How Much Control Does a Trustee Have in a Ponzi Scheme Case?

How Much Control Does a Trustee Have in a Ponzi Scheme Case?

 Consider three recent events in the Bernard Madoff Ponzi scheme case, which demonstrate a certain unevenness and perhaps even inconsistency in the authority vested in the trustees who are administering these types of cases. Trustees act under the authority of the Bankruptcy Code or the Securities Investor Protection Act, as is applicable in the Madoff case, with the objective of maximizing returns for the people who lost money in connection with a Ponzi scheme.

1. The Trustee is in charge on the fraudulent transfer front.

The Second Circuit recently affirmed the Madoff trustee’s control over fraudulent transfer claims and an injunction barring two creditors from pursuing their own claims against a fraudulent transferee defendant that the Trustee had sued. Marshall v. Picard (In re Bernard L. Madoff Investment Securities LLC), 2014 U.S. App. LEXIS 600 (2d Cir. Jan. 13, 2014) [an enhanced version of this opinion is available to subscribers]. The Trustee had entered into a settlement with Jeffry Picower resolving the Trustee’s fraudulent transfer claims against Picower. The settlement resulted in recovery of $5 billion for the estate and about $2.2 billion to be forfeited to the government. Creditors Susanne Stone Marshall and Adele Fox separately sued Picower under state law tort theories, but the lower court enjoined such actions when it approved the Trustee’s settlement with Picower.

That injunction provided that:

[A]ny BLMIS customer or creditor of the BLMIS estate who filed or could have filed a claim in the liquidation, anyone acting on their behalf or in concert or participation with them, or anyone whose claim in any way arises from or is related to BLMIS or the Madoff Ponzi scheme, is hereby permanently enjoined from asserting any claim against the Picower BLMIS Accounts or the Picower Releasees that is duplicative or derivative of the claims brought by the Trustee, or which could have been brought by the Trustee against the Picower BLMIS Accounts or the Picower Releasees . . . .

The court agreed that the claims asserted in appellants' Florida actions were "duplicative or derivative" of those claims that could have been or were asserted by the Trustee in the New York action and, accordingly, were barred by the terms of the injunction. The Second Circuit explained, “Although appellants seek damages that are not recoverable in an avoidance action, their complaints allege nothing more than steps necessary to effect the Picower defendants' fraudulent withdrawals of money from BLMIS, instead of ‘particularized’ conduct directed at BLMIS customers.”

2. It is unclear what power the trustee has to bring third party tort claims.

The Supreme Court is struggling with what to do with the Madoff trustee’s appeal of a decision denying him the ability to bring claims against certain financial institutions that he asserts are liable for damages for aiding and abetting the fraud, among other things.

On October 9, 2013, the Madoff trustee filed a petition for writ of certiorari seeking review of a Second Circuit decision that upheld the dismissal of his claims on the basis that the trustee did not have standing to sue the banks and that the trustee “stands in the shoes” of Madoff’s firm and therefore cannot sue the banks for losses caused by Madoff’s fraud.

The Trustee contends that there is a split in the circuits on these issues and that the appeals court misinterpreted the U.S. Securities Investor Protection Act, which the Trustee argues authorizes trustees to sue wrongdoers to recoup money.

Apparently still undecided about whether to grant cert, the Supreme Court docket in the case of Picard v. JPMorgan Chase & Co. et al, contains this notation dated January 13, 2014: “The Solicitor General is invited to file a brief in this case expressing the views of the United States.”

While the Madoff case may have a different outcome because it is a SIPA proceeding, bankruptcy trustees generally have standing to bring tort claims against third parties if the claim belongs to the debtor, but not if the claim belongs to individual creditors. Caplin v. Marine Midland Grace Trust Co. of New York, 406 U.S. 416, 433-34 (1972) [enhanced version]. However, bankruptcy trustees are frequently barred from bringing such claims under the in pari delicto doctrine which imputes wrongful conduct of the debtor’s agents to the debtor in whose shoes the trustee stands. See, e.g., Baena v. KPMG LLP, 453 F.3d 1, 6 (1st Cir. 2006) [enhanced version]; Official Comm. of Unsecured Creditors v. R.F. Lafferty & Co., 267 F.3d 340, 354-60 (3d Cir. 2001) [enhanced version].

It remains to be seen whether the U.S. government will weigh in on the subject and whether the Supreme Court will grant cert of the Madoff trustee’s appeal. If so, this case could have significant ramifications for trustees and for the creditors for whose benefit the trustees act in filing lawsuits against third parties.

As a footnote to this issue, JPMorgan, which is one of the defendants in the Trustee’s lawsuits to recover from financial institutions on aiding and abetting theories, recently entered into a Deferred Prosecution Agreement with the government and agreed to pay $1.7 billion in forfeited funds along with $350 million to the Office of the Comptroller of the Currency, $325 million to the Madoff trustee, and $218 million to settle class action claims. In the DPA, JPMorgan admitted to many of the allegations made by the Madoff Trustee in his complaint, making the Trustee’s claims even more compelling on a factual basis. Although the Trustee has now settled with JPMorgan, as of now, unless the Supreme Court grants cert, the Trustee has no authority to bring these claims against the other banks because they have been dismissed on procedural grounds. It is the defrauded victims and creditors who stand to lose if the Supreme Court says no.

3. Issues regarding distribution of funds to creditors are complicated and confused.

In a SIPA proceeding like the Madoff case, the distribution scheme is controlled by the statute. Distributions to go first to “customers” and only to other creditors if there are funds leftover in the general fund.

In a case under the bankruptcy code, there is no distinction between customers, defrauded victims, and other general unsecured creditors.

However, when a parallel government forfeiture action intersects with either a SIPA or a bankruptcy proceeding, many of the distribution rules and priorities get turned on their head.

This is the result in the Madoff case. The government, in connection with its forfeiture proceeding, recently appointed a special master to distribute forfeited funds to “victims.” The government’s definition of “victims” however, is different than the definition of “customers” under SIPA guidelines or “creditors” under the Bankruptcy Code.

The special master recently posted a letter on his website at, and he sent the letter to each of the “customers” in the SIPA proceeding. In his letter, he explained:

Some may not understand why there are two separate programs to help people who invested in Madoff: a "forfeiture" program and a "bankruptcy" program. The answer is that these two programs have different objectives. The U.S. Congress created the bankruptcy process to allow insolvent firms to reorganize, or to be liquidated in an orderly manner in accordance with established priorities. Where a former broker dealer firm such as Madoff Securities is being liquidated, the law limits distributions of most bankruptcy estate assets to "customers". The term customer is defined very narrowly to require a claimant to have held a direct account with Madoff Securities. Since more than 80% of investors in Madoff did not have a "direct" account, bankruptcy law creates significant disparities among former investors as to who can recover. Out of approximately 16,500 claims in the bankruptcy proceedings, claims covering only 2,186 accounts were "allowed" (roughly 18%). More than 14,000 bankruptcy claims were rejected, most commonly because the individual invested through a feeder fund or similar entity.

Separately, Congress also created forfeiture laws to allow law enforcement authorities to seize the proceeds of criminal activity. By law forfeited assets are used to help "victims" of the criminal activity that gave rise to the forfeitures.

The statements made in the letter are not entirely accurate (treating a bankruptcy and a SIPA proceeding as interchangeable, which they are not), but the letter does provide a glimpse into the nature of the problem. For the lucky few who are both “customers” and “victims,” they should receive distributions from both the Madoff trustee and the special master. For those who are general unsecured creditors but not “customers” or “victims,” e.g, a landlord or a janitor who were not paid, they will get nothing out of either distribution scheme. Getting money back to the empty-handed landlord and janitor is an issue completely out of the control of both the Madoff trustee and the special master and leaves one questioning the fairness of the distribution schemes.

In addition to the conflict between who is a “customer” under SIPA, who is a “victim” under forfeiture laws, and who is a “creditor” under the Bankruptcy Code, each of these systems strains under the tug of war over the assets that will get distributed to the customers, victims or creditors. The government seeks to forfeit all proceeds of the crime, which is usually most if not all of the assets to be administered in a bankruptcy or SIPA proceeding. Trustees seek to gain control over the very same assets as part of their duties and distribution guidelines. So should those assets be distributed to “victims” under the forfeiture laws, to “customers” under SIPA, or to all creditors pursuant to the bankruptcy code? Depending on who is administering the assets (a SIPA trustee, a bankruptcy trustee or the government), the money will end up in the hands of different categories of claimants, again leaving one questioning the fairness of these clashing systems.

Efforts are increasing among the Department of Justice and bankruptcy groups to foster a level of cooperation and coordination among the different systems when there are parallel forfeiture and bankruptcy proceedings to most efficiently and cost-effectively administer assets of the fraudster to maximize recoveries for those who lost money in the Ponzi scheme. The Federal Judicial Center recently posted a YouTube video entitled "Asset Forfeiture and Bankruptcy Case Coordination." This video provides an excellent discussion of the issues that arise in this context.

So Do Trustees Have Control?

It is not an exaggeration to call this a mess. It is a patchwork of uncoordinated, conflicting and sometimes inequitable and dysfunctional rules that are borrowed from other circumstances to apply in Ponzi scheme cases. Our present system for pursuing just compensation for Ponzi scheme victims is certainly not one that we would create if we were to start from scratch. Maybe it’s time to think about doing that.

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, and more information about the book can be found at

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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