By David Bario, From The Litigation Daily

Bernie Madoff’s humongous Ponzi scheme failed, costing investors a fortune, because it was built on deceit. But the deception paid off for many years, delivering conjured-up profits to Madoff’s customers.

On Monday, investors who pocketed billions in the six years before the scheme collapsed deflected a bid by Madoff bankruptcy trustee Irving Picard to claw back a big chunk of their “fictitious” profits. Affirming a lower court judge, the U.S. Court of Appeals for the Second Circuit concluded that Picard’s campaign to recover much of the investors’ earnings is barred by a bankruptcy law provision that was designed, ironically, to minimize uncertainty in the securities markets.

Back in 2011 we named Karen Wagner of Davis Polk & Wardwell Litigator of the Week for winning the key lower court ruling that the Second Circuit affirmed. That decision had the immediate effect of erasing massive liability for Wagner’s clients, New York Mets owners Fred Wilpon and Saul Katz. Wilpon and Katz later settled with Picard, however, so this time around the job of arguing for the investors fell to Richard Levy Jr. of Pryor Cashman, P. Gregory Schwed of Loeb & Loeb, and Helen Chaitman of Becker & Poliakoff.

In a statement, Schwed said the ruling would wipe out $1.6 billion in potential claims against about 1,600 Madoff investors. “The Court’s ruling sharply restricts the trustee’s litigation campaign against innocent victims of Madoff’s fraud,” Schwed said. “This ruling respects the balance set by Congress between the trustee’s goal of collecting money and the right of Madoff victims to keep amounts they received in good faith many years ago.”

The appeal hinged on Section 546(e) of the U.S. Bankruptcy Code, which was enacted in the wake of the Enron debacle to protect institutions with ongoing trading obligations from certain clawback actions related to “settlement payments” made “in connection with a securities contract.” The idea, as the Second Circuit recounts in Monday’s opinion, was to temper financial market turbulence stemming from industry-shaking bankruptcies.

Picard, represented as always by his partner David Sheehan at Baker & Hostetler, maintained that § 546(e) has no bearing on the clawback actions against Madoff’s net winners, since there were no “securities contracts” behind the investors’ profits—only Madoff’s Ponzi fantasy. U.S. District Judge Jed Rakoff in Manhattan rebuffed that argument in September 2011, finding that the safe harbor provision barred much of Picard’s case against Katz and Wilpon’s company, Sterling Equities. Rakoff applied the same reasoning in dismissing 84 additional clawback actions the following year.

Those decisions don’t stop Picard from seeking to claw back fraudulent payments made by Madoff’s firm in the two years leading up to the bankruptcy, which are covered by separate rules. They served to wipe out claims related to net winnings reaching back six years before the scheme collapsed, however, putting a major crimp in Picard’s efforts to collect on behalf of Madoff victims.

In affirming Rakoff on Monday, the Second Circuit determined that even if Madoff’s earnings were bogus, the net winners’ profits were indeed “settlement payments” made “in connection with a securities contract,” and thus the safe harbor provision applies.

“The clawback defendants, having every reason to believe that [Bernard L. Madoff Investment Securities] was actually engaged in the business of effecting securities transactions, have every right to avail themselves of all the protections afforded to the clients of stockbrokers, including the protection offered by § 546(e),” the panel wrote. “Permitting the clawback of millions, if not billions, of dollars from BLMIS clients—many of whom are institutional investors and feeder funds—would likely cause the very ‘displacement’ that Congress hoped to minimize in enacting § 546(e).”

Picard so far has recovered nearly $10.5 billion for victims of Madoff’s scheme. Monday’s ruling is just the latest in a series of courtroom setbacks to those efforts, however, as we’ve covered, for example, here and here.

IMAGE: Irving Picard

For more on this story go to: http://www.litigationdaily.com/id=1202678388109/Investors-Win-Madoff-Fictitious-Profits-Appeal#ixzz3LPmT2aUT