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Safe Harbors Gone Wild

posted by Stephen Lubben

Yesterday's decision from the District Court court in the Madoff-Mets litigation is yet another example of why Congress desperately needs to revisit the safe harbors which exempt a host of financial transactions from the workings of the Bankruptcy Code (in this case, the Code as incorporated into SIPA).

The opinion is available here, but briefly, Judge Rakoff blew a giant hole in the trustee's suit against the owners of the Mets, dismissing all claims based on preference and constructive fraudulent transfer, whether under the Code or New York Law. The basis? Section 546(e) of the Code, which provides 

Notwithstanding sections 544, 545, 547, 548 (a)(1)(B), and 548 (b) of this title, the trustee may not avoid a transfer that is a ... settlement payment, as defined in section 101 or 741 of this title, made by or to (or for the benefit of) a commodity broker, forward contract merchant, stockbroker...  in connection with a securities contract, as defined in section 741 (7)...  that is made before the commencement of the case, except under section 548 (a)(1)(A) of this title.

Madoff was a stockbroker, in the loose sense that he was registered as a stockbroker. We now know that he was not actually doing any stockbroker like things for his investors. The Judge does not look into the definition of stockbroker in §101(53A) of the Code -- I think there might be an argument Madoff didn't meet it -- and moves right to the analysis of whether the transactions involved securities contracts and settlement payments.

Of course, there is no real reason to apply the safe harbors to this case. Madoff's transactions are not going to disrupt the financial markets if they were subjected to avoidance actions -- there was essentially no link to the financial markets whatsoever. But the Judge went with the planing meaning of the statute, which contains no such common sense exception. Hence the need for Congress to get involved.


Dear Wingnut:

Who told you that you understand the way avoidance law works in the Ponzi context? You dont.

You seem to have misread 546e, which does not require that Madoff have been a stockbroker. 546e is one of the requirements to facitate our system of indirect amd anonymized trading of securities on open markets. Without 546e, financial intermediaries (the dtc, traders, market makers, secondary exchanges, interexchange trading systems, etc.) would have to create an entirely new network of data sharing (which might make their existence impossible), assume the risk that transfers will turn out to be fraudulent (imagine what *that* would do to transaction fees), or just not exist at all.

Anyway, there's no question that Madoff did, in fact, hold and sell securities for his victims. It just happens that they weren't the securities he claimed - instead it was treasuries and money markets.

Or is it your view that all of the bond counterparties received avoidable fraudulent transfers???

I'm sorry, but I more and more think you just don't understand how the bankruptcy system works in Ponzi cases.

I think Professor Lubben understands 546(e) quite well. The statute requires that the payments be "by" or "to" [or for the benefit of] "a .. strockbroker." (There are other kinds of entities that qualify, but there is no sign that the Madoff entity was one of them, so ignore those). In other contexts - e.g., LBO - the payments that a trustee seeks to avoid are often being made "to" a stockbroker. That is not this context, Here, it happens, that they were being made "by" a stockbroker, because the estate happened to have been a stockbroker. Which is why the Madoff entity has to be a stockbroker for defendants to prevail.

But I disagree with the Professor about the need for change, or at least the nature of such a change. I think it is a satisfactory public policy that those not proven to be involved in a fraud are left undisturbed by its cleanup. Yes, it reduces recoveries for some, but when those recoveries come at an innocent person's expense, they are just a zero sum game. And it's an expensive zero-sum game, costing tens and maybe hundreds of millions of dollars - with nothing having even gone to trial yet, as far as I know - depending on how many people's fees you count.

Mt: ummmm.... No. Madoff's entity was registered with the sec and was unquestionably a "financial intermediary" as defined in the statute, which neither you nor Lubben apparently bothered to read in full.

Good heavens! Why are you so nasty, Amos?! If you're going to be righteously indignant, you should at least make sure you're not clearly wrong, yourself. The term in the statute is either financial "institution" or "participant," but not "intermediary," so who appears not to have "bothered to read [the statute] in full"? Moreover, these arguments are not the basis for the ruling (and are probably wrong in any event).

The district court's conclusion here was that BLMIS was "a registered stockbrokerage" and that section 546(e) thus required DISMISSAL of the complaint (which can't be right, since this is a conclusion of fact and law that could only properly be made on summary judgment, not dismissal).

The problem, as Prof. Lubben suggests, is that stockbroker is defined in 101(53A) as a person "engaged in the business of effecting transactions in securities." Registration is beside the point. Other courts have concluded that Ponzi schemers are NOT "engaged in the business," even if they're misleadingly registered as such, if they're not really executing the trades they're reporting to customers. The language of this statute is NOT "plain" in the way the district court seems to have thought.

At a later point in the opinion, the district court glibly observes that the definition of settlement payment "clearly includes all payments made by Madoff Securities." You know when the court has to use the word "clearly" that it doesn't have a sufficient factual basis for its conclusion, and this is a conclusion of fact and/or law, "clearly" improper on a motion to dismiss (as opposed to summary judgment).

It might be that BLMIS qualifies as a "financial institution" simply because it is "an investment company registered under the Investment Company Act of 1940" per section 101(22)(B). It might be a "financial participant" per section 101(22A), as well, but neither of these arguments were apparently made to or relied upon by the district court . . . which makes me suspect they're not viable arguments.

I hope the trustee appeals Rakoff's decision, because it is not only bad policy, it's unquestionably bad law (at least procedurally). It was issued on a withdrawn reference, so the district court did not have the benefit of a bankruptcy judge's analysis. The SDNY Bankruptcy Court has analyzed this exact issue in another Madoff case and gotten it right (a few days before the issuance of the district court's opinion) in case no. 08-01789 (Lifland, 9/22/2011). Please, Mr. Picard, take this to the Second Circuit!

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