Kathy Bazoian Phelps
Senior Counsel in Ponzi Scheme Litigation
and Bankruptcy Matters

Kathy is a senior business trial attorney with more than 28 years experience prosecuting and defending claims for high net worth clients involved in Ponzi scheme matters and in bankruptcy proceedings. Kathy’s practice includes recovering assets for clients in complex fraud cases under standard fee and alternative fee arrangements. Kathy also serves as a mediator in bankruptcy matters, in complex business disputes, and in matters requiring detailed knowledge about fraud or Ponzi schemes.

Kathy’s Clients in Ponzi Scheme Cases and Bankruptcy Matters
Equity Receivers
Bankruptcy Trustees
High Net Worth Investors
Debtors in Bankruptcy
Secured and Unsecured Creditors

Tuesday, June 3, 2014

Did the Second Circuit Get SLUSA Right in the Madoff Ponzi Scheme Case?

Posted by Kathy Bazoian Phelps 

     In a very short and summary opinion, the Second Circuit concluded that nothing in a recent Supreme Court decision gave it any reason to revisit its prior ruling that SLUSA bars state law class action claims against banks in connection with the Bernard Madoff scheme. In re Herald, Primeo, and Thema, 2014 U.S. App. LEXIS 9871 (2d Cir. May 28, 2014).

     As discussed previously in this blog, the Supreme Court in Chadbourne & Park LLP v. Troice, 134 S. Ct. 1058 (2014), declined to bar certain class action claims in the Stanford Financial Ponzi scheme case on the grounds that: (1) the certificates of deposits sold were not “covered securities”; and (2) the fraud was not “in connection with the purchase or sale of a covered security.”

     The Second Circuit found no application of Troice in the Madoff case. Simply put, the court said, “Because the fraud perpetrated by Madoff Securities was ‘material to a decision by one or more individuals (other than the fraudster) to buy or to sell a 'covered security,' Troice, 134 S. Ct. at 1066, the Supreme Court's ruling confirms the logic and holding of In re Herald.’”

     The Second Circuit distinguished the Stanford Financial case from Madoff, stating, “the closest that the plaintiffs in Troice could get to statutorily defined ‘covered securities’ was the allegation that Stanford induced purchase of the uncovered securities by, among other misrepresentations, vague promises that the Stanford Investment Bank had significant holdings in various covered securities.” Quoting Troice, the court noted, “Thus, a plaintiff in Troice was entirely distinguishable from ‘a victim who took, tried to take, or maintained an ownership position in the statutorily relevant securities through 'purchases' or 'sales' induced by the fraud.’"

     The Second Circuit reached the following conclusion and put an end to the class action claims against the allegedly wrongdoing banks:
Madoff Securities, by contrast, fraudulently induced attempted investments in covered securities, albeit through feeder funds (not alleged in the instant complaints as anything other than intermediaries), and the defendant banks are alleged to have furthered that scheme. Madoff Securities' victims thus "tried to take . . . an ownership position in the statutorily relevant securities," i.e., covered securities. That Madoff Securities (a Ponzi scheme) fraudulently failed to follow through on its promise to place the investments in covered securities does not in any respect remove this case from the ambit of SLUSA as defined in Troice.
     Is this type of distinction fair to defrauded victims? In Stanford, they thought they were purchasing certificates of deposits. In Madoff, they handed their money to feeder funds for investment purposes, sometimes not even knowing how their money was being invested. The straightforward and uncontested fact is that there were no sales or purchases of “covered securities” by anyone in Madoff, just like in Stanford. Is there a fair reason to say that one group can sue to recoup losses and the other cannot? The Second Circuit has interpreted Troice to make such a distinction. 

     In addition to the concern that this interpretation leads to an uneven application of the law in Ponzi scheme cases, is this result the right one in the Madoff case? First the Madoff trustee was barred from suing some of these very same banks. Now the investors are barred from seeking recovery from the banks. So who is it that gets to hold the banks accountable and obtain recoveries to reimburse the defrauded victims for their losses? At least one bank, JPMorgan, has admitted knowledge of suspicious activity while engaged in the banking activity necessary to perpetuate the scheme. The only comfort so far is that the government pursued charges against that bank and reached an agreement with the bank to pay about $2 billion. This is better than nothing, but not enough to make the victims whole.

1 comment:

  1. It seems to be assuming that the banks bear responsibility for Madoff's fraud when you say:

    "So who is it that gets to hold the banks accountable and obtain recoveries to reimburse the defrauded victims for their losses?"

    The banks here did not steal the assets.

    Also, not sure how Chase factors into this. Chase provided Madoff's bank account -- where he kept the pot of money for the Ponzi scheme. I don't think there is any allegation here that these were Madoff's bankers.