By Jonathan Stempel
Feb 22 (Reuters) - People who lost money by investing in
funds that funneled their money to Bernard Madoff's Ponzi scheme
are not entitled to recover for their losses in the manner that
direct victims of the massive fraud can recover, a federal
appeals court ruled on Friday.
The decision by the 2nd U.S. Circuit Court of Appeals in New
York is a victory for Irving Picard, the trustee liquidating
Bernard L Madoff Investment Securities LLC and seeking money for
its former customers.
Picard, a partner at Baker & Hostetler, persuaded the court
that "indirect" investors who lost money in the fraud were not
Madoff customers who could recover from the bankruptcy estate.
Madoff, 74, is serving a 150-year prison sentence, and
Picard had estimated that customers lost $17.3 billion of
principal in the fraud.
The appeal was brought by 17 investors who had invested in
limited partnerships known as Spectrum Select. These in turn
sent their money to two Rye Select hedge funds overseen by
Tremont Group Holdings Inc.
Tremont was one of the largest Madoff "feeders," and settled
with Picard for $1.025 billion in July 2011.
Prior to the appeal, two lower court judges had found that
the 17 indirect investors could not recover from the estate
because they had not been Madoff customers, unlike the feeder
funds that dealt directly with him.
That distinction matters because it is customers, not
indirect investors, who may draw up to $500,000 each from a fund
overseen by the Securities Investor Protection Corp, to the
extent they cannot recover losses from a bankruptcy estate.
SIPC is a nonprofit created by Congress and funded by the
brokerage industry.
CRITICAL REQUIREMENT NOT SATISFIED
Writing for a three-judge 2nd Circuit panel, Circuit Judge
Reena Raggi said there were several reasons that the indirect
investors did not qualify as Madoff customers.
She said they had no direct relationship or accounts with
his firm, were not identified in the firm's books and records,
had no property interest in the assets sent there by the feeder
funds, and lacked control over the feeder funds' investments.
"We have identified the critical aspect of the 'customer'
definition to be the entrustment of cash or securities to the
broker-dealer for the purpose of trading securities," Raggi
wrote. "Appellants fail to satisfy this critical requirement."
William Chapman, who argued the indirect investors' appeal,
did not immediately respond to a request for comment.
A spokeswoman for Picard did not immediately respond to a
similar request.
The decision does not affect the ability of indirect
investors to sue the feeder funds, or share in any recovery by
those funds from the SIPC fund.
Friday's decision is the second this week by the 2nd Circuit
in a Madoff-related appeal.
On Wednesday, the court refused to let former investors
pursue claims against Madoff's brother Peter, as well as
Madoff's son Andrew and the estate of his late son Mark, over
the family members' roles in the fraud.
The court said allowing such claims would impede Picard's
effort to maximize payouts from the estate.
Among the investors who had challenged the trustee was a
charitable foundation for New Jersey Senator Frank Lautenberg.
Separately, Picard on Feb. 13 asked U.S. Bankruptcy Judge
Burton Lifland in Manhattan for permission to distribute another
$505 million to customers, boosting the total to $5.44 billion.
The case is Kruse et al v. Securities Investor Protection
Corp et al, 2nd U.S. Circuit Court of Appeals, Nos. 12-410,
12-437, 12-483 and 12-529.
Follow us on Twitter @ReutersLegal | Like us on Facebook