By: William M. Dailey

If you invested money with Bernard Madoff, were a net investment “loser” with him in his Ponzi scheme, but had hope to claw back some of your losses from other Madoff victims who were net “winners,” you just lost again.

In a decision proving yet again that justice is indeed blind, the 2d Circuit Court of Appeals this week affirmed an earlier decision by SDNY Judge Jed Rakoff in ruling that victims of Madoff who were profitable in the balance need not hand back their profits (a.k.a., suffer a “clawback”) for the benefit of other victims who had losses in the balance.

Madoff trustee Irving Picard had sued net profitable victims for their profits, so as to return them to other victims who were net unprofitable.  The decision in In re: Bernard L. Madoff Investment Securities LLC turned on whether Madoff’s Ponzi payouts (which came after he took in investors’ money into his broker-dealer, never invested it, and then distributed some of it back out to investors on demand) amounted to “a transfer made by [a] . . . stockbroker . . . in connection with a securities contract,” which is excepted under Section 546(e) of the Bankruptcy Code from clawback. Clawback defendants successfully argued to the Court that their account opening documents (customer agreement, trading authorization and options agreement) amounted to such a “securities contract,” even though no securities were ever bought by Madoff with the funds provided him by clawback defendants.

The Court agreed with the Madoff trustee (the plaintiff in the case) that the purpose of Congress in enacting such an exception to the Bankruptcy Code was to safeguard markets from suffering a domino effect and make them unstable, should completed and cleared securities transactions in the markets suddenly be called into question.  The Court also generally agreed with the trustee that no such risk existed here since no trades were actually effected.  However, the Court emphasized the expansive reach of the wording in the above clawback exception, going to the dictionary to discuss the broad meaning of terms like “any,” “similar” and “connection” that were found in the relevant sections of the Bankruptcy Code, and thus finding that the broad language of the statutory exception applied to this fact pattern (no matter how unfair it may seem to some).

Interestingly (and perhaps with no small amount of purposeful irony on Judge Rakoff’s part, given his legal battles with the SEC), the court cited various SEC-related decisions to support its decision.  It cited a series of cases where defendants were held liable for SEC Rule 10b-5 fraud (which requires the fraud to be “in connection with the purchase or sale of any security”) in cases where securities were never actually bought with victims’ money.

It is now up to trustee Picard if he wants to seek review by the U.S. Supreme Court of this decision.  Stay tuned….

Tags: Joseph Pastore, Securities, William M. Dailey