The trustee liquidating the Bernard Madoff Ponzi scheme under the Securities Investor Protection Act won a major victory in a test case in the Second Circuit. Among other things, the appeals court held that a Madoff customer who refused to return fictitious profits must pay 4% in prejudgment interest on judgments in favor of the trustee.
Because the lawsuits were filed some 12 years ago, defendants will be paying almost 50% more than the principal amount of the judgments.
The September 20 decision by Circuit Judge Rosemary S. Pooler agreed with the district court that there were no disputed issues of material fact and that the Madoff trustee was entitled to summary judgment mandating the return of fictitious profits received by customer within two years of bankruptcy.
The Second Circuit holds that customers are obliged to return two-year fictitious profits even if they were in good faith and were unaware that Madoff was a fraud. The profits were fictitious because the payments to customers were made with money stolen from other customers, not from trading profits.
Judge Pooler’s decision upholds a judgment in favor of the Madoff trustee for about $3 million, before prejudgment interest.
The $3 Million in Fictitious Profits
Madoff’s fraud was disclosed in 2008, followed quickly by a liquidation in the Manhattan Bankruptcy Court under the Securities Investor Protection Act, which incorporates large swaths of the Bankruptcy Code, including avoidance actions for the recovery of fraudulent transfers with “actual intent” under Section 548.
In litigations all the way to the Second Circuit, courts established years ago that customers were the recipients of fraudulent transfers with “actual intent” when Madoff had paid them more cash than the cash they had invested. Customers of this type are known as net winners. The cash they took out in excess of their cash investments is known as fictitious profits, because Madoff never bought a single share of stock with customers’ investments.
Under Second Circuit authority, customers branded as net winners are obliged to return fictitious profits received within two years of the Madoff bankruptcy, regardless of whether they knew there was fraud.
The Madoff trustee under SIPA filed about 120 adversary proceedings against customers who took fictitious profits from Ponzi scheme. In late 2010, the trustee sued a customer who had taken out almost $3 million in fictitious profits in the two years before bankruptcy.
The customer filed a motion to withdraw the reference from the bankruptcy court. The trustee consented to withdrawal and immediately filed a motion for summary judgment, to head off the customer’s plan to delay proceedings by waiting for a trial before a jury.
The customer’s strategy was thwarted when District Judge John G. Koeltl found no disputed issues of material fact and entered summary judgment in favor of the trustee for $2.925 million plus some $1.2 million in 4% prejudgment interest. See Picard v. JABA Assocs. LP, 528 F. Supp. 3d 219 (S.D.N.Y. March 24, 2021). The customer appealed to the Second Circuit, which heard argument in March.
No Disputed Facts
Hoping to overturn the grant of summary judgment, the customer mounted a creative but factually baseless argument. The customer argued that the transfers of fictitious profits came from Bernard Madoff personally and not from the limited liability corporation being liquidated under SIPA. Customers had advanced the same argument in other lawsuits but consistently lost.
The opinion by Circuit Judge Pooler is chock full of interesting rulings on evidence and hearsay, to divine whether the customer had uncovered material disputes of fact. She said that the “sparse evidence” advanced by the customer was “insufficient” to create disputed issues of fact.
The customer pointed to a district judge in another Madoff case who decided on the same facts that there were materially disputed facts. Judge Pooler said she “disagree[d]” with that district judge and upheld the finding by District Judge Koeltl “that the record did not raise a question of material fact.”
Prejudgment Interest
Having upheld the finding of liability for almost $3 million, Judge Pooler turned to the trustee’s entitlement to prejudgment interest.
The customer argued in the circuit that District Judge Koeltl’s award of 4% prejudgment interest was an abuse of discretion because they themselves were innocent victims of the fraud. The customer also contended that Section 548 does not explicitly allow prejudgment interest.
Judge Pooler said that the lack of a reference to interest in Section 548 was not dispositive. Instead, she applied Second Circuit authority for the imposition of prejudgment interest. To the idea that the customers were themselves victims, Judge Pooler said “that they have benefited from other customers’ stolen property and have not returned it for over a decade.”
Judge Pooler upheld prejudgment interest at 4%, the prime rate when the Madoff liquidation began in 2008. She said that the district court “properly balanced the equities,” given the trustee’s loss of use of the money and the customer’s profits “from having withheld the funds” from the trustee for 10 years.
The new Second Circuit opinion removes most of the defenses that customers could raise in other lawsuits and says that the trustee is entitled to summary judgment, without slogging through a trial before a jury.
The Concurrence
Circuit Judge Richard C. Wesley concurred in what he called Judge Pooler’s “fine opinion.” Usually, a concurrence reaches the same result on more narrow grounds, opening the door for rehearing en banc.
But not here. Judge Wesley would have affirmed on broader grounds, giving the customer fewer arguments to claim that the circuit opinion was in error.
Judge Pooler spent much of her opinion to decide that that there were no materially disputed facts regarding the Madoff LLC’s ownership of the bank accounts from which the transfers were made. For Judge Wesley, “it matters not,” he said.
To Judge Wesley, the ownership of the bank accounts did not matter because the money paid to the customers incontestably emanated from “customer property,” which a SIPA trustee is entitled to recover. Given Bernard Madoff’s control over disbursements, he said, “I respectfully concur.”
The trustee liquidating the Bernard Madoff Ponzi scheme under the Securities Investor Protection Act won a major victory in a test case in the Second Circuit. Among other things, the appeals court held that a Madoff customer who refused to return fictitious profits must pay 4% in prejudgment interest on judgments in favor of the trustee.
Because the lawsuits were filed some 12 years ago, defendants will be paying almost 50% more than the principal amount of the judgments.
The September 20 decision by Circuit Judge Rosemary S. Pooler agreed with the district court that there were no disputed issues of material fact and that the Madoff trustee was entitled to summary judgment mandating the return of fictitious profits received by customer within two years of bankruptcy.
The Second Circuit holds that customers are obliged to return two-year fictitious profits even if they were in good faith and were unaware that Madoff was a fraud. The profits were fictitious because the payments to customers were made with money stolen from other customers, not from trading profits.
Judge Pooler’s decision upholds a judgment in favor of the Madoff trustee for about $3 million, before prejudgment interest.