More than seven years after the bankruptcy court in Manhattan began liquidating the Bernard Madoff Ponzi scheme, the trustee is on the cusp of obtaining his first judgment for the recovery of fictitious profits that customers received within two years of bankruptcy.
Seeing the handwriting on the wall, some customers already settled, enabling the Madoff trustee to have recovered more than $11.1 billion toward customers’ claims totaling some $17.5 billion. Many of those still fighting the trustee are incensed at being sued for money they received as allegedly fraudulent transfers when they had no inkling that fraud was afoot.
As a matter of common sense, customers who took out more than they invested believe they should be entitled to retain profits they took out because they were unaware of fraud, even though Madoff never bought a single share of stock with money the customers thought he had invested for them in the stock market. In legal parlance, customers have been arguing that the profits shown on their account statements gave them “value” defenses under Section 548(c) to obviate fraudulent transfer claims.
The delay in landing the first judgment was not occasioned by Irving Picard, the trustee appointed under the Securities Investor Protection Act. District Judge Jed Rakoff in Manhattan withdrew the reference for hundreds of Picard’s lawsuits and proceeded over several years to lay down the law on many pivotal issues governing the Madoff trustee’s claims to recover money that investors withdrew before the Ponzi scheme blew up in December 2008.
The major Madoff decisions by Judge Rakoff and the Second Circuit governing the recovery of fraudulent transfers arising from Ponzi schemes are summarized in Bankruptcy Judge Stuart M. Bernstein’s new opinion on April 25. Judge Bernstein said that two rules govern lawsuits against so-called net winners, or investors who took out more cash than they invested.
First, Judge Bernstein said that a customer “does not give value beyond his deposits of principal.” Second, he said that “net winners cannot argue that the payment of fictitious profits satisfied an antecedent debt or obligation or provided value within the meaning of Bankruptcy Code Section 548(c).”
The guinea pig for Judge Bernstein’s April 25 opinion is a customer named Cohen, who took out profits of more than $1.1 million in the two years before bankruptcy. On an agreed-upon set of facts, Judge Bernstein recommended that the district court enter final judgment in that amount. The parties conceded that Stern v. Marshall does not permit the bankruptcy judge to enter a final judgment by himself.
Once the judgment in Cohen’s case traverses the district court, the inevitable Second Circuit appeal will set a precedent, one way or the other, governing almost 400 other lawsuits with hundreds of defendants.
Cohen did not concede liability. Although he mounted a vigorous defense, Judge Bernstein said that his “defenses amount to a challenge to prior rulings by the District Court and the [Bankruptcy] Court regarding the scope of the value defense under Section 548(c).” He said that Cohen’s arguments have “been litigated and expressly or implicitly rejected in four previous opinions.” Judge Bernstein said that his April 25 opinion became the fifth to reject the defense claiming that fictitious profits represent value to defeat a fraudulent transfer claim.
Given the precedent to result from the Cohen case, lawyers for defendants in 57 other suits filed motions to intervene or participate as amicus curiae. In a companion decision also on April 25, Judge Bernstein did not permit intervention, nor did he allow the similarly situated defendants to become amicus curiae.
Judge Bernstein concluded that the other defendants were not entitled to intervene, even though the issues are the same and stare decisis will effectively preclude them from relitigating the legal principles. He denied them amicus status because they would not provide “neutral assistance on the issue.”
Affirmed in the Second Circuit, District Judge Rakoff held that the safe harbor for securities transactions under Section 546(e) prohibits the Madoff trustee from suing to recover fictitious profits taken out more than two years before bankruptcy, unless the customer had actual knowledge of the fraud.