Supreme Court Deals $4 Billion Blow To Madoff Recovery Efforts

The Supreme Court refused to consider an appeal brought by the court-appointed bankruptcy responsible for recovering assets for Bernard Madoff's massive Ponzi scheme, instead leaving intact an appellate decision that prevents the recovery of "false profits" by Madoff profiteers beyond the two-year period preceding the collapse of Madoff's scheme.  Irving Picard, the court-appointed trustee, had estimated that an adverse ruling could result in the inability to recover an additional $4 billion for the benefit of the thousands ensnared by Madoff's historic fraud.  Picard's efforts have already resulted in the recovery of nearly $11 billion for victims, with an additional $4 billion recovered through government settlements set to be distributed through a more expansive claims process.  The decision will have no effect on the funds recovered to date.

One of the principal sources of recoveries in the aftermath of a collapsed Ponzi scheme is those investors who were fortunate enough not only to realize a recovery of their invested principal but also some form of profits.  While characterized as interest or returns, the operation of a Ponzi scheme meant that those profits were nothing more than the redistribution of funds raised from other newer investors.  A bankruptcy trustee is able to utilize avoidance powers under the U.S. Bankruptcy Code as well as fraudulent transfer claims under state law, often with the ability to recover prejudgment interest from the time of the transfer.  Picard has brought hundreds of such suits, known as clawback suits, since his appointment with significant success - including a $7 billion settlement with the estate of Jeffry Picower, a close friend of Madoff's and early investor. Picard's success prompted many to settle with Picard for all or a majority of the illicit funds they received from the scheme.

However, a federal bankruptcy judge ruled in 2011 that several executives with the New York Mets baseball team could only be held liable for transfers they received in the two years preceding the collapse of Madoff's scheme, citing the "safe harbor" provision codified in section 546(e) of the Bankruptcy Code.  In relevant part, that section provides:

Notwithstanding sections 544, 545, 547, 548(a)(1)(B), and 548(b)…, the trustee may not avoid a transfer that is a … settlement payment … made by or to (or for the benefit of) a … stockbroker … or that is a transfer made by or to (or for the benefit of) a … stockbroker … in connection with a securities contract…, except under section 548(a)(1)(A). 

Both U.S. District Judge Jed S. Rakoff, as well as the U.S. Court of Appeals for the Second Circuit, concluded that Section 546(e) applied to the situation present in the Madoff suits: the Madoff account documents qualified as a securities contract, customer distributions were made in connection with that "securities contract," and those distributions also qualified as settlement payments.   As Judge Rakoff concluded, Section 546(e) covers an extremely broad definition of "settlement payments", and "clearly includes all payments made by Madoff Securities to its customers."  Thus, by its "literal language," the Bankruptcy Code prohibits Picard from bringing any clawback action against Madoff customers except those paid in the case of actual fraud.  The Second Circuit affirmed Judge Rakoff's ruling in December 2014.

Picard's legal team has estimated that upholding the Second Circuit's decision could prevent the recovery of more than $4 billion - consisting of approximately $2 billion in direct recoveries and complicating efforts to seek an additional $2 billion.