With several billions of dollars ultimately at stake, the Second Circuit has affirmed that Section 546(e) of the Bankruptcy Code, a safe-harbor protecting certain securities-related payments from bankruptcy “claw backs,” barred Irving Picard, Trustee of Bernard L. Madoff Investment Securities, LLC (“BLMIS”), from asserting all but a limited category of avoidance and recovery claims. In re Bernard L. Madoff Inv. Sec. LLC, No. 12-2557 (L) (2d Cir. Dec. 8, 2014). The affected claims are premised on transfers made by BLMIS more than two years prior to the commencement of its liquidation proceeding, and allegedly preferential transfers made within 90 days of the commencement of the liquidation proceeding. Unless overturned by an en banc panel or the United States Supreme Court, the Second Circuit’s ruling will result in the dismissal of such claims in hundreds of the adversary proceedings commenced by the BLMIS Trustee.

The Second Circuit agreed with the analysis of Judge Jed Rakoff in the District Court that the transfers challenged by Picard were “made in connection with a securities contract” and “were also ‘settlement payment[s]’” within the broad ambit of Section 546(e).

In rejecting the BLMIS Trustee’s argument that Section 546(e) should not apply “because BLMIS never initiated, executed, completed or settled the securities transactions it promised to engage in,” the Second Circuit explained that the argument “misses the point.” The Court ruled that Picard’s position “does not engage with the language Congress chose for . . . § 546(e),” which does not contain a purchase or sale requirement. The Second Circuit pointed to the expansive statutory definition of “securities contract” in Section 741(7) of the Bankruptcy Code, as including “any other agreement . . . that is similar to a contract for the purchase, sale or loan of a security, and the broad interpretation of the “in connection with a purchase or sale of any security” requirement set forth in Merrill Lynch, Pierce Fenner & Smith Inc. v. Dabit, 547 U.S. 71 (2006). From these premises, the Second Circuit had “little difficulty” in concluding that the payments BLMIS made to its customers were made “in connection with” a securities contract if it is “related to” or “associated with” the securities contract.

Similarly, citing Section 741(8) of the Bankruptcy Code and its decision in Enron Creditors Recovery Corp. v. Alfa, 651 F.3d 329, 334 (2d Cir. 2011), the Second Circuit concluded that the transfers were “settlement payments” within the meaning of the statutory safe-harbor. The court rejected the BLMIS Trustee’s argument that “BLMIS never engaged in actual securities trading,” as focusing on the wrong analysis. The court explained the statutory definition of “settlement payments” should be broadly construed to apply to “the transfer of cash or securities made to complete [a] securities transaction” and “[e]ach time a customer requested a withdrawal from BLMIS, he or she intended that BLMIS dispose of securities and remit payment to the customer. Thus, the court concluded that the payments were settlements “even if the broker may have failed to execute the trade and sent me cash stolen from another client.”

The Second Circuit drew an important distinction between its earlier ruling, In re BLMIS, 654 F.3d 229 (2d Cir. 2011), in which it interpreted “net equity” in “a manner that would harmonize it within the SIPA [Securities Investor Protection Act] framework as a whole,” and its current interpretation of Section 546(e), which is part of the Bankruptcy Code, not SIPA. In enacting the Bankruptcy Code, Congress struck “careful balances” between the need for an equitable result for the debtor and its creditors, and “the need for finality.” By enacting Section 546(e), Congress provided that, for a very broad range of securities-related transactions, “the interest in finality is sufficiently important that they cannot be avoided by a bankruptcy trustee at all, except as actual fraudulent transfers under § 548(a)(1)(A),” which limits the look-back period to two years. The Second Circuit was “obliged to respect the balance Congress struck among these complex competing considerations.”

For the thousands of direct and indirect investors with BLMIS targeted by the Trustee, finality and closure have been elusive. Perhaps the Second Circuit decision will be the turning point.

Photo of Gregg Mashberg Gregg Mashberg

Gregg Mashberg is the former co-head of the Securities Litigation Group and a former chair of the Litigation Department. He has a broad-based practice and experience before numerous judicial and administrative forums.

Gregg has a particular focus on securities litigation, defending public companies…

Gregg Mashberg is the former co-head of the Securities Litigation Group and a former chair of the Litigation Department. He has a broad-based practice and experience before numerous judicial and administrative forums.

Gregg has a particular focus on securities litigation, defending public companies and their directors and officers in class actions, SEC investigations and enforcement actions. Gregg also has broad experience in defending directors and officers in shareholder derivative and class actions arising from mergers and acquisitions and direct breach of fiduciary duty suits under state law. As part of his securities litigation practice, Gregg is outside litigation counsel for The Depository Trust & Clearing Corporation and its subsidiaries, the nation’s principal securities settlement and depository institutions. He has litigated in trial and appellate courts around the country, successfully defending against claims challenging the securities clearing and settlement system.

In addition, Gregg has been active in litigation concerning various high-tech industries. He has substantial experience litigating disputes relating to telecommunications services and automated systems for processing securities transactions.

Gregg also has substantial litigation experience involving core aspects of Proskauer’s litigation practice, including general commercial disputes, antitrust, bankruptcy, entertainment, sports, First Amendment and trade secrets. He recently won summary judgment in a commercial dispute on behalf of a major British company, dismissing a complaint seeking $100 million in damages. Gregg is an experienced courtroom lawyer; for example, he won a $3 million federal jury verdict in a stockholders’ derivative action in a case involving the closing of a Wall Street brokerage house.

Following law school, Gregg spent five years in the New York City Corporation Counsel’s Office, becoming an Assistant Chief of the General Litigation Division. In that position, Gregg was lead counsel for the City in major institutional change class actions. He also represented the City in litigation concerning significant public policy disputes.

Gregg has maintained his interest in public law, most recently serving as lead counsel to St. Vincent’s Catholic Medical Center in defending against an Article 78 proceeding that challenged the NYC Landmarks Preservation Commission’s decision to permit St. Vincent’s to demolish a building in the Greenwich Village Historic District in order to make way for a new proposed $850 million hospital building. He also represented the NY Metropolitan Transportation Authority in successfully defending against challenges to the MTA’s 2003 decision to raise fares and tolls in the amount of $900 million.

Photo of Richard Spinogatti Richard Spinogatti

Richard Spinogatti is a senior counsel in the Litigation Department. Rich has more than 40 years of experience in federal and state courts in New York and other jurisdictions across the nation. In addition to litigating, trying cases, and arguing appeals at all…

Richard Spinogatti is a senior counsel in the Litigation Department. Rich has more than 40 years of experience in federal and state courts in New York and other jurisdictions across the nation. In addition to litigating, trying cases, and arguing appeals at all levels, he has advised national and international clients in connection with internal investigations and represented them in civil and criminal investigations, in administrative proceedings before federal, state and local government agencies, and before industry regulatory organizations.

Through his extensive representation of international, national, regional and local accounting firms, Rich has developed a broad knowledge of accounting, auditing and related professional services, and the complex regulatory structure governing the accounting profession. Rich is frequently called upon to consult with accountants and other professionals in pre-litigation contexts to avoid or minimize exposure risks. He has lectured and taught seminars for partners and employees of accounting firms on subjects ranging from accountants’ liability to litigation support.