Stockbroker Safe Harbor Defense in Ponzi Schemes Remains Unresolved Following Picard v. Katz Settlement

Stockbroker Safe Harbor Defense in Ponzi Schemes Remains Unresolved Following Picard v. Katz Settlement

The stockbroker defense in § 546(e) of the Bankruptcy Code creates a safe harbor for recipients of certain types of transfers and can bar fraudulent transfer claims brought by a trustee. In Picard v. Katz, this was a $1 billion issue, and one that will now not go up on appeal due to the settlement in that case.

The statute, in relevant part, states that "the trustee may not avoid . . . [a] settlement payment . . . made by or to (or for the benefit of) a . . . stockbroker . . . in connection with a securities contract." 11 U.S.C. § 546(e).

In Picard v. Katz, District Judge Rakoff found that § 546(e) is a defense to all of the claims except the actual fraudulent transfer claims. "Because Madoff Securities was a registered stockbrokerage firm, the liabilities of customers like the defendants here are subject to the 'safe harbor' set forth in section 546(e) of the Bankruptcy Code." Picard v. Katz, 462 B.R. 447 (S.D.N.Y. 2011). The court found that the plain meaning of the statute barred the claims: "By its literal language, therefore, the Bankruptcy Code precludes the Trustee from bringing any action to recover from any of Madoff's customers any of the monies paid by Madoff Securities to those customers except in the case of actual fraud."

And that was that. One billion dollars of claims were struck from Picard's case. Picard attempted to appeal this ruling, and others, before a final judgment was entered in the adversary proceeding, but Judge Rakoff denied these attempts. Picard v. Katz, 2012 U.S. Dist. LEXIS 5143 (S.D.N.Y. Jan. 13, 2011).

As of yesterday, we learned that the claims in the Picard v. Katz have been settled, so Judge Rakoff's decision will stand without further review.

However, Picard received more favorable results on this same issue in the bankruptcy court. Judge Lifland, the bankruptcy judge presiding over the Madoff SIPA liquidation proceeding, has rejected the stockbroker defense on two occasions. In Picard v. Merkin (In re Bernard L. Madoff Inv. Sec. LLC), 440 B.R. 243 (Bankr. S.D.N.Y. 2010), leave to appeal denied, 2011 U.S. Dist. LEXIS 97647 (S.D.N.Y. Aug. 31, 2011), Judge Lifland held that § 546(e) is inapplicable in fraudulent schemes:

Section 546(e) was intended to promote stability and instill investor confidence in the commodities and securities markets. . . . Courts have held that to extend safe harbor protection in the context of a fraudulent securities scheme would be to "undermine, not protect or promote investor confidence . . . [by] endorsing a scheme to defraud SIPC," and therefore contradict the goals of the provision. . . . Simply stated, the transfers sought to be avoided emanate from Madoff's massive Ponzi scheme, and the safe harbor provision "does not insulate transactions like these from attack."

Judge Lifland also found that there was no support for the position that "a Ponzi scheme operator, who allegedly did not execute any trades, was deemed, at the pleading stage, to be a 'stockbroker' for purposes of Section 546(e)."       

Judge Lifland reached the same result in Picard v. Madoff (In re Bernard L. Madoff Inv. Sec. LLC), 458 B.R. 87 (Bankr. S.D.N.Y. 2011), leave to appeal denied, 464 B.R. 578 (S.D.N.Y. 2011):

[T]he Court cannot find as a matter of law that [the § 546(e) safe harbor] applies to the transactions at issue. Whether Madoff, through BLMIS, was a stockbroker "engaged in the business of effecting transactions in securities" is dubious. Courts have held that Ponzi scheme operators do not affirmatively "make securities transactions happen" on behalf of legal "customers," and thus do not fit the definition of "stockbroker" for purposes of section 546(e). . . . As asserted in the Complaint, Madoff, through BLMIS, "never in fact purchased any of the securities he claimed to have purchased for customer accounts."

Id. at 116 (citations omitted).

On the issue of whether the payments made were "settlement payments," Judge Lifland found:

For the same reason, it is doubtful whether the payments from BLMIS to the Defendants are settlement payments as contemplated by the statute. Settlement payments subject to the safe harbor of section 546(e) must be made in the context of a "securities transaction." . . . While the Second Circuit recently defined "transaction in securities" broadly, In re Enron Creditors Recovery Group, 651 F.3d 329, 2011 U.S. App. LEXIS 13177, 2011 WL 2536101, at *6-7 (holding settlement payment does not require change in ownership of the security and limiting the requirement of "commonly used in the securities trade" in connection with settlement payments), it suggested that "settlement payments" must be made in relation to an actual securities transaction . . . Here, where securities may never have been bought, sold, or otherwise existent at BLMIS, withdrawals from IA Accounts may not constitute "settlement payments" under section 546(e) of the Code.

Id. (citations omitted).

On the other hand, two weeks ago, the bankruptcy court presiding over a proceeding related to the Thomas Petters Ponzi case held that § 546(e) is applicable and granted summary judgment to the defendants. Peterson v. Enhanced Investing Corp. (Cayman) Ltd. (In re Lancelot Investors Fund L.P.), 2012 Bankr. LEXIS 914, at *26-27 (Bankr. N.D. Ill. Mar. 7, 2012). Judge Cox concluded:

The court cannot accept the Trustee's position that the redemption payments herein are not settlement payments eligible for safe harbor protection because they may be tainted by fraud. Congress did not exempt all fraudulent transfers from safe harbor protection, only those involving actual fraud, claims that allege and prove that a debtor acted "with actual intent to hinder, delay or defraud any entity" to which the debtor was indebted. 11 U.S.C. § 548(a)(1)(A). Congress' judgment call on this matter is clear from the opening language of Section 546(e) . . . Section 741(8) of the Code defines settlement payment as "a preliminary settlement payment, a partial settlement payment, an interim settlement payment, a settlement payment on account, a final settlement payment, or any other similar payment commonly used in the securities trade ...." 11 U.S.C. § 741(8). (emphasis added).

Plainly, the application of § 546(e) is a big-money issue in Ponzi cases. We will continue to follow it closely.

See also: Wall Street Journal Talks with "The Ponzi Book" Co-Author Kathy Bazoian Phelps about Madoff-NY Mets Settlement

Kathy Bazoian Phelps is the co-author of The Ponzi Book: A Legal Resource for Unraveling Ponzi Schemes available for purchase at www.lexisnexis.com/ponzibook. More information about The Ponzi Book can be found at www.theponzibook.com.

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