A federal district court judge in New York has delivered bad news to participants in ERISA-regulated plans that invested with Bernard Madoff when the court concluded that the individual participants were not “customers” of the Madoff funds within the meaning of the Securities Investor Protection Act (“SIPA”). SIPC v. Jacqueline Green Rollover Account, No. 12-cv-1039 (S.D.N.Y. 2012). The determination of Judge Denise Cote serves a blow because the participants are no longer eligible to receive payments of up to $500,000 under SIPA, a program that provides benefits to customers of the failed brokerage firm.

The court’s ruling carries significant weight because the numerous participants in the ERISA funds cannot individually pursue payments under SIPA for their losses. 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 creditors. 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.

The SPIC trustee of the Bernard L. Madoff Investment Securities LLC (“BLMIS”) denied the claims of participants in ERISA-regulated funds access to SIPC advances because they were not “customers” within the meaning of SIPA. The SPIC trustee sought approval from the court for his determination, and he got it.

ERISA-Regulated Plan Assets Are Owned by the Plan

The claimants were indirect investors who had accounts under ERISA-regulated plans with third-party entities who held BLMIS accounts. The ERISA plans, and not the investors themselves, were the named account holders. The claimants attempted to satisfy the definition of “customer” under SIPA without success by arguing that the money they deposited with BLMIS through the ERISA-regulated plan made them customers. While SIPA does define the term “customer” to include “any persons . . . who has deposited cash with the debtor for the purpose of purchasing securities,” the court determined that claimants fell outside this definition because the cash that was deposited by the plans belonged to the plans and not to the individual investors.

The court looked to the holding of the Second Circuit in Milgram v. Orthopedic Associates Defined Contribution Pension Plan, 66 F. 3d. 68, 74 (2d Cir. 2011), to inform its determination. In Milgram, the Second Circuit held that the assets of an ERISA-regulated plan are “legally owned by the trustee and managed for the benefit of all plan participants, with gains and losses shared by them on a pro rata basis.” The court agreed that an individual participant’s account is merely a booking entry that is used at the time of the participant’s retirement to determine his benefits. Thus, the court was convinced that the undistributed assets of an ERISAregulated plan are legally owned by the trustee of the plan and not its participants.

The court also looked to New York property law as instructive. The court concluded that the claimants did not own any cash deposited with BLMIS because the claimants had “invested in, and not through” the third-party plans. These third-party plans were general partnerships, or limited liability companies that had been established under New York law or group trusts established pursuant to IRS regulations. The court found that New York law, with respect to these entities, was clear that none provided ownership rights to the claimants. This was because, under New York law, a general partner has no personal right in any specific partnership property. Similarly, under the common law of trusts, it is the trustee, not the beneficiaries, who hold title to trust property.

The offering memoranda and operating agreements for each of the third-party plans offered no relief for the claimants as these agreements did not confer an ownership interest in the plan’s assets on the participants. The court found that these agreements indicated that the participants intended the plans to hold title to the fund’s assets, or stated the assets belonged to the plan itself, and not its members, beneficiaries or investors.

A Possible Equity Interest in Plan Assets was Insufficient

The claimants further argued that they were customers under SIPA because ERISA provided them with an equity interest in “plan assets” invested by the if plans. In rejecting this argument, the court posited that while ERISA regulations afforded a limited equity interest in some assets, this interest stemmed from a need to set the scope of fiduciary duty between participants and investment managers, and did not confer an ownership interest as a matter of general commercial law. The court found that this interpretation was supported by the Department of Labor’s own writings which stated that the definition of “plan asset” under ERISA was intended to expand the fiduciary obligations towards participants in ERISA plans, making fiduciary protections available to smaller plans that might use collective investment agreements, and providing certainty as to the scope of fiduciary responsibilities in light of the limitations of the ERISA statute.

The court also rejected the argument that the definition of “plan assets” under ERISA preempted state property law regarding ownership rights. While ERISA’s preemption provision is expansive, the state property laws at issues were laws of general applicability. The property laws at issued did not control or supersede any central ERISA function like eligibility for benefits, amounts of benefits, or means of securing unpaid benefits. New York’s property laws also did not impede the objectives of the ERISA statute as the claimants may bring private damages actions against those responsible for their plan’s involvement in BLMIS.

The Relationship With BLMIS Was Insufficient

The claimants further argued that they were customers under SIPA because they had a fiduciary relationship with BLMIS since they could exercise some control over their investments. This argument was also unsuccessful. The court concluded that the participation in the defined contribution plan did not alter the fact that title the claimants’ money passed to their plan when they made their contributions. While participants had the ability to control the size of their investments, withdrawals and rollover funds, and to choose among a limited set of investment alternatives, this was not equivalent to having a direct financial relationship with or directly entrusting one’s own funds to a broker-dealer or exercising control over investment decisions. The court further concluded that contact between BLMIS and the claimants did not amount to sufficient contact to confer customer status.


As customer status under SIPA, and the protections that come with it, hinged on ownership rights in the assets invested with BLMIS, the participants in the ERISA-regulated plans, who had no ownership rights, were out of luck. The court’s ruling was consistent with its holding at the beginning of this year in In re Aorzora Bank Ltd., 11-cv-5686 (DLC), 2012 WL 28468 (S.D.N.Y Jan. 4, 2012), which found that the investors of 16 “feeder funds” — hedge funds that invested directly with Madoff — were not individual “customers” entitled to payments under SIPA. Thus, SIPA advances are out of reach for both groups.