IN RE: BERNARD L. MADOFF INVESTMENT SECURITIES LLC
Docket Nos. 20-1333, 20-1334
UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT
August 30, 2021
August Term 2020
(Arguеd in Tandem: March 12, 2021 | Decided: August 30, 2021)
IRVING H. PICARD, TRUSTEE FOR THE LIQUIDATION OF BERNARD L. MADOFF INVESTMENT SECURITIES LLC, Plaintiff-Appellant,
and
SECURITIES INVESTOR PROTECTION CORPORATION, Appellant,
v.
CITIBANK, N.A., CITICORP NORTH AMERICA, INC., Defendants-Appellees.+
IRVING H. PICARD, TRUSTEE FOR THE LIQUIDATION OF BERNARD L. MADOFF INVESTMENT SECURITIES LLC, Plaintiff-Appellant,
and
SECURITIES INVESTOR PROTECTION CORPORATION, Appellant,
v.
LEGACY CAPITAL LTD., KHRONOS LLC Defendants-Appellees.
Before: WESLEY, SULLIVAN, MENASHI, Circuit Judges.
Plaintiff-Appellant Irving H. Picard was appointed as the trustee for the liquidation of Bernard L. Madoff Investment Securities LLC (“BLMIS“) pursuant to the Securities Investor Protection Act (“SIPA“),
ROY T. ENGLERT, JR., Robbins, Russell, Englert, Orseck, Untereiner & Sauber LLP, Washington, D.C., Special Counsel (David J. Sheehan, Seanna R. Brown, Amy E. Vanderwal, Matthew D. Feil, Chardaie C. Charlemagne, Baker & Hostetler LLP, New York, NY; Matthew M. Madden, Leslie C. Esbrook, Robbins, Russell, Englert, Orseck, Untereiner & Sauber LLP, Washington, D.C., Special Counsel, on the brief), for Plaintiff-Appellant Irving H. Picard, Trustee for the Liquidation of Bernard L. Madoff Investment Securities LLC.
NATHANAEL S. KELLEY, Associate General Counsel (Kenneth J. Caputo, General Counsel, Kevin H. Bell, Senior Associate General Counsel, on the brief), Securities Investor Protection Corporation, Washington, D.C., for Appellant Securities Investor Protection Corporation.
CARMINE D. BOCCUZZI, JR. (E. Pascale Bibi, Ariel M. Fox, on the brief), Cleary Gottlieb Steen & Hamilton LLP, New York, NY, for Defendants-Appellees Citibank N.A., Citicorp North America, Inc.
ERIC B. FISHER (Lindsay A. Bush, on the brief), Binder & Schwartz LLP, New York, NY, for Defendants-Appellees Legacy Capital Ltd., Khronos LLC.
These appeals are the latest installments in the long-running litigation arising from Bernard Madoff‘s Ponzi scheme. Madoff falsely claimed to invest money he received from customers of Bernard L. Madoff Investment Securities LLC (“BLMIS“). When customers wanted to withdraw money, BLMIS transferred funds directly to them, the initial transferees, some of whom then transferred the funds to their own investors, the subsequent transferees. Irving H. Picard, trustee for the liquidation of BLMIS, brought actions against initial transferee Legacy Capital Ltd. and subsequent transferees Citibank, N.A., Citicorp North America, Inc., and Khronos LLC, seeking to avoid and recover the transfers pursuant to his authority under the Securities Investor Protection Act (“SIPA“),
The United States District Court for the Southern District of New York (Rakoff, J.) held that in a SIPA liquidation, a lack of good faith requires a showing of at least willful blindness to the fraud on the part of the transferee and the trustee bears the burden of pleading the transferee‘s lack of good faith. Applying that decision, the United States Bankruptcy Court for the Southern District of New York (Bernstein, J.) dismissed Picard‘s actions against Appellees for failure to plead their willful blindness. We vacate both judgments of the bankruptcy court and hold that lack of good faith in a SIPA liquidation applies an inquiry notice, not willful blindness, standard, and that a SIPA trustee does not bear the burden of pleading the transferee‘s lack of good faith.
BACKGROUND
The details of the Madoff Ponzi scheme1 are described at length in previous
Customers ranging from banks and hedge funds to individuals and charities entrusted BLMIS with their money, expecting it to make investments on their behalf. A number of the customers were “feeder funds,” firms that pooled money from investors and invested directly (or indirectly) with BLMIS. When a feeder fund wanted to withdraw money, it received a transfer directly from BLMIS, making it an “initial transferee.” When an investor of a feeder fund wanted to withdraw money, the feeder fund transferred money it received from BLMIS, making that investor a “subsequent transferee.” See In re Picard, 917 F.3d 85, 93 (2d Cir. 2019), cert. denied sub nom HSBC Holdings PLC v. Picard, 140 S. Ct. 2824 (2020).
BLMIS was a sham. It sent its customers account statements with fabricated returns; in actuality, it was making few, if any, trades. “At bottom, the BLMIS customer statements were bogus and reflected Madoff‘s fantasy world of trading activity, replete with fraud and devoid of any connection to market prices, volumes, or other realities.” Sec. Inv. Prot. Corp. v. BLMIS (In re BLMIS), 424 B.R. 122, 130 (Bankr. S.D.N.Y. 2010) (hereinafter “SIPC“), aff‘d, 654 F.3d 229 (2d Cir. 2011). The customers’ funds were commingled in BLMIS‘s bank account. When сustomers withdrew their “profits” or principal, BLMIS paid them from this commingled account. As a result, each time BLMIS transferred payments to a customer, it was money stolen from other customers. See In re BLMIS, 654 F.3d at 232.
Amid the global financial crisis of 2007-08, concerned customers began to withdraw their investments, leading to BLMIS‘s collapse as “customer requests for payments exceeded the inflow of new investments.” See SIPC, 424 B.R. at 128. Following Madoff‘s arrest for securities fraud on December 11, 2008,2 the Securities Investor Protection Corporation (“SIPC“) requested that the United States District Court for the Southern District of New York (Stanton, J.) place BLMIS into a SIPA liquidation to recover and distribute funds to BLMIS‘S customers who lost their investments.3 The district court granted SIPC‘s petition, appointed Picard as the trustee, and referred the SIPA liquidation of BLMIS to the bankruptcy court. In this ongoing liquidation, Picard
I. The SIPA Liquidation of BLMIS
Congress enacted SIPA in 1970 to protect customers of bankrupt broker-dealers. As we have previously explained, “[a] trustee‘s primary duty under SIPA is to liquidate the [failed] broker-dealer and, in so doing, satisfy claims made by or on behalf of the broker-dealer‘s customers for cash balances.” Marshall v. Picard (In re BLMIS), 740 F.3d 81, 85 (2d Cir. 2014). “In a SIPA liquidation, a fund of ‘customer property,’ separate from the general estate of the failed broker-dealer, is established for priority distribution exclusively among customers.” In re BLMIS, 654 F.3d at 233. The “customer property” fund consists of “cash and securities . . . at any time received, аcquired, or held by” the debtor on behalf of the customers, including “the proceeds of any such property transferred by the debtor” and “property unlawfully converted.”
Although investors of BLMIS are considered “customers” under SIPA, see In re BLMIS, 654 F.3d at 236, under certain circumstances, those who indirectly invested in BLMIS do not qualify as customers, see Kruse v. Picard (In re BLMIS), 708 F.3d 422, 426-27 (2d Cir. 2013).4 Only BLMIS‘s customers with “allowed claims” are entitled to a distribution from the customer property fund. SIPA requires customers to “share ratably in such customer property on the basis and to the extent of their respective net equities.”
Picard‘s goal in this liquidation is to satisfy the allowed customer claims. A SIPA liquidation is “conducted in accordance with, and as though it were being conducted under chapters 1, 3, and 5 and subchapters I and II of chapter 7 of [the Bankruptcy Code].”
II. The Instant Actions Under Bankruptcy Code Sections 548 and 550
Avoidance and recovery are related but distinct concepts. Section 548 governs the avoidance of actually and constructively fraudulent transfers by the debtor. It permits a trustee to “avoid“—i.e., cancel—“any transfer ... made or incurred on or within 2 years before the date of the filing of the [bankruptcy] petition, if the debtor . . . made such transfer . . . with actual intent to hinder, delay, or defraud any entity to which the debtor was or became . . . indebted.”
Voidability under
Recovery, by contrast, focuses on the transferee. As discussed above, Section 550 authorizes a trustеe to recover transfers voided under Section 548 from initial and subsequent transferees. See
Picard sued Appellees because, as alleged, BLMIS made fraudulent transfers to them, which are voidable under
A) Picard‘s Action Against Citi8
Citi did not receive transfers directly from BLMIS. Instead, it received at least $343 million in subsequent transfers between June 2005 and March 2008 from feeder fund Rye Select Broad Market Prime Fund, L.P. (“Prime Fund“) “as repayment of funds [Citi] loaned to Prime Fund to invest with BLMIS[].” No. 20-1333 J.A. 333–34. Beginning in the spring of 2005, Citigroup Global Markets, Inc. (“CGMI“), the main Citi affiliate that conducted BLMIS-related business, uncovered facts suggesting that BLMIS was engaged in fraudulent activity. Specifically, in its diligence for deals with feeder funds, Citi was “unable to independently verify that BLMIS maintained segregated customer accounts, or even that the assets existed in any account,” and it was “unable to find any evidence that BLMIS was in fact making the options trades” it was reporting to its customers. Id. at 335.
In March 2005, CGMI performed a quantitative analysis in its diligence on the deal with feeder fund Fairfield Sentry Limited (“Fairfield Sentry“). The results revealed BLMIS was not using Madoff‘s purported “split strike conversion” (“SSC“) investment strategy9 because BLMIS‘s returns outperformed the market in a manner that appeared statistically impossible. In addition, CGMI knew BLMIS lacked an independent custodian for its customers’ assets, giving BLMIS sole control over customers’ funds and making it more likely BLMIS could steal or misuse those funds.
Around the same time, Leon Gross, a managing director at CGMI, conducted a separate investigation of BLMIS after Harry Markopolos, a CGMI customer, asked him to analyze BLMIS‘s investment strategy. Gross considered possible strategies Madoff could have been using to explain BLMIS‘s returns. He, too, concluded that the SSC strategy was incapable of producing BLMIS‘s reported returns and that Madoff did not engage in any options transactions. As a result, Gross discerned that “either the returns are not the returns or the strategy is not the strategy.” Id. at 369. Markopolos submitted a report to the SEC detailing the evidence of fraud at BLMIS and identifying Gross as one of the experts the SEC should contact for more information. In June 2007, Markopolos
CGMI was unable to confirm Madoff‘s purported options trades. Nor did CGMI prepare questions related to its main suspicions of fraud for a meeting it held with Madoff in November 2006, when it was planning to renew its deal with Prime Fund. Instead, the meeting was a “check-the-box exercise where CGMI sought only basic information that amounted to a ‘corporate overview’ of BLMIS.” Id. at 389. Nevertheless, in its deal with Prime Fund, Citi “demanded a unique contractual indemnification provision related directly to fraud at BLMIS,” and insisted on it before renewing the deal. Id. at 374, 392. Around the same time, CGMI rejected a separate proposed deal with Tremont Partners, Inc., Prime Fund‘s general partner, because it lacked such indemnification.
Picard seeks to avoid and recover $343,084,590 in subsequent transfers from Prime Fund to Citi, arguing that the Citi defendants received these transfers “at a
time when they were willfully blind to circumstances suggesting a high probability of fraud at BLMIS.” Id. at 413.
B) Picard‘s Action Against Legacy and Khronos10
Legacy is a British Virgin Islands corporation that invested solely in BLMIS. Jimmy Mayer and his son, Rafael Mayer, run Legacy. Acting in their individual capacities, the Mayers invested in the Meritage fund, a hedge fund managed by Renaissance Technologies LLC (“Renaissance“). Meritage invested in BLMIS, and Rafael was a member of the committee responsible for overseeing Meritage‘s investments.
Suspicious of BLMIS‘s returns, Renaissance analyzed Madoff‘s purported SSC investment strategy and produced a report in October 2003 presenting its results, entitled the “Renaissance Proposal.” The Renaissance Proposal was shared with the Meritage committee members, including Rafael. It revealed that the market could not support the options volume BLMIS purported to trade, that many of BLMIS‘s trades were at improbable prices, and that there was no footprint of its trades. These findings sparked email exchanges in November 2003 between Meritage committee members, who expressed concern about the risk of fraud at
BLMIS; Rafael was included in these emails. When Renaissance decided to redeem Meritage‘s investment in BLMIS in 2004, Rafael was the only member of the Meritage committee who objected.
Rafael convinced the Meritage committee to delay redeeming half of Meritage‘s investment; Legacy ultimately bought that half in July 2004. Legacy then instructed Khronos, which provided accounting services to Legacy, to investigate BLMIS. Khronos was co-founded by Rafael and his brother, David Mayer, who were also the managing directors of Khronos. In addition to relying on Khronos rather than an independent third party to investigate BLMIS, Rafael and David restricted the access of Khronos‘s employees to Legacy and its BLMIS account statements, “[c]ontrary to Khronos‘s standard investment monitoring process.” No. 20-1334 J.A. 102. As a result, Rafael and David, as the managers of Khronos, were the only ones permitted to review Legacy‘s account details. Khronos‘s evaluation of BLMIS‘s trading data confirmed that the trades were “statistically
Picard seeks to avoid and recover $213,180,068 that Legacy received from BLMIS in initial transfers, and $6,601,079 that Khronos received “as investment management and accounting services fees” in subsequent transfers, arguing both defendants received these transfers with “willful blindness to circumstances suggesting a high probability of fraud at BLMIS.” Id. at 91, 124–25.11
III. The Decisions Below
Appellees moved to withdraw their cases from the bankruptcy court to the district court to decide “whether SIPA and other securities laws alter the standard the [t]rustee must meet in order to show that a defendant did not receive transfers in ‘good faith’ under either
The district court made two rulings on the “good faith” defense. First, the court concluded that a lack of good faith in a SIPA liquidation requires “a showing
that the defendant acted with willful blindness to the truth, that is, he intentionally chose to blind himself to the red flags that suggest a high probability of fraud.” Id. at 21 (internal quotation marks, alteration, and citation omitted) (emphasis added). It rejected applying an inquiry notice standard, “under which a transferee may be found to lack good faith when the information the transferee learned would have caused a reasonable person in the transferee‘s position to investigate the matter further.” Id. (internal quotation marks and citation omitted).
Second, the court set the pleading burden for the good faith defense, finding that good faith is an affirmative defense and acknowledging that “in the context of an ordinary bankruptcy proceeding,” the defendant bears the burden of pleading this affirmative defense under both Section 548(c) and Section 550(b)(1). Id. at 24. The district court nevertheless concluded that “SIPA . . . affects the burden of pleading good faith or its absence” and alters the traditional framework such that, in a SIPA liquidation, the trustee bears the burden of pleading the defendant‘s lack of good faith. Id.
The district court returned the cases to the bankruptcy court, which applied the standard articulated by the district court and dismissed both actions. The bankruptcy court denied Picard leave to amend his complaint against Citi, finding it would be futile because his proposed amended complaint does not plausibly allege willful blindness. It also dismissed Picard‘s amended complaint against Legacy and Khronos for failing to plausibly allege their willful blindness to the fraud committed by BLMIS.13 Picard and SIPC appeal both judgments of the bankruptcy court.
There are two14 issues before us: (1) the definition of “good faith” in the context of a SIPA liquidation; and (2) which party bears the burden of pleading good faith or the lack thereof.
I. Defining “Good Faith” in a SIPA Liquidation
As recounted above, the district court rejected the inquiry notice standard, “under which a transferee may be found to lack good faith when the information the transferee learned would have caused a reasonable person in the transferee‘s position to investigate the matter further.” Good Faith Decision, 516 B.R. at 21
+ The Clerk of Court is respectfully directed to amend the caption as set forth above.
(internal quotation marks and citation omitted). Instead, it decided the appropriate standard is willful blindness, under which the defendant lacks good faith if it “intentionally [chose] to blind [itself] to the red flags that suggest a high probability of fraud.” Id. (internal quotation marks and citation omitted).
Inquiry notice is distinct from willful blindness both in degree and intent. “[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.” Glob.-Tech Appliances, Inc. v. SEB S.A., 563 U.S. 754, 769 (2011) (emphasis added). Inquiry notice requires knowledge of suspicious facts that need not suggest a “high probability” of wrongdoing but are nonetheless sufficient to induce a reasonable person to investigate. See Merck & Co., Inc. v. Reynolds, 559 U.S. 633, 650-51 (2010) (collecting cases). Willful blindness also imputes a heightened sense of culpability, whereas a defendant on inquiry notice who fails to investigate does not necessarily do so with the purpose of avoiding confirming the truth.
The district court reasoned that because (1) SIPA is part of the securities laws, (2) a lack of good faith under the securities laws requires fraudulent intent, and (3) SIPA “expressly provides that the Bankruptcy Code applies only ‘[t]o the extent consistent with the provisions of this chapter [of the federal securities laws],‘” the inquiry notice standard for good faith applicable under the Bankruptcy Code “must yield” to the willful blindness standard for good faith required under the securities laws. Good Faith Decision, 516 B.R. at 21-22 (quoting
On appeal, Citi mounts an alternative defense of the district court‘s ruling. It argues that the ordinary meaning of good faith in the Bankruptcy Code applies a willful blindness standard to establish lack of good faith. Legacy and Khronos primarily defend the district court‘s “securities-law
A) A Lack of Good Faith Under Sections 548(c) and 550(b) of the Bankruptcy Code Does Not Require Willful Blindness
The Bankruptcy Code does not define “good faith.” “When a term goes undefined in a statute, we give the term its ordinary meaning.” Taniguchi v. Kan Pac. Saipan, Ltd., 566 U.S. 560, 566 (2012). “To assess ordinary meaning, we consider the commonly understood meaning of the statute‘s words at the time Congress enacted the statute, and with a view to their place in the overall statutory scheme.” New York v. Nat‘l Highway Traffic Safety Admin., 974 F.3d 87, 95 (2d Cir. 2020) (internal quotation marks and citations omitted).
Dictionary definitions and case law predating the Bankruptcy Code of 1978, “usual source[s] that might shed light on the statue‘s ordinary meaning,” Food Mktg. Inst. v. Argus Leader Media, 139 S. Ct. 2356, 2363 (2019), demonstrate that “good faith” encompasses inquiry notice. At the time of the Bankruptcy Code‘s drafting, Black‘s Law Dictionary defined good faith as “[h]onesty of intention, and freedom from knowledge of circumstances which ought to put [a party] upon inquiry,” as well as “[a]n honest intention to abstain from taking any unconscientious advantage of another, even through technicalities of law, together with absence of all information, notice, or benefit or belief of facts which render [a] transaction unconscientious.” Black‘s Law Dictionary 822 (rev. 4th ed. 1968) (emphases added); see also Black‘s Law Dictionary 623 (5th ed. 1979) (same); id. at 624 (defining “good faith purchasers” as “[t]hose who buy without
Aside from dictionary definitions, “[t]he meaning—or ambiguity—of certain words or phrases may only become evident when placed in context.” Food & Drug Admin. v. Brown & Williamson Tobacco Corp., 529 U.S. 120, 132 (2000); see also Antonin Scalia & Bryan A. Garner, Reading Law: The Interpretation of Legal Texts 70 (2012) (explaining that because “[m]ost common English words have a number of dictionary definitions” and “[m]any words have more than one ordinary meaning,” “[o]ne should assume the contextually appropriate ordinary meaning unless there is reason to think otherwise“). Here, the context is
Early fraudulent conveyances cases exemplify the principle that transferees of a fraudulent transfer did not act in good faith when they had inquiry notice of the debtor-transferor‘s fraud. See, e.g., Bentley v. Young, 210 F. 202, 205 (S.D.N.Y. 1914) (Learned Hand, J.) (“It must be remembered that [the transferee‘s] personal good faith is not enough; the question is, not what he individually believed, but whether the circumstances would have put a reasonable man in his situation upon inquiry, and whether that inquiry would have led to sufficient knowledge of the facts to prevent the sale.“) (emphasis added), aff‘d 223 F. 536 (2d Cir. 1915); Johnson v. Dismukes, 204 F. 382, 382 (5th Cir. 1913) (affirming district court‘s avoidance of fraudulent transfer under the Bankruptcy Act of 1898 where “the facts and circumstances accompanying the transaction were calculated to put [the transferee] upon inquiry“); see also Harrell v. Beall, 84 U.S. 590, 591 (1873) (noting that the transferee not only “intentionally shut his eyes to the truth” but also “had such notice and information as made it his duty to inquire further, and that the slightest effort by him in that direction would have discovered the whole fraud“).
In 1918, the National Conference of Commissioners on Uniform State Laws approved and recommended the Uniform Fraudulent Conveyance Act (“UFCA“) in an attempt to end the then-existing confusion
The Bankruptcy Act of 1938 (the “1938 Act“), predecessor of the Bankruptcy Code of 1978, built upon this established inquiry notice standard for good faith. Portions of the 1938 Act were a “federal codification” of the UFCA. Cohen v. Sutherland, 257 F.2d 737, 741 (2d Cir. 1958). Section 67d(6) of the 1938 Act permitted “bona-fide” transferees of fraudulent transfers to retain those transfers. See Pub. L. No. 75-696, 52 Stat. 840, 878 (1938). Courts and scholars accepted “bona-fide” as synonymous with good faith, see Cohen, 257 F.2d at 743 n.4, and concluded that—as with good faith under the UFCA—“the presence of any circumstances placing the transferee on inquiry as to the financial condition of the transferor may be a contributing factor in depriving the former of any claim to good faith,” Steel Structures, Inc. v. Star Mfg. Co., 466 F.2d 207, 215-16 (6th Cir. 1972) (quoting 4 Collier on Bankruptcy § 67.41, at 589-90 (14th ed.)); see also Paul J. Hartman, A Survey of the Fraudulent Conveyance in Bankruptcy, 17 Vand. L. Rev. 381, 409 (1964) (“‘Good faith’ on the part of the transferee, so as to be protected under section 67d(6) of the [1938] Act, seems to presuppose lack of knowledge of such facts as would put a reasonably prudent person on inquiry.“).
In light of this background understanding of the term good faith in early American fraudulent conveyance law, the 1938 Act, and typical legal usage at the time of the enactment of the Bankruptcy Code, the plain meaning of good faith in
Moreover, our sister circuits that have addressed the issue unanimously accept an inquiry notice standard. In In re Nieves, 648 F.3d 232 (4th Cir. 2011), the court held that, “[i]n determining good faith for the purposes of a § 550(b)(1) defense, . . . a transferee does not act in good faith when he has sufficient [actual] knowledge to place him on inquiry notice of the debtor‘s possible insolvency.” Id. at 238 (citation omitted). “In so holding, [the court] arrive[d] at the same conclusion as . . . three other circuit courts [(the Seventh, Eighth, and Ninth Circuits)] that have addressed the issue.” Id. (citing In re Sherman, 67 F.3d 1348, 1355 (8th Cir. 1995); In re Agric. Rsch. & Tech. Grp., Inc., 916 F.2d 528, 535-36 (9th Cir. 1990); Bonded Fin. Servs., Inc. v. Eur. Am. Bank, 838 F.2d 890, 897-98 (7th Cir. 1988)).20 The Fifth and Tenth Circuits agree. See In re Am. Hous. Found., 785 F.3d 143, 164 (5th Cir. 2015), revised (June 8, 2015); In re M & L Bus. Mach. Co., Inc., 84 F.3d 1330, 1334-38 (10th Cir. 1996).
In a prior BLMIS-liquidation opinion, we too expressed that “[t]he presence of good faith [under § 548(c)] depends upon, inter alia, whether the transferee had information that put it on inquiry notice that the transferor was insolvent or that the transfer might be made with a fraudulent purpose.” Marshall, 740 F.3d at 91 n.11 (2d Cir. 2014) (internal quotation marks and citation omitted). And while the district court dismissed this language as dictum, see Good Faith Decision, 516 B.R. at 22 n.2, even before Marshall, we expressed that “[a] transferee does not act in good faith when he has sufficient knowledge to place him on inquiry notice of the debtor‘s possible insolvency.” Banner v. Kassow, 104 F.3d 352 (2d Cir. 1996) (unpublished opinion) (quoting In re Sherman, 67 F.3d at 1355).21
The then-current dictionary definitions when the Bankruptcy Code was enacted and early case law fail to establish that the common understanding of lack of good faith in the fraudulent conveyances context was, at a minimum, willful blindness. In many of the early cases on which
Citi also fails to appreciate the distinction between preferential transfers, where the debtor makes payments to certain creditors and not others, and (actually) fraudulent transfers, where, as discussed above, the debtor possesses an intent to defraud and reduces the assets available to all creditors. See Van Iderstine v. Nat‘l Disc. Co., 227 U.S. 575, 582 (1913). Citi contends that the district court‘s willful blindness standard is supported by this Court‘s decision in In re Sharp Int‘l Corp., 403 F.3d 43 (2d Cir. 2005), which held that a transferee did not act in bad faith under New York‘s UFCA where the transferee was alleged to have at least inquiry notice that the debtor had made certain preferential transfers to the defendant. See id. at 48, 54-55. But In re Sharp and the cases upon which it relies, see id. at 54-55 (citing, inter alia, Bos. Trading Grp., Inc. v. Burnazos, 835 F.2d 1504, 1512 (1st Cir. 1987)), do not affect the meaning of good faith here, much less support the distriсt court‘s willful blindness standard. Rather, In re Sharp stands for the principle that a transfer is not voidable on the ground that it is constructively fraudulent under the UFCA (which requires showing a transferee‘s bad faith) where the transferee is aware “that the transferor is preferring him to other creditors.” Id. at 54-55 (internal quotation marks omitted). Given the Ponzi scheme presumption establishing that BLMIS‘s transfers were fraudulent, the absence of an inquiry notice standard in the preferential transfers context simply has no bearing on the meaning of good faith here. Indeed, In re Sharp acknowledged that this Court had previously adopted an inquiry notice standard for good faith under the UFCA in HBE Leasing, 48 F.3d 623, but distinguished that case because it involved a fraudulent transfer, whereas In re Sharp concerned a preferential transfer. See id. at 55.23
Lastly, Appellees’ contention that lack of good faith requires willful blindness is premised in part on the misconception that
Inquiry notice is not purely objective, nor is it a negligence standard. Although some courts have characterized inquiry notice as an “objective test,” under which “courts look to what the transferee objectively ‘knew or should have known’ in questions of good faith,” In re Bayou Grp., LLC, 439 B.R. 284, 313 (S.D.N.Y. 2010) (citation omitted), “what the transferee should have known depends on what it actually knew, and not what it was charged with knowing on a theory of constructive notice.” In re Nieves, 648 F.3d at 238 (emphases added). As a result, even courts that use the phrase “should have known” acknowledge that the first step in the inquiry notice analysis looks to what facts the defendant knew. See, e.g., In re Sherman, 67 F.3d at 1355; In re Bayou Grp., LLC, 439 B.R. at 310 (“The first question typically posed is whether the transferee had information that put it on inquiry notice that the transferor was insolvent or that the transfer might be made with a fraudulent purpose.“) (emphasis added). Our view of inquiry notice incorporates both objective and subjective components. Inquiry notice “signifies actual awareness of suspicious facts that would have led a reasonable [transferee], acting diligently, to investigate further and by doing so discover” a debtor-transferor‘s fraud. In re Sentinel Mgmt. Grp., Inc., 809 F.3d 958, 961 (7th Cir. 2016).24
Thus, the good faith defense under
In sum, we join all of our sister circuits that have addressed the issue in holding that a lack of good faith under
B) The Securities Laws Do Not Impose a Willful Blindness Standard for Lack of Good Faith in a SIPA Liquidation
Even accepting that good faith under the Bankruptcy Code uses inquiry notice, Legacy, Khronos, and to a lesser extent Citi argue that willful blindness is required here because SIPA is different. They defend the district court‘s theory, which no court of appeals has ever adopted,25 that because SIPA “is part of the securities laws and expressly provides that the Bankruptcy Code applies only [t]o the extent consistent with the provisions of this chapter [of the federal securities laws],” and because “good faith in the securities context implies a lack of fraudulent intent,” lack of good faith in a SIPA liquidation requires willful blindness. Good Faith Decision, 516 B.R. at 22 (internal quotation marks and citation omitted) (alterations in original). The cornerstone of the district court‘s theory is that SIPA prohibits the trustee from utilizing the inquiry notice standard under the Bankruptcy Code because it is inconsistent with the willful blindness standard under federal securities laws. It reached this view through an analysis of the text and policy considerations underlying SIPA and federal securities laws.
Despite this incorporation of SIPA into the 1934 Act, the securities-law theory does not hold up. By making SIPA an amendment to the 1934 Act, Congress intended for SIPA to apply if the 1934 Act is inapplicable or inconsistent with SIPA. It is a “well established canon of statutory interpretation” that “the specific governs the general.” RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 566 U.S. 639, 645 (2012) (citation omitted). Moreover, when “the scope of the earlier statute is broad but the subsequent statute[] more specifically address[es] the topic at hand,” there is even greater reason to assume the later statute controls. Food & Drug Admin. v. Brown & Williamson Tobacco Corp., 529 U.S. 120, 143 (2000). As a result, where SIPA speaks and the 1934 Act is silent, SIPA governs.
Nothing in the 1934 Act (minus SIPA) concerns liquidation proceedings of insolvent securities broker-dealers. “The 1934 Act was intended principally to protect investors against manipulation of stock prices through regulation of transactions upon securities exchanges and in over-the-counter markets, and to impose regular reporting requirements on companies whose stock is listed on
national securities exchanges.” Ernst & Ernst v. Hochfelder, 425 U.S. 185, 195 (1976). Its overall goal is “to protect investors against false and deceptive practices that might injure them.” Id. at 198. Over time, Congress enacted statutes such asHowever, unlike the 1934 Act,
Accordingly, the general “fraudulent intent” requirement in the 1934 Act is irrelevant to the specific context of a
the
But even if we accept for argument‘s sake that “this chapter” in
Finally, by clarifying that inquiry notice is not a negligence standard, see Section I.A., supra, we also reject the district court‘s and Appellees’ contentions that the inquiry notice standard is “unworkable” and contrary to
The district court criticized inquiry notice as impracticable, questioning “how could [an investor investigate his broker‘s internal practices] anyway?” Good Faith Decision, 516 B.R. at 21 (citation omitted). We cannot provide an answer for every case. The adequacy of an investigation is, of course, a fact-intensive inquiry to be determined on a case-by-case basis, which naturally takes into account the disparate circumstances of differently-situated transferees. Courts routinely conduct that inquiry seemingly without a hitch. See, e.g., Janvey v. GMAG, L.L.C., 977 F.3d 422, 428 (5th Cir. 2020) (concluding that, in analyzing the good faith defense under the Texas Uniform Fraudulent Transfer Act, the record evidence did not show that the defendants-appellees “diligently investigated” the debtor-transferor‘s Ponzi scheme after being put on inquiry notice).
The text of
II. Burden of Pleading Good Faith, or the Lack Thereof
The district court found that good faith is an affirmative defense under
A) Good Faith is an Affirmative Defense Under Sections 548 and 550 of the Bankruptcy Code
As with the definition of good faith,
If a trustee establishes a prima facie case under the fraudulent transfer provisions, then he or she is entitled to recovery unless the transferee can establish an affirmative defense. One affirmative defense applies whether a trustee seeks to recover under § 548(a)(1)(A) . . . . It permits a transfereе who ‘takes for value and in good faith’ to retain the transfer to the extent of the value given.
Gettinger, 976 F.3d at 190 (emphases added) (quoting
Citi contends that, in contrast to good faith under
the extent that a transfer is avoided under [(inter alia)] section . . 548 . . ., the trustee may recover,
Citi contends that the “[e]xcept as otherwise provided” clause in
Moreover, although
Our reading of
The legislative history further substantiates our view. The Senate Report accompanying the modern Bankruptcy Code notes that “[i]n order for the transferee to be excepted frоm liability under [
The legislative history also demonstrates that Congress did not intend to create a different pleading burden with respect to subsequent transferees compared to initial transferees. As expressed in the Senate Report accompanying the Bankruptcy Code, “[t]he phrase ‘good faith’ [under
Finally, the Trustee‘s access to discovery before filing the complaint under Rule 2004 of the Federal Rules of Bankruptcy Procedure does not affect our analysis. Rule 2004 has never been interpreted to permit shifting the pleading burden. Indeed, the fact that “good faith” concerns the transferee‘s knowledge of suspicious facts and other information “peculiarly within the knowledge and control of the defendant” supports the allocation of the pleading burden on the defendant-transferee. See Gomez v. Toledo, 446 U.S. 635, 640–41 (1980); see also Nat‘l Commc‘ns Ass‘n Inc. v. AT&T Corp., 238 F.3d 124, 130–31 (2d Cir. 2001) (explaining that “all else being equal, the burden [of proving an issue] is better placed on the party with easier access to relevant information” and that “courts should avoid requiring a party to shoulder the more difficult task of proving a negative“).
The structural similarity of
B) SIPA Does Not Require the Trustee to Plead an Affirmative Defense
The district court‘s policy-based justifications for departing from
Second, placing the burden to plead good faith on the initial and subsequent transferees does not contradict the goals of
A transferee‘s burden to plead the affirmative defense of good faith does not “undercut”
Nothing in
CONCLUSION
We VACATE the judgments of the bankruptcy court and REMAND for further proceedings consistent with this opinion.
20-1333, 20-1334
In re Bernard L. Madoff Inv. Sec. LLC
MENASHI, Circuit Judge, concurring:
The court‘s decision in this case might appear counterintuitive. Citibank received a repayment of a loan it made to a fund that invested with Bernard L. Madoff Investment Securities (“BLMIS“). Legacy Capital received back the principal it invested with BLMIS.1 Yet the court holds that each party‘s receipt of funds it was owed amounts to a fraudulent transfer accepted in bad faith.
Normally, when a creditor receives a payment from a debtor—even if the creditor knows that the debtor is insolvent and the payment will prevent other creditors from being repaid—that payment is considered a preference, not a fraudulent transfer. See Sharp Int‘l Corp. v. State St. Bank & Trust Co. (In re Sharp Int‘l Corp.), 403 F.3d 43, 54 (2d Cir. 2005) (“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.“) (alteration omitted) (quoting Ultramar Energy Ltd. v. Chase Manhattan Bank, N.A., 191 A.D.2d 86, 90-91 (N.Y. App. Div. 1st Dep‘t 1993)). Under these normal principles, creditors such as Citibank and Legacy would be able to retain the repayments despite knowledge of the debtor‘s insolvency as long as the transfers occurred outside the relatively brief period in which preferential transfers may
be avoided2
I
In this case, however, we do not follow normal principles because we have applied the “Ponzi scheme presumption.” Accordingly, we presume that transfers from a debtor in furtherance of a Ponzi scheme are made with fraudulent intent rather than to satisfy an antecedent debt.4 Some courts have rejected the Ponzi
scheme presumption on the ground that it improperly treats preferences as fraudulent transfers. See, e.g., In re Unified Com. Cap., Inc., 260 B.R. 343, 350 (Bankr. W.D.N.Y. 2001) (“[T]he fraudulent conveyance statutes cannot and should not be utilized by courts as a super preference statute to effect a further reallocation and redistribution that should be specifically provided for in a statute enacted by Congress.“); Finn v. Alliance Bank, 860 N.W.2d 638, 647 (Minn. 2015) (concluding that “there is no statutory justification for relieving the Receiver of its burden of proving—or for preventing the transferee from attempting to disprove—fraudulent intent” under the “Ponzi-scheme presumption” and that a creditor must “prove the elements of a fraudulent transfer with respect to each transfer, rather than relying on a presumption related to the form or structure of the entity making the transfer“).5
Under normal principles, fraudulent transfer law prevents pre-insolvency transfers to non-creditors or colluding creditors, not bona fide creditors; “[t]he 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.” Boston Trading Grp., Inc. v. Burnazos, 835 F.2d 1504, 1509 (1st Cir. 1987); see also In re Sharp, 403 F.3d at 54; Bonded Fin. Servs., Inc. v. Eur. Am. Bank, 838 F.2d 890, 892 (7th Cir. 1988). It is “the preference provisions,”
This use of the fraudulent transfer statute is questionable. See In re Unified, 260 B.R. at 350 (“By forcing the square peg facts of a ‘Ponzi’ scheme into the round holes of the fraudulent conveyance statutes in order to accomplish a further reallocation and redistribution to implement a policy of equality of distribution in the name of equity, I believe that many courts have done a substantial injustice to these statutes and have made policy decisions that should be made by Congress.“)6. But as the court notes, no party to this case challenges the Ponzi scheme presumption. See ante at 11 (“[T]he
parties do not dispute the applicability of the Ponzi scheme presumption here.“). Therefore, we apply that presumption.7
By treating debt repayments as fraudulent transfers and not as preferences, the Ponzi scheme presumption assumes that creditors of a Ponzi scheme are not owed a valid contractual antecedent debt like bona fide creditors. See Finn, 860 N.W.2d at 651 (“[C]ourts that adopt the Ponzi-scheme presumption effectively deem a contract between the operator of a Ponzi scheme and an investor to be unenforceable as a matter of public policy.“). Thus, we do not apply the normal rule that, when the transferee is a creditor, “a lack of good faith ‘does not ordinarily refer to the transferee‘s knowledge of the source of the debtor‘s monies which the debtor obtained at the expense of other creditors.‘” In re Sharp, 403 F.3d at 54 (quoting Boston Trading, 835 F.2d at 1512). Normally, “the law will not charge” a creditor who “may know the fraudulent purpose of the grantor” with “fraud by reason of such knowledge,” even though the law assumes that an arm‘s-length “purchase[r] for a present consideration . . . enters [the transaction] for the purpose of aiding that fraudulent purpose” if the purchaser knows “the fraudulent purpose of the grantor.” English v. Brown, 229 F. 34, 40 (3d Cir. 1916) (quoting Atl. Refin. Co. v. Stokes, 75 A. 445, 446-47 (N.J. Ch. 1910)). Yet
That level of notice must be the same as normally required when evaluating the good faith of a transferee under the Bankruptcy Code. In this case, the district court‘s decision to adopt a different standard from the securities laws might have helped to avoid the counterintuitive results of treating a payment to a creditor as a fraudulent transfer. See Sec. Inv. Prot. Corp. v. Bernard L. Madoff Inv. Seс. LLC (In re Madoff Sec.), 516 B.R. 18, 22 (S.D.N.Y. 2014) (“[W]here the Bankruptcy Code and the securities laws conflict, the Bankruptcy Code must yield.“). But that approach would add an additional departure from the statutory scheme. Accordingly, I concur in the court‘s opinion.
II
Some courts have suggested that repayments such as those Citibank and Legacy Capital received “occur as part of the fraud” and therefore do not qualify as “repayment of a debt that was antecedent to the company‘s fraud.” In re Manhattan Inv. Fund Ltd., 397 B.R. 1, 11 (S.D.N.Y. 2007). In other words, there was no valid antecedent debt. Yet here, even the Trustee refers to the Madoff victims as “creditors,” see, e.g., Trustee‘s Br. 4, and indeed the purpose of
Other courts have suggested that these sorts of “redemption payments . . . were necessarily made with intent to ‘hinder, delay or defraud’ present and future creditors” because those payments “constituted an integral and essential component of the fraudulent Ponzi scheme.” In re Bayou Grp., LLC, 362 B.R. 624, 638 (Bankr. S.D.N.Y. 2007).8 But it is unclear that thе statutory phrase “intent to hinder, delay, or defraud” would by itself include repayments to creditors simply because such repayments are a critical part of the Ponzi scheme. Preferences generally “hinder” payments to other creditors yet are not for that reason considered fraudulent transfers. See Richardson v. Germania Bank, 263 F. 320, 325 (2d Cir. 1919) (“A very plain desire to prefer, and thereby incidentally to hinder creditors, is (1) not as a matter of law an intent obnoxious to [the fraudulent transfer provision]; and (2) is not persuasive in point of fact that such intent, evil in itself, ever existed.“). A contrary argument would “obliterate” the preferential transfer provision “from the statute.” Irving Trust Co. v. Chase Nat‘l Bank, 65 F.2d 409, 411 (2d Cir. 1933). Moreover, when a statutory phrase—here, “hinder, delay, or defraud“—has a “well-established common-law meaning,” we
transfers in exchange for “good Consyderation, & bona fide“); In re Goldberg, 277 B.R. 251, 291-92 (Bankr. M.D. La. 2002). The Statute of 13 Elizabeth prevented debtors from shortchanging creditors by squirreling away assets out of their creditors’ reach.9 The phrase refers to keeping assets away from all creditors rather than preferences among creditors, and courts presumably ought to follow “the specialized legal meaning that the term . . . has long possessed.” Moskal, 498 U.S. at 121 (Scalia, J., dissenting).
It may be that there are better arguments for the Ponzi scheme presumption, but consideration of that issue must await an appropriately contested case.10 Because the parties do not raise the issue here, I concur.