The Madoff trustee and Madoff victims hoped to hold the banks liable for alleged wrongdoing. The banks hoped to escape liability on the theory that the Madoff trustee, standing in the shoes of Madoff’s company, was a wrongdoer that should be barred from suing the banks.
The Second Circuit has now spoken on the issue. The court affirmed the dismissals of the lawsuits that the Madoff trustee had filed against JPMorgan Chase Bank and HSBC Bank. Picard v. JPMorgan Chase & Co. (In re Bernard L. Madoff Investment Securities LLC), 2013 U.S. App. LEXIS 12551 (2d Cir. June 20, 2013). There will be no recovery through the trustee for the billions of dollars in damages allegedly caused by the banks’ conduct in aiding and abetting Madoff’s fraud. And this seemed to be a relatively easy decision for the Second Circuit.
Some perspective on the Second Circuit’s view of these issues is helpful, however, in analyzing this decision. The Second Circuit is quite fond of its Wagoner rule, established in Shearson Lehman Hutton, Inc. v. Wagoner, 944 F.2d 114, 120 (2d Cir. 1991), in which it held that "A claim against a third party for defrauding a corporation with the cooperation of management accrues to creditors not to the guilty corporation."
Citing its own Wagoner rule, the court held that the in pari delicto doctrine deprived the trustee of standing to pursue the debtor’s claims. It is important to note that no other circuit, nor indeed most courts – including lower courts in the Second Circuit – agrees with the Wagoner rule, because it combines in pari delicto and standing issues. See The Ponzi Book: A Legal Resource for Unraveling Ponzi Schemes, at 13.02[e].
Although alone in its view of in pari delicto as a threshold standing bar to trustees’ claims, the Second Circuit nevertheless went through a more traditional analysis of the in pari delicto doctrine to reach its holding that bars the Madoff trustee from bringing the claims against the banks. The court summarily rejected the trustee’s first six arguments, noting that they "are resourceful, but they all miss the mark." Picard v. JPMorgan, at *21.
- On the trustee’s argument that a SIPA trustee is exempt from the Wagoner rule, the court stated that the trustee cited no authority.
- On his argument that the in pari delicto doctrine should not apply because he is not a wrongdoer, the court pointed out that neither were the other trustees in the cases in which the court did apply the doctrine.
- On his argument that applying the doctrine impeded the enforcement of the securities law under Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299, 105 S. Ct. 2622 (1985), the court summarily stated that Bateman Eichler was inapposite.
- On his argument the "adverse interest" exception to the defense should apply, the court stated that the exception was "narrow" and only applied when the fraud was committed against the corporation and not on its behalf, citing Kirschner v. KPMG LLP, 15 N.Y.3d 446, 912 N.Y.S.2d 508, 938 N.E.2d 941, 952 (N.Y. 2010).
- On his equitable argument that the proceeds of a recovery by a SIPA trustee would benefit the blameless customers of the wrongdoer, the court cited the New York Court of Appeals in Kirschner v. KPMG LLP, 938 N.E.2d 941, 958 (N.Y. 2010), rejecting the trustee’s argument.
- On the trustee’s argument that the defense should not be sustained at the pleading stage, the court observed that the New York Court of Appeals had held otherwise and that it "is appropriate where (as here) the outcome is plain on the face of the pleadings." Picard v. JPMorgan, at *6.
The court focused most of the rest of its attention in the opinion on rejecting the trustee’s argument that he has standing to pursue his claims under Redington v. Touche Ross & Co., 592 F.2d 617 (2d Cir. 1978), under St. Paul Fire & Marine Insurance Co. v. PepsiCo, Inc., 884 F.2d 688 (2d Cir. 1989), under bailment law, and under SIPA itself.
As to Redington, the trustee argued that the Supreme Court’s subsequent reversal of that decision addressed only the merits of the plaintiff’s claim and left intact the Second Circuit’s holding that a SIPA trustee has standing. The court held otherwise, stating that "Redington should be put to rest; it has no precedential effect. Even if Redington retained some persuasive value, it would not decide this case." Picard v. JPMorgan, at *36.
The trustee argued that under St. Paul Fire & Marine Insurance, 884 F.2d 688 (2d Cir. 1989), a trustee may bring a claim if the "claim is a general one, with no particularized injury arising from it, and if that claim could be brought by any creditor of the debtor." Id. at 701. The Second Circuit, however, held that this decision did not broadly grant trustees standing to pursue creditors’ claims, because such a reading would put it in conflict with Caplin v. Marine Midland Grace Trust Co. of N.Y., 406 U.S. 416, 92 S. Ct. 1678 (1972), which held that the trustee has no standing to pursue creditors’ claims.
In responding to the trustee’s two additional theories supporting his standing argument, the Second Circuit noted that, "The Trustee attempts to blunt the force of Caplin and its progeny by arguing that a SIPA liquidation is unique and is therefore not controlled by precedent under the bankruptcy code." Picard v. JPMorgan at *42. The trustee had argued that BLMIS’s customers were bailors, and that he, as a bailee, had a sufficient interest to pursue recovery on customers’ claims to recover their lost property. The court rejected this ground for standing, finding that nothing in SIPA, the bankruptcy code or common law supports it.
Finally, the court rejected the trustee’s claim of standing based on a theory of subrogation arising under SIPA due to his previous payments on the claims of BLMIS’s customers. The court held that although 15 U.S.C. § 78fff–3(a) gave SIPC the right of subrogation as to the customers’ claims against the estate, nothing in that provision suggested that it also granted to the trustee subrogation of the customers’ claims against third parties.
Curiously, in its final footnote, the court suggested a path that could lead to the defendants’ liability. "Picard and SIPC contend that, absent his exclusive authority to bring these customer claims, the Defendants would in effect be immunized from suit. But it is not obvious why customers cannot bring their own suits against the Defendants. In fact, the Defendants make clear that customers have already filed such actions." Id. at *58 n.29. Of course, this suggestion ignores the questions of whether creditors would have standing to pursue the same types of claims that the trustee sought to pursue or whether they may encounter their own legal barriers to recovery. And, even if they could legally bring their own claims, could they realistically finance litigation against well-funded institutions like JPMorgan and HSBC?
This case, and many other recent decisions, go to great lengths to justify bars to recovery by bankruptcy trustees, SIPA trustees, and even regulatory receivers. This raises the question of why we have these fiduciaries in the first place. Absent the wave of recent decisions applying in pari delicto as a bar to these fiduciary plaintiffs, one would have thought that the point of the statutory schemes (Bankruptcy Code and SIPA) and the equitable case law (regulatory receiverships) in appointing fiduciaries was to redress the wrongs of the defrauded victims in fraud cases. One must now question what we had understood to be a basic premise of those laws. Are fiduciaries intended to be mere paper pushers, reconstructing the fraud that left victims penniless, but creating a paper trail that leads to nowhere?