August 19, 2022

DealBook: In Shift to New Court, Risks for Madoff Trustee’s Case

Irving H. Picard, the court-appointed trustee in the Madoff fraud case.Shannon Stapleton/ReutersIrving H. Picard, the court-appointed trustee in the Madoff fraud case.

When it comes to the Madoff bankruptcy case, the venue matters.

Prominent lawsuits filed by Irving H. Picard, the trustee in the case, will be reviewed in Federal District Court rather than in United States Bankruptcy Court. It is an important shift, one that may result in the dismissal of some claims and limit the amount Mr. Picard can recover for investors.

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Mr. Picard is looking to recover billions of dollars from banks he has accused of aiding Bernard L. Madoff’s huge Ponzi scheme by turning a blind eye to the fraud. He is seeking $19.9 billion from JPMorgan Chase; $1 billion from the New York Mets owners Saul Katz and Fred Wilpon; $10 billion from HSBC; and nearly $60 billion from UniCredit and other banks affiliated with Sonja Kohn.

The bankruptcy court is viewed as a friendlier venue for Mr. Picard, not the least because it has sided with him on important issues regarding who can make claims as part of the liquidation.

The court adopted his approach in holding that those who withdrew more from their accounts than they invested — the so-called net winners — were subject to a lawsuit seeking to have them repay their profits while denying any claim for losses based on their final account statements. The net winners issue was appealed to the United States Court of Appeals for the Second Circuit, and a decision is expected in the near future.

Bernard L. Madoff, exiting federal court in New York City on March 10, 2009, has criticized the judge who sentenced him.Mario Tama/Getty ImagesBernard L. Madoff

Last week, the bankruptcy court again sided with Mr. Picard in holding that those who invested with Mr. Madoff indirectly through feeder funds were not “customers” under the law. Therefore, the court said, investors can only look to the feeder fund for compensation and are not eligible for a payment of up to $500,000 through the Securities Investor Protection Corporation. There is likely to be an appeal to the Second Circuit on that issue as well.

For some of Mr. Picard’s most important claims, Judge Jed S. Rakoff and Judge Colleen McMahon of United States District Court for the Southern District in Manhattan have temporarily withdrawn the cases from the bankruptcy court since they involve issues outside of bankruptcy law.

Here is a rundown of some of the issues the judges will decide, and their potential effect on Mr. Picard’s recovery efforts.

Sterling Equities
Mr. Picard is seeking $1 billion from Sterling Equities and dozens of other entities controlled by Mr. Katz and Mr. Wilpon, in what is called a “fraudulent conveyance” action, usually referred to as a clawback suit. The lawsuit seeks repayment of $300 million in fictitious profits the two withdrew and an additional $700 million because, the suit claims, they ignored red flags about the fraud.

On July 1, Judge Rakoff decided to withdraw the case from the bankruptcy court to rule on whether Mr. Katz and Mr. Wilpon bear any responsibility for allowing the Ponzi scheme to continue. Under fraudulent conveyance law, the responsibility is based on whether there were “badges of fraud,” which can include circumstantial evidence to infer fraudulent intent. That is a fairly low threshold that would make it much easier for Mr. Picard to establish liability against Mr. Katz and Mr. Wilpon.

Judge Rakoff, however, questioned whether that was the proper standard. In a Bloomberg News article, the judge asked: “How can it be that the law governing someone’s duty to inquire is determined, not by what the governing laws in place were at the time, but by the happenstance that the entity later went into bankruptcy?”

Under federal securities law, proving fraud requires establishing “scienter,” which means intent or at least recklessness. One means of establishing intent is through what is known as “willful blindness,” that a person deliberately ignored signs of misconduct.

The Supreme Court recently explained in Global-Tech Appliances Inc. v. SEB, S.A. that “a willfully blind defendant is one who takes deliberate actions to avoid confirming a high probability of wrongdoing and who can almost be said to have actually known the critical facts.”

Mr. Picard’s lawsuit highlights various warnings signs over the years. But whether that shows that Mr. Wilpon and Mr. Katz had actual knowledge of the fraud is open to question, especially given how Mr. Madoff repeatedly fooled so many others, including the Securities and Exchange Commission.

If Judge Rakoff requires proof of a higher level of intent to establish fraud in dealings with Mr. Madoff, that may also affect other cases by Mr. Picard that seek to hold financial institutions responsible for being complicit in the Ponzi scheme.

The fact that Mr. Madoff succeeded in covering up his scheme for as long as he did may limit what can be recovered from banks and feeder funds that can claim they were misled like everyone else.

HSBC and UniCredit
The lawsuits against HSBC and UniCredit stem from the $9 billion funneled by Ms. Kohn to Mr. Madoff’s firm, transfers that the banks facilitated. The HSBC case seeks $10 billion based on the bank’s alleged breach of common law duties for failing to monitor Mr. Madoff or make any effort to protect investors. The UniCredit suit makes many of the same claims, with the additional twist of seeking nearly $60 billion based on violations of the Racketeer Influenced and Corrupt Organizations Act, better known as R.I.C.O., which authorizes triple damages.

On June 27, HSBC pushed to dismiss the case in a motion before Judge Rakoff. The bank argued that Mr. Picard did not have standing to file a claim on behalf of the investors who lost money in the Ponzi scheme because he only represented Mr. Madoff’s firm.

If that argument succeeds, then Mr. Picard may be limited in whether he can pursue the financial institutions through which Mr. Madoff funneled billions of dollars for anything more than the profits they made from acting as his bankers, almost a pittance compared with the billions of dollars in investor losses.

As for the lawsuit against UniCredit of Italy, it is not clear whether R.I.C.O. can be applied to foreign parties that did not act in the United States. The Supreme Court has ruled that American law cannot extend to activities outside the country unless the statute clearly states otherwise. R.I.C.O. does not contain any explicit reference to extraterritorial application, which may block the claim.

The $60 billion R.I.C.O. claim against UniCredit and other European banks is the trustee’s largest single claim. So if those allegations are dismissed, then the potential recovery will be significantly diminished.

JPMorgan Chase
Mr. Picard recently amended his suit against JPMorgan, which held Mr. Madoff’s primary bank account, to ask for $19 billion for failing to properly monitor his operations. Like other claims, the suit alleges that there were enough indications of fraud that the failure to act made the bank liable to investors.

Judge McMahon has agreed to consider JPMorgan’s argument that a federal law designed to limit private securities fraud claims should block Mr. Picard from pursuing his case.

A federal statute called the Securities Litigation Uniform Standards Act prohibits claims based on state law when the underlying transaction involved trading in securities subject to the federal securities law. Congress adopted it in 1998 to prevent plaintiff class action firms from bypassing the federal courts to pursue claims under more friendly state laws.

JPMorgan argued that Mr. Picard’s claim essentially alleges that it helped Mr. Madoff engage in securities fraud, and therefore, under the federal statute, it must be dismissed.

The same argument for dismissal under that statute is being pursued by HSBC and UniCredit, so Judge Rakoff will also have to deal with this issue along with Judge McMahon. If the state common law claims are blocked by the law, then billions of dollars could be whittled from Mr. Picard’s claims against the banks.

The issues in these cases turn on fairly narrow legal questions, including what is the proper standard to assess intent to defraud and how to determine standing to pursue a claim. As is often the case, legal technicalities may well have the greatest effect. If Judge Rakoff and Judge McMahon rule against the trustee, the potential recovery ultimately available to Mr. Madoff’s investors could shrink drastically.

Peter J. Henning, who writes White Collar Watch for DealBook, is a professor at Wayne State University Law School.

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