The Second Circuit's affirmation of the narrow
interpretation of customer under SIPA is likely to have a broad impact on the
remaining Madoff cases before Judge Rakoff in the Southern District of New
York, as well as the various SIPA cases currently working their way through
courts across the United States.
On February 22, 2013, the United States Court of Appeals
for the Second Circuit in In re Bernard L. Madoff Investment Securities LLC
[an enhanced version of this opinion is available to lexis.com
subscribers] held that certain individuals who had invested
indirectly in Bernard L. Madoff Investment Securities LLC ("BLMIS")
through certain limited partnerships (the "Investors") were not
"customers" of BLMIS under the Securities Investor Protection Act
("SIPA"). The significance of this decision is that because the
Investors are not customers of BLMIS, they will not be eligible to have their
investment losses compensated up to the $500,000 cap authorized by the
Securities Investor Protection Corporation ("SIPC"). The Investors
had invested in certain limited partnerships, which limited partnerships had
invested in certain hedge funds (or "Feeder Funds"). The Feeder Funds
in turn invested with BLMIS. The Investors had no direct financial dealings
with BLMIS. The Second Circuit affirmed the decisions of the bankruptcy
trustee, the Bankruptcy Court and the U.S. District Court for the Southern
District of New York, effectively eliminating the individuals' chances of
recouping their investment losses.
The Second Circuit's holding in this case reaffirmed its
prior ruling in Stafford v. Giddens (In re New Times Security Services,
Inc.), 463 F.3d 125, 127 (2d Cir. 2006), that "judicial interpretations
of 'customer' status support a narrow interpretation of the SIPA's
provisions," as well as its prior determination in In re Bernard L.
Madoff Investment Securities LLC, 654 F.3d 229, 236 (2d Cir. 2011) [enhanced version], that the key aspect of the
definition of customer is the entrustment of cash or securities to the
broker-dealer for the purpose of trading. The Second Circuit found that the
Investors: (1) had no direct financial relationship with BLMIS (as a result of
the investment through the Feeder Funds); (2) had no property interest in the
assets that the Feeder Funds invested with BLMIS (because the limited
partnership interests sold by the Feeder Funds did not confer an ownership
interest in the money that was invested in BLMIS by the Feeder Funds); (3) had
no securities accounts with BLMIS, as demonstrated by the record; (4) lacked
control over the Feeder Funds' investments in BLMIS (as demonstrated by the
Feeder Funds' offering memorandum); and (5) were not identified or otherwise
reflected in BLMIS's books and records.
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