Rakoff Order Wilpon Motion to Dismiss (N0002771)

8/4/2019 Rakoff Order Wilpon Motion to Dismiss (N0002771)

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Amended Complaint seeks to recover over a b i l l i o n d o l l a r s from thedefendan ts on theor ies of ac tu a l f raud, cons t ruc t ive f raud,pre f e r e n t i a l t r ans r , and th e l i ke , i n v i o l a t i o n of var iousprovis ions of f edera l bankruptcy law and New York Sta te debtor andc re d i t o r law. For the fo l lowing reasons, the Cour t dismisses a l lclaims except those a l l eg in g ac tu a l f raud and equ i tab le subordina t ionand narrows the s tandard fo r recovery under th e remaining c la ims.

Although t h i s l awsui t ra i ses impor tant and in some r espec t sunse t t l ed i s sues of the i n t e r a c t i o n o f s e c ur i t s law with bankruptcylaw, given the publ ic i n t e r e s t in t h i s case it i s wel l to begin withth e bas ics . A deb tor with a s se t s l e s s than i t s o b l ig a t i o n s i sconsidered i n so lven t in the eyes of the law and may apply fo r , o r beforced in to , bankruptcy. See gene ra l ly , Bankruptcy Code, 11 U.S.C. 101 e t seq. Issues then a r i s e regarding whether p r i o r payments madeby the deb to r can be, e f f e c t , resc inded - o r , in the language ofbankruptcy law, "avoided" and the money re tu rned ("clawed back") toth e bankrup t ' s e s t a t e , from where it can be d i s t r i bu t e d amongcred i to rs in accordance with l ega l and equ i tab le pr inc ip les ofbankruptcy law.

Some of the avoided payments may take the form of"prefe rences ." I f , p r i o r to the bankruptcy f i l i ng , the bankruptt r a n s fe r s some o r a l l of i t s remaining a s se t s to some of i t s c re d i t o r sin prefe rence to th e o th e r c re d i t o r s , t h i s t r a ns f e r , known as a2

Case 1:11-cv-03605-JSR Document 40 Filed 09/27/11 Page 2 of 18


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"prefe rence ," may be "avoided" - regardless of th e fac va l i d i t y ofthe t r ans fe r o r the i n t e n t of th e pa r t to the t r a ns f e r - i f itoccurred within 90 days of th e f i l i ng bankruptcy . 11 U.S.C. 547(b) . The idea t h a t , while an ongoing business may f ree lydec which of i t s cred i to rs to pay f t , an i n so lven t businesscannot be al lowed to deple te i t s remaining asse t s in favor of onec re d i t o r over ano ther .

Other avoided payments may take the form of " f raudu len tt r ans fe r s . " For example, i f an i n so lven t deb tor i n t e n t iona l lyto defraud h is c re d i t o r s - as when a deb tor who has a huge judgmentf i l ed aga ins t him i n t e n t i o n a l l y seeks to hinder recovery byt r a n s fe r r i n g a l l h i s a sse t s to a f r i end - th e t r a ns f e r can beavoided as an ac tua l ly f raudulent t r a ns f e r . 11 U.S.C. 548 (a) (1) (A). S t i l l o ther t r a n s fe r s can be avoided asf tconst ruct ively f raudu len t , " , as f raudulent e f f e c t , evenno t in i n t e n t . Thus, i f the i n so lven t deb tor , r egard les s oft r a n s fe r s h is remaining a s se t s to h i s f r i end i n re tu rn fo r p l a i n l yinadequate cons idera t ion , t h a t t r a ns f e r can be avoided as"cons t ruct ively f raudu len t . " 11 U.S.C. 548(a) (1) (B)

Under the Bankruptcy Code, f raudulent t r a ns f e r s (whether ac tua lo r cons t ruc t ) can be avoided i f they occurred within 2 years of thebankruptcy f i l i ng . 11 U.S.C. 548(a) (1) . But the Bankruptcy Codealso adopts these purposes the "appl icable [ s ta te] law," see 113



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U.S.C. 544(b) which means in t h i s case New York Debtor andCred i to r Law, under which f raudulent t r ans fe r s can be avoided i f theyoccurred within 6 years of the f i l i n g . See N.Y. C.P.L.R. 213(8) .

In the case of the bankruptcy of Madoff S ecu r i t s , however,these bas ic pr i p l es a re af fec ted by severa l spec ia l f ea tu res .Fi r s t , Madoff Secur i t i e s was a reg i s t e red s e c u r i t s brokerage f i rm, af ac t t h a t d i r e c t ly invokes ce r ta in "safe harbor" prov i s ions of theBankruptcy Code, permi t s the appointment of a SIPA Trustee , andi nd i r e c t ly impl ica tes c e r t a in i p l e s of the t i e s laws.Second, Madoff and Madoff Secur i t i e s were, a t 1 t imes here r e levan t ,engaged in the s p ec i a l kind of f raud known as a "Ponzi scheme," bywhich customers of Madoff Secur s , who were led to be l i eve t h a tt h e i r monies were being inves ted in pro f i t a b l e s e c ur i t i e st r ansac t ions , were paid the p r o f i t s from new monies rece ived fromcustomers , without any ac tu a l s e c ur i t i e s t r ades t ak ing p lace .

Because Madoff Secur i t i e s was a r e g i s t e r e d stockbrokeragefirm, the l i a b i l i t i e s of customers l ike th e fendants here a resub jec t to the "safe harbor" s e t fo r th in sec t ion 546(e) of theBankruptcy Code. "By re ing a bankruptcy t r u s t e e ' s power torecover payments t ha t a re otherwise avoidable under the BankruptcyCode, the safe harbor s tands ' a t th e i n t e r s e c t ion of two impor tan tna t iona l l e g i s l a t i ve p o l i c i e s on a c o l l i s i on course - the po l i c i e s ofbankruptcy and s e c ur i t l aw. ' " In re Enron Cred i to r s Recovery4



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Corp. , F.3d , 2011 WL 2536101 (2d Cir . June 28, 2011) a t *5(quoting In Re Resor ts I n t ' l , Inc . , 181 F.3d 50S, 515 (3 d Cir . 1999) ) .Spec i f i ca l ly , sec t ion 546(e) of the Bankruptcy Code provides t ha t" [n]o twi ths tanding sec t ions 544 , 545 , 547, 548(a) (1) (B) and 548(b) oft h i s title [ i . e . , a l l the sec t ions deal ing with pre fe rences andconst ruc t ive f raud under the Bankruptcy Code and, by reference , a l lapp l icab le sec t ions of New York Sta te law] , the t r u s t ee may not avoida t r ans f e r t ha t i s a . se t t lement payment, as def ined i n sec t ion

. 741 of t h i s t i t l e , made by o r (or fo r the be ne f i t of) a .s tockbroker o r t ha t i s a t r ans fe r made by or (or fo r thebe ne f i t of) a . s tockbroker , in connec t ion wi th a secu r i t i e scon t r ac t , as def ined in sec t ion 741(7) . . except under sec t ion548(a) (1) (A) of t h i s title [deal ing with ac tua l f raud] ." 11 U.S.C 546(e) (emphasis suppl ied) . Sect ion 741(7) def ines a " s ecu r i t i e s

contractU as a "contrac t for the purchase , sa l e , o r loan of asecur i ty , " which i s the kind o f con t r ac t Madoff Se c ur i t i e s had withi t s customers . Sect ion 741(8) def ines " se t t l emen t payment" as "aprel iminary se t t l emen t payment, a p a r t i a l se t t l emen t payment, anin ter im se t t lement payment, a se t t lement payment on account , a f ina lse t t l emen t payment, o r any o t h e r s i m i l a r payment commonly used in th es ecu r i t i e s t r ade" an "extremely broad" de f in i t i on , see Enron, 2011WL 2536101 a t *5 (col lec t ing cases ) , which c l ea r ly inc ludes a l lpayments made by Madoff Secur i t i e s to i t s customers . Furthermore, any5



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payment by Madoff Secur i t i e s to i t s cus tomers t ha t somehow does notqua l i fy as a " se t t l emen t payment" qua l i f i e s as a " t rans fe r" made " inconnect ion with a secu r i t i e s cont rac t . " By s l i t e r a l l anguage,the re fo re , the Bankruptcy Code precludes the Trus tee from br inging anyac t ion to recover from any of Madoff 's cus tomers any of the moniespa id by Madoff Secur i t i e s to those customers except in the case ofac tua l f raud.

Notwiths tanding the p la in language of sec t ion 546(e) , theTrustee argues t ha t it should not be appl ied here , because doing sowould (supposedly) not accord wi th the s t a t u t e ' s purpose . Congressenacted 546(e) " to minimize the displacement caused in thecommodities and secu r i t i e s markets in the event of a major bankruptcya f fec t ing those indus t r i es . " In re Manhattan Inv. Fund Ltd . , 310 B.R.500, 513 (Bankr. S.D.N.Y. 2002) (quot ing H.R. Rep. No. 97-420 (1982),r ep r in ted in 1982 U.S.C.C.A.N. 583, 583) . Although the Trus tee arguest ha t avoiding Madoff Secur i t s ' t r ans f e r s to cus tomers cannot causethe "displacement" t ha t 546(e) aims to prevent , t h i s seems a tvar iance with h is own Amended Complaint , which a l l eges t ha t the Madofff raud involved approximate ly $68 b i l l i o n and 4,900 customers .Amended Complaint 39. As in Enron, t h i s Court sees "no reason toth ink t ha t undoing" such la rge t r ans f e r s involving so many customers

...

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from so long ago as 2002 "would not a l so have a s ubs t an t i a l ands imi l a r ly negat ive e f fec t on the f inanc ia l markets ." Enron, 2011 WL2536101 a t *9.

In any event , r e s o r t to l e g i s l a t i v e his to ry i s inappropr ia tewhere, as here , the language of the s t a t u t e i s pla in and cont ro l l i ngon i t s face . "[C]ourts must presume t ha t a l eg i s l a tu re says in as t a tu te what it means and means in a s t a t u t e what it says t he re . "Conn. N a t ' l Bank v. Germain, 503 U.S. 249, 253 54 (1992) . Indeed, todev ia t e from what Congress has c l ea r ly and cons t i t u t i ona l l y decreed i sa power the j ud ic i a ry does no t possess . See Lamie v. U.S. Trus tee ,540 U.S. 526, 534 (2004) . Thus, here , as in Enron, the re i s ne i the r aneed nor a bas i s " to address . . arguments regard ing [the]l eg i s l a t ive h i s t o ry [of 546(e)] Enron, 2011 WL 2536101 a t *9. 3II

3 While the Trus tee a lso argues the sec t ion 546(e) was designed to pro t e c t only s tockbrokers , no t customers, t h i s , aga in , i s nowhere ind ica ted on the face of the s t a t u t e . From the s t andpo in t of Madoff Secur i t i e s ' customers (except fo r any who were ac tua l pa r t i c ipan t s in the f raud) , the se t t l emen t payments made to them by Madoff Se c ur i t i e s were en t i r e ly bona f ide , and they the re fo re are fu l ly en t i t l ed to invoke the pro tec t ions of sec t ion 546(e) . Indeed, were it otherwise , the very uncer ta in ty t h a t the Trus tee says the s t a t u t e was designed to obvia te would pr eva i l . In any event , there i s no reason to ignore the breadth of the s t a tu to r y language. Sect ion 546(e) has been r ev i s i t ed by Congress on numerous occas ions , as r ecen t ly as 2006, when it was amended to i t s presen t wording. Financ ia l Net t ing Improvements Act of 2006, Pub. L. No. 109-390, 5, 120 Sta t . 2692, 2697-98 (2006) ( inse r t ing "o r fo r the be ne f i t of" and " in connect ion with a

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Accordingly, the cour t gran t s defendants ' motion todismiss a l l cla ims pred ica ted on p r i n c i p l e s o f prefe rence o rcons t ruc t ive f raud under the Bankruptcy Code, as wel l as a l l cla imsunder New York law, c o l l e c t i ve ly corresponding to Counts 2 through 9of the Amended Complaint .

This leaves, pr inc ipa l ly , the Trus tee ' s claim fo r ac tua l fraudunder 548(a) (1) (A) of the Bankruptcy Code (Count 1 of the AmendedC o m p l a i n t ) . ~ Sect ion 548(a) (1) (A) permits the Trustee to avoid anypayment made by Madoff Secur i t i e s to s customers within two ofthe f i l i ng of the bankruptcy pe t i t i on i f the debtor (MadoffSecur i t i e s ) "made such t r a ns f e r with ac tua l i n t e n t to hinder ,de lay , o r def raud any en t i t y to which the debtor was o r became .indebted." Since it i s undisputed t ha t Madoff 's Ponzi scheme beganmore than two years before the f i l i ng of the bankruptcy pe t i t i on andcontinued to almost the very day of f i l i ng , it i s pa ten t t ha t a l l o fMadoff Secur i t i e s ' t r ans fe r s dur ing the two-year per iod were made with

s e c ur i t i e s con t rac t , " and thereby broadening the s t a t u t e ' s app l i ca t ion ) . I f Congress d id not mean it to be taken l i t e r a l ly , Congress had ample oppor tuni ty to narrow o r a l t e r the wording, but Congress chose no t to . 4 The Trus tee ' s o ther two cla ims no t barred by sec t ion 546(e) , for disa l lowance and subordina t ion of the defendants ' own cla ims (Counts 10 and 11 of the Amended Complaint) , a re discussed below.

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ac tu a l i n t e n t to defraud presen t and fu tu re c re d i to r s , i.e., thosel e f t holding th e bag when th e scheme was uncovered. s Nonetheless ,subsec t ion (c l of sec t ion 548 provides t h a t "a t rans fe ree o r obl igeeof such a t r a ns f e r o r ob l iga t ion t ha t t akes fo r value and in goodfa i th . . may r e t a in such any i n t e r e s t t r a n s fe r r e d o r may enforceany ob l iga t ion incurred , as the case may be , to th e ex ten t t ha t sucht r ans fe ree o r obl igee gave va lue to the deb to r in exchange fo r sucht r a ns f e r o r ob l iga t ion . " 11 U. S. C. 548 (c ) (emphasis supp l i ed ) . I ti s c l e a r tha t the p r i n c i p a l inves ted by any of Madoff 's customers"gave value to the debtor ," and the re fo re may not be recovered by theTrustee absent bad f a i t h . As fo r t r a n s fe r s made by Madoff Secur i t i e sto i t s customers in excess of the customers ' p r i n c i p a l - t h a t i s , thecustomers ' p r o f i t s - these were in excess of the "ex ten t" to which thecustomers gave value, and hence, if adequately proven, may berecovered r egard les s of the customers ' good f a i t h .

5 On the fac t s of t h i s case as a l leged in th e Amended Complaint (which fo r purposes of t h i s motion must be taken as t r ue ) , the re i s therefore no need to invoke any "Ponzi scheme presump tion ." = = ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ - = = = ~ ~ ~ = = f 487 F.3d 295, 301 (5 th Cir . 2007) ("In t h i s c i r c u i t , proving t ha t IERC opera ted as a Ponzi scheme es tab l i shes the f raudu len t i n t e n t behind the t r a n s fe r s it made.") ; In re Agric . Research & Tech. Grp. , 91 6 F.2d 528, 53 5 (9th Cir . 1990) (" [T]he deb to r ' s ac tu a l i n t e n t to hinder , delay o r defraud i t s c re d i t o r s may be i n fe r red from th e mere exis tence of a Ponzi scheme .") .

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The defendants a t tempt to r e s i s t t h i s t e r conclusion,arguing tha t , as long as they ac ted in good f a i t h , t h e i r p r o f i t s , asre f lec ted in Madoff Secur i t i e s ' monthly s ta tements to them purpor t ingto r e f l e c t ac tu a l s e c ur i t i e s t r ades , were l ega l ly binding ob l iga t ionsof Madoff Secur i t i e s , so t ha t any payments of those p r o f i t s tocustomers were simply discharges of an tecedent debts . In t h i s regard,the defendants re ly heavi ly on In re Sharp Int'l Corp. , which heldt ha t a "conveyance which s a t i s f i e s an antecedent debt made while thedeb tor i s insolvent i s ne i the r f raudulent nor otherwise improper, eveni f i t s e f f e c t i s to pre one c re d i to r over another ." 403 F.3d 43,54 (2d Cir . 2005) (quot ing Ul t ramar Energy Ltd. v . Chase ManhattanBank, N.A., 191 A.D.2d 86, 90-91 (1s t Dep' t 1993) ) . Sharp, however,did no t apply th i s hold ing to ac tua l ly f raudulent t r a ns f e r s . Ins tead ,it found t h a t the a t t empts to avoid ac tua l ly f raudu len t t r ans fe r sfa i led " for the independent reason t ha t Sharp inadequa te ly a l lege[d]f raud." Id . a t 56. Here, the a l l ega t ions of the Amended Complaintc lea r ly make out a cla im t ha t a l l of the t r a ns f e r s made by MadoffSecur i t i e s the two years p r i o r to the f i l i ng of the bankruptcype t i t i on were made with the i n t e n t on the pa r t of Madoff S ecu r i t s to"hinder , de lay, o r defraud" pas t and fu ture customers, so t ha t a primafac ie case of ac tu a l fraud under sec t ion 548(a) (1) (A) has been

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adequately pled . Whether, in these ci rcumstances , defendants canava i l themselves of the af f i rmat ive defense of taking fo r value and in good fa i th under sec t ion 548(c) i s in no way con t ro l l ed by Sharp. See, e . g . , In re Manhattan Inv. Fund Ltd . , 397 B.R. 1, 11 (S.D.N.Y. 2007) ("At most , [Sharp] s imply means t h a t cour ts must be sure t ha t the t r ans fe r s sought to be avoided a re r e l a t e d to the [Ponzi] scheme.") .

In o ther words, while , as to payments rece ived by thedefendants from Madoff Secur i t i e s equal to a re tu rn of t h e i r p r i n c i p a ldefendants can defea t the Trus tee ' s claim of ac tua l f raud simply byproving t h e i r good f a i t h , as to payments rece ived by the defendants inexcess of t h e i r p r i n c i p a l defendants can defea t the Trus tee ' s claim ofac tu a l f raud only by showing t ha t they not only were proceeding ingood fa i th but a l so t h a t they took fo r value . 6

6 Although, given the d i f f i cu l ty defendants w i l l have in e s t ab l i sh ing t ha t they took t he i r ne t p r o f i t s fo r value, the Trustee might wel l preva i l on summary judgment seeking recovery of the pro f i t s , how to determine which p r o f i t s the Trustee can recover remains an open ques t ion . Spec i f i ca l ly , the Court does not resolve on t h i s motion whether the Trustee can avoid as p r o f i t s only what defendants rece ived in excess o f t h e i r investment during the two year look back pe r iod spec i f i ed by sec t ion 548 or ins tead the excess they rece ived over the course of t h e i r investment with Madoff. According to the Amended Complaint, defendan t s ' pro f i t s amounted to $83,309,162 in the two years preceding the bankruptcy and $295,465,565 over the course of t he i r investment . Amended Complaint 1105, 1108.

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It remains only to def ine what i s meant by lack o f "goodfa i th" in t h i s context . Both s ides agree t ha t i f the defendants hadac tua l knowledge of Madoff 's scheme, it would c ons t i t u t e lack of goodf a i t h . But even th e Trus tee does not appear to under take th e dubioustask of p laus ib ly pleading t ha t th e defendants knowingly inves ted in aPonzi scheme. Both s ides a l so agree, however, t ha t i f the defendantsw i l l fu l l y bl inded themselves to th e fac t t h a t Madoff Secur i t i e s wasinvolved in some kind o f f raud, th i s too might , depending on th efac t s , cons t i tu t e a l ack o f good fa i th .? The Amended Complaintp la in ly advances t h i s theory of w i l l fu l bl indness . See, e . g . , AmendedComplaint 9 ("Given St e r l i ng ' s dependency on Madoff, it comes as nosu rp r i s e t ha t the St e r l i n g par tner s wi l l fu l l y turned a b l ind eye toevery ob jec t ive i nd ic i a of f raud before them.") . But why woulddefendants w i l l f u l b l ind themselves to the f a c t t h a t they hadinves ted in a f raudulent en te rp r i s e? The Amended Complaint a l l eges ,in e f f e c t , t ha t it was because they f e l t they could r e a l i z esu b s t a n t i a l shor t - te rm pro f i t s while pro tec t ing themselves aga ins t th e

7 For th e purposes of t h i s motion, bu t no t necessa r i ly otherwise, the Cour t f inds , based on th e a l l ega t ions of the Amended Complaint a t , 659, 853-864, t ha t the defendan t s ' inves tment dec is ions were su f f i c i en t l y coord ina ted t ha t th e i n t e n t of t h e i r common veh ic le , St e r l i n g Equi t i e s , and i t s p r i n c i p a l s , can be imputed to the o th e r defendants . See Baker v. Latham Sparrowbush Assocs. , 72 F.3d 246, 255 (2d Cir . 1995) i SEC v. Manor Nursing Ctrs . ( Inc . , 458 F.2d 1082, 1089 n .3 (2d Cir . 1972).

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long-term r i s k . Although defendants vehemently deny theseaccusa t ions , 8 the Amended Complaint, while ss than overwhelming inth i s regard , pleads s u f f i c i e n t a l l ega t ions to survive a motion todismiss so fa r as t h i s claim of w i l l f u l bl indness i s concerned. See,

, Amended Complaint 702-710, 941-948 (defendants se r ious lycons idered purchas ing f raud insurance wi th respect to theinvestments in Madoff Secur i t s and crea ted t h e i r own hedge fund in2002 a t l ea s t pa r t l y to l im i t the exposure in Madoff Se c ur i t i e s ) .

Perhaps recognizing the problems with t h i s approach, however,the Trus tee f a l l s back on arguing tha t , a l t e rna t ive ly , defendants wereon " inqui ry not ice H of the f raud but fa i led to d i l i gen t l y i nves t iga teMadoff Secur i t i e s and t ha t s a l so cons t i tu te s l ack of good f a i t h .See In re Manhattan Inv. Fund Ltd . , 397 B.R. 11 22-23 (S.D.N.Y. 2007)Defendants fo r t h e i r par t s t renuous ly con tes t t ha t t h i s theory i sappl icable in the i n s t a n t s e t t i ng .

The d i f fe rence between the i nqu i ry no t ice approach and thew i l l fu l bl indness approach i s e s s e n t i a l l y the d i f fe rence between anobject ive s tandard and a sub jec t ive s tandard . Under the former

8 The de t a i l s of these den ia l s a re l a rge ly se t for th as p a r t ofdefendants 1 reques t t ha t the Court conver t t h e i r motion to dismissin to a motion fo r summary judgment. Finding t ha t the Trus tee hasmade a reasonable argument t ha t he i s en t i t l ed to fu r t h e rdiscovery before a motion fo r summary judgment i s fu l l y r ipe thecour t dec l defendants 1 i nv i t a t i on to conver t .

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approach, a t rans fe ree has inqui ry not ice when the " informat ion [ thet ransferee] learned would have caused a reasonable [person] in [thet rans fe ree ' s ] pos i t ion ' t o i nves t iga te th e mat te r fu r the r . '"Manhattan, 39 7 B.R. a t 23 (quoting N a t ' l W. Life Ins . Co. v. M er r i l lLynch, Pierce , Fenner & Smith, In c . , 89 Fed. App'x 287, 291 (2 d Cir .2004 . In such circumstances, a f a i l u r e to fu r the r inves t iga tecons t i tu t es lack of good fa i th unless even d i l i nqu i ry would nothave unear thed the fraud. See In re Agric . Res. & Tech Grp. , 916 F.2d528, 536 (9th Cir . 1990).

Although t h i s approach i s not wi thout some preceden t inordinary bankruptc ies , it has much l e s s a pp l i c a b i l i t y , th e Courtconcludes , in a context of a SIPA t rus t eesh ip , where bankruptcy law i sinformed by f edera l s e c ur i t s law. Ju s t as f raud, in th e context off edera l t i e s law, demands proof of sc , so too "good f th"in th i s context impl ies a lack of f raudulent i n t e n t . See Erns t &Erns t v. Hochfelder , 425 U.S. 185, 21 5 (1976) (holding t ha t screquires "proof of more than neg l igen t nonfeasance") . A s e c ur i t i e sinves to r has no i nhe ren t duty to inquire about h is s tockbroker , andSIPA crea tes no such duty . See genera l ly In re New Times Sec. Servs . ,371 F.3d 68, 87 (2d Cir . 2004). I f an t o r , nonethe less ,i n t en t iona l ly chooses to b l ind himse l f to the "red f lags" t ha t sugges ta high probab i l i ty of f raud, h is "wi l l fu l bl indness" to th e t r u th i s

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tantamount to a lack of good f a i t h . See United Sta tes v. Rodriguez,983 F.2d 455, 45 8 (2d Cir . 1993) ("conscious avoidance ," ano ther termfo r w i l l fu l bl indness , means " t h a t th e defendant was aware a highprobab i l i ty of the fac t in di spu te and consc ious ly avoided conf irmingtha t f ac t" ) . But i f , simply confronted with suspic ious circumstances,he f a i l s to launch an i nves t iga t ion of h i s b roker ' s i n t e rna l p ra c t i c e s- and how could he do so anyway? h is lack of due d i l igence cannot beequated with a l ack of good fa i th , a t l e a s t so fa r as sect ion 548(c)i s concerned as appl ied in th e context of a SIPA t r u s t e e sh i p .

In shor t , the Court concludes t ha t , as to the c of ac tua lf raud (Count I ) , the Trustee can recover defendants ' n e t p r o f i t s overthe tw o years pr i o r to bankruptcy simply by showing t ha t th edefendants led to provide value fo r those t r a ns f e r s , but theTrustee can recover the defendants ' re tu rn of p r i n c i p a l during t ha tsame per iod only by showing an absence of good f a i t h on defendants 'p a r t based on t he i r w i l l f u l bl indness . 9

Turning to the remaining cla ims, the Trustee seeks to disa l lowthe defendan t s ' own cla ims made on Madoff Secur i t , es t a t e (Count10) or a t l eas t to equ i tab ly subordinate them to o ther customers '

9 While th e burden of s ing th e defense of good f a i t h i si n i t ly o n the defendants , the ques t ion of whether, once thedefendants have made a prima f ac ie showing of good f a i t h , theburden sh i f t s back to the Trustee to show lack of good f a i t h , i san i s sue t h a t need not be decided on t h i s motion.

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cla ims (Count 11). As to disa l lowance , here aga in the re i s a conf l i c tbetween the pol ic ie s of the bankruptcy laws in genera l and of thes ecur i t i e s laws, in t h i s case expressed through SIPA. Thus, whilesec t ion 502(d) of the Bankruptcy Code would suppor t d isa l lowance ofthe cla ims made aga ins t a bankruptcy es t a t e by a par ty who receivedt r an s fe r s t ha t were void o r voidab le , t h i s sec t ion i s overr idden inthe con tex t of a SIPA t rus t eesh ip by Sect ion 78ff f -2 of SIPA, whichprovides t ha t s ecur i t i e s customers who have received avoidablet r ans fe r s may still seek to pursue those t r ans f e r s as c red i t o r s of theSIPA es t a t e . 15 U.S.C. 78f f f -2 (c ) (3) . The po in t , once again, i s toprovide s t ab i l i t y in the s ecur i t i e s markets by impart ing a g rea t e rdegree of ce r ta in ty to s ecur i t i e s t ransac t ions than to o the r kinds oft ransac t ions . Accordingly, Count 10 must be dismissed.

I t does not fo l low, however, t h a t because a secu r i t i e scustomer pursu ing a l leged ly voidable cla ims i s not wholly barred frompursuing them in a SIPA l i qu ida t ion , the cla ims still s tand on thesame foot ing as a l l o ther claims. Under 5l0(c) of the BankruptcyCode, "the cour t may . under p r i nc ip l e s of equ i tab lesubordina t ion , subordinate fo r purposes of d i s t r i bu t i on a l l or pa r t ofan allowed claim./I Courts equi tably subordina te cla ims when thecla imant has "engaged in some type of inequ i tab le conduct" and the"misconduct must have resu l t ed in in jury to the c redi tor s of the

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bankrupt or conferred an u n fa i r advantage on the c la imant ." In reMobile Stee l Co., 56 3 F.2d 692, 700 (5th Cir . 1977). Inequi tableconduct "encompasses conduct t ha t may be l awful but i s never thelesscont ra ry to equi ty and good conscience." = = - = = - ~ = = = = = = ~ = = ~ , 343B.R. 444, 461 (Bankr. S.D.N.Y. 2006). Because the Amended Complaintadequate ly a l l eges t h a t the defendants d id no t rece ive f raudulentt r a n s fe r s in good f a i t h , it a l so adequately a l l eges t ha t they engagedin inequ i tab le conduct. Moreover, t h i s a l leged misconduct would havein ju red any inves to r s who inves ted Madoff Se c u r i t i e s based on theimpressive r e tu rns o ther s appeared to r ece ive . Thus, while th eTrustee cannot disa l low the defendants ' cla ims aga ins t the MadoffSecur i t i e s ' e s ta te , he can po te n t i a l l y subord ina te them by provingt ha t the defendants inves ted with Madoff Se c u r i t i e s with knowledge, orin r eck les s dis regard , of i t s fraud.

In summary, the Court hereby dismisses a l l Counts of theAmended Complaint except Counts 1 and 11. Under Count 1, the Trusteemay recover defendan t s ' ne t p r o f i t s simply by proving t ha t thedefendants did not provide va lue fo r the monies rece ived, bu t theTrustee may recover the re tu rn of the defendants ' p r i n c i p a l only byproving t ha t the defendants wil l fu l ly bl inded themselves to MadoffSecur i t i e s ' fraud. Final ly , the Trustee can subordina te the

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defendan t s ' own claims aga ins t th e e s t a t e only by making the sameshowing requi red under Count 1 o r i t s equ i tab le equ iva len t .

The p a r t i e s a re d i rec ted to appear in cour t tomorrow,September 28, 2011 a t 3:00 P.M. to s e t a schedule fo r a l l fu r the rproceedings r e l a t i ng to the remaining c la ims .

SO ORDERED.

Dated: New York, New YorkSeptember 27, 2011

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Documents

Rakoff Order Wilpon Motion to Dismiss (N0002771)