery, the property so transferred shall be deemed to have been
the property of the debtor and, if such transfer was made to a customer or
for his benefit, such customer shall be deemed to have been a creditor, the
laws of any State to the contrary notwithstanding.” 15 U.S.C. § 78fff2(c)(3) (emphasis added).
It is true that under this section, property held by the broker, which under state
law is property of the customers, is deemed to be property of the debtor for avoidance
purposes, because only transfers of debtor property can be avoided. But this fiction is
necessary for the assertion of any avoidance claim—preference or fraudulent
conveyance—and the rest of this section makes plain that it is intended to enable
preference, not fraudulent conveyance, claims. A preference claim avoids a transfer to a
“creditor.” 11 U.S.C. § 547(b)(1). A creditor is an “entity that has a claim against the
debtor.” 11 U.S.C. § 101(10)(A). A transfer to a creditor is, therefore by definition, a
payment on antecedent debt. Although such a transfer may be avoided as preferential, it
cannot be avoided as fraudulent. See 11 U.S.C. §§ 544, 548. Because under some state
law customers might not be considered “creditors,” SIPA § 78fff-2(c)(3) makes it easier
to bring preference claims against customers by deeming them to be creditors for
avoidance purposes. If Congress had intended in Section 78fff-2(c)(3) to enable

York’s “discovery rule,” there is no support for this contention, nor has the Trustee met
his evidentiary burden to come forward with an unsecured creditor to support his claim.
18

fraudulent conveyance claims, Congress would have provided that customers were not to
be considered creditors. Congress did the opposite. 15
The Trustee and SIPC also contend that they are permitted to sidestep altogether
the rules governing fraudulent conveyances by arguing that the challenged payments are
avoidable simply because they were made with “other people’s money.” (See, e.g.,
Trustee Supp. Br. at 17 n.21; SIPC Supp. Br. at 8, 23; Trustee Opp. at 1, 5, 92; SIPC
Opp. at 26-27.) This contention also ignores applicable law. First, under the principles
enunciated in Sharp and Boston Trading, if a payment discharges a valid debt, the
payment does not harm the creditor body and the origin of funds is irrelevant. (See supra
at 4-6; see also Sterling Br. at 58-66; Sterling Reply Br. at 50-53.) Second, under Article
8, no tracing concept may displace the “willful blindness” standard for challenging a
securities entitlement held in the indirect holding system. “The idea that discrete objects
might be traced through the hands of different persons has no place in the Revised Article
8 rules for the indirect holding system.” NYUCC § 8-503 cmt. 2. Therefore, to avoid the
payments, the Trustee must invalidate the entitlements. He cannot do so by relying upon
the “other people’s money” mantra.

15

SIPA § 78fff-1(a) confirms this reading of Section 78fff-2(c)(3) by defining
the Trustee’s powers to include the right to avoid “preferences.” This reading is
consistent with SIPA’s enactment as a securities law and with its objective of customer
protection. Although evening out recoveries within 90 days of an insolvency filing by
use of the preference avoidance power serves an equalization function, the severe
disruption that avoidance of transfers to customers over several decades would cause is
contrary to the entire structure established by the securities laws as a whole.
19

III.

BY ITS PLAIN MEANING, SECTION 546(E) APPLIES IN THIS CASE
Section 546(e) of the Bankruptcy Code “stands ‘at the intersection of two

important national legislative policies on a collision course—the policies of bankruptcy
and securities law.’” Enron, 2011 U.S. App. LEXIS 13177, at *14. As set forth in the
Sterling Motion, Section 546(e) balances these competing objectives by precluding the
avoidance of transfers made by a “stockbroker or financial institution . . . in connection
with a securities contract,” unless the transfers occurred within two years of a filing and
were intentionally fraudulent under 11 U.S.C. § 548(a)(1)(A). (Sterling Br. at 80-84;
Sterling Reply Br. at 55-58.) Since the briefing of the Sterling Motion was completed,
the Court of Appeals for the Second Circuit has confirmed that Section 546(e) must be
given a plain meaning interpretation. Enron, 2011 U.S. App. LEXIS 13177, at *16-17
(holding that, under the plain meaning of Section 546(e)’s “settlement payment” safe
harbor provision, pre-petition redemptions of commercial paper could not be avoided).
Under the plain meaning of Section 546(e), the Trustee “may not avoid” as
preferential any of the transfers at issue, as they were made by a stockbroker (BLMIS) or
financial institution (JPMorgan Chase) in connection with a securities contract. No
transfer may be avoided as fraudulent either, except as to transfers within two years of the
filing date and for which the proof required by Section 548(a)(1)(A) is offered. The
Trustee does not and cannot contest this analysis. Instead, he represents that BLMIS
traded no securities for customers, and, therefore, the purpose of Section 546(e) would
not be furthered by its application in this case. He also argues that there were no
“securities contracts” pursuant to which payments were made. Both arguments must fail.

20

First, in applying Section 546(e) to the redemption of commercial paper, the
Second Circuit recognized that the scope of Section 546(e) is broad and its objectives
would not be served by limiting its application to specific factual scenarios. Relying on
analogous reasoning that “undoing long-settled leveraged buyouts would have a
substantial impact on the stability of the financial markets, even though only private
securities were involved and no financial intermediary took a beneficial interest in the
exchanged securities during the course of the transaction,” the Court saw no reason why
undoing Enron’s long-settled redemption payments would not also have a “substantial
and similarly negative effect on the financial markets.” Enron, 2011 U.S. App. LEXIS
13177, at *26-27 (emphasis added).
The same reasoning applies here. In this case, the plain meaning of Section
546(e) must be applied, as mandated by Enron. But its application is entirely consistent
with its purpose. In this litigation alone the Trustee seeks to undo a billion dollars worth
of settled transactions between the Sterling Defendants and BLMIS—transactions that
occurred over more than twenty years. Indeed, he seeks to avoid similar transfers to
thousands of securities customers in nearly 1000 cases. Avoidance of thousands, if not
millions, of transactions between a registered broker and its customers over many
decades surely would have a “substantial and negative” impact on the financial markets
and would completely undermine the balance between avoidance and commercial
certainty and predictability established by Congress in Section 546(e).
Second, since the enactment of the provision at issue in Enron, Congress has
expanded the scope of Section 546(e) even further to provide a safe harbor for transfers
“in connection with a securities contract.” “Securities contract” is defined broadly in the
21

Bankruptcy Code, see 11 U.S.C. § 741(7), and includes no purchase or sale requirement.
Ignoring the breadth of this definition, the Trustee contends that no securities contracts
existed because BLMIS conducted no trades. This contention is without merit. BLMIS
defrauded its customers and breached its contracts to buy and sell securities, but those
contracts did not become retroactively void by virtue of that fraud. Securities contracts
existed, and the payments made by BLMIS were consistent with its obligations under
those securities contracts. The plain meaning application of Section 546(e) protects those
payments from avoidance in accordance with its terms.

CONCLUSION
For the reasons set forth above and in the Sterling Defendants’ Motion, the
Sterling Defendants respectfully request entry of judgment dismissing the Complaint
pursuant to Rules 12(b)(6) and 56 of the Federal Rules of Civil Procedure.
Dated: New York, New York
August 12, 2011
DAVIS POLK & WARDWELL LLP
By: /s/ Karen E. Wagner
Karen E. Wagner
Dana M. Seshens
450 Lexington Avenue
New York, New York 10017
Telephone:
[phone]
Facsimile:
[phone]

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

Attorneys for the Sterling Defendants

22