Helen Chaitman of Becker & Poliakoff represents more than 300 investors who had accounts with Bernard Madoff. For more than two years she’s hammered away at one particular argument in federal bankruptcy court, in Congress, even on YouTube: Madoff bankruptcy trustee Irving Picard of Baker & Hostetler shouldn’t be allowed to demand the return of profits that Madoff investors pulled out of their accounts as long ago as 2002, six years before the Ponzi scheme imploded in December 2008. On Tuesday night, Chaitman finally found vindication, even though it wasn’t in any of her cases. Manhattan federal judge Jed Rakoff, ruling in Picard’s fraud case against the owners of the New York Mets, concluded that a section of the federal bankruptcy code precludes Picard from attempting to claw back money Madoff investors pulled out of the Ponzi scheme before 2006.
“This is something I’ve been saying from the beginning,” Chaitman told me. “Anyone who didn’t withdraw their money in the last two years [of Madoff's scheme] is out completely.” Jonathan Landers of Milberg, who represents 30 clawback clients, agreed: “This is a very, very significant ruling.”
That’s putting it mildly. Judge Rakoff’s 18-page ruling could completely upend the Madoff bankruptcy. Among the big-name Madoff investors who would be off Picard’s hook completely if Rakoff’s ruling stands is former Securities and Exchange Commission general counsel David Becker, who’s in hot water for allegedly failing to alert SEC commissioners of a potential conflict of interest stemming from his parents’ long-closed Madoff account. Picard had filed a clawback suit against Becker, who inherited money after his parents’ account was liquidated in 2002; Rakoff’s ruling would wipe out Picard’s suit.
Other big winners from Rakoff’s ruling could be Madoff’s surviving children, who would still face a $58.7 million clawback claim for their two-year withdrawals but not claims on another $83.3 million they withdrew between 2002 and 2006, according to Picard’s 2009 complaint. Bank Medici founder Sonja Kohn’s clawback exposure would be reduced from $38.8 million to $11.2 million. Madoff’s early alleged enablers Frank Avellino and Michael Bienes would be looking at $17.2 million in clawback claims, not $56 million. Hard luck Madoff investor Melvyn Weiss, the onetime securities class action kingpin who was convicted for paying kickbacks to name plaintiffs, won’t see much relief from Rakoff’s ruling. His two-year exposure is $17.5 million, only $2 million less than Picard’s six-year claim.
Under Rakoff’s ruling, Madoff mentor Jeffrey Picower’s clawback liability would have been slashed from $2.4 billion to a fraction of that amount. But according to Picower counsel William Zabel of Schulte Roth & Zabel, the reduction in Picower’s case is “irrelevant,” since his widow decided to return $7.2 billion to the Madoff estate to remove any taint from her foundation.
Picard has asserted a total of about $8 billion in clawback claims, seeking the return of fictitious profits withdrawn from Madoff Securities accounts. That total includes claims against the financial institutions, such as UBS, UniCredit, and HSBC that allegedly abetted Madoff’s fraud. If Judge Rakoff’s ruling stands, about $5 billion of those clawbacks would be disallowed because the money was withdrawn before 2006.
The decision is obviously a boon to the Mets owners and their lawyers at Davis Polk & Wardwell. The judge left standing only one of Picard’s fraud counts against the Mets, limiting the Madoff trustee’s potential recovery to no more than $386 million, rather than the nearly $1 billion in principal and profits Picard wanted. Moreover, for Picard to get his hands on any of the Mets owners’ principal, he will have to prove they were “willfully blind,” a prospect Judge Rakoff doesn’t seem to consider very likely. He said Picard’s evidence that the Mets owners deliberately ignored warnings of Madoff’s fraud was sufficient to get past the Mets’ motion to dismiss but still “less than overwhelming.”
That’s only the beginning of this ruling’s story, though. Judge Rakoff has offered an interpretation of the intersection of bankruptcy and securities laws that could extend well beyond the Madoff bankruptcy. Bankruptcy lawyers are just beginning to parse the decision, but there’s no doubt that if it stands, it could have profound implications for bankruptcy trustees trying to recover money for defrauded investors.
Rakoff’s ruling is based on a provision of the federal bankruptcy code that offers a so-called “safe harbor” in cases involving stock brokerages and securities contracts. The provision restricts a bankruptcy trustee’s ability to undo securities transactions except in cases of actual fraud. The intent of the provision was to quell market chaos, putting a two-year time limit on a trustee’s attempts to go after counterparties in stock deals. The safe harbor cuts out fraudulent conveyance claims based on state laws, which often have longer time frames. (New York, for instance, has a six-year statute of limitations on fraud, which is the source of Picard’s assertion that he can recover fictitious profits dating back six years.)
In the Madoff Chapter 11, Manhattan bankruptcy court judge Burton Lifland ruled that the safe harbor provision doesn’t apply in the Madoff case. Federal appeals courts have found that the provision does not apply to Ponzi schemes, and Manhattan federal court senior judge Kimba Wood recently ruled, albeit indirectly, that the safe harbor doesn’t come into play in the Madoff case.
Judge Rakoff, however, found it does. He concluded that under a June 2011 ruling by the U.S. Court of Appeals for the Second Circuit, in a case involving a trustee’s attempt to recover money from a redemption of Enron debt, he must look at the plain language of the safe harbor provision. And under a strict reading of the law, he said, Madoff investors are shielded from fraudulent conveyance claims except in instances of actual fraud. “Because Madoff Securities was a registered stock brokerage firm,” the judge wrote. “The liabilities of customers like [the Mets owners] are subject to the ‘safe harbor’ provision.” Madoff’s contracts with his customers, Judge Rakoff wrote, fell under the provision’s definition of a securities contract; and his customers’ withdrawals from their accounts constituted “settlement payments” or transfers “in connection with a securities contract” under the language of the law.
Rakoff expressly rejected arguments by Picard’s Baker & Hostetler lawyers that Congress did not intend the safe harbor to protect investors who cashed out fictitious profits, because seeking the return of their ill-gotten withdrawals would have no effect on the broader market. They also argued that Congress meant the law to protect only brokers, not investors. Judge Rakoff said that didn’t matter. “Resort to legislative history is inappropriate where, as here, the language of the statute is plain and controlling on its face,” he wrote.
Landers of Milberg said Rakoff’s interpretation was compelled by the Second Circuit’s Enron decision, which holds that “there’s no squirreling around with [the provision]-if it applies, it applies.”
Picard has no automatic right to appeal Judge Rakoff’s ruling, but must petition the judge to grant leave for an appeal. Spokeswoman Amanda Remus declined comment on the trustee’s plans.
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Interestingly, Judge Ramos is now presiding over the Ambac suit against EMC, Bear Stearns and JP Morgan. I wonder how his view of those defendants will be affected by having presided over their prior lawsuit with their insurers.