October 6, 2011
What's Wrong With Picard v. Katz? Just About Everything.
Editor’s Note: The following post comes to us from Dr. Anthony Michael Sabino, a Professor in the Department of Law at The Peter J. Tobin College of Business at St. John’s University. (SJP)
WHAT’S WRONG WITH PICARD V. KATZ? JUST ABOUT EVERYTHING.
Anthony Michael Sabino, Professor of Law, St. John’s University, Tobin College of Business; Partner, Sabino & Sabino, P.C.
I have long been an admirer of Judge Jed Rakoff of New York’s Southern District. Like many, I have long considered him to be the dean of the federal securities bar, at least as to its judicial contingent. However, I found his latest decision, entitled Picard v. Katz, to be so deeply mistaken, particularly as to its usurpation of settled bankruptcy law doctrine, that I can scant believe this is the same jurist. Since an appeal is a near certainty, I can only look forward to the Second Circuit righting this wrong.
For the (few that remain) unacquainted, the plaintiff is Irving Picard, the trustee of the defunct investment advisory business of the infamous Bernard Madoff, now about two years into his 150 year prison sentence for masterminding the greatest Ponzi scheme of the new century. Defendant “Katz” is Saul Katz, business partner of Fred Wilpon, and, along with Wilpon, an owner of Major League Baseball’s New York Mets. All are defendants in the instant case.
The Wilpons and various of their enterprises were heavy investors with Madoff, and reaped many millions in profits over the years, some of those profits going to fund the Mets’ cash flow. With the vast majority of those profits now proven to be fictitious, and the discovery that said “profits” were paid from monies deposited by subsequent Madoff victims, at bottom this litigation is all about Trustee Picard’s efforts to recover anywhere from $ 300 million to $ 1 billion from the Mets’ owners, based upon various theories, the paramount ones being “fraudulent conveyances,” as set forth in the Bankruptcy Code and New York state law.
In addition to the above preface, let me be clear that, in this limited space, I am not addressing Judge Rakoff’s earlier decisions, both as to these parties and similarly situated Madoff defendants, where the court discarded somewhat “novel” theories that the Trustee claimed entitled him to recover up to a billion dollars from the Wilpons alone. Rather, I am strictly confining myself to the new Katz decision, wherein Judge Rakoff tossed out causes of action so fundamental and traditional to litigation of this kind, that I was frankly aghast at the outcome. My consternation is focused upon three key points.First, Judge Rakoff dismissed the “constructive fraud” count of the fraudulent conveyance claim. Briefly, constructive fraud is proven by a straightforward and purely objective test, to wit, a simple arithmetical calculation of what you received as compared to what you paid. By its nature, the early beneficiaries of a Ponzi scheme receive more than they paid in, and so easily fail the test. Case law, including that of the Second Circuit, is clear that Ponzi beneficiaries unfailingly are liable to return false profits, since those monies came from subsequently defrauded investors. Indeed, the Second Circuit’s most recent decision in the Madoff case, in validating Trustee Picard’s methodology for calculating the actual losses of Madoff’s victims, reflects that jurisprudence. Then how can Judge Rakoff’s decision be so at odds with those clear precedents? Not for long, I hope.
In addition, constructive fraud, because it is an objective test, will survive where the “actual fraud” allegation, dependent upon subjective proof, will oft times fail. Yet Katz is permitting the actual fraud allegations, the ones far more susceptible of being tossed for a lack of proof of the defendants’ state of mind, to proceed, while the more durable allegations, based upon simple math, are dismissed. This makes no sense. Lastly, Katz limits the fraudulent conveyance claims to the two year statute of limitations found under the Bankruptcy Code. Wrong---Trustee Picard sued in parallel under New York’s fraudulent conveyance statutes, which provide a more liberal six year limitary period to reach back to recover fraudulent conveyances. This misapplication of the correct statutory periods is sure to be corrected by the appellate court.
My second point of contention is Katz’s complete confusion of “settlement payments,” as defined in Title 11, with the ill gotten goods the Defendants allegedly received here. The court immunizes the Defendants’ receipts from the Trustee’s allegations, by characterizing them as settlement payments from a broker. That misses the mark by a country mile. First, while the statutory definition of settlement payment is admittedly lucid, both the text and its history make clear as crystal that monies so paid are protected because they represent payments by brokers to customers as part of actual securities transactions.
That is not what happened here. These defendants allegedly took out far more than they invested, based upon fictitious profits produced by Madoff’s fertile and devious imagination. As we learned to our sorrow, Bernie Madoff never actually bought or sold any securities. As such, monies received by these defendants are inapposite to the settlement payments (and the underlying transactions) the law is designed to protect. Put another way, Congress wrote statutory protections for settlement payments into the Bankruptcy Code, at the behest of the legitimate securities industry, in order to protect the orderly flow of actual business. Money paid out in a Ponzi scheme is light years away from that, and thus wholly undeserving and unintended for such protections.
Moreover, Katz is internally inconsistent in this regard. It notes that Ponzi schemes such as Madoff’s transpire “without any actual securities trades taking place.” Yet in the next paragraph it bestows statutory protection upon those same non-existent transactions. If the transaction is a sham, how can it be deserving of the law’s “safe harbor”?
Third, Katz purportedly seeks to reconcile important provisions of the Bankruptcy Code with the federal securities laws, foremost from the latter body the Securities Investor Protection Act, called “SIPA.” Having extensively litigated and written about the intersection of bankruptcy law with the federal securities statutes, I agree this is no small task. But Katz does not provide an intersection; it gives us a train wreck. For instance, Katz asserts that in this context “bankruptcy law is to be informed by federal securities law.” Yet what this opinion provides instead is an annihilation of the Bankruptcy Code in favor of misconstrued concepts of the securities laws.
Katz ignores that a SIPA liquidation of an investment firm (as is the case here with Madoff’s investment advisory business) is to be conducted in harmony and in conjunction with the Bankruptcy Code. That is why the Code contains specific provisos for stockbroker liquidations, and SIPA cases are administered in bankruptcy courts by bankruptcy trustees. Trustee Picard was not stripped of his traditional powers to recover fraudulent conveyances under bankruptcy or state law. Nor are the securities laws to be construed to artificially restrict his powers. This has long been the law of the Second Circuit, and things will surely be put to rights on the appeal (Trustee Picard’s attorneys have already indicated that an interlocutory appeal will be sought).
In closing, Katz perpetrates a great wrong: first by utterly misunderstanding fraudulent conveyance law, particularly the aspect of “constructive fraud;” second, by misconstruing portions of the federal securities laws to immunize fraudulent conveyances from rightful recovery; and third, by crushing established bankruptcy and SIPA provisos via the misapplication of the federal securities laws.
The fortunate news is that the cases are legion, especially in the Second Circuit, in proof of the errors of Katz. Surely a swift appeal will put this misbegotten decision to rest, and these defendants will find their exposure on the “constructive fraud” fraudulent conveyance counts will amount to nearly $300 million. We should yet see legitimate victims benefiting by recoveries from the recipients of fictitious profits paid out with their money.
 ___ F.Supp.2d ___ (S.D.N.Y. Sept. 27, 2011) (11 Civ. 3605) (JSR).
 11 U.S.C. § 548. The Bankruptcy Code is often referred to as “Title 11,” per its ordination in the U.S. Code.
 New York Debtor and Creditor Law (“D.C.L.”) § 270, et seq.
 In re Bernard L. Madoff Investment Securities LLC, ___ F.3d ___ (2d Cir. August 16, 2011) (Jacobs, C.J.).
 Compare Sabino, “Applying the Law of Fraudulent Conveyances to Bankrupt Leveraged Buyouts: The Bankruptcy Code’s Increasing Leverage Over Failed LBOs,” 69 North Dakota Law Review 15 (1993).
 Sabino, “Failed Stockbrokers and the Bankruptcy Courts in the 21st Century: Bringing Order to Chaos,” Annual Survey of Bankruptcy Law 2002 317 (West 2002).
 Katz, slip op. at 14.
 Parenthetically, Judge Rakoff claimed that he declined the defendants’ request to convert their Rule 12(b)(6) motion to dismiss to a motion for summary judgment pursuant to Rule 56. Katz, slip op. at 13 n.8. Yet I find that contradictory, as in pertinent part it appears to me the court is more according summary judgment on these claims than merely dismissing them.
 Katz, slip op. at 11 n.6.
This is a well thought out analysis, but unfortunately it is based upon a false premise. This was not a Ponzi scheme and the declaration by Mr. Picard does not make it so. A Ponzi scheme has been declared, not proven, by Mr. Picard. The trading done by Mr. Madoff's firm coupled with securities laws and regulations clearly show that the securities Mr. Katz owned via his confirmations and statements sent to him by Mr. Madoff's firm were his to liquidate and withdraw from Mr. Madoff's firm. When this fact is considered you will see that Judge Rakoff's decision is spot on.
Posted by: Anonymous | Oct 13, 2011 1:26:15 PM
First, thank you for the compliment, much appreciated.
Second, re your comment, it's not just me who characterizes it as a "Ponzi"
scheme. In the just reported case of Picard v. HSBC Bank, 454 B.R. 25, at 28, Judge Rakoff calls it a Ponzi scheme. So has the 2d Circuit, the SEC, and others. I'd call that law of the case.
Posted by: Prof. Sabino | Oct 17, 2011 9:28:07 AM