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November 8‚ 2011
Picard Cannot Make It So:
Madoff Trustee’s Recoveries Curtailed Again
By Kevin J. Walsh and Ella Shenhav
In a client
advisory sent by our office a few months ago, we described a
decision in the Madoff saga in which the District Court for the Southern
District of New York (the Court) closed off a potential avenue of
significant recovery for the Madoff Trustee (the Trustee) and the Ponzi
scheme victims by denying the Trustee standing to pursue certain claims
against feeder funds – firms that sent investors’ funds to Madoff and that
failed to detect the fraud. Now, not only has another judge reinforced that
decision (see Picard v. JP Morgan Chase and UBS AG, et al., Decision and
Order Granting Defendants’ Motion to Dismiss Certain Common Law Claims, No.
11-civ-913, Docket #70 (S.D.N.Y. Oct. 31, 2011)) by holding that the
Trustee does not have standing to sue the big bank defendants for amounts
in excess of $20 billion, but in another decision, the Court has once again
curtailed the possible recovery by the Trustee, thus once more holding
steadfastly to the law rather than being swayed by the plight of Madoff’s
victims.
In Picard v. Katz, --- F. Supp. 2d ----, 2011 WL
4448638 (S.D.N.Y. Sep. 27, 2011), the Court limited the Trustee’s ability
to pursue fraudulent transfer claims in two ways. First, the Court held
that the potential disgorgement liability of customers is subject to the
safe harbor provision of section 546(e) of the Bankruptcy Code. This
holding means that the Trustee cannot recover from customers any monies
received from Madoff more than two years before the bankruptcy filing.
Second, having limited the scope of the Trustee’s recovery to
actual fraudulent transfers made in the two years prior to the bankruptcy
filing (and recognizing that every transfer made during this time period
was made by Madoff with the actual intent to defraud creditors), the Court
turned its attention to the applicability of a defense to actual fraudulent
transfers provided by the Bankruptcy Code — namely, that a transferee may
retain a transfer taken for value and in good faith by the transferee. The
Trustee argued that customers did not act in good faith because they were
on inquiry notice of the fraud but failed to diligently investigate Madoff
Securities. Disagreeing, the Court held that lack of good faith required a
finding that the customers intentionally chose to blind themselves to the
red flags that suggest a high probability of fraud. Such a “willful
blindness” to the truth, held the Court, would constitute bad faith and
allow the Trustee to recover the payments. However, if the customer is
“simply confronted with suspicious circumstances [and] fails to launch an
investigation of his broker’s internal practices … his lack of due
diligence cannot be equated with a lack of good faith.” 1
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1 Addressing the
value prong of the fraudulent transfer defense, the Court noted that the
amount of invested principal clearly constitutes ‘value’ to the debtor and
likely would be insulated from recovery. The Court mused, however, that
customers likely would have much difficulty proving that the amounts they
received in excess of their invested principal, e.g., investment gains,
would satisfy the ‘value’ prong of the defense. In a footnote, the Court
left open the issue of whether disgorgement of profits is limited to two
years.
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