The chance that Bernard Madoff’s victims will ever get back all $17.5 billion they invested in his Ponzi scheme was left in doubt after arguments before the U.S. Court of Appeals in Manhattan over the scope of lawsuits to claw back money stolen from investors.
Irving Picard, the trustee unwinding Madoff’s investment firm in bankruptcy, is seeking court permission to sue “net winners” — customers who withdrew more than they invested with Madoff — as far back as six years before the Ponzi scheme collapsed.
The case turns on the so-called safe harbor in Section 546(e) of the Bankruptcy Code, which bars suits going back more than two years to recover payments made “in connection with a securities contract.” In the case on appeal, U.S. District Judge Jed Rakoff let the trustee go back only two years.
Picard told the appeals court Wednesday that the safe harbor shouldn’t apply because Madoff never bought a single security with his customers’ money. Instead, he used newly invested funds to pay off prior investors.
Investors who got their money out more than two years before the firm’s 2008 bankruptcy are relying in part on a 2-1 opinion from the same appeals court from June 2011, in Enron Creditors’ Recovery Trust v. Alfa SAV de CV, which said the safe harbor must be accorded “extremely broad” interpretation.
Speaking for the trustee, attorney David Sheehan of Baker & Hostetler LLP in New York argued that a different decision fixing the amount of Madoff claims should govern because that opinion, by the same appeals court, barred customers from relying on a fiction that there really were securities in their accounts.
One of the three judges on the panel Wednesday responded by saying the Bankruptcy Code isn’t exclusively about equity. The judge said sometimes there are “arbitrary rules” laid down by Congress in statutes.
The judges also asked Sheehan how they could depart from the statute when the customers’ contracts with Madoff were typical of securities contracts used by legitimate brokers.
One judge offered Picard and Sheehan a glimmer of hope by asking Richard Levy, the lead lawyer for the “net winners,” why someone should be able to keep millions of dollars more than was invested when the money was stolen from other customers.
Also giving Picard some hope, Circuit Judge Barrington D. Parker Jr. said the safe harbor is an exception to the general rule that money obtained from fraud must be given back whether the recipient knew there was fraud or not. Parker said courts should be “careful” when applying exceptions to general rules.
The judges also asked whether or how they could draw a line when, hypothetically, some securities actually were purchased and others were not.
On the whole, Sheehan faced tougher questions than the three lawyers who argued on behalf of “net winners.” Still, questions from the bench can’t be relied on to predict how a court will decide.
The judges didn’t say when they will rule.
So far, Picard has recovered about $9.8 billion, representing some 56 percent of principal that customers invested. Were he to win the appeal, the trustee could reinstate hundreds of lawsuits, leaving open the possibility of recovering enough money to return all customers the cash they invested.
The appeals court has already ruled that Madoff investors don’t have so-called customer claims for fictitious profits shown on their account statements.
Madoff’s firm began liquidating in December 2008 with the appointment of Picard as trustee under the Securities Investor Protection Act. Madoff individually went into an involuntary Chapter 7 liquidation in April 2009, and his case was later consolidated with the investment firm’s liquidation. He’s serving a 150-year prison sentence following a guilty plea.
The Madoff trustee’s appeal is Picard v. Ida Fishman Revocable Trust (In re Bernard L. Madoff Investment Securities LLC), 12-02557, U.S. Court of Appeals for the Second Circuit (Manhattan). The Madoff liquidation is Securities Investor Protection Corp. v. Bernard L. Madoff Investment Securities LLC, 08-bk-01789, U.S. Bankruptcy Court, Southern District of New York (Manhattan).