Bloomberg News

Rakoff Will Decide If Madoff Trustee Can Sue for False Profits

September 17, 2011

Sept. 17 (Bloomberg) -- U.S. District Judge Jed Rakoff said that he rather than a bankruptcy judge will initially decide whether the trustee for Bernard L. Madoff Investment Securities Inc. has the right to sue customers for recovery of so-called fictitious profits.

One of Madoff’s customers, James Greiff, argued on July 29 Rakoff should take a lawsuit away from the bankruptcy court in which Irving Picard, the Madoff trustee, sued Greiff for taking more cash out of the Madoff firm that he put in. Picard has sued hundreds of other Madoff customers on the same grounds. Rakoff said in a ruling yesterday that he would make initial decisions on two issues.

Rakoff told Greiff and the Madoff trustee to explain whether the profits shown on Greiff’s account statements represent valid debt to counter a fraudulent transfer claim. Rakoff also wants the parties to explain whether a provision in bankruptcy law known as the safe harbor bars suits because they stem from trades in securities.

Rakoff said he will later file a written opinion giving reasons for his ruling in detail.

Rakoff is revisiting the same issues that were decided in a 26-page opinion on Aug. 31 by U.S. District Judge Kimba M. Wood, another federal district judge in Manhattan. Wood ruled that the Madoff trustee is using valid theories to recover money customers took out of the Ponzi scheme before the fraud was discovered.

Merkin Funds

Wood said that U.S. Bankruptcy Judge Burton L. Lifland was correct last year when he ruled Picard was justified in bringing $34 million in claims against the Ariel and Gabriel funds controlled by Ezra Merkin. Woods said Picard’s claims withstand attack at the early stages of the lawsuit.

In one of the issues Rakoff said he will decide, Wood ruled for the Madoff trustee in saying that a defrauded customer’s claim against the broker didn’t constitute “value” to offset a fraud claim.

Like Greiff, Merkin contended that he’s protected from a lawsuit by Section 546(e) of the Bankruptcy Code known as the safe harbor. Again on the same issue that Rakoff will decide, Wood ruled in August that there was no authority for the proposition that a Ponzi scheme operator qualifies a stockbroker when no actual trades in securities were ever made.

The Merkin case decided by Wood is different, according to Helen Davis Chaitman, Greiff’s lawyer. Where Merkin was accused of participating in fraud, “this kind of allegation is totally absent from the complaints against” Greiff and about 5,000 other innocent Madoff victims, Chaitman said in an e-mail.

As federal district judges of the same rank, Rakoff is not bound by Wood’s 26-page opinion.

SIPC

The Madoff trustee sued Greiff last year in bankruptcy court. The Madoff firm began liquidating in December 2008, with the appointment of the trustee under the Securities Investor Protection Act. Bernard Madoff individually went into an involuntary Chapter 7 liquidation in April 2009. His bankruptcy case was consolidated with the firm’s liquidation. Madoff is serving a 150-year prison sentence following a guilty plea.

The Greiff case in district court is Picard v. Greiff, 11- 03775, U.S. District Court, Southern District of New York (Manhattan). The Madoff liquidation case is Securities Investor Protection Corp. v. Bernard L. Madoff Investment Securities Inc., 08-01789, U.S. Bankruptcy Court, Southern District of New York (Manhattan). The criminal case is U.S. v. Madoff, 09-cr- 00213, U.S. District Court, Southern District of New York (Manhattan).

--Editor: John Pickering

To contact the reporter on this story: Bill Rochelle in New York at wrochelle@bloomberg.net.

To contact the editor responsible for this story: John Pickering at jpickering@bloomberg.net


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