Case 1:17-cv GBD Document 14 Filed 11/01/17 Page 1 of 23

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1 Case 1:17-cv GBD Document 14 Filed 11/01/17 Page 1 of 23 UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK SECURITIES INVESTOR PROTECTION CORPORATION, v. Plaintiff-Applicant, BERNARD L. MADOFF INVESTMENT SECURITIES LLC, Adv. Pro. No (SMB) SIPA LIQUIDATION (Substantively Consolidated) Defendant. In re: BERNARD L. MADOFF, Debtor. IRVING H. PICARD, Trustee for the Substantively Consolidated SIPA Liquidation of Bernard L. Madoff Investment Securities LLC and Bernard L. Madoff, Plaintiff, v. Adv. Pro. No (SMB) No. 17 Civ (GBD) CAROL NELSON, Defendant, IRVING H. PICARD, Trustee for the Substantively Consolidated SIPA Liquidation of Bernard L. Madoff Investment Securities LLC and Bernard L. Madoff, Plaintiff, v. CAROL NELSON, individually and as joint tenant; and STANLEY NELSON, individually and as joint tenant, Adv. Pro. No (SMB) No. 17 Civ (GBD) Defendants.

2 Case 1:17-cv GBD Document 14 Filed 11/01/17 Page 2 of 23 IRVING H. PICARD, Trustee for the Substantively Consolidated SIPA Liquidation of Bernard L. Madoff Investment Securities LLC and Bernard L. Madoff, Plaintiff, v. HELENE SAREN-LAWRENCE, Adv. Pro. No (SMB) No. 17 Civ (GBD) Defendant. MEMORANDUM OF LAW OF THE SECURITIES INVESTOR PROTECTION CORPORATION IN OPPOSITION TO DEFENDANTS MOTIONS TO WITHDRAW THE REFERENCE SECURITIES INVESTOR PROTECTION CORPORATION 1667 K St., NW, Suite 1000 Washington, D.C Telephone: (202) JOSEPHINE WANG General Counsel KEVIN H. BELL Senior Associate General Counsel for Dispute Resolution NATHANAEL S. KELLEY Assistant General Counsel

3 Case 1:17-cv GBD Document 14 Filed 11/01/17 Page 3 of 23 TABLE OF CONTENTS PAGE STATEMENT OF THE ISSUE...2 BACKGROUND...2 I. The BLMIS Ponzi Scheme...2 II. The SIPA Liquidation...3 III. The Claims Determinations...5 IV. The Movants Claims...6 V. The Avoidance Actions...7 ARGUMENT...11 VI. THE STANDARD FOR WITHDRAWAL OF THE REFERENCE...11 VII. THE MOVANTS SUBMITTED TO THE JURISDICTION OF THE BANKRUPTCY COURT BY FILING A PROOF OF CLAIM...12 A. The Determination of the Avoidance Actions Is Integral to the Determination of the Movants Claims and Restructuring the Debtor-Creditor Relationship...12 B. Bankruptcy Code Section 502(d) Requires the Bankruptcy Court to Determine the Avoidance Actions Before Allowing the Movants Claims...14 CONCLUSION...17 i

4 Case 1:17-cv GBD Document 14 Filed 11/01/17 Page 4 of 23 TABLE OF AUTHORITIES CASES: PAGE Bankr. Serv., Inc. v. Ernst & Young (In re CBI Holding Co.), 529 F.3d 432 (2d Cir. 2008)...12, 13 In re Bernard L. Madoff Inv. Sec. LLC, 654 F.3d 229 (2d Cir. 2011), cert. dismissed, U.S., 132 S. Ct (2012), cert. denied, 567 U.S. 934 (2012)...6, 7, 10 Burns v. Dennis (In re Se. Materials, Inc.), 467 B.R. 337 (Bankr. M.D.N.C. 2012)...16 Davis v. R.A. Brooks Trucking Co., Inc. (In re Quebecor World (USA), Inc.), 491 B.R. 379 (Bankr. S.D.N.Y. 2013)...15 Donell v. Kowell, 533 F.3d 762 (9th Cir.2008)...9 Exchange National Bank of Chicago v. Wyatt, 517 F.2d 453 (2d Cir. 1975)...4, 16 Ferris, Baker Watts, Inc. v. Stephenson (In re MJK Clearing, Inc.,), 286 B.R. 109 (Bankr. D. Minn. 2002), aff d, 2003 WL (D. Minn. Apr. 07, 2003), aff d, 371 F.3d 397 (8th Cir. 2004)...8 First Fid. Bank N.A., N.J. v. Hooker Invs. Inc. (In re Hooker Invs., Inc.), 937 F.2d 833 (2d Cir. 1991)...13 Germain v. Connecticut Nat. Bank, 988 F.2d 1323 (2d Cir. 1993)...14 Granfinanciera v. Norberg, 492 U.S. 33 (1989)...13 Jackson v. Mishkin (In re Adler, Coleman Clearing Corp.), 263 B.R. 406 (S.D.N.Y. 2001)...5 Katchen v. Landy, 382 U.S. 323 (1966)...15 Keller v. Blinder (In re Blinder, Robinson & Co.), 135 B.R. 899 (D. Colo. 1992)...5 Langenkamp v. Culp, 498 U.S. 42 (1990)...12, 13 In re Lloyd Secs., Inc., 75 F.3d 853 (3d Cir. 1996)...4 Mason v. Ivey, 498 B.R. 540 (M.D.N.C. 2013) National Union Fire Insurance Co. of Pittsburgh, Pa. v. Camp (In re Government Securities Corp.), 972 F.2d 328 (11th Cir. 1992)...4 ii

5 Case 1:17-cv GBD Document 14 Filed 11/01/17 Page 5 of 23 CASES: TABLE OF AUTHORITIES (cont.) PAGE In re New Times Sec. Servs., Inc., 371 F.3d 68 (2d Cir. 2004) Orion Pictures Corp. v Showtime Networks, Inc. (In Re Orion Pictures Corp.), 4 F.3d 1095 (2d Cir. 1993), cert. dismissed, 511 U. S (1994) Picard v. Katz, 462 B.R. 447 (S.D.N.Y. 2011), abrogated on other grounds by Sec. Inv r Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, 513 B.R. 437 (S.D.N.Y. 2014)...9 Sagor v. Picard (In re Bernard L. Madoff Inv. Sec., LLC), Case No , 2017 WL (2d Cir. June 1, 2017)...6 Sec. Inv r Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, 476 B.R. 715 (S.D.N.Y. 2012), supplemented (May 15, 2012), aff d sub nom. In re Bernard L. Madoff Inv. Sec. LLC, 773 F.3d 411 (2d Cir. 2014)...9, 10 Sec. Inv r Prot. Corp. v. Ambassador Church Finance/Development Group, Inc., 788 F.2d 1208 (6th Cir.), cert. denied sub nom, Pine Street Baptist Church v. Sec. Inv r Prot. Corp., 479 U.S. 850 (1986)...4 Sec. Inv'r Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, 490 B.R. 46 (S.D.N.Y. 2013)...15 Sec. Inv r Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, 499 B.R. 416 (S.D.N.Y. 2013), certification for interlocutory appeal denied, 987 F. Supp. 2d 309 (S.D.N.Y. 2003) Sec. Inv r Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, 513 B.R. 437 (S.D.N.Y. 2014)...9, 14 Sec. Inv r Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, 531 B.R. 439 (Bankr. S.D.N.Y. 2015)...8 Solution Trust v Grand LLC (In re AWTR Liquidation Inc.), 547 B.R. 831 (Bankr. C.D. Cal. 2016)...15 Stern v. Marshall, 564 U.S. 462 (2011)...12, 13, 15 Turner v. Davis Gillenwater & Lynch (In re Investment Bankers Inc.), 4 F.3d 1556 (10th Cir. 1993), cert. denied, 510 U.S (1994)...5 iii

6 Case 1:17-cv GBD Document 14 Filed 11/01/17 Page 6 of 23 CASES: TABLE OF AUTHORITIES (cont.) PAGE U. S. Lines, Inc. v. Am. S.S. Owners Mut. Prot. & Indem. Ass n. (In re U. S. Lines, Inc.), 197 F.3d 631 (2d Cir. 1999), cert. denied, 529 U.S (2000)...12 U.S. Bank Nat. Ass n v. Verizon Commc ns Inc., No. 3:10-CV-1842-G, 2012 WL (N.D. Tex. Mar. 21, 2012), aff d, 761 F.3d 409 (5th Cir. 2014), as revised (Sept. 2, 2014), cert. denied, U.S., 135 S Ct (2015)...16 STATUTES AND RULES: Securities Investor Protection Act, as amended, 15 U.S.C. 78eee(b) eee(b)(4) eee(d) fff(a) fff(b)...1, 4 78fff-1(a) fff-2(c) fff-2(c)(1)(B)...7, 8 78fff-2(c)(3)...1, 8, 10 78fff-3(a) lll(4) lll(11)...5 United States Bankruptcy Code, as amended, 11 U.S.C. 502(d)...4, 11, 14, 15, , , 5, 14, (a)(1)...8, 9 548(a)(1)(A) (c)...8, (a)...4, U.S.C. 157(d)...2, (b)(2)(A) (b)(2)(H) (b)(2)(O)...4 iv

7 Case 1:17-cv GBD Document 14 Filed 11/01/17 Page 7 of 23 The Securities Investor Protection Corporation ( SIPC ) 1 submits this memorandum of law in opposition to the motions (the Motions ) of Helene Saren-Lawrence ( Saren-Lawrence, Case No. 17-cv-05157), Carol Nelson ( Nelson, Case No. 17-cv-05162), and Carol Nelson and Stanley Nelson, individually and as joint tenants (the Nelsons, Case No. 17-cv-05163; collectively the Movants ) to withdraw the reference of their respective adversary proceedings from the United States Bankruptcy Court for this District ( Bankruptcy Court ). In these proceedings, the trustee ( Trustee ) for the substantively consolidated liquidation proceedings of Bernard L. Madoff Investment Securities LLC ( BLMIS or Debtor ) under the Securities Investor Protection Act, 15 U.S.C. 78aaa 78lll ( SIPA ), 2 and Bernard L. Madoff ( Madoff ), seeks to recover fictitious profits paid to the Movants in furtherance of the Ponzi scheme conducted through BLMIS. The actions (the Avoidance Actions ) are brought under avoidance and recovery provisions of the Bankruptcy Code, U.S. Code Title 11 (the Bankruptcy Code ), made applicable under SIPA sections 78fff(b) and 78fff-2(c)(3). The Movants urge the Court to withdraw the reference of the proceeding because the Movants asserted right to a jury trial necessitates withdrawal. The Movants, however, have filed claims in this liquidation. The Trustee denied those claims, and the Movants filed objections to those denials in the Bankruptcy Court, seeking Bankruptcy Court review of the net equity purportedly owed to them by the BLMIS estate. Those objections remain outstanding and subject to the Bankruptcy Court s jurisdiction under the Bankruptcy Code and SIPA. Under Supreme Court precedent and the law of the case, the Movants have therefore submitted themselves to the equitable jurisdiction of the Bankruptcy 1 SIPC is a party-in-interest and a statutory intervenor in all liquidations under the Securities Investor Protection Act. See 15 U.S.C. 78eee(d). 2 For convenience, further references to SIPA shall omit 15 U.S.C.

8 Case 1:17-cv GBD Document 14 Filed 11/01/17 Page 8 of 23 Court for the allowance and disallowance of claims. The determination of the Movants liability to the estate on fraudulent transfer actions is part and parcel of that jurisdiction. Accordingly, the Movants request for withdrawal of the reference should be denied. The Motions present the following issue: STATEMENT OF THE ISSUE Whether under 28 U.S.C. section 157(d), withdrawal of the reference for a jury trial of an adversary proceeding arising in a liquidation proceeding under SIPA is warranted or appropriate where the Movants have claims under SIPA pending in the liquidation proceeding before the Bankruptcy Court, resolution of which would require resolution of the Avoidance Actions involving the same issues and transactions. SIPC respectfully submits that under the facts presented, withdrawal of the reference to the Bankruptcy Court is neither warranted nor appropriate. I. The BLMIS Ponzi Scheme BACKGROUND BLMIS infamously operated as a Ponzi scheme, where investor withdrawals were funded by deposits from new investors. BLMIS investors made deposits into, and withdrawals from, their accounts for the purpose of investing in the securities market. Their account statements reflected numerous securities positions allegedly bought and sold by BLMIS and the dates and prices of the trades. In reality, however, no trading took place in the accounts. The purchases of securities were created within the BLMIS system with backdated prices that were selected in order to yield returns invented by Madoff. Investors never had securities positions, so when these positions were sold, the cash from the sale was illusory. As in the classic Ponzi scheme, Madoff used new investors money to pay previous investors profits in order to perpetuate the scam. Any profits in the account were phantom 2

9 Case 1:17-cv GBD Document 14 Filed 11/01/17 Page 9 of 23 profits, the product of Madoff s imagination. The only real events that occurred in each account i.e., activity supported by the movement of actual cash or securities were the investors deposits of funds into accounts and their withdrawals. Because no trades occurred and no profits were generated, withdrawals of funds did not come from an investor s account. Instead, withdrawals came from other investors deposits. In certain cases, because of the sizeable appreciation of profits in the accounts, the total amounts withdrawn by customers exceeded many times over the total amounts they deposited. Those investors who withdrew their principal and profits before BLMIS failed necessarily did better than other investors, including many who made no withdrawals at all. With their withdrawals from the scheme, some investors not only recovered their principal but received millions of dollars in false profits as well. Other customers, whose monies were used to pay those investors who withdrew their principal and more, have yet to recover the amounts they deposited with the broker. II. The SIPA Liquidation On December 15, 2008, upon an application by SIPC, BLMIS was placed in SIPA liquidation by Order of this Court under SIPA section 78eee(b). Sec. Inv r Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, Adv. Pro. No smb, ECF No. 1 (Bankr. S.D.N.Y. Dec. 15, 2008). 3 The Court appointed Irving H. Picard, Esquire, as trustee for the estate and, following the directive of SIPA section 78eee(b)(4), removed the liquidation proceeding to the Bankruptcy Court. SIPA section 78eee(b)(4) further provides that upon removal of the liquidation proceeding from the District Court to the Bankruptcy Court, [t]he latter court shall thereupon have all of the 3 Unless otherwise noted, future ECF references are to the main liquidation proceeding for BLMIS, Sec. Inv r Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, Adv. Pro. No smb (Bankr. S.D.N.Y.). 3

10 Case 1:17-cv GBD Document 14 Filed 11/01/17 Page 10 of 23 jurisdiction, powers, and duties conferred by [SIPA] upon the court to which application for the issuance of the protective decree was made. Under SIPA section 78fff(b), to the extent consistent with SIPA, a SIPA liquidation proceeding is to be conducted 1) in accordance with and 2) as though it were being conducted under chapters 1, 3, and 5 and subchapters I and II of chapter 7 of title 11. The provisions of Title 11 referred to in section 78fff(b) are the bankruptcy liquidation provisions of the Code, except for the stockbroker and commodity broker provisions. In order for the SIPA liquidation to be conducted in accordance with Title 11, the bankruptcy provisions, including sections 502(d), 548, and 550(a), must be held to apply in a SIPA liquidation. Cf., National Union Fire Insurance Co. of Pittsburgh, Pa. v. Camp (In re Government Securities Corp.), 972 F.2d 328, (11th Cir. 1992). SIPA section 78fff-1(a) specifies that the SIPA Trustee is vested with the same powers and title with respect to the debtor and the property of the debtor as a trustee in a case under title 11. The section includes one illustrative example of those powers, namely, including the same rights to avoid preferences. The fact that a SIPA liquidation is simply an outright bankruptcy proceeding for all practical purposes has been consistently recognized. See SIPA 78fff(a), (b); see also Exchange National Bank of Chicago v. Wyatt, 517 F.2d 453, (2d Cir. 1975) ( Wyatt ); In re Lloyd Sec., Inc., 75 F.3d 853, 857 (3d Cir. 1996); Sec. Inv r Prot. Corp. v. Ambassador Church Finance/Development Group, Inc., 788 F.2d 1208, 1210 (6th Cir.), cert. denied sub nom. Pine Street Baptist Church v. Sec. Inv r Prot. Corp., 479 U.S. 850 (1986). An adversary proceeding involving core matters such as administration of the estate, the adjustment of the debtorcreditor relationship, and avoidance and recovery actions, 28 U.S.C. 157(b)(2)(A), (H), (O) brought in the context of a SIPA liquidation therefore should be adjudicated no differently than 4

11 Case 1:17-cv GBD Document 14 Filed 11/01/17 Page 11 of 23 the same proceeding in a bankruptcy case. See, e.g., Turner v. Davis Gillenwater & Lynch (In re Investment Bankers Inc.), 4 F.3d 1556, 1558, 1563 (10th Cir. 1993) (holding that the bankruptcy court had jurisdiction to determine avoidance actions under Bankruptcy Code sections 547 and 548 in a SIPA liquidation), cert. denied, 510 U.S (1994); Jackson v. Mishkin (In re Adler, Coleman Clearing Corp.), 263 B.R. 406, 479, 496 (S.D.N.Y. 2001) (affirming the bankruptcy court s judgment that fraudulent transfers to customers were avoidable in a SIPA liquidation); Keller v. Blinder (In re Blinder, Robinson & Co.), 135 B.R. 899, 901 (D. Colo. 1992). III. The Claims Determinations Upon the Trustee s application, the Bankruptcy Court approved procedures for filing claims with the Trustee. The procedures provided, among other things, for the submission of claims to the Trustee, a determination by the Trustee, satisfaction by the Trustee of allowed claims, and an opportunity for any customer who disagreed with the determination of its claim to seek Bankruptcy Court review. [ECF No. 12.] Due to the nature of BLMIS s Ponzi scheme, the Trustee determined that the BLMIS account statements reflected fictitious securities and profits and thus could not be relied upon to establish a customer s claim. Instead, the Trustee processed all claims based upon the Net Investment Method. Under this method, the customers net equity that is, what customers were owed, calculated as the difference between what the broker owes the customer and what the customer owes the broker, see SIPA 78lll(11) was the net amount deposited by the customers with BLMIS. For customers with a positive net equity deemed net losers, having deposited more than they withdrew the Trustee allowed the claims as ones for securities, making each customer eligible for an advance from SIPC of up to $500,000, in addition to a pro rata share of customer property held by BLMIS or recovered by the Trustee. See SIPA 78fff-3(a); see In 5

12 Case 1:17-cv GBD Document 14 Filed 11/01/17 Page 12 of 23 re New Times Sec. Servs., Inc., 371 F.3d 68, 87 (2d Cir. 2004) ( In re New Times ). Those investors who had a negative net equity who withdrew more than they deposited were deemed net winners and had no allowable customer claim. When claimants objected to the Trustee s use of the Net Investment Method, the Trustee sought the Bankruptcy Court s approval of his calculation. In opposition, the claimants argued that a customer s net equity should be calculated by the Last Statement Method, which relies upon the last fictitious account statement issued by BLMIS. After briefing and argument, the Bankruptcy Court approved the use of the Net Investment Method. On direct appeal, the Second Circuit determined that the Net Investment Method was the method more consistent with the definition of net equity and with the legislative intent under SIPA to treat customers equally. In re Bernard L. Madoff Inv. Sec. LLC, 654 F.3d 229, 235 (2d Cir. 2011) ( Net Equity Decision ), cert. dismissed, U.S., 132 S. Ct (2012), and cert. denied, 567 U.S. 934 (2012). In contrast, the use of the Last Statement Method would yield inequitable treatment among customers and have the absurd effect of treating fictitious and arbitrarily assigned paper profits as real. Id.; see also Sagor v. Picard (In re Bernard L. Madoff Inv. Sec., LLC), Case No , 2017 WL (2d Cir. June 1, 2017). IV. The Movants Claims Saren-Lawrence filed a customer claim with the Trustee seeking the value of her account as reported on the last fictitious statement. [ECF No. 612, 5.] By Notice of Trustee s Determination of Claim dated October 19, 2009, the Trustee denied Saren-Lawrence s claim because no securities were purchased for her account, and she had withdrawn more from her account than she had deposited. [Id., Ex. A.] Thus, Saren-Lawrence had a negative net equity and was a net winner who had received other investors money. On November 4, 2009, Saren- 6

13 Case 1:17-cv GBD Document 14 Filed 11/01/17 Page 13 of 23 Lawrence filed her objection to the Trustee s determination. [Id.] Saren-Lawrence s objection is pending for review by the Bankruptcy Court. Nelson filed customer claims with the Trustee seeking the value of two accounts as reported on the last fictitious statements. [ECF No. 646, 4; ECF No. 648, 5.] By Notices of Trustee s Determination of Claim dated October 19, 2009, the Trustee denied Nelson s claims because no securities were purchased for her accounts, and she had withdrawn more from her accounts than she had deposited. [ECF No. 646, Ex. A; ECF No. 648, Ex. A.] Thus, Nelson had a negative net equity and was a net winner who had received other investors money. On November 6, 2009, Nelson filed her objections to the Trustee s determination. [ECF No. 646; ECF No. 648.] Nelson s objections are pending for review by the Bankruptcy Court. The Nelsons filed customer claims with the Trustee seeking the value of their account as reported on the last fictitious statement. [ECF No. 647, 5.] By Notice of Trustee s Determination of Claim dated October 19, 2009, the Trustee denied the Nelsons claims because no securities were purchased for their account, and they had withdrawn more from their account than they had deposited. [Id., Ex. A.] Thus, the Nelsons had a negative net equity and were net winners who had received other investors money. On November 6, 2009, the Nelsons filed their objection to the Trustee s determination. [Id.] The Nelsons objection is pending for review by the Bankruptcy Court. V. The Avoidance Actions As noted by the Second Circuit, customers share ratably in customer property on the basis of their net equity, [SIPA] 78fff-2(c)(1)(B);... [and] the main purpose of determining net equity is to achieve a fair allocation of the available resources among the customers. Net Equity Decision, 654 F.3d at 240. In the BLMIS Ponzi scheme, however, where no securities 7

14 Case 1:17-cv GBD Document 14 Filed 11/01/17 Page 14 of 23 were purchased, customer property consists solely of deposited cash. While some investors, such as the Movants, won by withdrawing more cash than they deposited, many investors lost, having deposited more than they withdrew, only to see the Movants and other net winners end up with the net losers cash. Under SIPA section 78fff-2(c)(3), when customer property is insufficient to satisfy customer claims, the Trustee is empowered to recover transfers voidable under the Bankruptcy Code that would have been customer property but for a fraudulent conveyance. Such recoveries become customer property for pro rata distribution to all customers with allowed claims. See SIPA 78fff-2(c)(1)(B), 78fff-2(c)(3). The concept of customer property in SIPA section 78lll(4) is expansive and includes property unlawfully converted; it is designed to ensure that the pool of customer property is funded for priority distribution to customers. See SIPA 78lll(4); Ferris, Baker Watts, Inc. v. Stephenson (In re MJK Clearing, Inc.,), 286 B.R. 109, (Bankr. D. Minn. 2002), aff d, 2003 WL (D. Minn. Apr. 07, 2003), aff d, 371 F.3d 397 (8th Cir. 2004). Under Section 548(a)(1) of the Bankruptcy Code, the Trustee may avoid an actually fraudulent transfer that was made within two years of the filing date. 11 U.S.C. 548(a)(1). Given that BLMIS was operating as a Ponzi scheme, all transfers made in furtherance of that Ponzi scheme are presumed to have been made with fraudulent intent. Sec. Inv r Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, 531 B.R. 439, 471 (Bankr. S.D.N.Y. 2015). Once voidability of a fraudulent transfer made within the Two-Year Period has been determined under Section 548(a)(1), however, the transferee may, under Section 548(c), retain a voidable fraudulent transfer to the extent that the transferee took the transfer for value and in good faith. 11 U.S.C. 548(c). Where a transferee received fraudulent transfers in good faith, the sole question becomes whether the transferee provided value in exchange for the fraudulent 8

15 Case 1:17-cv GBD Document 14 Filed 11/01/17 Page 15 of 23 transfers. In addressing the question of value, this Court held that transfers from Madoff Securities to defendants that exceeded the return of defendants principal, i.e., that constituted profits, were not for value. Sec. Inv r Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, 476 B.R. 715, 725 (S.D.N.Y. 2012) ( Greiff ), supplemented (May 15, 2012), aff d sub nom. In re Bernard L. Madoff Inv. Sec. LLC, 773 F.3d 411 (2d Cir. 2014). Thus, transfers made by Madoff Securities to its customers in excess of the customers principal that is, the customers profits [] were in excess of the extent to which the customers gave value, and hence, if adequately proven, may be recovered regardless of the customers good faith. Picard v. Katz, 462 B.R. 447, 453 (S.D.N.Y. 2011), abrogated on other grounds by Sec. Inv r Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, 513 B.R. 437 (S.D.N.Y. 2014). To determine the value provided by a transferee to BLMIS, the Trustee applied the Net Investment Method. The Trustee s approach to valuation under Section 548(c) was approved by this Court, which explicitly defined how the Net Investment Method applied to the calculation of the amounts recoverable by the Trustee in this liquidation: As for the calculation of how much the Trustee may recover under these claims, the Court adopts the two-step approach set forth in Donell v. Kowell, 533 F.3d 762, (9th Cir. 2008). First, amounts transferred by Madoff Securities to a given defendant at any time are netted against the amounts invested by that defendant in Madoff Securities at any time. Second, if the amount transferred to the defendant exceeds the amount invested, the Trustee may recover these net profits from that defendant to the extent that such monies were transferred to that defendant in the two years prior to Madoff Securities filing for bankruptcy. Any net profits in excess of the amount transferred during the two-year period are protected from recovery by the Bankruptcy Code s statute of limitations. See 11 U.S.C. 548(a)(1). Greiff, 476 B.R. at 729. When the Trustee s use of the Net Investment Method to calculate a good faith transferee s liability was again questioned by defendants, this Court recognized that under the Trustee s position, a customer s net equity and the amounts sought in avoidance and recovery 9

16 Case 1:17-cv GBD Document 14 Filed 11/01/17 Page 16 of 23 proceedings (assuming the customer s good faith) are two sides of the same coin. Sec. Inv r Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, 499 B.R. 416, 420 (S.D.N.Y. 2013) ( Antecedent Debt Decision ), certification for interlocutory appeal denied, 987 F. Supp. 2d 309 (S.D.N.Y. 2003). In reaffirming the Trustee s calculations, the Court highlighted the harmony between the net equity calculation for the determination of claims and the calculation for determining a transferee s liability for receipt of false profits: Id. at 428. SIPA mandates the equitable treatment of all customers, which the Net Investment Method supports, as SIPA prioritizes the pro rata distribution of customer property on the basis and to the extent of their respective net equities. 15 U.S.C. 78fff-2(c); see also Greiff, 476 B.R. at 727 ( SIPA specifically connects its priority system to its incorporation of the fraudulent transfer provisions... ). Indeed, this approach harmonizes the avoidance and recovery scheme with the Second Circuit s decision upholding the Trustee s net-equity calculation, even if the issue of the scope of the Trustee s avoidance power was not explicitly before the Second Circuit in that case. See In re Bernard L. Madoff Inv. Sec. LLC, 654 F.3d at 242 n. 10 ( [I]n the context of this Ponzi scheme[, ]the Net Investment Method is nonetheless more harmonious with provisions of the Bankruptcy Code that allow a trustee to avoid transfers made with the intent to defraud, and avoids placing some claims unfairly ahead of others. (internal quotation marks, brackets, and citations omitted)). For all of these reasons, the Court finds that the Net Investment Method is the better approach, The present Avoidance Actions seek to avoid and recover actually fraudulent transfers made to the Movants in the two years prior to the filing date in excess of the value the Movants provided to the Debtor, pursuant to Bankruptcy Code sections 548(a)(1)(A) and 550(a) and SIPA section 78fff-2(c)(3). The Trustee s calculation of value and thus the Movants liability utilizes the same Net Investment Method and same legal theories which the Trustee used to deny the Movants claims and which is currently being challenged by the Movants. The Trustee seeks to recover two-year transfers of at least $261,000 from Saren-Lawrence, at least $2,610,000 from the Nelsons, and at least $455,077 from Nelson. Because of the Ponzi scheme, these so-called profits received by Movants, representing amounts received in excess of the amounts the 10

17 Case 1:17-cv GBD Document 14 Filed 11/01/17 Page 17 of 23 Movants deposited, were not generated through investment but, in reality, were other customers stolen funds. These fake profits are therefore customer property appropriate for recovery and pro rata distribution to all customers in accordance with the principles of net equity under SIPA. ARGUMENT Under SIPA and the law of the case, the determination of the Movants claims must be reviewed by the Bankruptcy Court. Having filed claims and sought review by the Bankruptcy Court, the Movants have submitted themselves to the jurisdiction of that Court. The Avoidance Actions must now be considered along with the claims as part of reorganizing the debtor-creditor relationships. Importantly, in this SIPA liquidation, the Avoidance Actions are the other side of the net equity coin which is central to the Movants claims. Furthermore, any determination of the Movants claims requires a determination of whether they must return any fraudulent conveyances received from BLMIS. 11 U.S.C 502(d). Accordingly, the Movants have submitted themselves to the jurisdiction of the Bankruptcy Court, and no basis exists for withdrawal. VI. THE STANDARD FOR WITHDRAWAL OF THE REFERENCE Section 157(d) of U.S. Code Title 28 permits a district court to withdraw the reference [o]n timely motion of any party, for cause shown. 28 U.S.C. 157(d). Courts in this jurisdiction consider a number of factors in determining whether cause for a discretionary withdrawal of the reference exists. The Second Circuit, however, has emphasized that the threshold question is whether a claim is core or non-core. See Orion Pictures Corp. v. Showtime Networks, Inc. (In re Orion Pictures Corp.), 4 F.3d 1095, (2d Cir. 1993), cert. dismissed, 511 U.S (1994) ( Orion Pictures Corp. ). In fact, determination of this question has a profound impact on the relevance of many of the factors often considered in connection 11

18 Case 1:17-cv GBD Document 14 Filed 11/01/17 Page 18 of 23 with a motion for discretionary withdrawal, including, importantly, whether judicial efficiency is best served by withdrawal of the reference. See, e.g., Orion Pictures Corp., 4 F.3d at 1101 (explaining that questions of efficiency and uniformity will turn on whether a claim is core or non-core). VII. THE MOVANTS SUBMITTED TO THE JURISDICTION OF THE BANKRUPTCY COURT BY FILING A PROOF OF CLAIM A. The Determination of the Avoidance Actions Is Intergral to the Determination of the Movants Claims and Restructuring the Debtor-Creditor Relationship The Supreme Court, as well as the Court of Appeals for the Second Circuit, has made clear that filing a claim may submit a party to the bankruptcy court s equitable jurisdiction for determination of that claim and related issues. See Stern v. Marshall, 564 U.S. 462, (2011) (examining whether adjudication of the creditor s proof of claim would necessarily resolve the debtor s counterclaim); Langenkamp v. Culp, 498 U.S. 42, 45 (1990) (per curiam) ( Respondents filed claims against the bankruptcy estate, thereby bringing themselves within the equitable jurisdiction of the Bankruptcy Court. ); Bankr. Serv., Inc. v. Ernst & Young (In re CBI Holding Co.), 529 F.3d 432, 466 (2d Cir. 2008) ( CBI Holding ). In Stern v. Marshall, the Court drew a distinction between actions filed against creditors and those filed against non-creditors, as the action filed against creditors become[s] integral to the restructuring of the debtor-creditor relationship if the action is resolvable by a ruling on the proof of claim. Stern, 564 U.S. at 497 (quoting Langenkamp, 498 U.S. at 44). Claims which adjust the debtor-creditor relationship are core claims. See U.S. Lines, Inc. v. Am. S.S. Owners Mut. Prot. & Indem. Ass n. (In re U. S. Lines, Inc.), 197 F.3d 631, 637 (2d Cir. 1999), cert. denied, 529 U.S (2000). In a holding directly on point, the Supreme Court in Langenkamp stated that a creditor s right to a jury trial on a bankruptcy trustee s preference claim depends upon whether the creditor has submitted a claim against the estate. Respondents filed claims against the bankruptcy estate, thereby bringing 12

19 Case 1:17-cv GBD Document 14 Filed 11/01/17 Page 19 of 23 themselves within the equitable jurisdiction of the Bankruptcy Court. Consequently, they were not entitled to a jury trial on the trustee s preference action. Langenkamp, 498 U.S. at 45 (quoting Granfinanciera v. Norberg, 492 U.S. 33, 58 (1989). In other words, once a proof of claim is filed, the trustee s claims that pertain to the proof of claim, such as an avoidance action, may be determined by a bankruptcy judge. Relying on Langenkamp, the Second Circuit elaborated, If the bankruptcy trustee responds by filing its own claim against the creditor that would eliminate the basis for the creditor s claim, those two claims become integral to the restructuring of the debtor-creditor relationship through the bankruptcy court s equity jurisdiction. As such, there is no Seventh Amendment right to jury trial. CBI Holding, 529 F.3d at 466. There, the claimant filed a proof of claim and the debtor filed claims in response, and the Second Circuit explained that the debtor s claims are either defenses to [the claimant s] claim or integrally related to those defenses, [and thus] the resolution of the [the debtor s] claims clearly affects the structuring of the debtor-creditor relationship.... Id. at 467. Accordingly, the claimant was not entitled to a jury trial. Although Stern limited the bankruptcy courts constitutional jurisdiction to the adjudication of public rights, it specifically left intact the Court s holding and reasoning in Langenkamp. Stern, 564 U.S. at 497. So too here: by filing a claim in the BLMIS liquidation proceeding, the Movants submitted to the jurisdiction of the Bankruptcy Court for determination of the Avoidance Actions and cannot now argue that the Bankruptcy Court should not have equitable jurisdiction over it. See, e.g., First Fid. Bank N.A., N.J. v. Hooker Invs. Inc. (In re Hooker Invs., Inc.), 937 F.2d 833, 838 (2d Cir. 1991). The Movants, however, do not even recognize the established law that filing a proof of claim submits a claimant to the jurisdiction of the bankruptcy court. See, e.g., Granfinanciera, 492 U.S. at 58 (1989) (holding that by filing a proof of claim, a creditor submits himself to the equitable jurisdiction of the bankruptcy court). Here, the Avoidance Actions are 13

20 Case 1:17-cv GBD Document 14 Filed 11/01/17 Page 20 of 23 garden variety fraudulent transfer actions derived from the Bankruptcy Code that must be litigated in order to determine the Movants proof of claims. The Movants claims are for their net equity and their share of customer property. The Trustee s claims are for the customer property that the Movants received in excess of their net equity. Any determination by the Bankruptcy Court of the Movants claims would necessarily impact the Trustee s claims. As such, the Movants filing of claims brings them clearly within the jurisdiction of the Bankruptcy Court. B. Bankruptcy Code Section 502(d) Requires the Bankruptcy Court to Determine the Avoidance Actions Before Allowing the Movants Claims Even if the determination of the Movants claims and the adjudication of the Avoidance Actions are not perfectly matched as two sides of the same coin, the Movants submission of claims means that, under Bankruptcy Code section 502(d), the Bankruptcy Court must first determine any avoidance claims brought by the Trustee before a customer claim can be satisfied. Bankruptcy Code section 502(d) provides that the court shall disallow any claim of any entity from which property is recoverable under section of this title or that is a transferee of a transfer avoidable under section of this title, unless such entity or transferee has paid the amount, or turned over any such property, for which such entity or transferee is liable. 11 U.S.C. 502(d) (emphasis added). As this Court explained, fundamentally, section 502(d) functions as an ordering provision. Its fundamental logic is that the estate should receive the property due to it before a liable creditor of the estate may obtain payment on its own claims. Sec. Inv r Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, 513 B.R. 437, 444 (S.D.N.Y. 2014). Accordingly, before a claim may be allowed, a court must resolve any preference issues that the trustee might raise. Germain v. Connecticut Nat. Bank, 988 F.2d 1323, 1327 (2d Cir. 1993). If the Trustee s determinations of the Movants claims are overturned by the Bankruptcy 14

21 Case 1:17-cv GBD Document 14 Filed 11/01/17 Page 21 of 23 Court, the Bankruptcy Court must nevertheless disallow those claims under section 502(d) until it can adjudicate the Avoidance Actions. As this Court held, where the Trustee has sought to disallow a claim under 502(d), the Bankruptcy Court will have to determine whether the claimant has received a transfer avoidable under section [or] 548. Sec. Inv r Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, 490 B.R. 46, 54 (S.D.N.Y. 2013); see also Katchen v. Landy, 382 U.S. 323, (1966) (holding that, under the statutory predecessor of 502(d), the bankruptcy referee may exercise summary jurisdiction over a voidable preference claim against a creditor whose claim may be disallowed because of the preference). Even in post-stern jurisprudence, courts are clear that where a defendant in an adversary proceeding has filed a claim in a related liquidation, the bankruptcy court has authority to adjudicate the adversary proceeding in the course of disallowing the claim under Section 502(d), and the defendant has waived its right to a jury trial. See, e.g., Davis v. R.A. Brooks Trucking Co., Inc. (In re Quebecor World (USA), Inc.), 491 B.R. 379, 384 (Bankr. S.D.N.Y. 2013) ( The Plaintiff s claims would necessarily be resolved in ruling on the Defendant s proof of claim as a result of Section 502(d) of the Bankruptcy Code.... Accordingly, the Court has the constitutional authority to issue a final judgment in this action. ); Solution Trust v Grand LLC (In re AWTR Liquidation Inc.), 547 B.R. 831, 838 (Bankr. C.D. Cal. 2016) ( Therefore, this Bankruptcy Court has the authority to issue final judgments or orders on the plaintiff s avoidance claims against the Primary Directors and RHM because, by virtue of 502(d), the plaintiffs claims would necessarily be resolved in the claims allowance process. (emphasis in original) (quoting Stern, 564 U.S. at 498)); Mason v. Ivey, 498 B.R. 540, 549 (M.D.N.C. 2013) ( The court concludes, therefore, that when a proof of claim has been filed in a bankruptcy case to which, as here, the trustee objects, a trustee s fraudulent transfer claims necessarily must be 15

22 Case 1:17-cv GBD Document 14 Filed 11/01/17 Page 22 of 23 resolved in the claims allowance process.... The filing of a proof of claim has historically transformed a matter ordinarily legal in nature (to which the Seventh Amendment may provide a right to a jury trial) to one equitable in nature, that is, the allowance or disallowance of a claim. ); Burns v. Dennis (In re Se. Materials, Inc.), 467 B.R. 337, 350 (Bankr. M.D.N.C. 2012) ( [T]here has been no dispute that a bankruptcy court must disallow any claim of any entity from which property is recoverable because of a preferential transfer or fraudulent conveyance. 11 U.S.C. 502(d). Such actions are core proceedings in which a bankruptcy court may enter a final order. ); U.S. Bank Nat. Ass n v. Verizon Commc ns Inc., No. 3:10-CV-1842-G, 2012 WL , at *3 (N.D. Tex. Mar. 21, 2012) ( Therefore, Section 502(d) makes the resolution of the preference or fraudulent transfer issue integral to the claims allowance process. In those circumstances, the right to a jury trial is extinguished for both parties. ), aff d, 761 F.3d 409 (5th Cir. 2014), as revised (Sept. 2, 2014), cert. denied, U.S., 135 S Ct (2015). Finally, bifurcating the determination of what the debtor owes the claimant and what the claimant owes the debtor, which effectively is the outcome if the Motions are granted and the District Court determines the Avoidance Actions while the Bankruptcy Court determines the claims, bifurcates a core proceeding, creating duplication, wasting time and judicial resources, and undermining the order imposed by Bankruptcy Code section 502(d). The determination of what the Debtor owes the Movants is clearly within the purview and expertise of the Bankruptcy Court. No less so is the determination of what the Movants owe the Debtor on the basis of the same issues and transactions. As the Second Circuit observed in a prior SIPA liquidation: This is the kind of business for which bankruptcy judges have developed special expertness and administrative skills and which Congress did not intend to dump on already overburdened district courts without needed clerical and other facilities. Wyatt, 517 F.2d at

23 Case 1:17-cv GBD Document 14 Filed 11/01/17 Page 23 of 23 CONCLUSION For all of the aforementioned reasons, the Motions should be denied, and the Avoidance Actions should remain with the Bankruptcy Court for adjudication. Dated: Washington, D.C. November 1, 2017 Respectfully submitted, JOSEPHINE WANG General Counsel KEVIN H. BELL Senior Associate General Counsel for Dispute Resolution s/ Nathanael S. Kelley NATHANAEL S. KELLEY Assistant General Counsel SECURITIES INVESTOR PROTECTION CORPORATION 1667 K St., NW, Suite 1000 Washington, D.C Telephone: (202) jwang@sipc.org kbell@sipc.org nkelley@sipc.org 17