In Pari Delicto under New York Law — Adverse Interest Exception and Sole Actor Doctrine — Supreme Court Reversal Drains Alternate Holdings of Precedential Effect Where Effect Is Lack of Subject Matter Jurisdiction
In re Bernard l. Madoff Inv. Secs. LLC, 2013 U.S. App. LEXIS 12551 (2d Cir. June 20, 2013):
Irving Picard ("Picard" or the "Trustee") sues in his capacity as Trustee under the Securities Investor Protection Act ("SIPA") on behalf of victims in the multi-billion-dollar Ponzi scheme worked by Bernard Madoff. The four actions presently before this Court allege that numerous major financial institutions aided and abetted the fraud, collecting steep fees while ignoring blatant warning signs. In summary, the complaints allege that, when the Defendants were confronted with evidence of Madoff's illegitimate scheme, their banking fees gave incentive to look away, or at least caused a failure to perform due diligence that would have revealed the fraud. The Trustee asserts claims for unjust enrichment, breach of fiduciary duty, aiding and abetting fraud, and negligence, among others. The Trustee's position is supported by the Securities Investor Protection Corporation ("SIPC"), a statutorily created nonprofit corporation consisting of registered broker-dealers and members of national securities exchanges, which intervened to recover some or all of the approximately $800 million it advanced to victims.
As we will explain, the doctrine of in pari delicto bars the Trustee (who stands in Madoff's shoes) from asserting claims directly against the Defendants on behalf of the estate for wrongdoing in which Madoff (to say the least) participated. The claim for contribution is likewise unfounded, as SIPA provides no such right. The decisive issue, then, is whether the Trustee has standing to pursue the common law claims on behalf of Madoff's customers. Two thorough well-reasoned opinions by the district courts held that he does not. See Picard v. HSBC Bank PLC, 454 B.R. 25 (S.D.N.Y. 2011) (Rakoff, J.); Picard v. JPMorgan Chase & Co., 460 B.R. 84 (S.D.N.Y. 2011) (McMahon, J.).
Our holding relies on a rooted principle of standing: A party must "assert his own legal rights and interests, and cannot rest his claim to relief on the legal rights or interests of third parties." Warth v. Seldin, 422 U.S. 490, 499 (1975). This prudential limitation has been consistently applied in the bankruptcy context to bar suits brought by trustees on behalf of creditors. See, e.g., Caplin v. Marine Midland Grace Trust Co., 406 U.S. 416 (1972); Shearson Lehman Hutton, Inc. v. Wagoner, 944 F.2d 114, 118 (2d Cir. 1991).
Picard offers two theories for why a SIPA liquidation is a different creature entirely, and why therefore a SIPA trustee enjoys third-party standing: (1) He is acting as a bailee of customer property and therefore can pursue actions on customers' behalf to recover such property; and (2) he is enforcing SIPC's rights of equitable and statutory subrogation to recoup funds advanced to Madoff's customers. Neither is compelling. Although a SIPA liquidation is not a traditional bankruptcy, a 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." 15 U.S.C. § 78fff-1(a). At best, SIPA is silent as to the questions presented here. And analogies to the law of bailment and the law of subrogation are inapt and unconvincing.
Footnote 1. The Defendants also argue that the Trustee has not met constitutional standing requirements, violates the Securities Litigation Uniform Standards Act, and fails to plead with particularity SIPC's purported subrogation claims. Given our holding, we decline to address these arguments.
We agree with the district courts that the Trustee's common law claims asserted on behalf of BLMIS are barred by the doctrine of in pari delicto.
Under New York law, one wrongdoer may not recover against another. See Kirschner v. KPMG LLP, 938 N.E.2d 941, 950 (N.Y. 2010). The principle that a wrongdoer should not profit from his own misconduct "is . . . strong in New York." Id. at 964. The New York Appellate Division, First Department, has long applied the doctrine of in pari delicto to bar a debtor from suing third parties for a fraud in which he participated. See Barnes v. Hirsch, 212 N.Y.S. 536, 539 (App. Div. 1st Dep't 1925) ("The bankrupts could not recover against these defendants for bucketing orders because they were responsible for the illegal transaction and parties to the fraud."), aff'd, 152 N.E. 424 (N.Y. 1926).
A "claim against a third party for defrauding a corporation with the cooperation of management accrues to creditors, not to the guilty corporation." Shearson Lehman Hutton, Inc. v. Wagoner, 944 F.2d 114, 120 (2d Cir. 1991) (citing Barnes, 212 N.Y.S. at 537). The debtor's misconduct is imputed to the trustee because, innocent as he may be, he acts as the debtor's representative. See Wight v. BankAmerica Corp., 219 F.3d 79, 87 (2d Cir. 2000) ("[B]ecause a trustee stands in the shoes of the corporation, the Wagoner rule bars a trustee from suing to recover for a wrong that he himself essentially took part in."); accord Breeden v. Kirkpatrick & Lockhart LLP (In re Bennett Funding Grp., Inc.), 336 F.3d 94, 99-100 (2d Cir. 2003) (applying Wagoner rule in the context of "the greatest Ponzi scheme [then] on record" and holding that "the defrauded investors and not the bankruptcy trustee" were entitled to pursue malpractice claims against attorneys and accountants arising from the fraud).
Picard alleges that the Defendants were complicit in Madoff's fraud and facilitated his Ponzi scheme by providing (well-paid) financial services while ignoring obvious warning signs. These claims fall squarely within the rule of Wagoner and the ensuing cases: Picard stands in the shoes of BLMIS and may not assert claims against third parties for participating in a fraud that BLMIS orchestrated.
Picard's scattershot responses are resourceful, but they all miss the mark. He contends that a SIPA trustee is exempt from the Wagoner rule, but adduces no authority. He argues that the rationale of the in pari delicto doctrine is not served here because he himself is not a wrongdoer; but neither were the trustees in the cases cited above. He contends that in pari delicto should not impede the enforcement of securities laws, citing Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299 (1985); but Bateman Eichler is inapposite. See id. at 315-16 (holding that in pari delicto would not prevent defrauded tippee from bringing suit against defrauding tipper, at least absent further inquiry into "relative culpabilities" of tippee and tipper). He invokes the "adverse interest" exception, which directs a court not to impute to a corporation the bad acts of its agent when the fraud was committed for personal benefit. See The Mediators, Inc. v. Manney (In re Mediators, Inc.), 105 F.3d 822, 827 (2d Cir. 1997). However, "this most narrow of exceptions" is reserved for cases of "outright theft or looting or embezzlement . . . where the fraud is committed against a corporation rather than on its behalf." Kirschner v. KPMG LLP, 938 N.E.2d 941, 952 (N.Y. 2010). It is not possible thus to separate BLMIS from Madoff himself and his scheme. Finally, Picard argues that the district courts should not have applied the in pari delicto doctrine at the pleadings stage; but the New York Court of Appeals has held otherwise. See id. at 947 n.3; see also Wagoner, 944 F.2d at 120. Early resolution is appropriate where (as here) the outcome is plain on the face of the pleadings.
Footnote 14. When, as here, principal and agent are "one and the same . . . the adverse interest exception is itself subject to an exception styled the 'sole actor' rule," which "imputes the agent's knowledge to the principal notwithstanding the agent's self-dealing." In re Mediators, Inc., 105 F.3d at 827.
The Trustee's claim for contribution is the only one that may escape the bar of in pari delicto. See Barrett v. United States, 853 F.2d 124, 127 n.3 (2d Cir. 1988) (explaining that parties seeking contribution are necessarily in pari delicto). The Trustee seeks contribution for payments made to BLMIS customers under SIPA, on the theory that the Defendants are joint tortfeasors with BLMIS under New York law.
Footnote 15. Some courts have suggested that Wagoner nevertheless bars a contribution claim. See, e.g., Devon Mobile Commc'ns Liquidating Trust v. Adelphia Commc'ns Corp. (In re Adelphia Commc'ns Corp.), 322 B.R. 509, 529 (Bankr. S.D.N.Y. 2005); Silverman v. Meister Seelig & Fein, LLP (In re Agape World, Inc.), 467 B.R. 556, 580-81 (Bankr. E.D.N.Y. 2012). We need not decide whether such a claim would survive a Wagoner challenge because, as explained in text, there is no contribution right under SIPA.
The New York statute provides that "two or more persons who are subject to liability for damages for the same personal injury, injury to property or wrongful death, may claim contribution among them whether or not an action has been brought or a judgment has been rendered against the person from whom contribution is sought." N.Y. C.P.L.R. § 1401 (McKinney). Section 1401 "requires some form of compulsion; that is, the party seeking contribution must have been compelled in some way, such as through the entry of a judgment, to make the payment against which contribution is sought." N.Y. State Elec. & Gas Corp. v. FirstEnergy Corp., No. 3:03-CV-0438 (DEP), 2007 WL 1434901, at *7 (N.D.N.Y. May 11, 2007) (emphasis added).
However, the SIPA payments for which Picard seeks contribution were not compelled by BLMIS's state law fraud liability to its customers; his obligation to pay customers their ratable share of customer property is an obligation of federal law: SIPA. SIPA provides no right to contribution, and it is settled in this Circuit that there is no claim for contribution unless the operative federal statute provides one. See Nw. Airlines, Inc. v. Transp. Workers Union of Am., AFL-CIO, 451 U.S. 77, 97 n.38, 97-99 (1981); see also Herman v. RSR Sec. Servs. Ltd., 172 F.3d 132, 144 (2d Cir. 1999) (affirming dismissal of New York state law contribution claims for liability under the Fair Labor Standards Act); KBL Corp. v. Arnouts, 646 F. Supp. 2d 335, 341 (S.D.N.Y. 2009) ("[A] plaintiff cannot use New York State common law as an end-around to make a claim for contribution that it could not make under the federal statutory scheme."); Lehman Bros., Inc. v. Wu, 294 F. Supp. 2d 504, 505 n.1 (S.D.N.Y. 2003) ("[W]hether contribution is available in connection with a federal statutory scheme is a question governed solely by federal law.") (citation and quotation marks omitted).
Picard emphasizes that he is not seeking contribution for violations of SIPA or any other federal statute, but that is beside the point. "The source of a right of contribution under state law must be an obligation imposed by state law." LNC Invs., Inc. v. First Fid. Bank, 935 F. Supp. 1333, 1349 (S.D.N.Y. 1996) (emphasis added). The issue is therefore whether the payments made by the Trustee, for which he is seeking contribution, are required by state or federal law--an easy question.
The $800 million paid out to customers fulfilled an obligation created by SIPA, a federal statute that does not provide a right to contribution "either expressly or by clear implication," Texas Industries, Inc. v. Radcliff Materials, Inc., 451 U.S. 630, 638 (1981). Unlike the Bankruptcy Act, SIPA does not require customers to establish a basis of liability as a prerequisite for the Trustee's disbursement obligation. The loss itself is enough. See 15 U.S.C. § 78fff-2(c) (the Trustee "shall allocate customer property of the debtor . . . to customers of such debtor, who shall share ratably in such customer property on the basis and to the extent of their respective net equities"); cf. Hill v. Day (In re Today's Destiny, Inc.), 388 B.R. 737, 753-56 (Bankr. S.D. Tex. 2008) (holding that Texas law governed contribution claim where debtor sought contribution for obligations set forth in proofs of claim alleging fraud under state law). Because the Trustee's payment obligations were imposed by a federal law that does not provide a right to contribution, the district courts properly dismissed these claims.
Having rejected the Trustee's claims asserted on behalf of BLMIS, we consider next whether the Trustee may assert such claims on behalf of BLMIS's customers. To proceed with these claims, the Trustee must first establish his standing. This he cannot do.
Standing is a "threshold question in every federal case, determining the power of the court to entertain the suit." Warth v. Seldin, 422 U.S. 490, 498 (1975). Standing depends, first, on whether the plaintiff has identified a "case or controversy" between the plaintiff and the defendants within the meaning of Article III of the Constitution. Ass'n of Data Processing Serv. Orgs., Inc. v. Camp, 397 U.S. 150, 152 (1970). "To have standing, '[a] plaintiff must  allege personal injury  fairly traceable to the defendant's allegedly unlawful conduct and  likely to be redressed by the requested relief.'" Hirsch v. Arthur Andersen & Co., 72 F.3d 1085, 1091 (2d Cir. 1995) (alterations in original) (quoting Allen v. Wright, 468 U.S. 737, 751 (1984)). In addition, the plaintiff must comply with "prudential" limitations on standing, of which the salient one here is that a party must "assert his own legal rights and interests and cannot rest his claim to relief on the legal rights or interests of third parties." Warth, 422 U.S. at 499.
We consider below Picard's arguments that: (A) existing Second Circuit precedent allows for third-party standing in a SIPA liquidation; and (B) SIPA itself confers standing, both by creating a bailment relationship between the Trustee and the debtor's customers, and by authorizing SIPC to pursue subrogation claims on customers' behalf.
The implied prohibition in Article III against third-party standing applies to actions brought by bankruptcy trustees. In Caplin v. Marine Midland Grace Trust Co. of N.Y., 406 U.S. 416 (1972), the Supreme Court ruled that federal bankruptcy law does not empower a trustee to collect money owed to creditors. That is because a bankruptcy trustee is not empowered "to collect money not owed to the estate"; the trustee's proper task "is simply to collect and reduce to money the property of the estates for which (he is trustee)." Id. at 428-29 (citation and internal quotation marks omitted). "[N]owhere in the statutory scheme is there any suggestion that the trustee in reorganization is to assume the responsibility of suing third parties" on behalf of creditors. Id. at 428. This way, creditors can "make their own assessment of the respective advantages and disadvantages, not only of litigation, but of various theories of litigation," id. at 431; no consensus is needed as to "the amount of damages to seek, or even on the theory on which to sue," id. at 432; and disputes over inconsistent judgments and the scope of settlements can be avoided, id. at 431-32.
Our Court has hewed to this principle. In Wagoner, the misappropriation of funds by the owner and president of the debtor company was facilitated by stock transactions effected through a third-party brokerage firm. Shearson Lehman Hutton, Inc. v. Wagoner, 944 F.2d 114, 117 (2d Cir. 1991). The trustee's claim that the brokerage aided and abetted the fraud was dismissed on summary judgment, and we affirmed, observing that "[i]t is well settled that a bankruptcy trustee has no standing generally to sue third parties on behalf of the estate's creditors, but may only assert claims held by the bankrupt corporation itself." Id. at 118 (citing Caplin, 406 U.S. at 434); see also Hirsch v. Arthur Andersen & Co., 72 F.3d 1085, 1094 (2d Cir. 1995) (holding that Chapter 11 trustee had no standing to bring creditor claims against accountants and law firms that had provided services to the debtor, a real estate partnership operated as a Ponzi scheme); The Mediators, Inc. v. Manney (In re Mediators, Inc.), 105 F.3d 822, 826 (2d Cir. 1997) (affirming dismissal of breach of fiduciary duty claim brought by creditors' committee functioning as bankruptcy trustee, against bank and law firm for allegedly aiding and abetting debtor's fraud).
The Trustee makes little effort to explain why Caplin and its progeny do not control. Instead, he relies on a single Second Circuit case that was overruled by the Supreme Court, and on dicta in another. Apart from lacking precedential force, both cases are readily distinguishable.
In Redington v. Touche Ross & Co., 592 F.2d 617 (2d Cir. 1978), rev'd, 442 U.S. 560 (1979), a SIPA trustee sued the accountant of an insolvent brokerage for violations of record-keeping provisions of Section 17(a) of the Securities Exchange Act, as well as violations of state common law. The district court dismissed the Section 17(a) claim for lack of an implied private right of action, and concluded that it lacked jurisdiction over the common law claims. See Redington v. Touche Ross & Co., 428 F. Supp. 483, 492-93 (S.D.N.Y. 1977).
In reversing, we held that Section 17(a) did create an implied private right of action. See Redington v. Touche Ross & Co., 592 F.2d 617 (2d Cir. 1978), rev'd, 442 U.S. 560 (1979). We then considered the trustee's claim that "[h]e is responsible for marshalling and returning [customer] property; to the extent that he is unable to do so, he argues, he may sue on behalf of the customer/bailors any wrongdoer whom they could sue themselves." Id. at 625. Relying on the Federal Rules of Civil Procedure, Redington concluded that "the Trustee, as bailee, is an appropriate real party in interest," id., and that "SIPC is subrogated to the right of action implied in section 17 in favor of brokers' customers against third parties such as accountants." Id. at 624. Redington would favor Picard's case, except that Redington is no longer good law.
The Supreme Court granted certiorari in Redington to decide whether Section 17(a) created an implied right of action and whether a SIPA trustee and SIPC had standing to assert that claim. See Touche Ross & Co. v. Redington, 442 U.S. 560 (1979). The Court held that no private right of action existed under Section 17(a), id. at 579, and therefore considered it "unnecessary to reach" the standing issue, id. at 567 n.9. The case was remanded to consider whether an alternative basis for jurisdiction existed, but none was found. See Redington v. Touche Ross & Co., 612 F.2d 68, 70 (2d Cir. 1979).
Picard argues that the Supreme Court left the standing question "untouched" because the opinion was "limited to a merits-based reversal on the issue of whether a private right of action existed under section 17(a)." Appellant Br. 31 (11-5044). However, the question of who may assert a right of action is presented ordinarily only if a right of action has been found to exist. See Nat. R.R. Passenger Corp. v. Nat. Assoc. of R.R. Passengers, 414 U.S. 453, 456 (1974) ("[T]he threshold question clearly is whether the Amtrak Act . . . creates a [private] cause of action . . . for it is only if such a right of action exists that we need consider whether the respondent had standing to bring the action[.]"). The Supreme Court's reversal on the threshold question drained the Second Circuit Redington opinion of force on other questions. See Newdow v. Rio Linda Union Sch. Dist., 597 F.3d 1007, 1041 (9th Cir. 2010) ("[W]hen the Supreme Court reverses a lower court's decision on a threshold question," the Court "effectively holds the lower court erred by reaching [other issues].").
Following the Supreme Court's reversal, this Court vacated its original judgment on the ground that subject matter jurisdiction was lacking. See Order, Redington v. Touche Ross, Nos. 77-7183, 77-7186 (2d Cir. Aug. 8, 1979); Appellee Br. Addendum A (11-5207). As the Trustee concedes, vacatur dissipates precedential force. See Appellant Br. 30 (11-5044). See also O'Connor v. Donaldson, 422 U.S. 563, 577 n.12 (1975) (observing that vacatur "deprives [the] court's opinion of precedential effect"); Brown v. Kelly, 609 F.3d 467, 476-77 (2d Cir. 2010).
Since Redington, at least six judges in this Circuit have questioned or rejected third-party claims brought by SIPA trustees, beginning with Judge Pollack in Mishkin v. Peat, Marwick, Mitchell & Co., 744 F. Supp. 531, 556-58 (S.D.N.Y. 1990). See also Picard v. JPMorgan Chase & Co., 460 B.R. 84, 100-101 (S.D.N.Y. 2011) (McMahon, J.); Picard v. HSBC Bank PLC, 454 B.R. 25, 33-34 (S.D.N.Y. 2011) (Rakoff, J.); Picard v. Taylor (In re Park South Sec., LLC), 326 B.R. 505, 516 (Bankr. S.D.N.Y. 2005) (Drain, J.); Giddens v. D.H. Blair & Co. (In re A.R. Baron & Co., Inc.), 280 B.R. 794, 804 (Bankr. S.D.N.Y. 2002) (Beatty, J.); SIPC v. BDO Seidman, LLP, 49 F. Supp. 2d 644, 653 (S.D.N.Y. 1999) (Preska, J.), rev'd on other grounds, 222 F.3d 63 (2d Cir. 2000).
Yet Redington has enjoyed something of a half-life, with several courts (including this one) assuming without deciding that Redington retains residual force.Redington should be put to rest; it has no precedential effect.
Even if Redington retained some persuasive value, it would not decide this case. First, Redington considered chiefly whether the trustee and SIPC had standing to bring a cause of action under Section 17 of the Exchange Act; the opinion said nothing about a SIPA trustee's ability to orchestrate mass tort actions against third parties. See Redington v. Touche Ross & Co., 592 F.2d 617, 618 (2d Cir. 978), rev'd, 442 U.S. 560 (1979) ("[W]e are presented with he question whether a private cause of action exists under section 17 of the Securities Exchange Act of 1934 against accountants who prepare misleading statements of a broker's financial affairs, and if so, who may maintain such an action."). Second, our holding in Redington turned, in part, on an analysis of Fed. R. Civ. P. 17(a), which sets forth rules concerning real parties in interest, and which has no application here. See id. at 625; see also infra p. 51 n.25. Third, Redington involved claims against a single accounting firm for a few discrete instances of alleged misconduct (the preparation of misleading financial statements). As a result, the policy concerns we express below (see infra pp. 59-69) would have been considerably diminished--and, indeed, were not even addressed by the Court. Fourth, and finally, in Redington the brokerage firm was not complicit in the wrongdoing, but rather "an entity distinct from its conniving officers [that] was directly damaged by Touche Ross' unsatisfactory audit." 592 F.2d at 620. The Redington Court therefore did not have occasion to consider whether the doctrine of in pari delicto barred all or part of the suit. In sum, Redington is both non-binding and inapposite.
Share this article: