Irving H. Picard v. Sage Realty

Background

The cases arise from the liquidation of Bernard L. Madoff Investment Securities, LLC (BLMIS) under the Securities Investor Protection Act (SIPA). The court appointed Irving H. Picard as trustee. After investigating BLMIS, the trustee determined that, with very few exceptions, BLMIS had not purchased securities for customers and had instead operated a Ponzi scheme in which customer money was used to pay other customers.

The trustee brought related proceedings in bankruptcy court against Sage Realty, Sage Associates, and individual defendants. He alleged that the defendants were “net winners”—customers who withdrew more money than they deposited—and sought to avoid and recover a $13,510,000 transfer to Sage Associates and a $3,370,000 transfer to Sage Realty. He also sought to hold the individual defendants jointly and severally liable based on their alleged roles as partners or joint venturers. Discovery had concluded, and the cases were close to trial.

The requested withdrawal

The defendants moved to withdraw the cases from the bankruptcy court. They argued that withdrawal was mandatory under 28 U.S.C. § 157(d) because resolving the dispute would require substantial and material consideration of SIPA, a federal statute outside the Bankruptcy Code. They specifically identified questions about whether the trustee could use the “Net Investment Method” to calculate their net equity in the BLMIS customer fund. They also argued that withdrawal should be allowed under the statute’s separate discretionary provision because the individual defendants had demanded a jury trial.

The court considered the two motions together because the proceedings involving Sage Realty and Sage Associates had proceeded together in bankruptcy court. The bankruptcy court had stayed the cases while the district court decided the motions.

Unsettled SIPA questions

Under the Net Investment Method, a customer’s net equity is calculated by subtracting the customer’s cash withdrawals from the customer’s cash deposits. The trustee used that method for BLMIS customers whose account statements reflected fictitious securities transactions. The defendants argued that their account statements were different: they allegedly reflected securities purchases they had authorized and directed, even though BLMIS never actually executed the trades.

The court identified several unresolved legal questions. First, it might have to decide whether account statements reflecting authorized but unexecuted trades accurately show a customer’s “securities positions” under SIPA. Second, it might have to decide whether the Net Investment Method remains legally permissible when those account statements are otherwise reliable. Third, even if the Net Investment Method were permissible but less favorable than the Last Statement Balance Method, the court might have to decide whether SIPA gives the trustee discretion to choose the Net Investment Method.

The court noted that prior appellate decisions had approved the Net Investment Method for the ordinary BLMIS accounts involved in earlier appeals, where the statements were fictitious and no securities had been purchased. But those decisions also recognized that the method might not be appropriate in other circumstances, including situations involving customer-directed stock purchases. The court determined that the existing decisions did not answer the questions presented by the defendants’ accounts.

Ruling

The court held that mandatory withdrawal applied. Mandatory withdrawal is required when resolving a proceeding calls for substantial and material interpretation of federal law outside the Bankruptcy Code, rather than merely routine application of settled law. The court concluded that these cases presented significant, unsettled questions of first impression under SIPA and would require interpretation of the statute in the first instance.

The court therefore granted the defendants’ motions. It withdrew the bankruptcy-court references in Case No. 20-cv-10109 and related Case No. 20-cv-10057. Because withdrawal was mandatory, the court did not address the defendants’ alternative request for discretionary withdrawal. The ruling did not decide the proper method for calculating the defendants’ net equity or the trustee’s claims to recover the transfers.