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Madoff Indirect Investors Lose US Court Appeal

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Bernard Madoff in 2009
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People who lost money by investing infunds that invested in Bernard Madoff's Ponzi schemeare not entitled to recover for their losses in the manner thatdirect victims of the massive fraud can recover, a federalappeals court ruled Friday.

The decision by the 2nd U.S. Circuit Court of Appeals in NewYork is a victory for Irving Picard, the trustee liquidatingBernard L Madoff Investment Securities LLC and seeking money forits former customers.

Picard, a partner at Baker & Hostetler, convinced the courtthat "indirect" investors who lost money in the fraud were notMadoff customers who could recover from the bankruptcy estate.

Madoff, 74, is serving a 150-year prison sentence, andPicard had estimated that customers lost $17.3 billion ofprincipal in the fraud.

The appeal was brought by 17 investors who had invested inlimited partnerships known as Spectrum Select. These in turnsent their money to two Rye Select hedge funds overseen byTremont Group Holdings.

Tremont was one of the largest Madoff "feeders," and settledwith Picard for $1.025 billion in July 2011.

Prior to the appeal, two lower court judges had found thatthe 17 indirect investors could not recover from the estatebecause they had not been Madoff customers, unlike the feederfunds that dealt directly with him.

That distinction matters because it is customers, notindirect investors, who may draw up to $500,000 each from a fundoverseen by the Securities Investor Protection, to theextent they cannot recover losses from a bankruptcy estate.

SIPC is a nonprofit created by Congress and funded by thebrokerage industry.

Critical Requirement Not Satisfied

Writing for a three-judge panel, Circuit JudgeReena Raggi said there were several reasons that the indirectinvestors did not qualify as Madoff customers.

She said they had no direct relationship or accounts withhis firm, were not identified in the firm's books and records,had no property interest in the assets sent there by the feederfunds, 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 thebroker-dealer for the purpose of trading securities," Raggiwrote. "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 asimilar request.

The decision does not affect the ability of indirectinvestors to sue the feeder funds, or share in any recovery bythose funds from the SIPC fund.

Friday's decision is the second this week by the 2nd Circuitin a Madoff-related appeal.

On Wednesday, the court refused to let former investorspursue claims against Madoff's brother Peter, as well asMadoff's son Andrew and the estate of his late son, Mark, overthe family members' roles in the fraud.

The court said allowing such claims would impede Picard'seffort to maximize payouts from the estate.

Among the investors who had challenged the trustee was acharitable foundation for New Jersey Sen. Frank Lautenberg.

Separately, Picard on Feb. 13 asked U.S. Bankruptcy JudgeBurton 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 ProtectionCorp et al, 2nd U.S. Circuit Court of Appeals, Nos. 12-410,12-437, 12-483 and 12-529.