Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 1 of 30

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1 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 1 of 30 UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK In re: BERNARD L. MADOFF INVESTMENT SECURITIES LLC, Debtor. Adv. Pro. No (BRL) SIPA LIQUIDATION (Substantively Consolidated) IRVING H. PICARD, Trustee for the Liquidation of Bernard L. Madoff Investment Securities LLC, Adv. Pro. No (BRL) v. Plaintiff, HAROLD J. HEIN, Consolidated Civ. Action No. 11 Civ (JSR) Defendant. TRUSTEE S MEMORANDUM OF LAW IN OPPOSITION TO HEIN S MOTION TO DISMISS BAKER & HOSTETLER LLP 45 Rockefeller Plaza New York, New York Telephone: (212) Facsimile: (212) Attorneys for Irving H. Picard, Trustee for the Substantively Consolidated SIPA Liquidation of Bernard L. Madoff Investment Securities LLC and Bernard L. Madoff

2 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 2 of 30 TABLE OF CONTENTS Page PRELIMINARY STATEMENT... 1 ARGUMENT... 2 I. STANDARD OF REVIEW... 2 II. III. IV. HEIN DID NOT PROVIDE VALUE UNDER SECTION 548(C) FOR THE FICTITIOUS PROFITS RECEIVED... 3 A. Hein s Affirmative Defenses under Section 548(c) Are Not Grounds for Dismissal... 3 B. Fabricated BLMIS Customer Statements Cannot Create Antecedent Debt... 4 C. Hein s Good Faith under Section 548(c) Is Irrelevant... 6 D. Article 8 of the Uniform Commercial Code Does Not Govern Here... 8 THE IRA STATUS OF HEIN S ACCOUNT HAS NO BEARING ON THE TRUSTEE S AVOIDANCE ACTION A. Hein s IRA Withdrawals Are Fraudulent Transfers Which Are Not Protected from Avoidance B. How Hein Chose to Spend BLMIS Withdrawals Is Irrelevant in Determining Avoidance Liability THE SAFE HARBOR PROTECTIONS OF SECTION 546(E) DO NOT APPLY HERE A. The Trustee Is Not Collaterally Estopped from Arguing that Section 546(e) Does Not Apply in this Case B. Applicable Law C. The Plain Language of Section 546(e) Supports the Trustee s Position The Transactions at Issue Are Not Settlement Payments within the Meaning of Section 546(e) The Fraudulent Transfers Were Not Made in Connection with a Securities Contract BLMIS Is Not a Stockbroker for Purposes of the 546(e) Safe Harbor Hein Fails to Satisfy His Burden of Proving that the Section 546(e) Affirmative Defense Bars the Trustee from Avoiding the Fraudulent Transfers D. Courts Interpreting Section 546(e) Find That It Does Not Apply to Fraudulent Schemes V. APPLICATION OF SECTION 546(E) HERE CONTRAVENES THE SECOND CIRCUIT S NET EQUITY DECISION CONCLUSION i-

3 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 3 of 30 TABLE OF AUTHORITIES Page(s) CASES Amer. Sur. Co. of N.Y. v. Sampsell, 327 U.S. 269 (1946)...8 Atlanta Shipping Corp. v. Chemical Bank, 818 F.2d 240 (2d Cir. 1987)...6 Ball v. A.O. Smith Corp., 451 F.3d 66 (2d. Cir. 2006)...15 In re Bayou Group, LLC, 396 B.R. 810 (Bankr. S.D.N.Y. 2008), rev d on other grounds, 439 B.R. 284 (S.D.N.Y. 2010)...7, 14 Bayou Superfund LLC v. WAM Long/Short Fund II LP (In re Bayou Grp., LLC), 362 B.R. 624 (Bankr. S.D.N.Y. 2007)...3, 5, 6 Bell Atl. Corp. v. Twombly, 550 U.S. 544 (2007)...3 In re Bernard L. Madoff Secs., LLC, 654 F.3d 229 (2d Cir. 2011)... passim Brandt v. B.A. Capital Co. LP (In re Plassein Int l Corp.), 590 F.3d 252 (3d Cir. 2009)...20 Cargo Partner AG v. Albatrans, Inc., 352 F.3d 41 (2d Cir. 2003)...3 Contemporary Indus. Corp. v. Frost, 564 F.3d 981 (8th Cir. 2009)...16 Cunningham v. Brown, 265 U.S. 1 (1924)...14 Daly v. Deptula (In re Carrozzella & Richardson), 286 B.R. 480 (D. Conn. 2002)...6 Donell v. Kowell, 533 F.3d 762 (9th Cir. 2008)... passim In re Enron Recovery Corp. v. Alfa, S.A.B. de C.V., 651 F.3d 329 (2d Cir. 2011)...16, 20, 21 First Fed. Sav. & Loan Ass n of Lincoln v. Bevill, Bresler & Schulman, Inc. (In re Bevill, Bresler & Schulman, Inc.), 59 B.R. 353 (D.N.J. 1986), appeal dismissed, 802 F.2d 445 (3d Cir. 1986)...8 -ii-

4 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 4 of 30 TABLE OF AUTHORITIES (continued) Page(s) Fisher v. Sellis (In re Lake States Commodities, Inc.), 253 B.R. 866 (Bankr. N.D. Ill. 2000)...5 Geltzer v. Mooney (In re McMenamin s Grill Ltd.), 450 B.R. 414 (Bankr. S.D.N.Y. 2011)...20 Glidepath Holding B.V. v. Spherion Corp., 590 F. Supp. 2d 435 (S.D.N.Y. 2007)...7 Gowan v. The Patriot Grp. (In re Dreier LLP), 452 B.R. 391 (Bankr. S.D.N.Y. 2011)...5 Grippo v. Perazzo, 357 F.3d 1218 (11th Cir. 2004)...5 Harris v. Tams, 258 N.Y. 229, 179 N.E. 476 (1932)...7 HBE Leasing Corp. v. Frank, 48 F.3d 623 (2d Cir. 1995)...6 In re Hill, 163 BR 598 (Bankr. N.D. Fla. 1994)...11 Industrial Enter. of America Inc. v. Tabor Academy (In re Pitt Penn Holding Co.), 2011 WL (Bankr. D. Del. Sept. 16, 2011)...20 In re J.P. Jeanneret Assocs., Inc., 769 F. Supp. 2d 340 (S.D.N.Y. 2011)...3 Jackson v. Mishkin (In re Adler, Coleman Clearing Corp.), 263 B.R. 406 (S.D.N.Y. 2001)...7, 8, 20 Janvey v. Alguire, 647 F.3d 585 (5th Cir. 2011)...12 Johnson v. Neilson (In re Slatkin), 525 F.3d 805 (9th Cir. 2008)...19, 20 Jonas v. Resolution Trust Corp. (In re Comark), 97 F.2d 322 (9th Cir. 1992)...16 Kaiser Steel Corp. v. Charles Schwab & Co., 913 F.2d 846 (10th Cir. 1990)...16 In re Key Communications, Inc., 24 F.3d 236 (5th Cir. 1994) iii-

5 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 5 of 30 TABLE OF AUTHORITIES (continued) Page(s) Kipperman v. Circle Trust F.B.O. (In re Grafton Partners, L.P.), 321 B.R. 527 (9th Cir. BAP 2005)...20 Kirschner v. KPMG LLP, 15 N.Y. 3d 446 (N.Y. 2010)...7 Leather v. Ten Eyck, 180 F.3d 420 (2d Cir. 1999)...15 Lustig v. Weisz & Assoc. Inc. (In re Unified Commercial Capital), 2002 WL (W.D.N.Y. June 21, 2002)...6 Lynn v. IRS (In Re Randazzo), 34 B.R. 76 (Bankr. D. Tex. 1983)...12 In re Manhattan Inv. Fund Ltd., 397 B.R. 1 (S.D.N.Y. 2007)...6 In re Maxwell Newspapers, Inc, 164 B.R. 858 (Bankr. S.D.N.Y. 1994)...7 Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71 (2006)...5 In re Morra, 2009 WL (Bankr. E.D.N.Y. 2009)...11 In re New Times Sec. Servs., Inc., 371 F.3d 68 (2d Cir. 2004)...4 In re Orr, 2008 WL (Bankr. C.D. Ill. Jan. 28, 2008)...11 Picard v. Chais, 445 B.R. 206 (Bankr. S.D.N.Y. 2011)...4 Picard v. Cohmad Secs. Corp. (In re Bernard L. Madoff Inv. Secs. LLC), 454 B.R. 317 (Bankr. S.D.N.Y. 2011)...4 Picard v. Katz, 2011 WL (S.D.N.Y. Sept. 27, 2011)...4, 6, 15, 19 Picard v. Katz, 2012 WL (S.D.N.Y. Jan. 17, 2012)... passim Picard v. Madoff, 2011 WL (Bankr. S.D.N.Y. Sept. 22, 2011)...18, 20 -iv-

6 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 6 of 30 TABLE OF AUTHORITIES (continued) Page(s) Picard v. Merkin (In re Bernard L. Madoff Inv. Secs., LLC), 2011 WL (S.D.N.Y. Aug. 31, 2011)...18, 20 Picard v. Merkin (In re Bernard L. Madoff Inv. Secs., LLC), 440 B.R. 243 (Bankr. S.D.N.Y. 2010)...4, 18, 20 Rieser v. Hayslip (In re Canyon Sys.), 343 B.R. 615 (Bankr. S.D. Ohio 2006)...3 S.E.C. v. Aragon Capital Management, LLC, 672 F. Supp. 2d 421 (S.D.N.Y. 2009)...12 Scholes v. Lehmann, 56 F.3d 750 (7th Cir. 1995)...5 SEC v. Zandford, 535 U.S. 813 (2002)...5 Sender v. Buchanan (In re Hedged-Invs. Assoc., Inc.), 84 F.3d 1286 (10th Cir. 1996)...5, 12 In re Sharp Int l. Corp. 403 F.3d 43 (2d Cir. 2005)...5, 6 SIPC v. BLMIS (In re BLMIS), 424 B.R. 122 (Bankr. S.D.N.Y. 2010), aff d, 654 F.3d , 20 Soule v. Alliot (In re Tiger Petroleum Co.), 319 B.R. 225 (Bankr. N.D. Okla. 2004)...5 Terry v. June, 432 F. Supp. 2d 635 (W.D. Va. 2006)...5 Wesbanco Bank Barnesville v. Rafoth (In re Baker & Getty Fin. Servs., Inc.), 106 F.3d 1255 (6th Cir. 1997)...18, 19 Whaley v. Whaley (In re Whaley), 190 B.R. 818 (Bankr. N.D. Miss. 1995)...12 Wider v. Wootton, 907 F.2d 570 (5th Cir. 1990)...20 Williams v. Morgan Stanley Capital Gp. (In re Olympic Natural Gas Co.), 294 F.3d 737 (5th Cir. 2002)...21 Wing v. Dockstader, 2010 WL (D. Utah 2010)...12, 14 -v-

7 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 7 of 30 TABLE OF AUTHORITIES (continued) Page(s) Wyle v. C.H. Rider & Family (In re United Energy Corp.), 944 F.2d 589 (9th Cir. 1994)...5 Wyle v. Howard, Weil, Labouisse, Friedrichs Inc. (In re Hamilton Co.), 114 F.3d 991 (9th Cir. 1997)...21 In re Yuhas, 104 F.3d 612 (3d Cir. 1997)...11 STATUTES 11 U.S.C. 101(53A) U.S.C U.S.C U.S.C. 546(e)... passim 11 U.S.C U.S.C U.S.C. 548(a) U.S.C. 548(a)(1)(A) U.S.C. 548(a)(1)(B) U.S.C. 548(b) U.S.C. 548(c)...3, 6, 7 11 U.S.C U.S.C. 741(7) U.S.C. 78aa et seq....1 N.Y. Debt & Cred. Law N.Y. Debt & Cred. Law N.Y. Debt. & Cred. Law U.C.C (2009)...8 U.S. Const., art. VI, cl vi-

8 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 8 of 30 TABLE OF AUTHORITIES (continued) Page(s) RULES 17 C.F.R c1-1(b)...17 C.P.L.R. 5205(c)...10, 11 Fed. R. Civ. P. 10(b)...5 Fed. R. Civ. P. 10(b) Fed. R. Civ. P. 12(b)(6)...2 Fed. R. Civ. P OTHER AUTHORITIES N.Y. Jur. Agency 2d Pub L , 96 Stat. 237 (July 27, 1982) vii-

9 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 9 of 30 Irving H. Picard (the Trustee ), as trustee for the substantively consolidated liquidation of the business of Bernard L. Madoff Investment Securities LLC ( BLMIS ) under the Securities Investor Protection Act, 15 U.S.C. 78aa et seq. ( SIPA ) and the estate of Bernard L. Madoff ( Madoff ) submits this memorandum of law in opposition to the Motion to Dismiss filed by Defendant Harold J. Hein ( Hein ). 1 PRELIMINARY STATEMENT All issues raised by Hein have already been before this Court. The controlling case law remains clear fictitious profits cannot be taken for value or in satisfaction of an antecedent debt. Once Hein exceeded his net investment with BLMIS, he could not have provided value within the meaning of 11 U.S.C Nonetheless, Hein urges that Madoff s fraudulent account statements created an obligation, and thus an antecedent debt to which he is entitled. For this proposition, Hein cites to the New York Uniform Commercial Code ( UCC ). Yet, not only is the UCC preempted by SIPA and the Bankruptcy Code, but the official comment to the UCC also states that it is inapplicable to SIPA and bankruptcy proceedings. Furthermore, Hein asks this Court to disregard controlling precedent and credit him for the balance on his December 2006 BLMIS account statement, the validity of which has already been rejected by the Second Circuit. 1 The Court consolidated the above-captioned case with 26 other separate actions pursuant to an Order dated Nov. 7, See Order Consolidating the Cases, Picard v. Hein, et al., 11 Civ (JSR) (S.D.N.Y. Nov. 7, 2011). To the extent applicable, all arguments made by the Trustee in this Opposition to the Motion to Dismiss ( Opposition ) apply to the joining defendants in the other 26 separate actions. In addition, the Trustee has filed amended complaints, contemporaneously herewith, against Hein and the defendants in the 26 consolidated actions. While the Trustee has addressed each argument raised by Hein s motion in this Opposition, to the extent any additional issues arise from the Amended Complaint or the Trustee s Opposition brief, Hein has agreed to address the same in his reply. 1

10 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 10 of 30 Hein s refuge in the safe harbor protections of 11 U.S.C. 546(e) is equally unavailing. In order to invoke this safe harbor, Hein must demonstrate that, as a matter of law, the transfers from BLMIS to him were either: (1) settlement payments; or (2) payments made in connection with a securities contract. Contrary to the explicit requirements of section 546(e), Hein does not point to a single settlement payment or securities contract, and instead argues that the expectation of a settlement payment is sufficient. This is contrary to the literal reading of the statute espoused by this Court in its recent decision. 2 As such, the safe harbor of section 546(e) is inapplicable here. Hein s final argument is that this Court should create a new safe harbor for stolen money withdrawn to attain a tax benefit under the Internal Revenue Code ( IRC ). Of course, Hein does not as he cannot cite to cases in support of this proposition. On the contrary, case law confirms that shielding net winners gains, albeit those withdrawn for mandatory expenses, would create a slippery slope and result in a major loss for victims who were defrauded out of their entire investment. 3 Regardless, Hein s reasons for withdrawal are irrelevant. Law and equity compel that he return fictitious profits to the Trustee for equitable distribution. Hein s Motion to Dismiss should therefore be denied in its entirety. ARGUMENT I. STANDARD OF REVIEW Federal Rule of Civil Procedure 12(b)(6) provides for the dismissal of a cause of action for failure to state a claim upon which relief can be granted. In reviewing a motion to dismiss pursuant to Rule 12(b)(6), a court must liberally construe all claims, accept all factual 2 See Picard v. Katz, 2012 WL , at *5 (S.D.N.Y. Jan. 17, 2012). 3 See Donell v. Kowell, 533 F.3d 762, 779 (9th Cir. 2008). 2

11 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 11 of 30 allegations in the Amended Complaint as true, and draw all reasonable inferences in favor of the plaintiff. 4 The only issue on a motion to dismiss is whether the plaintiff has adequately pled his claims. To do so, the Trustee is not required to plead detailed factual allegations, but rather must simply plead enough facts to state a claim to relief that is plausible on its face. 5 II. HEIN DID NOT PROVIDE VALUE UNDER SECTION 548(C) FOR THE FICTITIOUS PROFITS RECEIVED A. Hein s Affirmative Defense under Section 548(c) Is Not Grounds for Dismissal Hein admits that the issue of whether BLMIS s payments to him constitute transfers for value goes to his affirmative defense under section 548(c) of the Bankruptcy Code. 6 Resolution of this defense requires a fact-based inquiry upon which Hein bears the burden of proof. 7 Here, the Amended Complaint expressly and adequately pleads that no value was provided in exchange for the fictitious profits that Hein received. 8 On this basis alone, Hein s motion must be denied. 4 In re J.P. Jeanneret Assocs., Inc., 769 F. Supp. 2d 340, 353 (S.D.N.Y. 2011) (citing Cargo Partner AG v. Albatrans, Inc., 352 F.3d 41, 44 (2d Cir. 2003)); see also Bell Atl. Corp. v. Twombly, 550 U.S. 544, 572 (2007). 5 Twombly, 550 U.S. at See Hein s Mem. of Law in Supp. of Mot. to Dismiss ( Hein s Br. ) at See Bayou Superfund LLC v. WAM Long/Short Fund II LP (In re Bayou Grp., LLC), 362 B.R. 624, 631 (Bankr. S.D.N.Y. 2007) ( Bayou I ); Rieser v. Hayslip (In re Canyon Sys.), 343 B.R. 615, (Bankr. S.D. Ohio 2006). 8 Trustee s Amended Compl

12 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 12 of 30 B. Fabricated BLMIS Customer Statements Cannot Create Antecedent Debt Hein argues that the customer statements issued by BLMIS created a valid debt to each customer, such that no payment consistent with these statements could ever be avoided as a fraudulent transfer. 9 This argument has been squarely rejected by the Second Circuit. 10 BLMIS s Investment Advisory business (the IA Business ) was a Ponzi scheme. 11 The account statements were fabricated in furtherance of that scheme based upon manipulated and backdated transactions having no relation to reality. 12 As the Second Circuit has explained, notwithstanding the BLMIS customer statements, there were no securities purchased and there were no proceeds from the money entrusted to Madoff for the purpose of making investments. 13 Therefore, any [c]alculations based on made-up values of fictional securities would be unworkable and would create potential absurdities. 14 Because the statements were fictitious, and the securities positions reflected on those statements had no basis in reality, the account statements could not have created an antecedent debt. 9 Hein s Br. at In re Bernard L. Madoff Secs., LLC ( Second Circuit Net Equity Decision ), 654 F.3d 229, 234 (2d Cir. 2011). 11 See Trustee s Am. Compl , 22-29; Picard v. Cohmad Secs. Corp. (In re Bernard L. Madoff Inv. Secs. LLC), 454 B.R. 317, 330 (Bankr. S.D.N.Y. 2011) (citing Picard v. Chais, 445 B.R. 206, 220 (Bankr. S.D.N.Y. 2011)); Picard v. Merkin (In re Bernard L. Madoff Inv. Secs., LLC)( Merkin I ), 440 B.R. 243, 255 (Bankr. S.D.N.Y. 2010); Picard v. Katz, 2011 WL , at *2 (S.D.N.Y. Sept. 27, 2011). Hein argues, however, that BLMIS s proprietary and market-making units involved legitimate trading. Hein s Br. at 6. The fact that Madoff traded securities on his own account is completely irrelevant. BLMIS did not trade securities on behalf of his customers. What is more, this is a pure issue of fact, wholly improper on a motion to dismiss. 12 SIPC v. BLMIS (In re BLMIS), 424 B.R. 122, 139 (Bankr. S.D.N.Y. 2010) ( Bankr. Net Equity Decision ) (internal citations and quotation marks omitted), aff d, 654 F.3d Second Circuit Net Equity Decision, 654 F.3d at Id. at 241 (quoting In re New Times Sec. Servs., Inc., 371 F.3d 68, 88 (2d Cir. 2004)). 4

13 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 13 of 30 Yet, Hein still urges that having received payments on account of those fictitious statements somehow means that he took fictitious profits for value. 15 Hein misunderstands the simple reality that this money was never legitimately in the hands of BLMIS; it was stolen from other customers. That is why payments of fictitious profits made to investors in a Ponzi scheme do not satisfy an antecedent debt. 16 Not a single case provided by Hein to this Court holds that payments of fictitious profits can be considered for value. Hein cites to inapposite cases governed by different facts and different law. Some involve common law causes of action and have absolutely no bearing here. 17 Others involve commercially reasonable, contractually guaranteed rates of return in exchange for a deposit of principal like a loan that are factually and legally inapplicable Hein s Br. at 2, Donell v. Kowell, 533 F.3d 762, 770 (9th Cir. 2008); Gowan v. The Patriot Grp. (In re Dreier LLP), 452 B.R. 391, 440 n.44 (Bankr. S.D.N.Y. 2011) ( investors in a Ponzi scheme are not entitled to retain the fictitious profits they received ); see also Sender v. Buchanan (In re Hedged-Invs. Assoc., Inc.), 84 F.3d 1286, 1290 (10th Cir. 1996); Scholes v. Lehmann, 56 F.3d 750, 757 (7th Cir. 1995); Wyle v. C.H. Rider & Family (In re United Energy Corp.), 944 F.2d 589, 595 n.6 (9th Cir. 1994); Terry v. June, 432 F. Supp. 2d 635, 642 (W.D. Va. 2006); Bayou I, 362 B.R. at 636; Soule v. Alliot (In re Tiger Petroleum Co.), 319 B.R. 225, 239 (Bankr. N.D. Okla. 2004); Fisher v. Sellis (In re Lake States Commodities, Inc.), 253 B.R. 866, 872 (Bankr. N.D. Ill. 2000); In re Canyon Sys., 343 B.R. at See, e.g., Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71, 85 n.10 (2006) (addressing a securities class action brought under Oklahoma state law and reversing a Second Circuit opinion to hold that the Securities Litigation Uniform Standards Act should be interpreted broadly to apply to purchasers, sellers, and holders of securities); SEC v. Zandford, 535 U.S. 813, 819 (2002) (finding violations of 10(b) and Rule 10(b)-5 in a scheme to defraud and misappropriate real securities without investors knowledge or consent), Grippo v. Perazzo, 357 F.3d 1218, (11th Cir. 2004) (reversing dismissal of securities fraud action with state common-law claims because failure to allege specific securities in which defendant invested his monies is beyond the pleading requirements). 18 For example, Hein relies upon In re Sharp Int l. Corp. 403 F.3d 43 (2d Cir. 2005), which involved the lawful and disclosed payment of a valid contractual antecedent debt, to assert that the transfers from BLMIS discharged valid debts. See Hein Br. at 18. However, [w]hether... defendants can avail themselves of the affirmative defense of taking for value and in good faith 5

14 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 14 of 30 Here, the fictitious profits Hein received in excess of his principal were not promised to him when he initially invested in BLMIS. Nor did Hein give loans to Madoff with the promise of a reasonable rate of return. Rather, Hein invested with BLMIS in order to achieve Madoff s toogood-to-be-true returns, giving Madoff full discretion to invest Hein s money in the stock market with the understanding of the highly volatile nature of these types of investments. In such a relationship, profits can never be for value; this is especially true with fictitious profits. 19 In fact, the Second Circuit has already deemed fictitious profits to be valueless by rejecting any reliance on the BLMIS account statements, and finding that, to do otherwise would have the absurd effect of treating fictitious and arbitrarily assigned paper profits as real and would give legal effect to Madoff s machinations. 20 C. Hein s Good Faith under Section 548(c) Is Irrelevant As detailed above, Hein has not, and could not have, provided value in exchange for fictitious profits. Therefore, Hein s good faith is irrelevant here, as he already cannot satisfy the requirements of a section 548(c) affirmative defense. under section 548(c) is in no way controlled by Sharp. Picard v. Katz, 2011 WL at *4 (S.D.N.Y. Sept. 27, 2011) (citing In re Manhattan Inv. Fund Ltd., 397 B.R. 1, 11 (S.D.N.Y. 2007) ( At most, [Sharp] simply means that courts must be sure that the transfers sought to be avoided are related to the [Ponzi] scheme. ); see also Bayou I, 362 B.R. at 638 ( Unlike the lawful repayment of loan indebtedness to State Street, the redemption payments in this case were themselves inherently fraudulent, and Bayou s only possible intent in making the redemption payments was to hinder, delay and defraud creditors. ). Hein also cites to Daly v. Deptula (In re Carrozzella & Richardson), 286 B.R. 480, , 491 (D. Conn. 2002) (promise of a guaranteed rate of return for the use of the investor s money), Lustig v. Weisz & Assoc. Inc. (In re Unified Commercial Capital), 2002 WL (W.D.N.Y. June 21, 2002) (contractually mandated interest payments from debtor), HBE Leasing Corp. v. Frank, 48 F.3d 623 (2d Cir. 1995) (mortgages given in exchange for advances of cash), and Atlanta Shipping Corp. v. Chemical Bank, 818 F.2d 240 (2d Cir. 1987) (repayments of principal and interest on $6 million loan). 19 See supra note Second Circuit Net Equity Decision, 654 F.3d at

15 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 15 of 30 However, should the Court determine that Hein provided value for fictitious profits, Hein still cannot keep this money, because in doing so, he fails to satisfy the good faith prong of the section 548(c) affirmative defense. By virtue of the Account Opening Documents (defined below), Hein designated Madoff and BLMIS as his agents. 21 According to well-established agency principles, when a principal attempts to benefit from the fraudulent acts of his agent, the agent s fraud is imputed onto the principal. 22 This is because a principal who retains the fruits of his agent s fraudulent act stands in the same position as if he had participated in the fraudulent act himself. 23 Such imputation may be invoked notwithstanding the scope of Madoff s agency if Hein disclaims Madoff s authority to act, he has no grounds to retain the fruits thereof. 24 Here, however, Hein seeks to keep the fictitious profits with full awareness of Madoff s fraudulent acts and knowing that the funds are nothing more than money stolen from other investors. By choosing to retain the fictitious profits, Hein ratifies the fraudulent acts of his agent, and must now be imputed with the knowledge and fraudulent intent of Madoff, regardless of his own fraudulent intent. 25 Hein, therefore, cannot sustain a good faith affirmative defense A Customer Agreement between BLMIS and Defendant... states that [Defendant] understands that [Madoff] is acting as [Defendant] s agent and the Trading Authorization authorize[d] Bernard L. Madoff... as his agent See Kirschner v. KPMG LLP, 15 N.Y. 3d 446, 465 (N.Y. 2010); Jackson v. Mishkin (In re Adler, Coleman Clearing Corp.), 263 B.R. 406, (S.D.N.Y. 2001). 23 See id. at 454 (citing Harris v. Tams, 258 N.Y. 229, 179 N.E. 476, 479 (1932)). 24 In re Maxwell Newspapers, Inc, 164 B.R. 858, 867 (Bankr. S.D.N.Y. 1994). 25 Glidepath Holding B.V. v. Spherion Corp., 590 F. Supp. 2d 435, 453 n.6 (S.D.N.Y. 2007); N.Y. Jur. Agency 2d 188 (2011) ( If an agent acts outside the scope of the authority delegated to the agent by the principal and commits fraudulent acts, the principal is nevertheless liable if the principal later ratifies the fraudulent acts and retains the benefits derived from them. ). 26 In re Bayou Group, LLC, 396 B.R. 810, 856 (Bankr. S.D.N.Y. 2008), rev d on other grounds, 439 B.R. 284 (S.D.N.Y. 2010); In re Adler, Coleman Clearing Corp., 263 B.R. at In a 7

16 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 16 of 30 D. Article 8 of the Uniform Commercial Code Does Not Govern Here Notwithstanding the Second Circuit Net Equity Decision, Hein argues that the UCC, instead of SIPA and applicable bankruptcy law, governs the calculation of value of a customer s account in a SIPA liquidation. 27 However, the Official Comment to the UCC acknowledges that both the Bankruptcy Code and SIPA override the UCC if the entity s affairs are being administered in an insolvency proceeding. 28 This comment recognizes that the UCC is state law, and to the extent it is inconsistent with SIPA, the UCC is preempted under the Supremacy Clause of the United States Constitution. 29 Therefore, the Trustee and this Court must adhere to SIPA when determining the value of fictitious profits received by Hein. Hein claims that BLMIS was obligated to pay him the balance shown on his last statement. 30 This argument is based largely on Hein s misguided contention that the monthly failed attempt to distinguish Adler from the instant case, Hein states that Adler only concerned the right of an investor to collect from the customer fund. Hein s Br. at 24. However, in complete contradiction of his own statement, Hein admits that Adler Coleman involved the [SIPA Trustee s] avoidance of stock trades from customers. Hein s Br. at Hein s Br. at See U.C.C , cmt.1 (2009) ( applicable insolvency law governs how the various parties having claims against the firm are treated. For example, the distributional rules for stockbroker liquidation proceedings under the Bankruptcy Code and Securities Investor Protection Act... provide that all customer property is distributed pro rata among all customers.... ). 29 See U.S. Const., art. VI, cl. 2; First Fed. Sav. & Loan Ass n of Lincoln v. Bevill, Bresler & Schulman, Inc. (In re Bevill, Bresler & Schulman, Inc.), 59 B.R. 353, 378 (D.N.J. 1986), appeal dismissed, 802 F.2d 445 (3d Cir. 1986) (holding that any state law that is inconsistent with SIPA is preempted under the Supremacy Clause); see also Amer. Sur. Co. of N.Y. v. Sampsell, 327 U.S. 269, 272 (1946) ( [F]ederal bankruptcy law, not state law, governs the distribution of a bankrupt s assets to his creditors. ). 30 Hein s Br. at 5, However, as the Securities and Exchange Commission itself has noted, [a]ccount statements and confirmations sent to customers are not books used by brokerage firms to make entries crediting and debiting customer accounts with securities transactions. Brief for Securities and Exchange Commission as Amicus Curiae Supporting Appellee at 11, n.5, Second Circuit Net Equity Decision, 654 F.3d 229 (No ). 8

17 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 17 of 30 statements and confirmations that he received entitle him to the securities on those statements. 31 However, this argument assumes that, pre-bankruptcy, Hein could have walked into BLMIS and asked for the securities on his account statement. This is simply not true. Because his account was discretionary, Hein would only have been entitled to the securities that were actually in the account on the date of demand. Hein can hardly dispute that this amount would have been zero. Although the Trustee believes that this issue was settled by the Second Circuit, the Trustee nonetheless has decided to adopt a prophylactic approach. As such, pursuant to Fed. R. Civ. P. 15, the Trustee has amended his complaint to avoid the so-called obligations that Hein alleges were owed to him by BLMIS. Section 548(a) of the Bankruptcy Code provides that the trustee may avoid any transfer... or any obligation... incurred by the debtor.... Likewise, the New York Debtor & Creditor Law ( DCL ) provides for the avoidance of every conveyance made and every obligation incurred In his Amended Complaint, the Trustee has asserted causes of action under the Bankruptcy Code and the DCL to avoid any obligations of BLMIS or Madoff to Hein, to the extent that such obligations exist. 33 Accordingly, the Trustee s recovery of fictitious profits does not hinge on whether or not a customer statement created an obligation under the UCC. 31 Hein s Br. at DCL 273, 275 (emphasis added). 33 Trustee s Am. Compl , 49-76,

18 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 18 of 30 III. THE IRA STATUS OF HEIN S ACCOUNT HAS NO BEARING ON THE TRUSTEE S AVOIDANCE ACTION A. Hein s IRA Withdrawals Are Fraudulent Transfers Which Are Not Protected from Avoidance Hein claims that the IRA distributions from his IA account are exempt from the Trustee s claims, pursuant to New York Civil Practice Law and Rules ( CPLR ) 5205(c), which protects certain assets of the debtor from the normal remedies available to creditors seeking to enforce money judgments. 34 However, this exemption has no application here because all relevant IRA distributions received by Hein are deemed to be fraudulent conveyances and therefore fall within the exception under CPLR section 5205(c)(5). CPLR section 5205(c) states that all property while held in trust for a judgment debtor... is exempt from application to the satisfaction of a money judgment. 35 This includes payments from individual retirement accounts ( IRAs ). 36 However, this exemption excludes any additions to an IRA that are deemed to be fraudulent conveyances under the DCL. 37 The transfers that the Trustee seeks to recover here fall squarely within this exception. In applying the plain language of CPLR section 5205(c)(5) here, all additions to Hein s account beyond his principal investment were fraudulent conveyances 38 made by Madoff using money 34 Hein Br. at CPLR 5205(c)(1). 36 CPLR 5205(c)(2). 37 CPLR 5205(c)(5) ( Additions to an asset described in paragraph two of this subdivision shall not be exempt from application to the satisfaction of a money judgment... deemed to be fraudulent conveyances under article ten of the debtor and creditor law. ). 38 Under DCL 276, all transfers made by Madoff were made with the actual intent... to hinder, delay, or defraud either present or future creditors, and are therefore deemed to be fraudulent conveyances, for purposes of CPLR 5205(c)(5). 10

19 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 19 of 30 that was stolen from other investors. In other words, the money added by Madoff to Hein s account that supposedly represented earnings on his investments were the very fictitious profits that Hein thereafter withdrew. All such fictional additions are not [] exempt from application to the satisfaction of a money judgment While public policy favors protecting IRAs, this policy does not extend to money withdrawn from an IRA that was placed there by means of fraud and theft. 40 Without question, all withdrawals Hein made from his IA account within the relevant statutory period are comprised of other people s money. The CPLR never intended to protect these illegal transfers from avoidance by the Trustee. Such a result would be preposterous and would only serve to further legitimize Madoff s fraudulent activities. 41 B. How Hein Chose to Spend BLMIS Withdrawals Is Irrelevant in Determining Avoidance Liability Hein argues that because the Internal Revenue Code (the IRC ) requires IRA account holders over the age of 70 and one-half years to withdraw minimum distributions from their account each year, he should be permitted to keep other people s money. Hein cites to absolutely no relevant case law in support of this far-fetched theory, as there is none. Hein 39 CPLR 5205(c)(5); see also In re Morra, 2009 WL , at *3 (Bankr. E.D.N.Y. 2009) ( A debtor's conversion of nonexempt assets to exempt assets may constitute a transfer under the Bankruptcy Code... [which] may be subject to avoidance and recovery on a fraudulent transfer theory. ) (citing In re Orr, 2008 WL , at *3 (Bankr. C.D. Ill. Jan. 28, 2008)). 40 See In re Hill, 163 BR 598, 601 (Bankr. N.D. Fla. 1994) (holding that the exemption for IRA assets does not apply where assets were entirely funded via fraudulent actions, stating that the exemption laws could not be used as a safe harbor for ill-gotten gain, and should not be applied in such a way as to make them instruments of fraud.... ); In re Yuhas, 104 F.3d 612, 615 (3d Cir. 1997) (finding it reasonable to conclude that Congress intended to provide protection against the claims of creditors for a person s interest in pension plans, unless vulnerable to challenge as fraudulent or preferential transfers ); In re Key Commc ns, Inc., 24 F.3d 236, 236 (5th Cir. 1994) (noting that there is no authority for the proposition that pension plans can serve as safe harbors for fraudulent conveyances or voidable transfers. ). 41 See Second Circuit Net Equity Decision, 654 F.3d at 235,

20 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 20 of 30 simply insists that compliance with the IRC protects his fraudulent transfers from avoidance and cites two cases, neither of which involve a fraudulent scheme nor holds that IRA withdrawals should be protected from avoidance actions. 42 In fact, case law demonstrates the exact opposite. Courts have decline[d] to permit good faith investors to claim offsets for taxes or other expenses paid in connection with receipt and management of income from a Ponzi scheme. 43 In Donell v. Kowell, an action involving a Ponzi scheme, the receiver brought an avoidance action against an investor, Robert Kowell, seeking to disgorge Kowell s profits as fraudulent transfers. 44 Kowell argued that even if he is liable to return amounts in excess of his initial outlay, he should be permitted to offset this liability by amounts paid as income taxes on those gains, bank transfer fees, and other expenses. 45 The Ninth Circuit rejected this argument, 42 Hein s Br. at 23. See Lynn v. IRS (In Re Randazzo), 34 B.R. 76 (Bankr. D. Tex. 1983) (given that the debtor failed to deposit and pay certain employee withholding taxes, the court held that the IRS was owed an antecedent debt consisting of tax penalties, which was not voidable by the trustee under the fair consideration standard of the former Bankruptcy Act); Whaley v. Whaley (In re Whaley), 190 B.R. 818 (Bankr. N.D. Miss. 1995) (holding that an ex-husband in bankruptcy was not permitted to recover for his estate the value of paying alimony, child support, and COBRA payments to his ex-wife). 43 Donell v. Kowell, 533 F.3d 762, 779 (9th Cir. 2008); see also Janvey v. Alguire, 647 F.3d 585, 602 (5th Cir. 2011) (affirmed that taxes could not be offset by fraudulent transfers received); In re Hedged-Investments Assocs., Inc., 84 F.3d 1286, 1290 (10th Cir. 1996) (declined to allow investor to recover tax and interest payments paid out of Ponzi scheme investment, stating that this case, however, is not ordinary; it arises out of a Ponzi scheme and [a]ny recovery would not come from the debtors own assets because they had no assets they could legitimately call their own. Rather, any award of damages would have to be paid out of money rightfully belonging to other victims of the Ponzi scheme. ); Wing v. Dockstader, 2010 WL , at *6-7 (D. Utah 2010) (rejected defendants request to offset income taxes paid on fraudulent transfers, holding that allowing offsets would create problems of equity because any amount offset, which would differ based on the financial situation of each defendant, would come at the expense of other investors. ); S.E.C. v. Aragon Capital Management, LLC, 672 F. Supp. 2d 421, (S.D.N.Y. 2009) (declined to grant defendants any credit for taxes they may have paid for profits in scheme). 44 Donell v. Kowell, 533 F.3d at Id. at

21 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 21 of 30 finding that, not only did Kowell fail to cite to any authority in support of his position, but to offset his required tax payments would create a slippery slope for other mandatory expenses Kowell had to pay to avoid penalties, such as bank transfer fees or fund management fees. 46 The Ninth Circuit explained: There is simply no principle by which to limit such offsets; one could argue that every purchase made with the gains from the scheme would not have been made but for receipt of that money. If each net winner could shield his gains in their entirety in this manner, the purpose of UFTA would be defeated, and the multitude of victims who lost their entire investment would receive no recovery. 47 To exempt Hein s IRA withdrawals from avoidance could only come at the expense of innocent investors 48 who did not ma[ke] it out the exit door before the whistle blew on December 11th, Hein s reason for withdrawal has no relevance here it is not an element of the Trustee s cause of action or any defense available to Hein. The amount the Trustee seeks to recover is based purely on a technical cash-in/cash-out analysis. 50 Any calculation incorporating the compulsory expenses incurred by the individual investor would only aggravate the injuries caused by Madoff s fraud Id. 47 Id. at Id. ( [We] cannot discern the equity in permitting an offset here, when any taxpaid credit offered to Kowell must come at the expense of other... investors. ). 49 See Transcript of Oral Argument at 37, Picard v. Greiff, No. 11-cv-3775 (S.D.N.Y. argued Nov. 10, 2011). 50 See Second Circuit Net Equity Decision, 654 F.3d at See id. at 235; see also Donell, 535 F.3d at 779 ( [E]ven if we could limit permissible offsets to a few areas such as taxes paid, this would introduce complex problems of proof and tracing 13

22 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 22 of 30 To be clear, the Trustee s avoidance actions are not designed to punish Hein, but to instead place him in the same position as other similarly situated creditors who did not receive fraudulent [transfers]. 52 That Hein made these withdrawals to prevent paying a penalty simply does not allow him to keep fictitious profits. As the Ninth Circuit explained: Ponzi schemes leave no true winners once the scheme collapses even the winners were defrauded, because their returns were illusory. Those who receive gains from innocent participation in the scheme may be required to disgorge those amounts, long after the money has been spent. Addressing the victims of the original Ponzi scheme, the Supreme Court commented that [i]t is a case the circumstances of which call strongly for the principle that equality is equity. 53 Accordingly, equity compels Hein to share some of the hardship equally with those who lost their initial investment. 54 IV. THE SAFE HARBOR PROTECTIONS OF SECTION 546(E) DO NOT APPLY HERE While mindful of the Court s decision in Picard v. Katz, the Trustee still stresses that extending the safe harbor protections of section 546(e) to bar certain avoidance actions against the winners of Madoff s Ponzi scheme is not supported by the plain language of the statute or salient precedent, and indeed, undermines the statute s very purpose. into each case. This would severely reduce the receiver s ability to effectively gather what few assets can be located in the wake of a failed Ponzi scheme. ); Wing, 2010 WL , at *7 ( [A]llowing offsets would require complicated and imprecise accounting in order to determine which and the size of an offset should be allowed. Moreover, this process would lead to unjust results. ). 52 In re Bayou Group, LLC, 396 B.R. at Donell, 533 F.3d at 780 (citing Cunningham v. Brown, 265 U.S. 1, 13 (1924)). 54 Id. 14

23 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 23 of 30 A. The Trustee Is Not Collaterally Estopped from Arguing that Section 546(e) Does Not Apply in this Case Hein asserts that the Trustee is collaterally estopped from arguing whether section 546(e) applies in this instance. Defendant s argument ignores the law of collateral estoppel, which requires that resolution of the issue [be] necessary to support a valid and final judgment on the merits. 55 However, as this Court explicitly noted in its decision in Picard v. Katz, a final judgment has not been entered on this claim. 56 Furthermore, collateral estoppel seeks to prevent the re-litigation of an identical issue of ultimate fact. 57 Identical issues cannot exist here given that the account agreements in Picard v. Katz are distinguishable from Hein s account agreements. As this Court aptly noted, those very agreements and the context in which they were made will likely be presented as evidence at trial..., 58 and such factual issues are likely to be distinct as to each defendant in each proceeding. Finally, this Court issued a specific order instructing the parties to brief this issue, with which the Trustee must comply. 59 B. Applicable Law Section 546(e) provides, in pertinent part, that: 55 Ball v. A.O. Smith Corp., 451 F.3d 66, 69 (2d. Cir. 2006). 56 Picard v. Katz, 2012 WL , *1 (S.D.N.Y. Jan. 17, 2012) (This Court denied the Trustee s motion to enter a final judgment as to the claim that 546(e) of the Bankruptcy Code bars the Trustee from recovering under 544(b), 547(b), and 548(a)(1)(B) of the Code.). 57 Ball v. A.O. Smith Corp., 451 F.3d 66, 69 (2d. Cir. 2006); Leather v. Ten Eyck, 180 F.3d 420, 424 (2d Cir. 1999). 58 Picard v. Katz, 2012 WL , *3 (S.D.N.Y. Jan. 17, 2012). 59 Memorandum Order, Picard v. Hein, 11 Civ (JSR) (Nov. 28, 2011) (ECF No. 21) ( The Court withdraws the reference... for the limited purpose of deciding (ii) whether, in light of this Court s decision in Picard v. Katz, 2011 WL at *4 (S.D.N.Y. Sept. 27, 2011), 11 U.S.C. 546(e) applies, limiting the Trustee s ability to avoid transfers.... ). 15

24 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 24 of 30 Notwithstanding sections 544, 545, 547, 548(a)(1)(B), and 548(b) of this title, the trustee may not avoid a transfer that is a... settlement payment... made by or to (or for the benefit of) a... stockbroker... or that is a transfer made by or to (or for the benefit of) a... stockbroker... in connection with a securities contract... that is made before the commencement of the case, except under section 548(a)(1)(A) of this title. 60 C. The Plain Language of Section 546(e) Supports the Trustee s Position Section 546(e) shields from avoidance transfers that are settlement payments or transfers made in connection with a securities contract. The plain meaning of these terms in the statute supports the Trustee s position that section 546(e) does not apply here. 1. The Transactions at Issue Are Not Settlement Payments within the Meaning of Section 546(e) The transfers at issue here can never be considered settlement payments because no securities were ever purchased, sold or delivered, and, therefore, no securities transactions were ever completed. The Second Circuit recently held that a settlement payment refers to the completion of a securities transaction. 61 The Second Circuit s emphasis on the underlying securities transactions in the definition of settlement payment is consistent with the explanation of the term by the Securities and Exchange Commission ( SEC ). The SEC describes settlement as the delivery and receipt of funds and securities. 62 In addition, Rule 15c1-1(b) under the Securities Exchange Act of 1934 (the Act ) illustrates that the securities industry and its regulators recognize that the completion of a securities transaction occurs when a valid U.S.C. 546(e). 61 In re Enron Recovery Corp. v. Alfa, S.A.B. de C.V., 651 F.3d 329, 337 (2d Cir. 2011) (quoting Contemporary Indus. Corp. v. Frost, 564 F.3d 981, 985 (8th Cir. 2009)). 62 Securities Exchange Act Release No. 20,221 n.33 (Sept. 23, 1983); Securities Exchange Act Release No. 13, 163 n.56 (Jan. 13, 1977) (emphasis added); see also Kaiser Steel Corp. v. Charles Schwab & Co., 913 F.2d 846, 849 (10th Cir. 1990); Jonas v. Resolution Trust Corp. (In re Comark), 97 F.2d 322, 326 (9th Cir. 1992). 16

25 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 25 of 30 security is delivered into the account of a customer. 63 Here, no securities existed, and thus no security was ever delivered. Therefore, there were no settlement payments for purposes of section 546(e). Ultimately, however, whether a securities transaction was completed raises a question of fact not properly resolved on a motion to dismiss. 2. The Fraudulent Transfers Were Not Made in Connection with a Securities Contract The documents executed by Hein upon the opening of his account with BLMIS (the Account Opening Documents ) were not, and could not have been, securities contracts under section 546(e) of the Code. Obviously, the Trustee cannot address this issue without acknowledging that this Court found to the contrary in Picard v. Katz. Nonetheless, the Trustee submits that the Court reached an incorrect result. The plain language of section 741(7) of the Code makes clear that a securities contract is one which effects the purchase, sale or loan of a security. 64 The Account Opening Documents, however, merely provided for discretionary investment services pursuant to which BLMIS, as the customer s agent and broker, could from time to time enter into securities contracts with third party brokers or on the securities exchange. In other words, the Account Opening Documents C.F.R c1-1(b) U.S.C. 741(7) (A securities contract, in pertinent part, is a contract for the purchase, sale or loan of a security.... ). In 2006, Congress amended Title 11 and included the terms in connection with a securities contract to section 546(e) merely to conform to the language of other sections of the Code. The term securities contract was first defined and incorporated into certain sections of the Bankruptcy Code in 1982 pursuant to an Act to Amend Title 11. Pub L , 96 Stat. 237 (July 27, 1982). 17

26 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 26 of 30 did nothing more than authorize BLMIS, at some point in the future, to enter into securities contracts. The Account Opening Documents were not themselves securities contracts BLMIS Is Not a Stockbroker for Purposes of the 546(e) Safe Harbor Running the largest Ponzi scheme in history does not qualify BLMIS as a stockbroker under the Bankruptcy Code, despite BLMIS s registration under the Securities and Exchange Act (the Act ). 66 Section 101(53A) of the Bankruptcy Code defines a stockbroker as a person... with respect to which there is a customer, as defined in section and... that is engaged in the business of effecting transactions in securities... for the account of others; or... with members of the general public from or for such person s own account. 67 This Court must apply the plain language at hand 68 and determine whether, as a factual matter, 69 BLMIS was engaged in the business of effecting transactions in securities in connection with Hein s IA Account. 70 BLMIS was a member of SIPC by virtue of its registration as a broker-dealer with the SEC. 71 However, its status as a stockbroker under the Bankruptcy Code only depends on 65 Picard v. Merkin (In re Bernard L. Madoff Inv. Secs., LLC) ( Merkin II ), 2011 WL , at *12 (S.D.N.Y. Aug. 31, 2011); Merkin I, 440 B.R. at 267; Picard v. Madoff ( Madoff Family ), 2011 WL , at *16 (Bankr. S.D.N.Y. Sept. 22, 2011). 66 Trustee s Am. Compl. 19; see Madoff Family, 2011 WL , at *15 ( Whether Madoff, through BLMIS, was a stockbroker engaged in the business of effecting transactions in securities is dubious. ) (quoting 11 U.S.C. 101(53A)) U.S.C. 101(53A). 68 Wesbanco Bank Barnesville v. Rafoth (In re Baker & Getty Fin. Servs., Inc.), 106 F.3d 1255, 1260 (6th Cir. 1997). 69 See Merkin II, 2011 WL , at *12 (stating that defendants cited no decision in which a Ponzi scheme operator, who allegedly did not execute any trades, was deemed, at the pleading stage, to be a stockbroker for purposes of section 546(e) ) U.S.C. 101(53A). 71 Second Circuit Net Equity Decision at 233 n.3. 18

27 Case 1:11-cv JSR Document 26 Filed 01/25/12 Page 27 of 30 whether it was engaged in the business of effecting transactions in securities, and not on its registration status. 72 Both this Court and the SEC have acknowledged that Madoff and Madoff Securities were... engaged in... a Ponzi scheme... without any actual securities trades taking place. 73 Accordingly, BLMIS cannot be considered a stockbroker for purposes of Hein s IA Account. 4. Hein Fails to Satisfy His Burden of Proving that the Section 546(e) Affirmative Defense Bars the Trustee from Avoiding the Fraudulent Transfers Ultimately, whether BLMIS was a stockbroker that made transfers in connection with securities contracts or made transfers that qualify as settlement payments for purposes of section 546(e) are all questions of fact that require the Court to look beyond the pleadings. This is why courts addressing these issues have found that the assertion of section 546(e) at this early stage of 72 Compare Johnson v. Neilson (In re Slatkin), 525 F.3d 805, 819 (9th Cir. 2008) with In re Baker & Getty, 106 F.3d at Hein cites In re Baker & Getty Fin. Servs., Inc., 106 F.3d 1255 to explain that Madoff s fraud does not preclude this Court from finding that BLMIS was a stockbroker under section 101(53A) since one of the debtors of Baker & Getty ( B&G ), like Madoff, was running a Ponzi scheme and was found to be engaged in the business of effecting transactions in securities. See id. at , However, B&G, even though an unlicensed broker-dealer, conducted a legitimate business with all its customers [and]... achieved stockbroker status by virtue of its lawful business. See In re Baker & Getty Fin. Servs., Inc., 106 F.3d at Whereas, the case of BLMIS is more analogous to In re Slatkin, wherein the court refused to find Slatkin a stockbroker because all but a few of the transactions conducted by Slatkin were illegitimate. See In re Slatkin, 525 F.3d at Picard v. Katz, 2011 WL , at *2; see also Brief for Securities and Exchange Commission as Amicus Curiae Supporting Appellee, supra note 30 at 3, 10 ( [t]he Trustee s examination of BLMIS s books and records, as well as records of clearing firms and exchanges, did not show any trades actually effected for the customers accounts.... ). 19