District Court decides that in a broker-dealer liquidation governed by SIPA, where a trustee seeks to recover funds paid to the defendant under Sections 548(a) and 550(a) of the Bankruptcy Code, which impose liability for fraudulent conveyances where the defendant lacked good faith in receiving the funds: (i) the defendant’s good faith is evaluated under a subjective willful blindness standard, and (ii) to survive a motion to dismiss, the trustee bringing the fraudulent conveyance claims must plead facts sufficient to establish the defendant’s lack of good faith.


Irving Picard (Trustee), the trustee appointed under the Securities Investor Protection Act (SIPA) to liquidate Bernard Madoff’s firm, Bernard L. Madoff Investment Securities LLC (BLMIS), has brought more than a hundred lawsuits seeking, in the aggregate, billions of dollars in transfers from defendants whom the Trustee alleges received transfers of funds that originated with BLMIS.  In their motion to dismiss, filed before Judge Rakoff of the Southern District of New York, defendants raised three arguments—two of which involved issues of first impression—with respect to the good faith defense1  provided by the Bankruptcy Code:

  1. In a SIPA liquidation, what is the appropriate standard governing the good faith of an initial transferee?
  2. In a SIPA liquidation, what is the appropriate standard governing the good faith of a subsequent transferee? (issue of first impression)
  3. In a SIPA liquidation, does the Trustee have the burden of pleading facts sufficient to plausibly establish a defendant’s lack of good faith in order to survive a motion to dismiss? (issue of first impression)

Freshfields’ associate David Livshiz led the briefing and argued the above issues on behalf of Freshfields’ client Tensyr Limited2 and eight other financial institution defendants.

In an opinion issued on April 27, 2014, in In re Madoff Securities, 12-MC-115 (JSR) (S.D.N.Y. Apr. 27, 2014), Judge Rakoff concluded that in a SIPA proceeding, the transferees’ good faith is measured by a subjective willful blindness standard.  Moreover, Judge Rakoff held that the Trustee must allege facts to plausibly support the inference that the defendant took the challenged transfers with a lack of good faith.  Accordingly, a defendant can succeed on a dismissal motion if the Trustee fails to so allege.

While it is too soon to measure the full impact of Judge Rakoff’s ruling—it seems clear, for example, that the Trustee will now face substantial hurdles to withstand motions to dismiss the complaints he had previously filed—under Judge Rakoff’s ruling trustees pursuing fraudulent conveyance claims in SIPA liquidations will now have to meet a demanding pleading burden to survive a dismissal motion.


Seeking to recover funds for Madoff’s customers, the Trustee sued numerous defendants who allegedly received transfers from BLMIS (the so-called “initial transferees”).  In an effort to further augment the amount of potential recoveries, the Trustee also sued numerous financial institutions that received transfers not from BLMIS, but from entities that invested with BLMIS (the so-called “subsequent transferees”).  Recognizing that both sets of defendants would assert the good faith defense provided by Sections 548(c) (initial transferees) and 550(b) (subsequent transferees), many of the Trustee’s complaints alleged that defendants acted with a lack of good faith.  The gravamen of the Trustee’s complaints was the theory that defendants lacked good faith because they had failed to investigate publicly available information that a reasonable person in their circumstances would have investigated, and which, if investigated, may have uncovered Madoff’s fraud.

After withdrawing the reference from the Bankruptcy Court, Judge Rakoff requested briefing on what standard should govern the good faith defense in a liquidation proceeding under a federal securities law—SIPA.  In the briefing that followed, the Trustee argued that defendants’ good faith should be evaluated under an objective inquiry notice standard otherwise used in bankruptcy proceedings.  Defendants countered that their good faith should be evaluated under the subjective willful blindness standard that applies in many areas of federal securities law.  Thus, defendants argued that absent a showing that they actually knew of Madoff’s fraud or intentionally blinded themselves to the alleged red flags that suggested Madoff’s fraud, they should be deemed to have acted in good faith. 

A group of defendants also argued that the Trustee should bear the burden of pleading that defendants had acted with a lack of good faith.  In response, the Trustee relied heavily on the plain language of the Bankruptcy Code, arguing that a transferee’s good faith is an affirmative defense and the Trustee was therefore not obligated to allege a lack of good faith to survive a motion to dismiss.   

Judge Rakoff agreed with defendants on both points. 

The Decision

As an initial matter, Judge Rakoff reaffirmed his previous ruling in Picard v. Katz, 462 B.R. 447 (S.D.N.Y. 2011), that, in a SIPA liquidation, the good faith of an initial transferee is measured by a willful blindness standard.  In Katz, Judge Rakoff reasoned that while an inquiry notice approach may have applicability in an ordinary bankruptcy case, “it has much less applicability . . . in a context of a SIPA trusteeship, where bankruptcy law is informed by federal securities laws.”  Borrowing from securities laws, Judge Rakoff concluded that in the context of a SIPA liquidation, the good faith of an initial transferee is measured by a willful blindness standard.  Judge Rakoff noted that this was especially appropriate as an investor has “no inherent duty to inquire about his stockbroker” and “SIPA imposes no such duty.”  Reaffirming Katz, Judge Rakoff concluded that absent a duty to investigate, a failure to do so cannot, as a matter of law, equate to a lack of good faith.

Judge Rakoff then considered what standard should govern the good faith of subsequent transferees—i.e. those transferees who received their transfer not from BLMIS directly but from an entity that allegedly received a transfer from BLMIS, e.g.Fairfield Sentry.  Judge Rakoff held that the good faith of subsequent transferees is also governed by a willful blindness standard.  This made sense, Judge Rakoff noted, both “as a matter of statutory construction” and because it “reflects the impracticability of imposing a heightened duty of investigation on a securities market participant” that is further removed from the failed broker than is the initial transferee.

Finally, Judge Rakoff considered the question of “which party bears the burden of pleading a defendant’s good faith or lack thereof.”  Judge Rakoff acknowledged the Trustee’s argument that in a typical bankruptcy proceeding, the plain language of the Bankruptcy Code indicates that a defendant’s good faith is an affirmative defense.  Nevertheless, he concluded that “just as SIPA affects the meaning of ‘good faith,’” “so too it affects the burden of pleading good faith or its absence.”  Judge Rakoff then concluded that “it would totally undercut SIPA’s twin goals of maintaining marketplace stability and encouraging investor confidence if a Trustee could seek to recover the investors’ investments while alleging no more than that they withdrew proceeds from their facially innocent securities account.”  Accordingly, “in a SIPA proceeding,” “a defendant may succeed on a motion to dismiss by showing that the complaint does not plausibly allege that the defendant did not act in good faith.”

Judge Rakoff then ordered the individual cases returned to Bankruptcy Court to determine whether the Trustee’s allegations are sufficient to avoid dismissal. 


At its core, Judge Rakoff’s decision offers defendants facing fraudulent conveyance clawback claims in SIPA proceedings a viable, logical defense. This is true whether the defendants received transfers from a broker-dealer that failed because of fraud (BLMIS) or ordinary insolvency (Lehman Brothers or MF Global).