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IN RE BERNARD L. MADOFF INV. SEC., LLC
440 B.R. 243 (2010)
In re BERNARD L. MADOFF INVESTMENT SECURITIES LLC, Debtor.
Irving H. Picard, Trustee for the Liquidation of Bernard L. Madoff Investment Securities LLC, Plaintiff,
v.
J. Ezra Merkin, Gabriel Capital, L.P., Ariel Fund Ltd., Ascot Partners, L.P., Gabriel Capital Corporation, Defendants.
Bankruptcy No. 08-01789 (BRL). Adversary No. 09-1182 (BRL).
United States Bankruptcy Court, S.D. New York.
November 17, 2010.
Baker & Hostetler LLP, New York, NY, by David J. Sheehan, Marc E. Hirschfield, Marc D. Powers, for Irving H. Picard, Trustee for the Substantively Consolidated SIPA Liquidation of Bernard L. Madoff Investment Securities LLC and Bernard L. Madoff.
MEMORANDUM DECISION AND ORDER GRANTING IN PART AND DENYING IN PART DEFENDANTS' MOTIONS TO DISMISS TRUSTEE'S COMPLAINT BURTON R. LIFLAND, Bankruptcy Judge. Before this Court are the motions (the "Motions to Dismiss") of (1) J. Ezra Merkin
("Merkin") and Gabriel Capital Corporation ("GCC," and together with Merkin, the "Merkin Defendants"), and (2) Ariel Fund Limited ("Ariel") and Gabriel Capital, L.P. ("Gabriel," and together with Ariel, the "Fund Defendants" or the "Funds") (collectively, the "Moving Defendants") seeking to dismiss the second amended complaint (the "Complaint") of Irving H. Picard, Esq. (the "Trustee" or "Plaintiff"), trustee for the substantively consolidated Securities Investor Protection Act1 ("SIPA") liquidation of Bernard L. Madoff Investment Securities LLC ("BLMIS") and Bernard L. Madoff ("Madoff"), filed pursuant to SIPA sections 78fff(b) and 78fff-2(c)(3), sections 105(a), 502(d), 542, 544, 547, 548(a), 550(a) and 551 of the Bankruptcy Code (the "Code"), various sections of New York Debtor and Creditor Law2 (the "NYDCL") and other applicable law for turnover, accounting, preferences, fraudulent conveyances, damages, and objections to SIPA claims. The Moving Defendants assert that the Complaint fails to state a claim upon which relief can be granted pursuant to Federal Rule of Civil Procedure ("Rule") 12(b)(6), made applicable herein by Federal Rule of Bankruptcy Procedure ("Bankruptcy Rule") 7012, and should be dismissed in its entirety. For the reasons set forth below and at oral argument, the Motions to Dismiss are GRANTED in part and DENIED in part. Specifically, the Motions to Dismiss are GRANTED with respect to Counts One and Two of the Complaint, seeking immediate turnover under section 542 of the Code and avoidance of preferential transfers under section 547(b) of the Code, respectively. The Motions to Dismiss all remaining counts of the Complaint are DENIED. The Complaint arises in connection with the infamous Ponzi scheme perpetrated by Bernard L. Madoff for decades through his investment company, BLMIS. As recognized by the Securities Investor Protection Corporation ("SIPC"), "this is not a typical SIPC proceeding in which securities or cash were on hand at the time of the failure of the brokerage house." Letter from Stephen P. Harbeck, President of SIPC to the Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises at p. 6 (dated Sept. 7, 2010) [hereinafter "SIPC Letter"]. Rather, it was a fraud of unparalleled magnitude "in which the only assets were other people's money or assets derived from such funds." Id. During the course of this fraud, there were approximately 90,000 disbursements of fictitious profits to Madoff investors totaling $18.5 billion. Id. at p. 5. Due to the longstanding nature of the Ponzi scheme, many of the customer accounts presented multiple generational investments, requiring the Trustee to conduct a full forensic analysis of all of BLMIS's books and records, dating back to at least the early 1980s. Id. at p. 7. As of November 12, 2010, the Trustee has determined 14,769 claims, denied 2,752 claims, and allowed 2,291 claims in the amount of $5,739,853,405.38. Moreover,
SIPC has committed $743,928,341.68 in SIPC advances to these claimants. See http://www.madofftrustee.com (last visited Nov. 16, 2010). The Trustee has reviewed, and continues to review, millions of documents to determine the thousands of customer claims filed in this SIPA liquidation. SIPC Letter at p. 7.
1. 15 U.S.C. § 78aaa et seq. Hereinafter, "SIPA" shall replace "15 U.S.C." in reference to SIPA sections.
2. N.Y. Debt & Cred. Law § 270 et seq. (McKinney 2001).
3. A comprehensive discussion of the facts underlying this SIPA liquidation and Madoff's notorious Ponzi scheme is set forth in this Court's March 1, 2010 net equity decision. See Sec. Investor Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC (In re Bernard L. Madoff Inv. Sec. LLC), 424 B.R. 122, 125-33 (Bankr. S.D.N.Y.2010).
4. See SIPA § 78lll (7)(B) (defining the "Filing Date").
5. Pursuant to a Stipulation and Order filed on October 14, 2010, Ascot may move, answer or otherwise respond to the Complaint up to and including December 17, 2010 (Dkt. No. 83).
6. In a SIPA liquidation, a SIPA trustee may utilize the avoidance powers enjoyed by a bankruptcy Trustee. See SIPA §§ 78fff(b), 78fff-2(c)(3).
7. In Count Two of the Complaint, the Trustee concedes that his preference claim under section 547(b) of the Code is directed solely against Ascot. Compl. at ¶¶ 57-66. Accordingly, Count Two is dismissed as to all of the Moving Defendants. Moreover, the merits of the Trustee's preference claim against Ascot will not be addressed at this time. However, the Trustee has alleged that Merkin is personally liable, as general partner of Ascot, for any potential judgment on the claims against Ascot. Compl. at ¶¶ 37, 43, 110-13; infra at Section IV.
8. For example, there were only 4 months when the Fund Defendants received negative returns during the 100 months of reported operations from August 2000 through November 2008, when the Fund Defendants were customers of BLMIS. Compl. at ¶ 44(e).
9. For example, Defendants' December 2006 account statements reported sales of 169,224 shares, 21,315 shares and 27,191 shares of Merck, each of which was purportedly executed at a price of $44.61 on the trade date of December 22, 2006, with a settlement date of December 28, 2006. The daily price for Merck stock on December 22, 2006 ranged from a low of $42.78 to a high of $43.42, more than $1 below the price reported on the statements. Compl. at ¶ 44(g).
10. David Friehling is the subject of a criminal information filed by the United States alleging, inter alia, securities fraud. See Friehling Information, United States v. Friehling, No. 09-CR-0700 (AKH) (S.D.N.Y. July 17, 2009) (Dkt. No. 14). He has since pled guilty, and sentencing is scheduled for March 18, 2011. Id. at Dkt. No. 43.
11. Count Three (actual fraud under the Code) has been adequately pled against all of the Moving Defendants, despite that the Merkin Defendants are alleged to have received the Initial Transfers only as subsequent transferees. See infra at Section V.
12. Memorandum of Law in Support of Defendants J. Ezra Merkin's and Gabriel Capital Corporation's Motion to Dismiss Plaintiff's Second Amended Complaint (Dkt. No. 54) [hereinafter "Merkin Mem. Law"].
13. Corrected Memorandum of Law in Support of Motion by Defendants Ariel Fund Limited and Gabriel Capital, L.P. to Dismiss the Second Amended Complaint (Dkt. No. 59) [hereinafter "Fund Mem. Law"].
14. Moreover, the section 548(c) defense should not support dismissal because, by its terms, it does not operate as a complete bar to a claim. Affirmative defenses permitting dismissal must "bar the award of any remedy." 5B Wright & Miller, Fed. Prac. & Proc. Civ. § 1357 (3d ed. 2010); Flight Sys., Inc. v. Elec. Data Sys. Corp., 112 F.3d 124, 127 (3d Cir. 1997) (finding that affirmative defense must present an insuperable barrier to recovery by plaintiff). By contrast, even when proven by the transferee at the proper stage of the litigation, the 548(c) defense entitles a good faith transferee to retain his interest only "to the extent that such transferee . . . gave value." 11 U.S.C. § 548(c) (emphasis added).
15. Count Five (actual fraud under the NYDCL) has been adequately pled against all of the Moving Defendants, despite the fact that only the Fund Defendants are alleged to have received the Initial Transfers because the Trustee has properly alleged that the Merkin Defendants received the Initial Transfers as subsequent transferees. See infra at Section V; supra at n. 11.
16. This two-prong test is commonly applied to analyze scienter in securities fraud actions, but the "same standard has been applied in [the Second] Circuit to non-securities fraud claims." In re Musicland, 398 B.R. at 774, n. 7 (applying the two-prong test to establish fraudulent intent under section 544 of the Code and applicable state law); see also Official Comm. Of Asbestos Claimants of G-I Holding, Inc., 277 B.R. at 36-37 (applying the two-prong test to establish fraudulent intent under section 276 of the NYDCL); In re Saba Enters., Inc., 421 B.R. at 641-42 (applying the two-prong test to establish fraudulent intent under section 548(a)(1)(A) of the Code).
17. The Trustee has adequately pled that GCC is plausibly the alter ego of Merkin, who "dominated" GCC as its sole director and sole shareholder, using GCC as a mere instrument to facilitate Merkin's personal interests, rather than any corporate ends. Compl. at ¶ 34. Accordingly, Merkin and GCC are treated as one unit for purposes of determining the sufficiency of the Trustee's allegations. S. New England Tel. Co. v. Global NAPs Inc., No. 08-CV-4518, 2010 WL 3325962, at *17 (2d Cir. Aug. 25, 2010) ("[O]nce alter ego status is established, `the alter egos are treated as one entity' for purposes of . . . liability.") (internal quotations omitted).
18. Many courts use "badges of fraud" as a means of pleading fraudulent intent based on circumstantial evidence. See In re Saba Enters., Inc., 421 B.R. at 643; Picard v. Taylor (In re Park South Sec., LLC.), 326 B.R. 505, 518 (Bankr.S.D.N.Y.2005). It appears, however, that these badges are designed to establish the fraudulent intent of a transferor, rather than a transferee. Given that the Trustee has adequately pled the transferees' intent under the two-prong test above, the Court need not make a finding with respect to these badges. The above notwithstanding, certain of the badges are satisfied here, including badges (1), (2) and (8). The badges are: (1) the lack or inadequacy of consideration; (2) the family, friendship or close associate relationship between the parties; (3) the retention of possession, benefit or use of the property in question; (4) the financial condition of the party sought to be charged both before and after the transaction in question; (5) the existence or cumulative effect of a pattern or series of transactions or course of conduct after the incurring of debt, onset of financial difficulties, or pendency or threat of suits by creditors; (6) the general chronology of the event and transactions under inquiry; (7) a questionable transfer not in the usual course of business; and (8) the secrecy, haste, or unusualness of the transactions. Id. With respect to the first badge, and as discussed more fully infra at Section II, the Trustee has successfully pled that the Initial Transfers lacked "fair consideration" and "reasonably equivalent value." In connection with the second badge, Madoff and Merkin had a close business and social relationship. Compl. at ¶ 2. Last, with regard to the eighth badge, every transfer was unusual and secretive in that the Initial Transfers were made in the context of a Ponzi scheme and the Moving Defendants allegedly sought to conceal from investors the role of BLMIS as their money manager. Compl. at ¶ 44(s).
19. The Trustee and the Fund Defendants both apply New York law to their analyses of agency; however, if Delaware law were applied, as Gabriel is a limited partnership organized under the laws of Delaware, the result is the same. See Albert v. Alex. Brown Mgmt. Servs. Inc., Civ. Nos. 762-N and 763-N, 2005 WL 2130607, at *11 (Del.Ch. Aug.26, 2005) ("Delaware law states the knowledge of an agent acquired while acting within the scope of his or her authority is imputed to the principal.").
20. As the Trustee has adequately alleged the Moving Defendants' fraudulent intent, they are not entitled at this time to a defense under section 278(2) of the NYDCL as purchasers providing fair consideration. Rather, the Moving Defendants "must affirmatively show good faith in order to take advantage of [s]ection 278(2)." Mendelsohn v. Jacobowitz (In re Jacobs), 394 B.R. 646, 659 (Bankr.E.D.N.Y. 2008).
21. Only the Merkin Defendants have argued for dismissal of the Trustee's request for attorneys' fees. However, the Trustee's request for attorneys' fees has been adequately pled as to all of the Moving Defendants.
22. In Count Nine of the Complaint, in addition to attorneys' fees, the Trustee seeks to rely upon the "discovery rule" to avoid actual fraudulent transfers made more than six years before the Filing Date. Count Nine seems to be directed solely at Ascot, the only defendant alleged to have received transfers more than six years before the Filing Date. See Compl., Ex. B. Indeed, both Motions to Dismiss are silent as to this count (except with regard to attorneys' fees). As discussed above, as Ascot has not moved or answered, the merits of Count Nine will not be addressed at this time.
23. For this proposition, the Fund Defendants cite to the case of Balaber-Strauss v. Sixty-Five Brokers (In re Churchill Mortgage Inv. Corp.), 256 B.R. 664 (Bankr.S.D.N.Y.2000). In Churchill Mortgage, unlike here, good faith was not at issue because there were no allegations that the defendants had knowledge of, or participated in, the fraud. As such, the court there stated that a "parallel" existed between section 548 of the Code and the NYDCL solely in the context of the value of the consideration exchanged for the transfer. Id. at 667.
24. While the Merkin Defendants similarly argue that reasonably equivalent value under the Code and fair consideration under the NYDCL "have the same fundamental meaning," see Merkin Mem Law at p. 10 (citing In re Churchill Mortgage Inv. Corp., 256 B.R. at 677), they do, however, concede in a footnote that the NYDCL defines fair consideration to include a good faith component. See Merkin Mem. Law at p. 10, n. 4.
25. Although the Fund Defendants' argument addresses solely whether 546(e) offers protection from the Trustee's constructive fraud claims, see Fund. Def. Mem. Law at p. 27, the Court's analysis applies equally to preclude safe harbor protection at this stage of the proceedings from the Trustee's preference and state law fraud claims. Further, the Trustee's actual fraud claims under Section 548(a)(1)(A) of the Code are explicitly excepted from safe harbor protection by the language of the statute. 11 U.S.C. § 546(e).
26. Significantly, in the context of a SIPA proceeding, the Code provisions, including section 546(e), are incorporated only "to the extent consistent with the provisions of [SIPA]." SIPA § 78fff(b).
27. The Merkin Defendants' argument is directly solely at the Trustee's claims under the Code, even though the Complaint also alleges liability under the NYDCL. New York law permits recovery not just from transferees, but also from any individual who benefited from the transfer.
28. Delaware law is applicable, as Ascot is a Delaware limited partnership and its Partnership Agreement specifies that Delaware law will govern. See Declaration of Marc E. Hirschfield (Dkt. No. 64) ("Hirschfield Decl."), Ex. I at 20. While it is arguable that New York law should apply, as Ascot's principal office is located in New York, the analysis would be the same. See McKinney's Partnership Law § 98(1); 26(a)(2); 121-403(a) (stating that a general partner of a limited partnership is liable for the partnership's debts and obligations); U.S. v. 175 Inwood Assocs. LLP, 330 F.Supp.2d 213, 224 (E.D.N.Y.2004) ("[G]eneral partners in a limited liability partnership are not protected as individuals from liability incurred by the partnership if the assets of the partnership are insufficient to satisfy the liability.").
29. Although not necessary for the Court's decision, the Court is aware of additional information regarding the proportion of the Initial Transfers paid to the Merkin Defendants as fees for BLMIS investments provided in public records and certain attached documents, including the motion papers filed by the Merkin Defendants themselves. See Merkin Mem. Law at p. 5 (stating that as of December 2008, approximately 30% of Gabriel's and Ariel's respective assets were invested with BLMIS); State of New York v. J. Ezra Merkin, et al., 907 N.Y.S.2d 439, (N.Y.Sup.Ct.2010) ("From 2001 to 2008, between 20-30% of the assets of Gabriel and Ariel were managed by Madoff."); Hirschfield Decl., Ex. D (Excerpts from Amended Complaint in the matter of The People of the State of New York v. J. Ezra Merkin, et al., No. 450879-09, 2010 WL 936208) (alleging that the total fees taken by Merkin and GCC is approximately $169 million from Ascot between 1995 and 2007, ¶ 35; $242 million from Ariel between 1989 and 2007, ¶ 69; and $277 million from Gabriel between 1989 and 2007, ¶ 69). The amended complaint in the matter of The People of the State of New York v. J. Ezra Merkin, et al. additionally provides a table showing the proportion of Gabriel's assets allocated to BLMIS. Amended Complaint in the matter of The People of the State of New York v. J. Ezra Merkin, et al., No. 450879-09, 2010 WL 936208 (N.Y.Sup.Ct.2009).
30. Although only the Fund Defendants objected to the Trustee's disallowance of their SIPA claims, see Fund Mem. Law at pp. 33-36, Count Eleven of the Complaint has been adequately pled as to all of the Moving Defendants.
31. Three of the nine cases merely cite to SIPA section 78fff-2(c)(3) without any analysis or discussion. Togut v. RBC Dain Correspondent Servs. (In re S.W. Bach & Co.), 435 B.R. 866, 886 (Bankr.S.D.N.Y.2010); Sec. Investor Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC (In re Bernard L. Madoff), 429 B.R. 423, 427, n. 4 (Bankr.S.D.N.Y.2010) (Lifland, J.); Sec. Investor Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC (In re Bernard L. Madoff Inv. Sec. LLC), 424 B.R. 122, 136 (Bankr.S.D.N.Y.2010) (Lifland, J.). The remaining six cases analyze SIPA section 78fff-2(c)(3) in conjunction with avoidance provisions of the Code, supporting the Moving Defendants' interpretation. Picard v. Taylor (In re Park South Sec., LLC.), 326 B.R. 505, 512-13 (Bankr.S.D.N.Y.2005); Trefny v. Bear Stearns Sec. Corp., 243 B.R. 300, 320-23 (S.D.Tex.1999); Kusch v. Mishkin (In re Adler, Coleman Clearing Corp.), Nos. 95-08203(JLG), et al., 1998 WL 551972, at *17 (Bankr.S.D.N.Y. Aug.24, 1998); Mishkin v. Ensminger (In re Adler, Coleman Clearing Corp.), 218 B.R. 689, 702 (Bankr.S.D.N.Y. 1998); Hill v. Spencer S & L Ass'n (In re Bevill, Bresler & Schulman, Inc.), 94 B.R. 817, 825-27 (D.N.J.1989); Hill v. Spencer S & L Ass'n (In re Bevill, Bresler & Schulman, Inc.), 83 B.R. 880, 886-88 (D.N.J.1988) ("Bevill I").
32. See Cent. Virginia Comm. Coll. v. Katz, 546 U.S. 356, 369, 126 S.Ct. 990, 163 L.Ed.2d 945 (2006) (supporting the bankruptcy court's expansive in rem jurisdiction by upholding a trustee's avoidance actions against a state agency); State Comp. Ins. Fund v. Zamora (In re Silverman), No. 08-56508, 2010 WL 3169415, at *6 (9th Cir. Aug.12, 2010) (holding that a chapter 11 trustee may avoid and recover criminal restitution payments under section 547(b) of the Code).
33. It is conceivable, however, for the Trustee to find support at law outside of turnover, including the utilization of provisional remedies such as attachment.
34. Similarly, SIPA section 78fff-2(c)(3) provides that a customer in receipt of a preference "shall be deemed to have been a creditor" at the time of transfer in order to ensure that the SIPA trustee has standing under section 547 of the Code. See 11 U.S.C. § 547 ("[T]he trustee may avoid any transfer of an interest of the debtor in property—(1) to or for the benefit of a creditor....").
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