In the aftermath of the largest Ponzi scheme ever to hit investors, Bernie Madoff’s victims are still reeling from the tremendous losses they have suffered, and are looking for any possible avenue to recover even a fraction of their investments. One potential avenue of such recovery, “feeder funds”—firms that sent investors’ funds to Madoff Securities and that failed to detect the fraud—may have been closed off recently when the US District Court for the Southern District of New York held that the Madoff trustee, Irving H. Picard, has no standing to pursue certain common law claims against the funds. Picard v. HSBC Bank PLC, 2011 WL 3200298 (S.D.N.Y., July 28, 2011). Not only did this decision halt the pursuit of approximately $8.5 billion of claims against the funds, it may also foreclose Picard from pursuing lawsuits based on similar claims seeking $19 billion from JPMorgan Chase and nearly $60 billion from Bank Medici and other defendants.

Picard, who was appointed trustee pursuant to the Securities Investor Protection Act (SIPA) shortly after the Ponzi scheme was discovered in December 2008, has attempted to maximize the recovery to Madoff’s injured parties by bringing suits against alleged wrongdoers. In this recent proceeding, the trustee brought suits totaling more than $8.5 billion against HSBC Holdings and several other defendants that allegedly helped funnel money from foreign investors into Madoff’s fraudulent business. These feeder funds, argued Picard, violated a duty to Madoff’s investors by failing to investigate and detect the fraud, despite being confronted with “myriad red flags and indicia of fraud.” Picard sought recovery against these defendants on several common law theories, including unjust enrichment, aiding and abetting fraud, and aiding and abetting breach of fiduciary duty.

Refusing to address the issue of liability on the merits, Judge Rakoff, in an explicit and unequivocal decision, struck down each of Picard’s many arguments in support of his standing to bring such claims. The court determined that Picard did not have standing to bring the common law claims because such claims belonged to third parties—the defrauded investors—not to the trustee, who is standing in the shoes of Madoff Securities but not in the shoes of the investors. Under prudential limitations to the issue of standing, “a party must assert his own legal rights and interests, and cannot rest his claim to relief on the legal rights or interests of third parties.” Id. at *2 (internal citations omitted). The court also held that neither the Bankruptcy Code nor SIPA authorized standing to bring the common law claims.

Moving beyond the issue of standing, and perhaps sounding the death knell for many similar claims Picard has pending against other defendants, the court “amplified” its reasoning why Picard could not bring the common law claims on behalf of the estate. The court cited the common law doctrine of in pari delicto (“in equal fault”) and held that Picard cannot assert the common law claims because a wrongdoer like Madoff Securities may not recover from another wrongdoer; therefore, by extension, the trustee for Madoff Securities, stepping into the shoes of that wrongdoer, is barred by the same limitation from pursuing these claims. Now, even if the trustee has standing to pursue certain claims against other defendants, the court has validated the in pari delicto defense against any of Picard’s claims that he would bring on behalf of the estate.         

HSBC Bank could well be Picard’s Catch 22 in that many of the claims Picard would bring on behalf of injured investors would likely be barred by the standing doctrine, and any claims that Picard would bring on behalf of the estate, while standing would not be an issue, would likely be barred by the doctrine of in pari delicto.