The Second Circuit upheld an injunction against a group of victims of the Bernard Madoff Ponzi scheme who attempted unsuccessfully for a third time to mount their own lawsuit against someone who had already settled with the trustee by paying $7.2 billion for facilitating the fraud.
In a per curiam opinion on June 27, the appeals court held that the victims’ lawsuit raising claims under Section 20(a) of the Securities Exchange Act of 1934 was “actually a disguised fraudulent transfer claim that is [enjoined because it] is derivative of the [Madoff] Trustee’s fraudulent transfer claim.”
Although the carefully reasoned opinion is 12 single-spaced pages in length, the three-judge panel labeled the decision as nonprecedential. Nonetheless, the opinion stands for the important principle that creditors on their own cannot sue based on facts that caused damage to all creditors alike, even when the creditors base their suit on a theory of liability not available to the trustee.
The Proceedings Below
After Madoff could no longer perpetuate his $17.5 billion fraud, the district court appointed a trustee in December 2008 to liquidate the firm under the Securities Investor Protection Act. Since then, the trustee’s single-largest recovery has been a $7.2 billion settlement in 2011 paid by the estate of the late Jeffry Picower, to resolve fraudulent transfer claims. The trustee had alleged, in substance, that Picower knew about the fraud all along and withdrew funds from his Madoff account that had been stolen from other customers.
To ensure that the Picower parties would not end up paying creditors a second time, the 2011 settlement agreement enjoined anyone from bringing suits that were “derivative of” claims the trustee brought “or which could have been brought” by the Madoff trustee. On appeal, the Second Circuit upheld the settlement and the injunction.
Subsequently, a group of Madoff victims unsuccessfully attempted on three occasions to “plead around” the settlement injunction and sue Picower on their own. On the first attempt, the bankruptcy court enjoined the victims’ suit and was upheld in district court. They did not appeal to the circuit. The victims decided to file a third complaint rather than appeal when they were enjoined a second time by the bankruptcy court. The third complaint was the subject of the Second Circuit’s June 27 opinion.
In February 2016, Bankruptcy Judge Stuart M. Bernstein of Manhattan enjoined the victims from prosecuting the third complaint they had filed in district court in Florida raising claims under Section 20(a) of the Securities Exchange Act of 1934 based on allegations that Picower was a “control person” of Madoff’s brokerage. The theory for evading the injunction rested in part on the Madoff trustee’s concession that he did not have standing to bring Section 20(a) claims.
The victims contended that Section 20(a) expressly gave them their own claims to sue for violation of securities laws. Under Section 20(a), someone who controls an entity that violates securities laws is “jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable . . . .”
Leading to the instant appeal, District Judge Gregory H. Woods upheld Judge Bernstein’s injunction in January 2017. To read ABI’s reports on the decisions in the bankruptcy court and district court, click here and here.
The Second Circuit Appeal
The victims’ new lawsuit in Florida attempted to evade the injunction by pleading two additional facts intended to show that Picower was a person in control of the Madoff firm, thus allegedly giving them claims against Picower and his estate under Section 20(a) that the trustee could not bring.
They alleged that Picower made two loans totaling $200 million to prop up Madoff and avoid having the fraud disclosed earlier. Second, they alleged that Picower allowed himself to be listed as the counterparty in fictitious options trades, to avoid having regulators discover the fraud.
Although labeled as Section 20(a) claims, the Madoff trustee successfully contended in the lower courts that the claims were nonetheless derivative of his fraudulent transfer claims.
Affirming the lower courts, the circuit court held that the allegations in the new complaint “do not give rise to a colorable claim that Picower controlled [the Madoff firm],” because the allegations fell short of showing control.
Even if Picower propped up Madoff, “these allegations demonstrate no control over the ‘management and policies’ of [the Madoff firm],” the appeals court said, because “it is not reasonable to infer that Picower had that kind of influence merely because he could have caused [the Madoff fraud] to collapse earlier than it did.”
Allegations fared no better regarding the dissemination of false information about fictional options trading. According to the appeals court, “these allegations demonstrate only Picower’s understanding that his participation would result in the dissemination of false information, not that he actually directed the . . . dissemination of false information.”
“Ultimately,” the appeals court said, “the ‘control’ allegations . . . amount to nothing more than an attempt to ‘plead around’ the injunction” and do “not assert a colorable Section 20(a) claim.”
Looking beyond the labels, the appeals court said that the “only harm alleged” in the third complaint was, “as in the preceding complaints, for fraudulent transfer of assets from the estate.” Therefore, the new complaint was “a derivative claim, which is barred by the injunction.”
The last two pages of the opinion are devoted to distinguishing Picard v. JPMorgan Chase & Co. (In re Bernard L. Madoff Investment Securities LLC), 721 F.3d 54 (2d Cir. 2013), where the Second Circuit held that the trustee did not have standing to sue financial institutions allegedly responsible for assisting Madoff in his fraud.
First, the appeals court said that JPMorgan did not involve Section 20(a) claims. Second, the circuit court said that the alleged actions in JPMorgan did not harm all Madoff customers in the same way. The claims in JPMorgan therefore “belonged to injured customers,” not to the estate, the circuit said.