With several billions of dollars ultimately at stake, the Second Circuit has affirmed that Section 546(e) of the Bankruptcy Code, a safe-harbor protecting certain securities-related payments from bankruptcy “claw backs,” barred Irving Picard, Trustee of Bernard L. Madoff Investment Securities, LLC (“BLMIS”), from asserting all but a limited category of avoidance and recovery claims. In re Bernard L. Madoff Inv. Sec. LLC, No. 12-2557 (L) (2d Cir. Dec. 8, 2014). The affected claims are premised on transfers made by BLMIS more than two years prior to the commencement of its liquidation proceeding, and allegedly preferential transfers made within 90 days of the commencement of the liquidation proceeding. Unless overturned by an en banc panel or the United States Supreme Court, the Second Circuit’s ruling will result in the dismissal of such claims in hundreds of the adversary proceedings commenced by the BLMIS Trustee.

The Second Circuit agreed with the analysis of Judge Jed Rakoff in the District Court that the transfers challenged by Picard were “made in connection with a securities contract” and “were also ‘settlement payment[s]’” within the broad ambit of Section 546(e).

In rejecting the BLMIS Trustee’s argument that Section 546(e) should not apply “because BLMIS never initiated, executed, completed or settled the securities transactions it promised to engage in,” the Second Circuit explained that the argument “misses the point.” The Court ruled that Picard’s position “does not engage with the language Congress chose for . . . § 546(e),” which does not contain a purchase or sale requirement. The Second Circuit pointed to the expansive statutory definition of “securities contract” in Section 741(7) of the Bankruptcy Code, as including “any other agreement . . . that is similar to a contract for the purchase, sale or loan of a security, and the broad interpretation of the “in connection with a purchase or sale of any security” requirement set forth in Merrill Lynch, Pierce Fenner & Smith Inc. v. Dabit, 547 U.S. 71 (2006). From these premises, the Second Circuit had “little difficulty” in concluding that the payments BLMIS made to its customers were made “in connection with” a securities contract if it is “related to” or “associated with” the securities contract.

Similarly, citing Section 741(8) of the Bankruptcy Code and its decision in Enron Creditors Recovery Corp. v. Alfa, 651 F.3d 329, 334 (2d Cir. 2011), the Second Circuit concluded that the transfers were “settlement payments” within the meaning of the statutory safe-harbor. The court rejected the BLMIS Trustee’s argument that “BLMIS never engaged in actual securities trading,” as focusing on the wrong analysis. The court explained the statutory definition of “settlement payments” should be broadly construed to apply to “the transfer of cash or securities made to complete [a] securities transaction” and “[e]ach time a customer requested a withdrawal from BLMIS, he or she intended that BLMIS dispose of securities and remit payment to the customer. Thus, the court concluded that the payments were settlements “even if the broker may have failed to execute the trade and sent me cash stolen from another client.”

The Second Circuit drew an important distinction between its earlier ruling, In re BLMIS, 654 F.3d 229 (2d Cir. 2011), in which it interpreted “net equity” in “a manner that would harmonize it within the SIPA [Securities Investor Protection Act] framework as a whole,” and its current interpretation of Section 546(e), which is part of the Bankruptcy Code, not SIPA. In enacting the Bankruptcy Code, Congress struck “careful balances” between the need for an equitable result for the debtor and its creditors, and “the need for finality.” By enacting Section 546(e), Congress provided that, for a very broad range of securities-related transactions, “the interest in finality is sufficiently important that they cannot be avoided by a bankruptcy trustee at all, except as actual fraudulent transfers under § 548(a)(1)(A),” which limits the look-back period to two years. The Second Circuit was “obliged to respect the balance Congress struck among these complex competing considerations.”

For the thousands of direct and indirect investors with BLMIS targeted by the Trustee, finality and closure have been elusive. Perhaps the Second Circuit decision will be the turning point.