"No doubt, there are advantages to the course Picard wants to follow. But equity has its limits."
A federal appeals court dealt a significant setback to the quest to recover funds for victims of Bernard Madoff's $65 billion Ponzi scheme, ruling that the court-appointed bankruptcy trustee could not pursue claims totaling more than $30 billion against financial institutions accused of aiding the scheme. The U.S. Court of Appeals for the Second Circuit issued a unanimous order Thursday upholding the dismissal of claims that JP Morgan, HSBC, Unicredit, and UBS (the "Financial Institutions") 'aided and abetted' Madoff's fraud by ignoring numerous red flags that should have alerted them to the fraud. The three-judge panel agreed that, under the theory of in pari delicto, because the bankruptcy trustee, Irving Picard, stood in the shoes of Madoff's former firm, he was precluded from bringing claims against third parties for their role in a fraud that Madoff's firm masterminded.
Picard filed lawsuits against a multitude of financial institutions in 2009 and 2010, including the Financial Institutions. Originally filed in bankruptcy court, the Financial Institutions sought to have the actions removed to federal district court based on Picard's standing to assert the claims, as well as whether the claims were precluded by the Securities Litigation Uniform Standards Act. In late 2011, two different federal judges in the Southern District of New York granted motions to dismiss the trustee's common-law claims against the Financial Institutions, finding that Picard's claims were barred by the doctrine of in pari delicto. Picard immediately appealed those decisions.
The doctrine of in pari delicto, translating to 'in equal fault,' is a compelling defense in the realm of bankruptcy jurisprudence, as "a debtor’s misconduct is imputed to the trustee because, innocent as he may be, he acts as the debtor’s representative." The Wagoner rule, drawn from the seminal case of Shearson Lehman Hutton, Inc. v. Wagoner, bars a trustee from suing to recover for a wrong that he himself essentially took part in. 944 F.2d 114, 118 (2d Cir. 1991). Under this authority, the Second Circuit reasoned that
Picard alleges that the Defendants were complicit in Madoff’s fraud and facilitated his Ponzi scheme by providing (well-paid) financial services while ignoring obvious warning signs. These claims fall squarely within the rule of Wagoner and the ensuing cases: Picard stands in the shoes of BLMIS and may not assert claims against third parties for participating in a fraud that BLMIS orchestrated.
Dismissing Picard's claims that the doctrine did not apply or, in the event that it did, he was exempted as a trustee under the Securities Investor Protection Act, chief Judge Dennis Jacobs remarked that "Picard's scattershot responses are resourceful, but they all miss the mark."
While Picard appealed to principles of equity in contending he should be permitted to bring the claims, the Court questioned the merits of this approach, remarking "it is not obvious why customers cannot bring their own suits against the Defendants." As the Financial Institutions pointed out, indeed some victims have already done so.
While Picard still holds bankruptcy claims against the Financial Institutions totaling more than $4 billion, the Second Circuit's decision is a significant setback in the quest to recover funds for Madoff's victims, who to date have received three distributions of approximately 43% of approved losses. To date, Picard has approved approximately $11 billion in claims, while he has recovered approximately $9.3 billion.
A copy of the Court's decision is here.