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Legal Setbacks Threaten Madoff Trustee's Blockbuster Recovery

A recent series of legal setbacks threaten to derail the attainment of the ‘holy grail’ sought by the court-appointed trustee for Bernard Madoff’s massive Ponzi scheme: that litigation proceeds will allow investors to recover 100% of their net principal investment with Madoff.  In the past week, Irving Picard, the trustee overseeing the liquidation of Madoff’s defunct brokerage and tasked with recovering assets for distribution to defrauded investors, has seen his potential recovery for victims increasingly threatened by adverse rulings on his ability to bring such suits.  Of the over-1,000 suits filed thus far by Picard, nearly all seek the “clawback” of profits enjoyed in excess of an investor’s original principal.  The few non-clawback suits at issue instead seek billions of dollars in damages from high-profile banking entities that Picard alleged ignored red flags that should have alerted them to Madoff’s fraud in favor of lucrative profits from Madoff’s operations. 

In The Wizard of Lies, the pre-eminent book on Madoff's scheme written by esteemed New York Times financial reporter Diana B. Henriques, the author recounts a conversation with Madoff at the Butner Medium Security prison where Madoff is currently serving his 150-year sentence.  In discussing the fallout from his fraud, Madoff made the prediction that “people who were with me will make out better than if they’d been in the market [during the meltdown of 2008].”   (For reference, the S&P 500 Index declined 37% in 2008.)  While such a prediction seemed implausible, Picard’s unrelenting approach after his appointment enjoyed several early successes that soon gave birth to whispers suggesting that Madoff’s victims could see more than a statistically insignificant recovery. 

Such whispers reached a fever pitch at the end of 2010 on news of several important accomplishments.  First, Picard filed lawsuits in early December against several prominent banking entities (the “Banking Lawsuits”), including JP Morgan, HSBC, and UBS, seeking billions of dollars based upon the bank’s alleged failure to detect Madoff’s fraud.  Picard would later amend these claims to include a theory under the Racketeer Influenced Corrupt Organizations (“RICO”) Act, which allowed treble damages.  Under this later theory, Picard’s total amount demanded exceeded tens of billions of dollars in damages, including nearly $20 billion demanded from JP Morgan alone. 

The second important event came on December 17, 2010, when Picard announced that the estate of Jeffrey Picower, a longtime Madoff friend and investor, agreed to settle with Picard for the full amount sought - $7.2 billion.  Of that amount, $5 billion would be paid to Picard for distribution, and $2.2 billion would be forfeited to the Government and then distributed to victims.  With Picard estimating that total investor losses would be approximately $20 billion, the Picower settlement immediately boosted the amount of a Madoff investor’s potential recovery by 35%.  As detailed in an earlier Ponzitracker post, The announcement of the settlement, combined with the enormous amounts sought from the banks, caused the value of Madoff investor claims in the secondary marketplace to approach 70% - 75% of estimated losses – with no plan or timeline for eventual distribution even discussed.  

When the initial euphoria of an undeniably successful 2010 died down, it soon became clear that Picard would face a much more difficult legal battle against the banks.  Where the clawback lawsuits proceeded upon well-established bankruptcy principles, the Banking Lawsuits sought to impose liability based on much less-ironclad claims - the bank’s failure to detect Madoff’s fraud.  First, Picard lost his bid to keep the lawsuits within the friendly confines of Bankruptcy Court when several federal judges agreed with the banking entities that Picard’s legal theories encompassed non-bankruptcy claims and were more appropriately addressed in federal court. 

The banking entities then sought the dismissal of Picard's common law claims, including theories of unjust enrichment, aiding and abetting fraud, and aiding abetting breach of fiduciary duty.  At issue was who had legal standing to bring such claims.  Under the federal Bankruptcy Code, the trustee stands in the shoes of the debtor – not the creditors of the debtor.  Under this interpretation, the banking defendants argued only the creditors, and not Picard, could bring such claims. 

Picard countered that his standing to bring claims stemmed from two principal arguments.  First, he argued, the Securities Investor Protection Act (“SIPA”) conferred upon him broad powers outside the purview of the Bankruptcy Code.  Second, he argued that under the broad definition of customer property in SIPA, chiefly the catchall provision including “any other property of the debtor,” bestowed authority to bring such claims.

On July 28, 2011, the same day that Picard announced a $1 billion settlement with Tremont Group Holdings, United States District Judge Jed S. Rakoff issued a strongly-worded opinion dismissing Picard’s common-law claims against HSBC.  Calling Picard’s arguments “convoluted” and a “stretch,” Judge Rakoff concluded that all of the common law claims were to be dismissed.  Because Picard's claims lacked standing, Judge Rakoff declined to address HSBC's remaining contention that the claims were pre-empted by the Securities Litigation Uniform Standards Act.

The decision to dismiss the common law claims immediately removed nearly $9 billion from the roughly $100 billion sought by Picard.  While HSBC still faces bankruptcy claims seeking $2 billion, the focus has already shifted to the claims against JP Morgan, UBS, and Unicredit that suddenly appear on the verge of also eluding Picard's grasp.  As a result of Picard's ability to seek treble damages under RICO claims, the total amount sought from JP Morgan and Unicredit alone is nearly $80 billion.  Picard has also sought nearly $2 billion in common-law claims from UBS.  Many suspect that, with nearly $9 billion at stake, Picard will appeal Judge Rakoff's decision to the Second Circuit Court of Appeals.  Such a move would also open the possibility of a settlement to end the claims, although any conjecture is pure speculation.

No doubt encouraged by the HSBC ruling, UBS and JP Morgan recently asked United States District Judge Colleen McMahon to dismiss Picard's common-law claims.  Tracking the language of Judge Rakoff, JP Morgan asserted that Picard's claims were nothing more than

an illegitimate attempt by the trustee to usurp and assert thousands of state law securities claims that belong not to BLMIS but exclusively to its customers.

JP Morgan sought the dismissal not only of Picard's eight common-law claims, but also twelve of Picard's bankruptcy claims.  UBS, in its filing, urged the adoption of JP Morgan's arguments.  The two unlikely allies join UniCredit, who had filed a motion to dismiss the previous week. 

Picard will have an opportunity to respond in the coming two weeks.  But Judge Rakoff's well-reasoned order dismissing common-law claims against HSBC will prove both difficult to dispute by Picard and easy to adopt by other judges.  Rakoff is widely recognized for his expertise in securities law matters and is a leading authority on the topic of white collar crime.  

The $1 billion settlement with Tremont brings the total amount recovered to date to $8.6 billion - nearly half of the $17.3 billion Picard has estimated was the total principal lost by investors. 

 A copy of the Order dismissing Picard's common-law claims against HSBC is here.

A copy of JP Morgan's Motion to Dismiss is here.

A copy of UBS's Motion to Dismiss is here.

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