Brad Barr for The New York TimesFred Wilpon, front, and Saul Katz at the New York Mets training camp in February.

Investors in the Ponzi scheme perpetrated by Bernard L. Madoff have endured more twists and turns than the Cyclone on Coney Island. Judge Jed S. Rakoff of Federal District Court in Manhattan delivered an abrupt change in course when he limited the claims that Irving S. Picard, the trustee appointed to oversee the investor claims, could pursue against Saul Katz and Fred Wilpon, the owners of the New York Mets, from their accounts with Mr. Madoff’s firm.

Judge Rakoff ruled that Mr. Picard could only seek to reclaim profits withdrawn for the two years before Mr. Madoff’s firm was forced into bankruptcy rather than the full six years otherwise provided by federal bankruptcy law. In addition, he concluded that the usual rule for voiding payments made within 90 days of a bankruptcy filing, called “preferences,” also cannot be applied, further lowering the amount Mr. Picard can recover.

The opinion deals a significant blow to the trustee’s efforts to recover money from investors who took out more than they invested in Mr. Madoff’s investment advisory firm, reducing the estimated potential recovery by a total of $6.2 billion for fictitious profits and preferences. For Mr. Katz and Mr. Wilpon, the decision means the total claims against them would be reduced to $386 million, from $1 billion, with the stronger claim to recover transfers over the two years before the scheme’s collapse limited to about $86 million rather than the $300 million that Mr. Picard initially sought.

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The claims against investors like Mr. Katz and Mr. Wilpon for profits from their Madoff accounts are based on federal bankruptcy law, which allows the recovery of payments to creditors made up to two years before a bankruptcy filing. That law also allows a trustee use a longer period under fraudulent conveyance law if the state in which the company operated permits it. Because Mr. Madoff operated in New York, it permits a trustee to reach back six years to recover payments.

Judge Rakoff’s decision rejecting the six-year period involves a so-called “safe harbor” provision in federal bankruptcy law, 11 U.S.C. § 546(e), that limits fraudulent conveyance claims to just two years when it involves a “settlement payment” that is “made by or to (or for the benefit of) a … stockbroker, in connection with a securities contract.” The judge concluded that the plain language of the provision clearly precludes Mr. Picard’s from going back six years because Mr. Madoff’s firm was a registered stockbroker and payments to customers fell within the “extremely broad” definition of settlement payment.

The 18-page opinion provides only a terse — even cursory — analysis of the safe harbor provision. Judge Rakoff largely ignored other opinions interpreting it because “the language of the statute is plain and controlling on its face,” so there was no need for further discussion.

Judge Rakoff does reference a recent opinion of the United States Court of Appeals for the Second Circuit in Enron Creditors Recovery Corp. v. Alfa, SAB de CV, which found that the safe harbor for stock transactions was intended to prevent severe displacements in the securities markets if otherwise legitimate trades could be unwound years after settlement.

The Enron decision involved the company’s redemption in November 2001 of its commercial paper, which happened just weeks before it filed for bankruptcy. The United States Court of Appeals for the Second Circuit held that the transaction involved a payment of money in exchange for securities and therefore constituted a “settlement payment” that came within the safe-harbor provision, preventing claims against the banks the received money from the company.

The transactions made by Mr. Madoff’s firm were different from commercial paper transactions at Enron because he did not actually purchase (or sell) any securities on behalf of customers. And the “profits” paid out to investors was money drawn from other customers and not the result of any legitimate securities transactions on their behalf. So it may be that the Second Circuit’s analysis of the safe harbor in Enron is not directly applicable.

In addition, treating the transactions involving Mr. Madoff’s firm as similar to those of a legitimate brokerage firm may conflict with the Second Circuit’s decision in August that upheld Mr. Picard’s determination of which investors could make a claim for recovery. The court found that it was permissible to allow only the “net losers” who invested more than they withdrew to pursue a claim for recovery, while the “net winners” who took out more than they invested did not have a similar claim.

The Second Circuit rejected the argument that the last statements sent out by Mr. Madoff should be the basis for calculating claims. The Second Circuit held that Mr. Picard “properly declined to calculate ‘net equity’ by reference to impossible transactions. Indeed, if the Trustee had done otherwise, the whim of the defrauder would have controlled the process that is supposed to unwind the fraud.” The absence of any legitimate transactions by Mr. Madoff could mean that the safe harbor is inapplicable to Ponzi schemes that use a brokerage firm as the vehicle for defrauding customers.

Judge Rakoff’s decision also conflicts with the interpretation of the safe harbor provision by bankruptcy judge Burton R. Lifland in Mr. Picard’s clawback suit against J. Erza Merkin, one of feeders for Mr. Madoff.

Judge Lifland found the protection afforded securities transactions inapplicable because insulating fraudulent payments would undermine investor confidence rather than protect it. So there are conflicting decisions in the same bankruptcy case, an unusual situation.

Although the safe-harbor protection may not be as clear as Judge Rakoff asserts, a key question is whether he will permit Mr. Picard to pursue an interlocutory appeal of the decision before a trial on the two remaining claims against Mr. Katz and Mr. Wilpon that he refused to dismiss. Those claims involve Mr. Picard’s assertion that they were willfully blind to Mr. Madoff’s fraud, and that transfers within the two years before the Ponzi scheme’s collapsed are subject to recovery as fraudulent conveyances.

A federal statute, 28 U.S.C. § 1292(b), permits an appeal before a final decision in a civil case when the judge is “of the opinion that such order involves a controlling question of law as to which there is substantial ground for difference of opinion and that an immediate appeal from the order may materially advance the ultimate termination of the litigation.” Trial courts have been admonished to allow such appeals only in “rare cases” and to “exercise great care” in certifying a case for review, so it would not be a surprise if Judge Rakoff declined a request by Mr. Picard to allow an immediate appeal of the safe-harbor ruling.

The fallout from the decision is already being felt beyond the claims against Mr. Katz and Mr. Wilpon. Bloomberg News reported that defendants in clawback suits have filed motions to limit the trustee’s claims to only two years of withdrawals. Others who would appear to benefit from the two-year limitation on claims include David M. Becker, the former general counsel at the Securities and Exchange Commission, who was sued for an account held by his late mother that was closed in 2004, and members of Mr. Madoff’s family for any withdrawals prior to Dec. 11, 2006, two years before Mr. Madoff was arrested.

In addition, Mr. Picard postponed a distribution to investors with approved claims that had been scheduled to take place on Sept. 30 because of the uncertainty created by the decision. When he will be able to disburse funds to investors whose claims have been approved remains to be seen.

Judge Rakoff’s decision does not affect the amounts paid to the trustee to settle claims brought by the trustee. Mr. Picard has recovered more than $10 billion so far, and that money is safe because as a general rule parties to a settlement cannot undo the agreement because of later developments that call into question the validity or scope of a claim against them.

Investors in Mr. Madoff’s Ponzi scheme have been whipped back and forth as the courts try to apply the law to a case that is unprecedented in many ways. Judge Rakoff’s decision is unlikely to be the last word, but he has sent the case in a new, and rather unexpected, direction.

Article source: http://feeds.nytimes.com/click.phdo?i=59bc90708f933adc1aabacae7da22545