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Securities Investor v. Jacqueline Green Rollover Account

July 25, 2012


The opinion of the court was delivered by: Denise Cote, District Judge:

Irving H. Pickard, trustee (the "Trustee") for the substantively consolidated liquidation of Bernard L. Madoff Investment Securities LLC ("BLMIS") and the estate of Bernard L. Madoff ("Madoff"), has submitted a motion (the "ERISA Motion") for an order affirming the Trustee's determinations denying claims over ERISA-related objections filed by claimants (the "ERISA Claimants") who argue that the Employee Retirement Income Security Act of 1974 ("ERISA"), 29 U.S.C. § 1001, et seq., and related regulations confer on them "customer" status, as that term is defined by Section 78lll(2) of the Securities Investor Protection Act of 1970 ("SIPA") as amended, 15 U.S.C. §§ 78aaa-78lll. For the following reasons, the motion is granted.


Many of the basic facts in this matter were addressed in the Court's January 4, 2012 Opinion and Order in the related case In re Aozora Bank Ltd., 11 Civ. 5683 (DLC), 2012 WL 28468 (S.D.N.Y. Jan. 4, 2012) (the "January Opinion" or "Aozora"). They are recounted below as a convenience, along with additional facts relevant to the disposition of this matter.

The ERISA Claimants fall into two categories. One category consists of individuals (the "Individual Claimants") who claim that they participated in ERISA-regulated retirement plans that had accounts with BLMIS.*fn1 The other category consists of entities that claim to be ERISA-regulated plans or individual retirement accounts ("IRAs") that invested directly or indirectly in a BLMIS account-holder entity such as a hedge fund or trust (the "Plan Claimants").*fn2 None of the claimants in either category had their own accounts with BLMIS.

BLMIS did not in fact invest the assets entrusted to it. Instead, Madoff, the sole member and principal of BLMIS, stole these assets as part of a multi-billion dollar Ponzi scheme.

Madoff was arrested and charged with securities fraud on December 11, 2008. On December 15, 2008, the United States District Court for the Southern District of New York entered an order placing BLMIS's customers under the protections of SIPA.

SIPA provides certain benefits to customers of failed brokerage firms. In re Bernard L. Madoff Inv. Sec. LLC, 654 F.3d 229, 233 (2d Cir. 2011). During a SIPA liquidation, customers share in the recovery of "customer property," which generally consists of the cash and securities held by the liquidating broker-dealer for customers, on the basis of their respective "net equities" and to the exclusion of the brokerage firm's general creditors. 15 U.S.C. §§ 78fff--2(b) and (c)(1); In re New Times Sec. Servs., Inc., 463 F.3d 125, 128--29 (2d Cir. 2006). Where customer property is insufficient to satisfy the claims of customers, SIPA permits the Securities Investor Protection Corporation ("SIPC") to make advances to the SIPC trustee, within the statutory limits of protection from the SIPC Fund. For customers with securities accounts, SIPC may advance not more than $500,000 per customer. 15 U.S.C. §§ 78ddd, 78fff3(a); In re Bernard L. Madoff Inv. Sec. LLC, 654 F.3d at 233.

On June 11, 2010, the Trustee filed a motion for an order to affirm the Trustee's determinations denying the claims of claimants without BLMIS accounts in their names, namely, investors in so-called Feeder Funds (the "Feeder Funds Motion"). The sixteen Feeder Funds were essentially hedge funds structured as limited partnerships, a limited liability company, and other commercial entities that had accounts with and invested directly with BLMIS.

On June 28, 2011, the Bankruptcy Court issued an order affirming the Trustee's denial of these "customer" claims, concluding that the Feeder Funds themselves, not the objecting claimants who invested in the Feeder Funds, qualified as customers under SIPA. See Sec. Investor Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, 454 B.R. 285, 290 (Bankr. S.D.N.Y. 2011). This Court affirmed the Bankruptcy Court's decision in the January Opinion. See Aozora, 2012 WL 28468, at *1. The briefing on the Feeder Fund Motion did not address the question of the impact of ERISA on the determination of "customer" status under SIPA.

On October 5, 2011, the Trustee filed the ERISA Motion before the Bankruptcy Court. In the ERISA Motion, the Trustee sought an order: 1) affirming the Trustee's denial of the ERISA Claimants' claims, and 2) overruling the objections to the Trustee's interpretation of the term "customer" on the basis of ERISA and related regulations. On November 8, 2011, the Bankruptcy Court entered a Scheduling Order (the "Bankruptcy Court Scheduling Order") setting a schedule for briefing on the ERISA Motion, and indicating that any objections or arguments raised by the ERISA Claimants that are unrelated to ERISA would be resolved at a later date.

The Reynolds Plan and the Greens moved for withdrawal of the reference to the Bankruptcy Court in the above-captioned case number 12 Civ. 1039 on February 9, 2012, and the Construction Plans moved for withdrawal of the reference in the above-captioned case number 12 Civ. 1139 on February 14. On April 20, 2012, the ERISA Motion became fully submitted before the Bankruptcy Court. Also on April 20, this Court issued an order (the "April 20 Order") withdrawing the reference from the Bankruptcy Court with respect to the ERISA Motion. On April 26, the Court ordered that the briefing materials on the ERISA Motion that had been submitted to the Bankruptcy Court be resubmitted to the Court with the correct caption by May 18, 2012.

On May 25 counsel for the Reynolds Plan submitted a supplemental declaration in opposition to the ERISA Motion. By Order of June 5, the Court authorized supplemental briefing on the ERISA Motion. On June 14, counsel for the Greens submitted supplemental briefing on the motion. The Trustee and SIPC responded on June 28. Although the Court had not authorized a reply, the Greens submitted one on July 12.


At issue in this motion is the impact of ERISA on the customer status of indirect investors who did not themselves hold BLMIS accounts, but who had an interest in third-party entities that did hold BLMIS accounts.

I. The January Opinion The January Opinion determined that indirect investors who invested in certain third-party corporate entities -- i.e., the Feeder Funds -- did not qualify as customers under SIPA because, inter alia, they did not hold BLMIS accounts and they did not have an ownership interest in the assets invested with BLMIS. See Aozora, 2012 WL 28468, at *5-6. In short, the January Opinion determined that the corporate form was not to be overlooked in determining customer status under SIPA. Even if nearly all of the assets that a claimant invested in a Feeder Fund eventually ended up entrusted to the debtor, the claimant was not a customer if these assets belonged to a Feeder Fund and if the name on the debtor's account was that of a Feeder Fund. See id.

The claimants in this case are similarly situated to those in the January Opinion. They are indirect investors who invested in a BLMIS account-holder. In fact, at least one Plan Claimant, the Ltd. Ed. Plan, invested in the same Feeder Fund as did certain claimants in the January Opinion.

Unlike the claimants in Aozora, however, the claimants in these actions allege either that they invested in an ERISA-regulated plan, or that they are ERISA-regulated plans themselves.*fn3 They argue that pursuant to an appropriate application of ERISA law, they must be granted customer status under SIPA. This Opinion addresses whether this proposition is correct, and concludes that it is not.

II. Scope of this Opinion Pursuant to the Bankruptcy Court Scheduling Order, briefing

on this motion was to be limited to issues arising under ERISA. Accordingly, the claimants' briefing in support of the motions to withdraw the bankruptcy reference of February 9 and February 14 argued that the ERISA Motion involved significant and novel interpretations of SIPA and ERISA. The motions to withdraw the reference were granted partly on these grounds. The scope of this Opinion is therefore limited to the question of whether ERISA has any bearing on the ERISA Claimants' "customer" status under SIPA. Factual or legal arguments unrelated to issues arising under ERISA will not be addressed, and are left to be resolved by the Bankruptcy Court.

Thus, although the Trustee avers that certain claimants have failed to establish that ERISA applies to them, it will be assumed for purposes of this motion that ERISA applies to all claimants. In addition, the supplemental briefings submitted by the Reynolds Plan and the Greens on May 25 and June 15, respectively, purport to present evidence that these claimants had contact with BLMIS, that BLMIS traded in securities for their accounts, or that they were known to BLMIS. They do not present any arguments based on ERISA, or cite to any ERISA provision or accompanying regulation. These arguments are therefore beyond the scope of the ERISA Motion and will not be addressed in this Opinion. Following the disposition of this motion, the Bankruptcy Court may address the impact, if any, of the supplemental materials submitted by the Reynolds Plan and the Greens on their "customer" status.

III. Customer Status Under SIPA SIPA's principal purpose is "to protect investors against

financial losses arising from the insolvency of their brokers." In re New Times, 463 F.3d at 127 (citation omitted). "Customer" is a term of art, however, Arford v. Miller, 239 B.R. 698, 701 (S.D.N.Y. 1999) aff'd sub nom. In re Stratton Oakmont, 210 F.3d 420 (2d Cir. 2000), and "[j]udicial interpretations of 'customer' status support a narrow interpretation of SIPA's provisions." In re New Times, 463 F.3d at 127 (citation omitted); cf. S.E.C. v. F.O. Baroff Company, Inc., 497 F.2d 280, 282 (2d Cir. 1974) (declining to apply the "literal definition" of the term customer because SIPA "was not designed to protect a lender in appellant's class"). A person may be a customer with respect to some of his claims but not others. See id. at 282 n.2. In the Second Circuit, "[e]mphasis on the customer as investor and purchaser/trader has been a consistent theme." Investor Protection v. Morgan, Kennedy & Co., 533 F.2d 1314, 1317 (2d Cir. 1976) ("Morgan, Kennedy"). Overall, however, "the critical aspect of the 'customer' definition is the entrustment of cash or securities to the broker-dealer for the purposes of trading securities." In re Bernard L. Madoff Inv. Sec. LLC, 654 F.3d at 236 (citation and emphasis omitted).

A. The Statutory Language SIPA contains three statutory definitions of the term "customer." It defines the term as follows: any person (including any person with whom the debtor deals as principal or agent) who has a claim on account of securities received, acquired, or held by the debtor in the ordinary course of its business as a broker or dealer from or for the securities accounts of such person for safekeeping, with a view to sale, to cover consummated sales, pursuant to purchases, as collateral security, or for purposes of effecting transfer. The term 'customer' includes any person who has a claim against the debtor arising out of sales or conversions of such securities, and any person who has deposited cash with the debtor for the purpose of purchasing securities.

15 U.S.C. § 78lll(2). The first of the three alternative definitions is contained in the first sentence of this passage. The remaining two definitions are contained in the second sentence, which clarifies that the term includes persons with claims arising out of sales of "such securities," and persons who have deposited cash with the debtor.

The ERISA Claimants concede that they do not qualify for customer status under the first two definitions of customer in SIPA § 78lll(2). This is because these definitions presume that a customer must have a securities account with the debtor. See Aozora, 2012 WL 28468, at *4-6 (interpreting the first two definitions of SIPA § 78lll(2)). The ERISA claimants had no such accounts.

The ERISA Claimants argue, however, that they fit within SIPA's third definition of customer because they "deposited cash with the debtor for the purpose of purchasing securities." 15 U.S.C. § 78lll(2). The ERISA Claimants are mistaken.

One cannot deposit cash with the debtor if this cash belongs to another. See Aozora, 2012 WL 28468, at *6; In re Primeline Sec. Corp., 295 F.3d 1100, 1107 (10th Cir. 2002) ("The relevant inquiry is whether the brokerage firm actually received, acquired or possessed Claimants' property."); In re Old Naples Sec., Inc., 223 F.3d 1296, 1302 (11th Cir. 2000) (whether a claimant "deposited cash with the debtor" depends on "whether there was actual receipt, acquisition or possession of the property of a claimant by the brokerage firm under liquidation") (citation omitted); Sec. Inv. Prot. Corp., 454 B.R. at 298-99 (claimants could not have entrusted cash with BLMIS for the purpose of trading or investing in securities because this property belonged to the Feeder Funds). None of the ERISA Plan Claimants owned any cash deposited with ...

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