Did the Second Circuit Get SLUSA Right in the Madoff Ponzi Scheme Case?

 In a very short and summary opinion, the Second Circuit concluded that nothing in a recent Supreme Court decision gave it any reason to revisit its prior ruling that SLUSA bars state law class action claims against banks in connection with the Bernard Madoff scheme. In re Herald, Primeo, and Thema, 2014 U.S. App. LEXIS 9871 (2d Cir. May 28, 2014) [an enhanced version of this opinion is available to lexis.com subscribers].

As discussed previously in this blog, the Supreme Court in Chadbourne & Park LLP v. Troice, 134 S. Ct. 1058 (2014) [enhanced version], declined to bar certain class action claims in the Stanford Financial Ponzi scheme case on the grounds that: (1) the certificates of deposits sold were not “covered securities”; and (2) the fraud was not “in connection with the purchase or sale of a covered security.”

The Second Circuit found no application of Troice in the Madoff case. Simply put, the court said, “Because the fraud perpetrated by Madoff Securities was ‘material to a decision by one or more individuals (other than the fraudster) to buy or to sell a 'covered security,' Troice, 134 S. Ct. at 1066, the Supreme Court's ruling confirms the logic and holding of In re Herald.’”

The Second Circuit distinguished the Stanford Financial case from Madoff, stating, “the closest that the plaintiffs in Troice could get to statutorily defined ‘covered securities’ was the allegation that Stanford induced purchase of the uncovered securities by, among other misrepresentations, vague promises that the Stanford Investment Bank had significant holdings in various covered securities.” Quoting Troice, the court noted, “Thus, a plaintiff in Troice was entirely distinguishable from ‘a victim who took, tried to take, or maintained an ownership position in the statutorily relevant securities through 'purchases' or 'sales' induced by the fraud.’"

The Second Circuit reached the following conclusion and put an end to the class action claims against the allegedly wrongdoing banks:

Madoff Securities, by contrast, fraudulently induced attempted investments in covered securities, albeit through feeder funds (not alleged in the instant complaints as anything other than intermediaries), and the defendant banks are alleged to have furthered that scheme. Madoff Securities' victims thus "tried to take . . . an ownership position in the statutorily relevant securities," i.e., covered securities. That Madoff Securities (a Ponzi scheme) fraudulently failed to follow through on its promise to place the investments in covered securities does not in any respect remove this case from the ambit of SLUSA as defined in Troice.

Is this type of distinction fair to defrauded victims? In Stanford, they thought they were purchasing certificates of deposits. In Madoff, they handed their money to feeder funds for investment purposes, sometimes not even knowing how their money was being invested. The straightforward and uncontested fact is that there were no sales or purchases of “covered securities” by anyone in Madoff, just like in Stanford. Is there a fair reason to say that one group can sue to recoup losses and the other cannot? The Second Circuit has interpreted Troice to make such a distinction.       

In addition to the concern that this interpretation leads to an uneven application of the law in Ponzi scheme cases, is this result the right one in the Madoff case? First the Madoff trustee was barred from suing some of these very same banks. Now the investors are barred from seeking recovery from the banks. So who is it that gets to hold the banks accountable and obtain recoveries to reimburse the defrauded victims for their losses? At least one bank, JPMorgan, has admitted knowledge of suspicious activity while engaged in the banking activity necessary to perpetuate the scheme. The only comfort so far is that the government pursued charges against that bank and reached an agreement with the bank to pay about $2 billion. This is better than nothing, but not enough to make the victims whole.

Read additional articles at The Ponzi Scheme Blog

 Kathy Bazoian Phelps is the co-author of The Ponzi Book: A Legal Resource for Unraveling Ponzi Schemes  (LexisNexis 2012), along with Hon. Steven Rhodes.  The Ponzi Book, recently reviewed by the ABI Journal and Commercial Crime International, is available for purchase at www.lexisnexis.com/ponzibook, and more information about the book can be found at www.theponzibook.com

Kathy is also the author of is Ponzi-Proof Your Investments: An Investor’s Guide to Avoiding Ponzi Schemes and Other Fraudulent Scams. For more information, or to purchase the book, click here.

Watch Kathy’s interview on The Not So Legal Show.

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