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

Filing 68

REPLY MEMORANDUM OF LAW re: 41 Order,,, Reply Memorandum of Law of SIPC Regarding Calculation of Fictitious Profits. Document filed by Securities Investor Protection Corporation. (Attachments: # 1 Certificate of Service)(Attard, Lauren)

UNITED STATES DISTRICT 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)

Case No. 1:11-cv-03605-JSR

REPLY MEMORANDUM OF LAW OF THE
SECURITIES INVESTOR PROTECTION CORPORATION
REGARDING CALCULATION OF FICTITIOUS PROFITS
SECURITIES INVESTOR PROTECTION CORPORATION
805 Fifteenth 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
CHRISTOPHER H. LAROSA
Associate General Counsel
LAUREN T. ATTARD
Staff Attorney

TABLE OF CONTENTS
PAGE

SUMMARY OF THE ARGUMENT ............................................................................... 1
ARGUMENT ..................................................................................................................... 2
I. DEFENDANTS CONFLATE THE TERMS “TRANSFER” AND “VALUE”:
“TRANSFERS” ARE LIMITED TO THE TWO YEAR LOOK BACK, BUT “VALUE”
HAS NO SUCH TIME LIMITATION ............................................................................ 2
II. THE ACCOUNT BALANCES ARE NOT ENFORCEABLE OBLIGATIONS
AND, AS SUCH, CANNOT CONSTITUTE “VALUE”................................................ 3
III. UNDER SIPA, A GENERAL CREDITOR CLAIM CANNOT PROVIDE
“VALUE” IN EXCHANGE FOR A FRAUDULENT TRANSFER OF CUSTOMER
PROPERTY ..................................................................................................................... 5
CONCLUSION .................................................................................................................. 9

TABLE OF AUTHORITIES
CASES

PAGE

In re Adler Coleman Clearing Corp., 198 B.R. 70 (Bankr. S.D.N.Y. 1996) ................................. 6
In re Bell & Beckwith, 124 B.R. 35 (Bankr. N.D. Ohio 1990) ....................................................... 7
In re Government Sec. Corp., 90 B.R. 539 (Bankr. S.D. Fla. 1988) .............................................. 6
In re Hanover Square Sec., 55 B.R. 235 (Bankr. S.D.N.Y. 1985) ................................................. 6
In re Klein, Maus & Shire, Inc., 301 B.R. 408 (Bankr. S.D.N.Y. 2003) ........................................ 7
In re Lake States Commodities, Inc., 253 B.R. 866 (Bankr. N.D. Ill. 2000) .................................. 5
In re Manhattan Investment Fund Ltd., 398 B.R. 1 (S.D.N.Y. 2007) ............................................ 8
In re MV Sec., Inc., 48 B.R. 156 (Bankr. S.D.N.Y. 1985) .............................................................. 7
In re New Times Securities Services, Inc., 371 F.3d 68 (2d Cir. 2004) .......................................... 8
In re Oberweis Sec., Inc., 135 B.R. 842 (Bankr. N.D. Ill. 1991) .................................................... 7
Official Comm. of Unsecured Creditors v. Whalen (In re Enron Corp.), 357 B.R. 32 (Bankr.
S.D.N.Y. 2006) ........................................................................................................................... 3
Perkins v. Haines, __ F.3d __, 2011 WL 5103951 (11th Cir. Oct 27, 2011) ................................. 2
Picard v. Katz (In re BLMIS), 2011 WL 4448638 (S.D.N.Y. Sept. 27, 2011) ............................... 8
Picard v. Merkin (In re BLMIS), 2011 WL 3897970 (S.D.N.Y. Aug. 31, 2011) ........................... 8
SEC v. F. O. Baroff Co., 497 F.2d 280 (2d Cir. 1974) ................................................................... 6
SEC v. Howard Lawrence & Co., 1 Bankr. Ct. Dec. (CRR) 577 (Bankr. S.D.N.Y. 1975) ............ 7
Sender v. Buchanan (In re Hedged-Investments Assoc., Inc.), 84 F.3d 1286 (10th Cir. 1996) ...... 2
In re Sharp Intern. Corp., 403 F.3d 43 (2d Cir. 2005) ................................................................... 7
SIPC v. Associated Underwriters, Inc., 423 F.Supp. 168 (D. Utah 1975)...................................... 6
SIPC v. I.E.S. Mgmt. Group, 612 F.Supp. 1172 (D.N.J. 1985), aff=d w/o opinion, 791 F.2d 921
(3d Cir. 1986) .............................................................................................................................. 6
In re Stalvey & Associates, Inc., 750 F.2d 464 (5th Cir. 1985) .......................................................6

ii

TABLE OF AUTHORITIES
(cont.)
PAGE
STATUTES AND RULES:
Securities Investor Protection Act, as amended, 15 U.S.C. '
78fff(d) .............................................................................................................................................6
78fff-2(c)(1) .....................................................................................................................................6
78fff-2(c)(3) .....................................................................................................................................6
78fff-3(a) ..........................................................................................................................................6
78fff(e) .............................................................................................................................................7
United States Bankruptcy Code, 11 U.S.C. §
548(a)(1) ......................................................................................................................................2, 3
548(c) ...................................................................................................................................1, 2, 3, 5
726....................................................................................................................................................7
McKinney’s New York Uniform Commercial Code '
8-502 ................................................................................................................................................5
8-503 ............................................................................................................................................ 3-4
8-505 ................................................................................................................................................4
8-506 ................................................................................................................................................4
8-507 ................................................................................................................................................4
8-508 ................................................................................................................................................4
OTHER AUTHORITIES: 
James S. Rogers, An Essay on Horseless Carriages and Paperless Negotiable Instruments:
Some Lessons from the Article 8 Revision, 31 Idaho L. Rev. 689 (1995) ................................ 4
James S. Rogers, Policy Perspectives on Revised U.C.C. Article 8, 43 UCLA L. Rev. 1431,
1514-1517 (1996)................................................................................................................... 4-5

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Pursuant to this Court’s order of September 28, 2011, the Securities Investor Protection
Corporation (“SIPC”) submits this memorandum of law in reply to the Defendants’
Memorandum of Law Regarding Determination of “For Value” and Net Equity Decision
[Docket No. 62] (“Def. Mem.”). All capitalized terms used, but not defined, herein shall have
the meaning attributed to them in the Memorandum of Law of the Securities Investor Protection
Corporation Regarding Calculation of Fictitious Profits [Docket No. 61] (“SIPC Mem”).
SUMMARY OF THE ARGUMENT
Defendants, in their Memorandum, rely upon a novel method that has no precedent or
support for calculating “value” under section 548(c) of the Bankruptcy Code (“section 548(c)”).
Despite the significant amount of Ponzi scheme case law – all of which holds that fictitious
profits are determined by taking the total amount received by the customer and subtracting the
amount of his actual investment – Defendants contend that they are entitled to keep every penny
of fictitious profit – that is, other people’s stolen money – Madoff invented and bestowed on
them, up to the two years prior to the filing date.
This assertion lacks legal authority. It is incongruent with the plain language of the
Bankruptcy Code and with the purposes of SIPA. It fails to preserve the priority status of
customers under SIPA who have yet to recapture their principal, and allows the Defendants to
retain the millions of dollars of other people’s stolen money that Madoff chose to give them
while the BLMIS victims who withdrew less than they invested receive mere pennies on the
dollar.
Despite Defendants’ arguments to the contrary, there is no time limitation on the
determination of “value” under section 548(c). The Uniform Commercial Code does not provide
that fictitious profits shown on account statements are enforceable obligations and thus constitute

“value” under section 548(c). Even if, however, Defendants had an enforceable claim against
the Debtor, such a claim would not be a priority customer claim, but would at best be a general
creditor claim that could not be satisfied with customer property.
ARGUMENT
I.
DEFENDANTS CONFLATE THE TERMS
“TRANSFER” AND “VALUE”: “TRANSFERS” ARE
LIMITED TO THE TWO YEAR LOOK BACK, BUT
“VALUE” HAS NO SUCH TIME LIMITATION
As support for their novel argument that Defendants are entitled to retain fictitious profits
prior to the two year look back period, Defendants conflate the terms “transfer” and “value.” See
Def. Mem. at 2-6. Section 548(a)(1) states: “The trustee may avoid any transfer. . . that was
made . . . within 2 years before the date of filing the petition.” Section 548(c), however, provides
a defense for fraudulent transferees who “take[] for value and in good faith,” and does not
contain a time limitation on “value.” Further, Defendants have not identified any case in which a
time limitation was imposed on “value.” SIPC, on the other hand, has identified a number of
cases which look beyond two years to determine whether “value” was given in exchange for a
transfer made within the two year period. See, e.g, Perkins v. Haines, __ F.3d __, 2011 WL
5103951 (11th Cir. Oct 27, 2011) (holding that in a Ponzi scheme, only the amount invested with
a debtor constitutes “value,” even if the transfers were made up to nine years prior to the petition
date of the bankruptcy proceeding);1 Sender v. Buchanan (In re Hedged-Investments Assoc.,
Inc.), 84 F.3d 1286, 1290 (10th Cir. 1996) (looking to the twelve year history of investments).

1

A statement of facts is available in the Memorandum in Support of Trustee’s Motion for Partial
Summary Judgment, In re International Management Associates, LLC, Case No. 09-00601-pwb,
(Bankr. N.D. Ga. Apr. 1, 2009), Docket No. 7.

2

See also SIPC Mem. at 5-6.

Accordingly, Defendants have no basis for limiting the

determination of “value” to the two years prior to the liquidation of BLMIS.
Defendants further argue that because a customer could withdraw the fictitious profits in
his account two years plus one day prior to the liquidation, Defendants should be able to retain
fictitious sums received by them two years plus one day prior to the liquidation. See Def. Mem.
at 3. This argument has no basis in law or fact. In drafting section 548(a)(1), Congress
specifically set forth the bounds of fraudulent transfer law. Similar to a statute of limitations
period, this provision provides that if a transfer from the Debtor is made more than two years
prior to a liquidation, it cannot be avoided under section 548(a)(1). However, that is a different
question from whether the amounts in the account during that two year period are fictitious or
not.
II.
THE ACCOUNT BALANCES ARE NOT
ENFORCEABLE OBLIGATIONS AND, AS SUCH,
CANNOT CONSTITUTE “VALUE”
Defendants briefly state, without explanation, that Article 8 of the New York Uniform
Commercial Code (“NYUCC”) governs whether “value” was provided in exchange for the
receipt of transfers by Defendants. See Def. Mem. at 3. Presumably, Defendants contend that
under the NYUCC, the account statements by BLMIS create an enforceable obligation.2 The
plain language of the NYUCC, however, contradicts Defendants’ assertions.
Notably, the Official Comment to the NYUCC itself, expressly citing SIPA as an
example, specifies that SIPA overrides the NYUCC if the entity’s affairs are being administered
in an insolvency proceeding. See McKinney’s UCC § 8-503, Official Comment 1 (2009)
2

As stated on pages 4-5 of the SIPC Memorandum, a claim must be enforceable for it to
constitute value under section 548(c). See, e.g., Official Comm. of Unsecured Creditors v.
Whalen (In re Enron Corp.), 357 B.R. 32, 48-49 (Bankr. S.D.N.Y. 2006).

3

(“applicable 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 ….”).
Even assuming, arguendo, that it governed the property rights of Defendants, the
NYUCC does not provide Defendants with an enforceable claim against the Debtor for the value
on their account statements. Indeed, NYUCC section 8-503(a)-(b) limits the Defendants to a
“property interest consisting of a pro-rata claim to the fungible pool of underlying securities held
by the intermediary.” See James S. Rogers, An Essay on Horseless Carriages and Paperless
Negotiable Instruments: Some Lessons from the Article 8 Revision, 31 Idaho L. Rev. 689, 692
(1995). Even if this provision applied, which it does not, Defendants would have a property
interest only in their pro rata share of the securities held by BLMIS, not in the fictitious profits
on their account statements.
The remainder of section 8-503 of the NYUCC provides that a property interest may be
enforced against a broker only by exercising rights available under sections 8-505 through 8-508.
See NYUCC § 8-503(c). None of the enumerated rights apply here, relating, for example, to
duties as remote as the pass through of dividends (section 8-505), the exercise of voting rights
(section 8-506), the settlement of trades (section 8-507), and the pre-liquidation duty to transfer
the account to another securities intermediary (section 8-508). None relates to the right of a
customer to enforce fraudulent and fictitious account statements.
The NYUCC also fails to insulate transferees from being sued if they do not take “for
value.” A rule that “all customers get their securities back in every situation” is not only
impractical, but not supported by the UCC. James S. Rogers, Policy Perspectives on Revised
U.C.C. Article 8, 43 UCLA L. Rev. 1431, 1514-1517 (1996) (stating that “it would be an

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exercise in self-delusion to suppose that we could protect investors who hold through
intermediaries by adopting a commercial law regime based on simplistic property concepts of
that sort”). Moreover, NYUCC Section 8-502 provides that “[a]n 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 securities entitlement ...
for value and without notice of the adverse claim.” Thus, the NYUCC is congruent with section
548(c) of the Bankruptcy Code.
Finally, although a claimant must articulate the basis for a claim and provide public
notice of the claim being asserted, Defendants have not done so here. In In re Lake States
Commodities, Inc., 253 B.R. 866 (Bankr. N.D. Ill. 2000), the court held that defendants in a
fraudulent transfer action must articulate their fraud claim as part of their defenses to the
fraudulent transfer suit. Id. at 880 (explaining that in a Ponzi scheme, to succeed in its argument
that a defendant provided “value” for a fraudulent transfer because it satisfied a potential
restitution claim, the defendant must make out a prima facie case for restitution). Defendants
have not articulated a basis for a claim under the NYUCC or any other state or federal law.
Thus, the fictitious profits listed on account statements are not enforceable obligations and thus
cannot constitute “value” under 548(c).
III.
UNDER SIPA, A GENERAL CREDITOR CLAIM
CANNOT PROVIDE “VALUE” IN EXCHANGE FOR A
FRAUDULENT TRANSFER OF CUSTOMER PROPERTY
Defendants assert that the definitions of “value,” “debt,” and “claim” are not based on the
priority of any claim in an insolvency case, and that any “claims” must constitute “value.” See
Def. Mem. at 9. As a preliminary matter, as discussed in section II, supra, Defendants’ “claims”
are not enforceable and therefore cannot constitute “value.” Even assuming, arguendo, however,
that Defendants had enforceable “claims,” such claims cannot constitute “value” in this context
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because, among other things, they are, at best, against the general creditor estate, and the Trustee
is seeking to recover customer property, which is part of a separate, priority fund of customer
property.
In a SIPA proceeding, “customers” receive priority treatment to the exclusion of general
creditors. See SIPC v. I.E.S. Mgmt. Group, 612 F.Supp. 1172, 1177 (D.N.J. 1985), aff=d w/o
opinion, 791 F.2d 921 (3d Cir. 1986) (“customers” under SIPA receive preferential treatment by
being satisfied ahead of general creditors). See also In re Adler Coleman Clearing Corp., 198
B.R. 70, 71 (Bankr. S.D.N.Y. 1996) (“person whose claim against the debtor qualifies as a
>customer claim= is entitled to preferential treatment”); In re Hanover Square Sec., 55 B.R. 235,
237 (Bankr. S.D.N.Y. 1985) (“[a]ffording customer status confers preferential treatment”); In re
Government Sec. Corp., 90 B.R. 539, 540 (Bankr. S.D. Fla. 1988) (“customers” under SIPA have
“preferred status”).
SIPA creates two estates: the general estate and the fund of customer property. See, e.g.,
SIPA § 78fff-2(c)(1) (providing for the allocation of customer property); § 78fff(d) (providing
for apportionment of assets “between [the] general estate and customer property”).

Only

“customers” can share in customer property. See SIPA §78fff-2(c)(1). To the extent of any
shortfall in customer property and within limits, the balance of a customer’s claim may be
satisfied through an advance of SIPC funds. SIPA §78fff-3(a).
In contrast to customers, general creditors are not eligible to share in customer property
or in SIPC advances. See SEC v. F. O. Baroff Co., 497 F.2d 280, 282 n.2 (2d Cir. 1974) (stating
that customer status is determined by transaction); In re Stalvey & Associates, Inc., 750 F.2d 464,
471 (5th Cir. 1985). Accord, SIPC v. Associated Underwriters, Inc., 423 F.Supp. 168, 171 (D.
Utah 1975) (“SIPC is not an insurer, nor does it guarantee that customers will recover their

6

investments which may have diminished as a result of, among other things, market fluctuations
or broker-dealer fraud”); In re Klein, Maus & Shire, Inc., 301 B.R. 408, 421 (Bankr. S.D.N.Y.
2003) (claims for damages do not involve the return of customer property entrusted to broker and
are not “customer” claims. Claims for damages resulting from misrepresentation, fraud or
breach of contract are not protected and are general creditor claims); In re MV Sec., Inc., 48 B.R.
156, 160 (Bankr. S.D.N.Y. 1985) (no SIPA protection for innocent investor against broker’s
fraud); SEC v. Howard Lawrence & Co., 1 Bankr. Ct. Dec. (CRR) 577, 579 (Bankr. S.D.N.Y.
1975) (no SIPA protection for claims based on fraud or breach of contract); In re Oberweis Sec.,
Inc., 135 B.R. 842, 846 (Bankr. N.D. Ill. 1991) (claim for damages resulting from broker’s
failure to invest funds as instructed are basis only for general creditor claim); In re Bell &
Beckwith, 124 B.R. 35, 36 (Bankr. N.D. Ohio 1990) (no protection for claims based on broker’s
fraudulent conduct). While general creditors share in the general estate, if any, it is only in
accordance with the priority of distribution under section 726 of the Bankruptcy Code. See SIPA
§78fff(e).
In the case at hand, the transfers made to the Defendants consisted of customer property.
Notwithstanding the priority treatment of customers under SIPA and the fact that general
creditors cannot share in customer property, the Defendants argue that the unidentified,
speculative, and unproven, general creditor claims that they purport to have properly were
satisfied with customer property and therefore, constituted “value” for the transfer.

The

Defendants’ argument is specious, and flies in the face of SIPA.
Finally, the case law relied upon by Defendants has no bearing. See Def. Mem. at 10-11.
Thus, this Court previously has held In re Sharp Intern. Corp., 403 F.3d 43 (2d Cir. 2005), to be
inapplicable because in Sharp, the transfer was constructively fraudulent instead of actually

7

fraudulent, as here. See Picard v. Katz (In re BLMIS), 2011 WL 4448638, at *4 (S.D.N.Y. Sept.
27, 2011). Similarly, Defendants’ citation to In re Manhattan Investment Fund Ltd., 398 B.R. 1
(S.D.N.Y. 2007), is irrelevant to an avoidance action against a Ponzi scheme investor. In
Manhattan Investment, the trustee sought to avoid transfers into a margin account at a securities
brokerage, not fictitious profits received by a Ponzi scheme victim. Id. at 13-15. The issue of
value was not discussed in Manhattan Investment. Id. Finally, in Picard v. Merkin (In re
BLMIS), 2011 WL 3897970 (S.D.N.Y. Aug. 31, 2011), Judge Wood denied the defendant’s
motion for leave to appeal, and held that when allegations of bad faith are at issue, “the question
of whether a transfer is for ‘reasonably equivalent value’ is fact-intensive, and usually cannot be
determined on the pleadings.” Id. at *10. Judge Wood made no other rulings relevant to the
instant matter.3

3

It bears mention that Defendants contend that “[n]o party disputes that BLMIS owed its
customers the securities reflected on confirmations and statements issued to the customers …”
Def. Mem. at 6. The Defendants are gravely mistaken. In fact, the “securities” positions were
fictitious, having been randomly invented by Bernard Madoff in order to yield, on paper, specific
fictitious profits invented by him. Claimants had securities claims, thereby making them eligible
for the higher amount of SIPC protection ($500,000 for securities claims versus $100,000 for
cash claims) not because they were owed the fictitious securities positions shown on account
statements, but because they placed money with the Debtor in order to buy securities and
received confirmations of such purchases. See In re New Times Securities Services, Inc., 371
F.3d 68, 86 (2d Cir. 2004).

8

CONCLUSION
For all of the reasons stated above, calculation of Defendants’ receipt of fictitious profits
should be determined by looking to the history of transfers made to Defendants throughout their
relationship with BLMIS.
Dated: Washington, D.C.
November 4, 2011
Respectfully submitted,
JOSEPHINE WANG
General Counsel
KEVIN H. BELL
Senior Associate General Counsel for
Dispute Resolution
CHRISTOPHER H. LAROSA
Associate General Counsel
/s/ Lauren T. Attard
LAUREN T. ATTARD
Staff Attorney
SECURITIES INVESTOR
PROTECTION CORPORATION
805 15th Street, N.W.
Suite 800
Washington, D.C. 20005
Telephone: [phone]
E-mail: [e-mail]
E-mail: [e-mail]
E-mail: [e-mail]
E-mail: [e-mail]

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