Securities Investor Protection Corporation v. Bernard L. Madoff Investment Securities, LLC. et a

UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF NEW YORK
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SECURITIES INVESTOR PROTECTION 	:
CORPORATION, 	: 	Adv. Proc. No. 08-01789 (SMB)
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Plaintiff, 	: 	SIPA LIQUIDATION
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v. 	: 	(Substantively Consolidated)
:
BERNARD L. MADOFF INVESTMENT 	:
SECURITIES LLC, 	:
:
Defendant. 	:
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In re: 	:
:
BERNARD L. MADOFF, 	:
:
Debtor. 	:
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MEMORANDUM DECISION AND ORDER GRANTING MOTION
OF DIANA MELTON TRUST FOR RECONSIDERATION OF THE
DISALLOWANCE OF ITS CUSTOMER CLAIM AND ADHERING
TO THE COURT’S PREVIOUS DECISION AND ORDER
A P P E A R A N C E S:
BAKER & HOSTETLER LLP
45 Rockefeller Plaza
New York, NY 10111
David J. Sheehan, Esq.
Nicholas J. Cremona, Esq.
Jorian L. Rose, Esq.
Amy E. Vanderwal, Esq.
Jason I. Blanchard, Esq.
Of Counsel
Attorneys for Irving H. Picard, Trustee
for the Liquidation of Bernard L. Madoff
Investment Securities LLC
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DIANA MELTON TRUST
By Alan R. Melton, M.D. and Andrew Melton
Pro se
STUART M. BERNSTEIN
United States Bankruptcy Judge:
The Diana Melton Trust (the “Diana Trust”), by its sole trustees and beneficiaries,
Dr. Alan Melton and Andrew Melton (together, the “Meltons”), has moved (the
“Motion”) to vacate and reconsider the Order Granting Trustee’s Thirtieth Omnibus
Motion to Disallow Claims and Overrule Objections of Claimants Who Have No Net
Equity, dated Apr. 30, 2019 (“Disallowance Order”) (ECF Doc. # 18708) to the extent it
disallowed the Diana Trust’s customer claim. The Motion is opposed by Irving H.
Picard (the “Trustee”), the trustee for the liquidation of Bernard L. Madoff Investment
Securities LLC (“BLMIS”) under the Securities Investor Protection Act, 15 U.S.C. §§
78aaa, et seq. (“SIPA”).
For the reasons set forth below, the Court grants the Motion to the extent of
reconsidering the disallowance of the Diana Trust’s customer claim, and upon
reconsideration, adheres to the Disallowance Order.
BACKGROUND
A. 	Madoff’s Ponzi Scheme
Bernard L. Madoff operated the largest Ponzi scheme in history from the
investment advisory side of BLMIS satisfying customer withdrawal requests with earlier
deposits made by other customers. See SIPC v. BLMIS (In re BLMIS), 424 B.R. 122,
125-32 (Bankr. S.D.N.Y. 2010), aff’d, 654 F.3d 229 (2d Cir. 2011), cert. denied, 567 U.S.
934 (2012); Picard v. Legacy Capital Ltd. (In re BLMIS), Adv. Proc. No. 10-05286
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(SMB), 2019 WL 2593008, at *4-7 (Bankr. S.D.N.Y. June 25, 2019) (“Legacy”). On
December 11, 2008 (the “Filing Date”), Madoff was arrested for securities fraud and the
Securities and Exchange Commission (“SEC”) commenced an action against Madoff and
BLMIS alleging violations of the Investment Advisors Act of 1940, the Securities Act of
1933 and the Securities Exchange Act of 1934. Legacy, 2019 WL 2593008, at *1. The
Securities Investor Protection Corporation (“SIPC”) also filed an application for a
protective decree pursuant to SIPA § 78eee(a)(3) maintaining that BLMIS was unable to
meet its obligations to its customers and the customers needed the protections afforded
by SIPA. Id. The District Court granted SIPC’s application, appointed the Trustee and
his counsel pursuant to SIPA § 78eee(b)(3), and removed the SIPA proceeding to this
Court pursuant to SIPA § 78eee(b)(4). Id.
B. 	The Diana Trust BLMIS Account
The Diana Trust held BLMIS Account No. 1ZA699 (the “Account”). The Account
was formerly held in the name of the Ernest Melton Trust (the “Ernest Trust”).
(Declaration of Vineet Sehgal in Support of the Trustee’s Reply to the Objection of Dr.
Alan Melton to the Thirtieth Omnibus Motion to Disallow Claims and Overrule
Objections of Claimants Who Have No Net Equity, dated April 18, 2019 (“Sehgal Reply
Declaration”) at ¶ 6 (ECF Doc. # 18671).) A total of $320,000.00 in cash was deposited
in the Account while it was held in the name of the Ernest Trust. (See Sehgal Reply
Declaration, Ex. 2.) On September 4, 2007, Ernest Melton, Alan Melton, and Andrew
Melton faxed a letter (the “September 2007 Letter”) 1 to BLMIS officer Frank DiPascali
1 	A copy of the September 2007 Letter is attached to the Sehgal Reply Declaration as Exhibit 4.
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asking BLMIS to change the Account’s name and tax identification number (“TIN”)
from the Ernest Trust to the Diana Trust. According to the monthly statement
generated by BLMIS, the balance in the Account at the end of September 2007 was
$1,046,460.00. (Sehgal Reply Declaration, Ex. 7.) In fact, the cash withdrawals from
the Account by the Ernest Trust already exceeded the cash deposits by $345,000.00 and
the “balance” reflected on the monthly statement consisted entirely of entries made up
by Madoff and his staff and were entirely fictitious.
BLMIS complied with the request, changing the name of owner of the Account to
the Diana Trust and using the new TIN supplied by the trustees. No additional funds
were ever deposited into the Account after it was renamed, and by the Filing Date, the
Diana Trust had withdrawn an additional $62,500.00 from the Account. Thus,
withdrawals from the Account ultimately exceeded deposits by $407,500. (Sehgal
Reply Declaration, Ex. 2.)
C. 	The Claim Dispute
After the commencement of the BLMIS SIPA liquidation, and in accordance with
the Order on Application for an Entry of an Order Approving Form and Manner of
Publication and Mailing of Notices, Specifying Procedures for Filing, Determination,
and Adjudication of Claims; and Providing Other Relief, dated Dec. 23, 2008 (ECF
Doc. # 12), the Diana Trust filed a customer claim (the “Customer Claim”) in the amount
of $1,120,005.21 – the amount reflected on the Account’s final BLMIS monthly
statement sent prior to Madoff’s arrest. 2 On October 19, 2009, the Trustee sent a notice
2 	A copy of the Customer Claim is attached to the Sehgal Reply Declaration as Exhibit 1. The last
monthly statement, on which it was based, is attached to the Customer Claim.
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denying the Customer Claim (the “Trustee Determination”) 3 because no securities were
ever purchased for the Account and amounts withdrawn from the Account were greater
than the amounts deposited leaving the Account with negative net equity. (Trustee
Determination at MWPTAP01018738-41.)
Two months later, the Diana Trust, through its counsel, objected to the Trustee
Determination (the “Objection to Determination”). 4 Counsel argued, inter alia, that its
net equity should reflect the amount listed on the Account’s final customer statement
(Objection to Determination at ¶¶ 9, 11), the Diana Trust was entitled to interest on its
deposits under state law (id. at ¶ 12), at least some of the gains were not fictitious to the
extent BLMIS engaged in actual trades for the Account (id. at ¶ 14), the Diana Trust
should get an offset for the taxes paid based on fictitious gains (id. at ¶ 15), and the
Trustee’s net equity calculation did not give sufficient credit to an inter-account transfer
from one or more predecessor accounts. (Id. at ¶ 16.)
The legal issues raised by the Diana Trust were resolved through subsequent
litigation.5 First, the Second Circuit upheld the Trustee’s methodology for computing a
customer’s net equity claim. Under that approach, the Trustee ignored the last BLMIS
customer statements and all fictitious profits and calculated net equity by netting
deposits against withdrawals (the “Net Investment Method”). In re BLMIS, 654 F.3d
229, 233-35 (2d Cir. 2011) (“Net Equity Decision”), cert. denied, 567 U.S. 934 (2012). If
3 	A copy of the Trustee Determination is attached to the Sehgal Reply Declaration as Exhibit 2.
4 	A copy of the Objection to Determination is attached to the Sehgal Reply Declaration as Exhibit
3.
5 	The Diana Trust has not argued or offered proof that BLMIS engaged in actual trades for the
Account.
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a customer withdrew more from his BLMIS account than he deposited into that account,
he was a net winner and did not have a net equity claim.
Second, the Second Circuit ruled that the same methodology applied to inter-
account transfers between BLMIS accounts. Under the Inter-Account Method, the
transferee account did not receive credit for any amounts supposedly transferred in
excess of the transferor account’s net equity as computed under the Net Investment
Method. Sagor v. Picard (In re BLMIS), 697 F. App’x 708, 711 (2d Cir. 2017) (summary
order). Hence, if the transferor account was a net winner with zero net equity at the
time of the transfer, the transferee account did not receive any credit.
Third, the Second Circuit rejected the contention that a net equity claim must
account for inflation or interest, SIPC v. 2427 Parent Corp. (In re BLMIS), 779 F.3d 74,
79-81, 83 (2d Cir.), cert. denied, 136 S. Ct. 218 (2015), and this Court rejected the
argument that net equity should take into consideration the taxes paid by the customer.
SIPC v. BLMIS (In re BLMIS), 522 B.R. 41, 54 n. 9 (Bankr. S.D.N.Y. 2014), aff’d, 15 Civ.
1151 (PAE), 2016 WL 183492 (S.D.N.Y. Jan. 14, 2016), aff’d, 697 F. App’x 708 (2d Cir.
2017) (summary order); cf. Donell v. Kowell, 533 F.3d 762, 779 (9th Cir.) (rejecting an
offset for taxes paid by defendant on fictitious gains received from Ponzi scheme in
fraudulent transfer action), cert. denied, 555 U.S. 1047 (2008); Picard v. Estate of Igoin
(In re BLMIS), 525 B.R. 871, 893 (Bankr. S.D.N.Y. 2015) (“the withdrawal of the money
to pay taxes the Defendants never should have had to pay is not a defense to the
fraudulent transfer claims”).
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On March 14, 2019, the Trustee moved to disallow seven customer claims,
including the Customer Claim. Relying on the precedent just discussed, he argued in
substance that these customers were net winners and their BLMIS accounts had either a
negative or zero net equity. (Trustee’s Thirtieth Omnibus Motion to Disallow Claims
and Overrule Objections of Claimants Who Have No Net Equity, dated Mar. 14, 2019
(ECF Doc. # 18552).)
Up to this point, the Diana Trust had been represented by counsel. The Meltons,
however, now undertook the representation of the Diana Trust. 6 They submitted
numerous emails arguing that the Customer Claim should be allowed but failed to
appear on the return date of the Trustee’s motion. The Court ruled that the Diana Trust
was a net winner, granted the motion and entered the Disallowance Order.
D. 	The Motion to Vacate
Within hours of the entry of the Disallowance Order, the Meltons emailed the
Court asking that the Customer Claim not be disallowed and reiterating the arguments
made in their prior emails. In addition, the Meltons claimed that they had not received
notice of the hearing. (See ECF Doc. # 18709.)7 By Memorandum Endorsement and
6 	As a rule, a non-lawyer cannot represent a trust, which is a separate legal person. See 28 U.S.C. §
1654 (“In all courts of the United States the parties may plead and conduct their own cases personally or
by counsel as, by the rules of such courts, respectively, are permitted to manage and conduct causes
therein.”); Guest v. Hansen, 603 F.3d 15, 20 (2d Cir. 2010); Lattanzio v. COMTA, 481 F.3d 137, 139 (2d
Cir. 2007). Notwithstanding the general rule, a non-lawyer administrator and sole beneficiary of an estate
that has no creditors may represent that estate because he is the only affected party and is entitled to the
right of self-representation. Guest, 603 F.3d at 21. In advance of the hearing, the Meltons certified that
they were the only trustees and beneficiaries of the Diana Trust and the Diana Trust had no creditors.
Accordingly, the Court has allowed the Meltons to represent the Diana Trust in this matter.
7 	The Affidavit of Mailing, signed on March 15, 2019 (ECF Doc. # 18584) stated that notice of
hearing for the Trustee’s motion was served on Kachroo Legal Services, P.C. who served as counsel to the
Diana Trust. (See Notice of Appearance, dated Dec. 17, 2013 (ECF Doc. # 5609).) Kachroo Legal
Services, P.C. withdrew as counsel to the Diana Trust a week before the hearing on the Motion. (Order
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Order, dated April 30, 2019 (ECF Doc. # 18710), the Court ruled that it would treat the
Meltons’ latest email as a motion to vacate the Disallowance Order and scheduled a
hearing on the Motion.
DISCUSSION
Section 502(j) of the Bankruptcy Code 8 allows the Court to reconsider the
allowance or disallowance of a claim “for cause.” If reconsideration is granted, the Court
may allow or disallow the claim “according to the equities of the case.” 11 U.S.C. §
502(j). Motions made under section 502(j) within fourteen days of the order
disallowing the claim are governed by Rule 9023 of the Federal Rules of Bankruptcy
Procedure (which incorporates Rule 59 of the Federal Rules of Civil Procedure).
Davidson v. AMR Corp. (In re AMR Corp.), 566 B.R. 657, 665 (S.D.N.Y. 2017); Rozier v.
Rescap Borrower Claims Tr. (In re Residential Capital, LLC), No. 15 Civ. 3248 (KPF),
2016 WL 796860, at *15 (S.D.N.Y. Feb. 22, 2016). “To prevail on a motion under Rule
9023, the movant must show that the court overlooked controlling decisions of factual
matters that might materially have influenced its earlier decision, and the motion is
granted only when the movant identifies an intervening change of controlling law, the
availability of new evidence, or the need to correct a clear error or prevent manifest
Granting Motion to Withdraw Gaytri D. Kachroo and Kachroo Legal Services, P.C. as an Attorney or as
Attorneys of Record Pursuant to Local Bankruptcy Rule 2090-1(e), dated June 19, 2019 (ECF Doc. #
18821).)
8 	Chapters 1, 3, and 5 and subchapters I and II of chapter 7 of the Bankruptcy Code apply in SIPA
liquidation proceedings to the extent consistent with SIPA, SIPA § 78fff(b), and a claim in a SIPA
proceeding is the “functional equivalent” of a proof of claim in a bankruptcy case. SIPC v. BLMIS (In re
BLMIS), 513 B.R. 437, 443 (S.D.N.Y. 2014).
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injustice.” AMR, 560 B.R. at 666 (citations, internal quotation marks, and alteration
omitted).
The nub of the Diana Trust’s argument is that when the Ernest Trust trustees
wrote to BLMIS to change the name on the Account and use a new TIN, BLMIS was
legally required to withdraw the approximate $1 million in cash that purported to be the
balance in the Ernest Trust Account and redeposit that approximate $1 million in cash
in the Diana Trust Account even though they were the same account. The Diana Trust
argues that if this had been done, the it would have received a cash deposit of
approximately $1 million entitled to full credit under the Net Investment Method.
Because the Meltons’ theory became clear at the argument on the Motion, I will
reconsider the disallowance in light of that argument but will dispense with any further
argument as it would not assist the Court in deciding the ultimate question of allowance.
Upon reconsideration, I adhere to my prior ruling that the Customer Claim
cannot be allowed. First, BLMIS did exactly what the trustees of the Ernest Trust asked
BLMIS to do in the September 2007 Letter. It changed the name on the Account and
used the new TIN. The Account number remained the same and was listed on the Diana
Trust’s monthly customer statements. The Diana Trust has not pointed to any legal
authority, such as a statute or regulation, to support its underlying contention that
BLMIS was required as a matter of law to withdraw cash from and then redeposit cash
in the Account. They have alluded to conversations with representatives at Vanguard
and Fidelity, (June 26, 2019 Hr’g Tr. at 6:15-17 (ECF Doc. # 18863)), but these
statements are hearsay and, in any event, are inadmissible to prove the law.
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Second, even if BLMIS had withdrawn the cash from the Ernest Trust and
redeposited the same cash into the renamed Account, the Diana Trust and its
transferees would be subject to substantial liability and the Customer Claim would still
have to be disallowed as a matter of law. BLMIS operated as a Ponzi scheme, and any
fictitious profits withdrawn from the Account within two years of the Filing Date
constituted intentional fraudulent transfers. Legacy, 2019 WL 2593008, at *2-7. As
noted, the Ernest Trust was already overdrawn by $345,000.00 in September 2007 and
the cash withdrawal of an additional $1,046,460.00 that the Diana Trust argues it
should have received would have consisted entirely of fictitious profits. Under those
circumstances, the Diana Trust would be liable to the SIPA estate for more than $1
million and the Customer Claim would be automatically disallowed under 11 U.S.C. §
502(d) unless and until the Diana Trust repaid those sums to the SIPA estate. 9
The Court sympathizes with the Meltons and the personal tragedies that Madoff’s
Ponzi scheme has visited upon them and their families. Nevertheless, the Court must be
guided by the legal principles, discussed above, that govern the allowance of the
Customer Claim. Furthermore, the principles of equitable distribution that animate
bankruptcy law also support the Court’s conclusion. Only $320,000.00 was ever
deposited into the Account while a total of $727,500.00 was withdrawn during its
9 	Section 502(d) states:
Notwithstanding subsections (a) and (b) of this section, the court shall disallow any claim
of any entity from which property is recoverable under section 542, 543, 550, or 553 of
this title or that is a transferee of a transfer avoidable under section 522(f), 522(h), 544,
545, 547, 548, 549, or 724(a) 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
under section 522(i), 542, 543, 550, or 553 of this title.
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sixteen-year existence. In this sense, it was a profitable investment although not as
profitable as the phony BLMIS customer statements indicated. The net losers were not
so lucky.
Moreover, the Customer Claim is based on a myth. The $1,120,005.21 balance
reflected in the Account’s final customer statement is a made-up number consisting
entirely of fictitious profits arbitrarily assigned by Madoff and BLMIS. If the Trustee
pays the Diana Trust $1,120,005.21, those funds must come from money that will
otherwise be used to pay the customer claims of net losers. Though innocent of
Madoff’s fraud, the Diana Trust has no right as a matter of equity to enjoy the fruits of
that fraud at the expense of equally innocent victims who have lost their principal
investments. Cf. Trs. of the Upstate N.Y. Eng’rs Pension Fund v. Ivy Asset Mgmt., 843
F.3d 561, 568 (2d Cir. 2016) (“The loss of an opportunity to lay hands on funds
belonging to others is not a legally cognizable injury. In this case, it is a missed chance
for innocent enjoyment of a fraud. A court of equity ‘will not lend its power to assist or
protect a fraud.’”) (quoting Kitchen v. Rayburn, 86 U.S. 254, 263 (1873)), cert. denied,
137 S. Ct. 2279 (2017).
So ordered.
Dated: 	New York, New York
July 25, 2019
/s/ Stuart M. Bernstein
STUART M. BERNSTEIN
United States Bankruptcy Judge
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