In re: Bernard L. Madoff Investment Securities LLC
Bernard L. Madoff orchestrated a massive Ponzi scheme through the investment advisory unit of Bernard L. Madoff Investment Securities LLC (“BLMIS”). After the scheme collapsed, Irving H. Picard (the “Trustee”) was appointed trustee for BLMIS pursuant to the Securities Investor Protection Act,
Section 546(e) of the Bankruptcy Code, in turn, establishes an important exception to a trustee’s clawback powers.
See
Invoking his clawback powers, the Trustee sued hundreds of BLMIS customers who withdrew more from their accounts than they had invested and, as a result, profited (whether knowingly or not) from Madoffs scheme. The Trustee contends that, if BLMIS had not preferentially paid these customers, the money would have been customer property available to be distributed ratably to all customers, including those who, over time, had withdrawn less than they had invested.
Several defendants moved to dismiss the actions on the ground that the payments received by BLMIS customers were securities-related payments that cannot be avoided under
The United States District Court for the Southern District of New York (Rakoff,
J.)
concluded that the payments were shielded by
BACKGROUND
Because this appeal is from dismissals under
I
BLMIS purported to execute a “split strike conversion strategy” for customers of its investment advisory unit. This strategy, had it actually been executed, would have consisted of timing the market to purchase a basket of stocks on the S
&
P 100 Index, and then hedging those purchases with related options contracts.
See SIPC v. Bernard, L. Madoff Inv. Secs. LLC (In re Bernard L. Madoff Inv. Secs. LLC),
In reality, however, BLMIS’s investment advisory business conducted no actual securities or options trading on behalf of its customers. Instead, BLMIS deposited customer investments into a single commingled checking account and, for years, fabricated customer statements to show fictitious securities trading activity and returns ranging between 10 and 17 percent annually. When customers sought to withdraw money from their accounts, including withdrawals of the fictitious profits that BLMIS had attributed to them, BLMIS sent them cash from the commingled checking account. The Trustee seeks to claw back funds from customers who, over time, were able to take out more money than they had invested with BLMIS.
II
In December 2008, the Madoff scheme was exposed and liquidation proceedings began in the district court. As a SIPA trustee, Picard was obligated to collect and set aside a fund of “customer property” specifically earmarked to repay BLMIS customers ratably in proportion to each customer’s “net equity.”
See
The Trustee invokes two different theories under the Bankruptcy Code to avoid transfers of fictitious profits to customers. The Trustee’s first theory is that certain transfers are voidable as “fraudulent transfers” under
Because § 544(b) of the Bankruptcy Code permits a trustee to avoid any transfers that an unsecured creditor could avoid under applicable state law, the Trustee’s second theory is that the transfers may be clawed back pursuant to New York’s fraudulent conveyance law.
See
Many clawback defendants moved to dismiss the Trustee’s claims as barred by
The clawback defendants first litigated the applicability of
Following the bankruptcy court’s decisions, the district court withdrew the bankruptcy reference in one clawback action— the
Katz
case. After reexamining the issue, Judge Rakoff held that
Judge Rakoffs decision in
Katz
represented the first successful assertion of the
In
SIPC v. BLMIS,
Judge Rakoff granted the motions to withdraw the bankruptcy reference in 84 additional clawback cases.
To streamline this Court’s review, the Trustee agreed to a limited consolidation of all pending actions brought by the Trustee raising the
DISCUSSION
may not avoid a transfer that is a ... settlement payment, as defined in section ... 741 of this title, made by [a] ... stockbroker ..., or that is a transfer made by [a] ... stockbroker ... in connection with a securities contract, as defined in section 741(7), ... except undersection 548(a)(1)(A) of this title.
The Trustee argues that
I
Section 741(7) of the Bankruptcy Code, to which
(i) a contract for the purchase, sale or loan of a security ... or ... option to purchase or sell any such security ...; [or]
(vii) any other agreement or transaction that is similar to an agreement or transaction referred to in this subparagraph .... [or]
(x) a master agreement that provides for an agreement or transaction referred to in clause (i) [or] ... (vii) ..., except that such master agreement shall be considered to be a securities contract under this paragraph only with respect to each agreement or transaction under such master agreement that is referred to in [clauses (i) through (ix) ]; or
(xi) any security agreement or arrangement ... related to any agreement or transaction referred to in this subparagraph, including any guarantee or reimbursement obligation by or to a stockbroker. ...
Thus, the term “securities contract” expansively includes contracts for the purchase or sale of securities, as well as any agreements that are
similar
or
related
to contracts for the purchase or sale of securities.
Id.
This concept is broadened even farther because
While neither the Bankruptcy Code nor SIPA defines purchase or sale, the Securities Exchange Act of 1934 — of which SIPA is a part — defines the terms to “include
any
contract to buy, purchase, or otherwise acquire ... [or] to sell or otherwise dispose of’ a security.
The clawback defendants argue that a “securities contract” was created by three of the documents that BLMIS customers were required to execute when opening their accounts. In the first, a “Customer Agreement,” each customer authorized BLMIS to “open[] or maintain[] one or more accounts” for his benefit. J.A. 1257. In a second document, a “Trading Authorization,” each customer appointed BLMIS to be the customer’s “agent and attorney in fact to buy, sell and trade in stocks, bonds, and any other securities in accordance with [BLMIS’s] terms and conditions for the [customer’s] account.” J.A. 1264. And in a third document, an “Option Agreement,” each customer authorized BLMIS to engage in options trading for the customer’s account. J.A. 1261-62. The defendants contend that these three account opening documents (together, the “Account Documents”) authorized BLMIS to engage in securities transactions on behalf of its customers, although they did not expressly require BLMIS to conduct any such transactions, and consequently established a “securities contract.”
We agree. On their face, the Account Documents are agreements by which BLMIS will “acquire or dispose of securities” on behalf of its customers. The Customer Agreement established the broker-customer relationship, and the Trading Authorization authorized BLMIS to trade in securities for the customer’s account. A-2147-49, A-2144. These documents also specify the terms by which BLMIS will acquire and dispose of securities for the customer. Were it not for the Account Documents, there would be no basis for a customer to make deposits or request withdrawals. Thus, the transfers at issue originated with, and could not have been
The function contemplated for the Account Documents also satisfies the definition of “securities contract” in
Yet another indication that Congress intended
The Trustee advances several arguments why, in his view, these agreements do not constitute a “securities contract” and the transfers at issue should not be shielded from avoidance. None are persuasive.
First,
the Trustee argues that
Furthermore, the interpretation pressed by the Trustee risks the very sort of significant market disruption that Congress was concerned with. The magnitude of BLMIS’s scheme, which included thousands of customers and billions of dollars under management, is unprecedented. Permitting the clawback of millions, if not billions, of dollars from BLMIS clients— many of whom are institutional investors and feeder funds — would likely cause the very “displacement” that Congress hoped to minimize in enacting
Second,
the Trustee argues that the Account Documents are not securities contracts because they do not specifically “identify any security, issuer, quantity, price, or other terms necessary to describe a security transaction.”
4
See
Trustee Br. 38. This argument constructs a requirement that the law does not contain. The Trading Authorization identifies a specific category of public securities (S & P 100 stocks) to be traded. A-1646 ¶ 21. Nothing in our reading of
Third, the Trustee argues that the Account Documents merely authorize BLMIS to conduct securities transactions on behalf of its customers, but never expressly obligate BLMIS to carry out any such transactions. Trustee’s Br. 38-39. Accordingly, the Trustee contends that even if customers reasonably expected that BLMIS would conduct securities transactions on their behalf, this would establish an obligation sounding in “quasi-contract” at most, bqt would not constitute a true contractual obligation. Id. at 39. Alternatively, the Trustee argues that the Account Documents establish an “agency” relationship between BLMIS and its customers, similar to that between a real estate broker and a home buyer, and “are no more contracts for the purchase and sale of a security than a real estate brokerage agreement is a contract for the purchase or sale of a house.” Id. at 42.
The Trustee might be correct that the record reflects no written contract for the purchase or sale of a specific security between BLMIS and its customers. Further, the Trustee is right that the Account Documents function by authorizing BLMIS to act as an agent for the customer in unspecified expected future securities transactions. The Trustee is also correct that, standing alone, the Account Documents would not effectuate the purchase or sale of any particular security.
But, as we have seen, the statutory definition of a “securities contract” is not limited in the way the Trustee would have us read it, and to the contrary, encompasses the relationship created by the Account Documents. As discussed above, the definition includes
“any other agreement ...
that is
similar
to” a “contract for the purchase, sale or loan of a security.”
We similarly have little difficulty concluding that the payments BLMIS made to its customers were made “in connection with” the securities contracts identified above. In the context of § 546(e), a transfer is “in connection with” a securities contract if it is “related to” or “associated with” the securities contract.
See
Webster’s 3d New Int’l Dictionary 481 (1993) (defining “connection” as “relationship or association in thought”);
cf. Shaw v. Delta Air Lines, Inc.,
SIPC argues that Ponzi scheme payments, by definition, are not “in connection with” a securities contract. SIPC’s Br. 16. SIPC contends that in order for the payments to have been made “in connection with” a securities contract, there must necessarily have been some relation or connection between the payment and the contract. Id. at 27-28. According to SIPC, although the payments of fictitious profits were purported to have been made in connection with the agreements, they were not in fact made in connection with the agreements because the agreements were either irrelevant or the payments were not authorized by the agreements. Id. at 28-30.
We are not persuaded. Section 546(e) sets a low bar for the required relationship between the securities contract and the transfer sought to be avoided. Congress could have raised the bar by requiring that the transfer be made “pursuant to,” or “in accordance with the terms of,” or “as required by,” the securities contract, but it did not. Instead, Congress merely required that the transfer have a connection to the securities contract, which these payments do.
Certainly SIPC and the Trustee are correct that these transfers were also made “in connection with” a Ponzi scheme and, as a result, were fraudulent. See id. at 29. Indeed, BLMIS’s conduct was in flagrant breach of the agreements it made with its customers. But the fact that a payment was made in connection with a Ponzi scheme does not mean that is was not at the same time made in connection with a (breached) securities contract. After all, a transfer can be connected to, and can be made in relation to, multiple documents or purposes simultaneously.
II
We also conclude that the transfers constituted “settlement payments,” which provides another basis to shield the transfers from avoidance under § 546(e). As described above, § 546(e) provides that a trustee “may not avoid a transfer that is a ... settlement payment, as defined in ... this title, made by [a] ... stockbroker.” Section 741(8) defines “settlement payment” as a “preliminary settlement payment, a partial settlement payment, an interim settlement payment, a settlement payment on account, a final settlement payment, or any other similar payment commonly used in the securities trade.”
The Trustee again contends that these transfers did not constitute “settlement payment[s]” because BLMIS never engaged in actual securities trading. But we have held that the statutory definition should be broadly construed to apply to “the transfer of cash or securities made to complete [a] securities transaction.”
Enron,
Ill
Finally, we disagree with the Trustee’s contention that affirming the district court’s decision would be inconsistent with our decision in
In re BLMIS,
This argument, albeit compelling, is ultimately not convincing. In our earlier decision, we interpreted “net equity” in a manner that would harmonize it with the SIPA statutory framework as a whole.
See In re BLMIS,
CONCLUSION
The judgment of the district court is AFFIRMED.
Notes
. According to the Trustee, the hundreds of complaints in this case are substantially identical with respect to the issues raised in this appeal. Trustee’s Br. 9 n. 4. As a result, when we refer to the Trustee's allegations, we cite the complaint in Picard v. Greiff, Adv. Pro. No. 10-4357 (Bankr.S.D.N.Y. Nov. 30, 2010), J.A. 594-623.
. Similarly, the Exchange Act's inclusion of contracts to "otherwise acquire” or "dispose of” securities in its definition of "buy” and "sell” necessarily contemplates agreements beyond those for a simple sale or purchase.
See
. This conclusion is congruent with the broad interpretation of the "in connection with a purchase or sale of any security” requirement of Rule 10b-5 in the context of federal securities laws.
See Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit,
.The Securities Investor Protection Corporation ("SIPC”), also an appellant in this case, assumed arguendo for the purposes of its brief that the Account Documents are securities contracts. See SIPC Br. 2, 14.