United States Court of Appeals for the Second Circuit Clarifies Limits on the Standing of a SIPA (or Bankruptcy) Trustee to Bring Common Law Claims Against Third Parties

June 21, 2013

On June 20, 2013, a three-member panel of the United States Court of Appeals for the Second Circuit issued an important decision that significantly curtails the authority of Irving Picard, as Trustee for the liquidation of Bernard L. Madoff Investment Securities LLC (BLMIS), to bring actions against alleged aiders and abettors of Madoff’s Ponzi scheme, and provides much needed clarity on the question of a SIPA trustee’s standing to bring tort claims on behalf of a defunct broker-dealer’s estate and/or the estate’s creditors.  In an opinion authored by Chief Judge Jacobs in In re Bernard L. Madoff Investment Securities LLC, Nos. 11-5044, 11-5051, 11-5175, and 11-5207, a Second Circuit panel unanimously affirmed the decisions of two district court judges (Judges Colleen McMahon and Jed Rakoff) and held that the Madoff Trustee was barred from asserting various tort claims, including claims for aiding and abetting fraud, aiding and abetting breach of fiduciary duty, and contribution, against financial institutions that allegedly ignored warning signs and prolonged the Ponzi scheme.


Following the late 2008 discovery that BLMIS was operated as a massive Ponzi scheme, and the arrest of its founder, Bernard L. Madoff, the Securities Investor Protection Corporation (SIPC) filed an application under the Securities Investor Protection Act (SIPA) seeking court protection for the broker-dealer and its estate.  The United States District Court for the Southern District of New York appointed Irving Picard as Trustee and referred the proceeding to the Bankruptcy Court for the Southern District of New York.  Since his appointment, the Madoff Trustee has recovered and distributed more than $5 billion to customers of BLMIS, including approximately $800 million advanced by SIPC.

In 2009 and 2010, Mr. Picard initiated separate proceedings in the Bankruptcy Court against, among others, JPMorgan Chase & Co., UBS AG, UniCredit Bank Austria AG, and HSBC Bank PLC, financial institutions that either established and marketed Madoff feeder funds or maintained bank accounts for BLMIS.  Picard alleged that each of those defendants knew or should have known that BLMIS was operated as a fraudulent enterprise, but ignored warning signs because of the substantial profits they realized from BLMIS-related business.  These suits, which were grounded in a variety of tort-based legal theories, asserted aggregate damages claims totaling approximately $30 billion dollars.  Following withdrawal of the proceedings from the Bankruptcy Court to the District Court, two District Court judges rendered consistent opinions in 2011 that dismissed all of the common law claims asserted by the Madoff Trustee for lack of standing.

Following an appeal by Mr. Picard, the Second Circuit affirmed the two District Court opinions, rejecting the Madoff Trustee’s alternative arguments that, as a SIPA trustee, he was authorized to bring common law tort claims on behalf of (i) the BLMIS estate and/or (ii) the creditors of the BLMIS estate.

Claims Brought on Behalf of the BLMIS Estate

The claims brought by the Madoff Trustee on behalf of the BLMIS estate were founded on the theories that the defendants, as alleged joint tortfeasors, (i) were directly liable to the Madoff Trustee (who stands in the shoes of BLMIS) for furthering the fraud, and (ii) were indirectly liable to the Madoff Trustee for ratable contribution toward the payments made by the Trustee to the customers of BLMIS.  In rejecting the direct claims of the BLMIS estate, the Second Circuit held that the doctrine of in pari delicto – the principle that a wrongdoer should not profit from his own misconduct – bars such claims.  Citing Shearson Lehman Hutton, Inc. v. Wagoner, 944 F.2d 114 (2d Cir. 1991), and its progeny, the Second Circuit reaffirmed the proposition that a corporate enterprise is saddled with the status of a wrongdoer where its management participated in the wrongful conduct, and that such corporation – or, importantly, a trustee standing in its shoes – is barred by the doctrine of in pari delicto from bringing claims against alleged joint tortfeasors.  The court rejected Mr. Picard’s “scattershot” efforts to avoid Wagoner, finding that “they all miss the mark.”  Among others things, the Second Circuit confirmed that it was irrelevant that Picard himself was not a wrongdoer, and that the in pari delicto doctrine can be applied at the pleadings stage in cases where “the outcome is plain on the face of the pleadings.”

With respect to the contribution claims of the BLMIS estate, the Second Circuit held that such claims apply only where one tortfeasor has been compelled to make payment in respect of the joint tort.  In the case of the Madoff Trustee, the Second Circuit held that the Trustee’s obligation to distribute funds to customers was a statutory obligation imposed by SIPA, not a state-law obligation arising out of tort liability.  Thus, the court held, federal law governs that obligation and, because SIPA does not provide a right of contribution, the Madoff Trustee cannot assert state-law contribution claims against third parties to recover monies paid out to customers of BLMIS.

Claims Brought on Behalf of Creditors

In finding that the Madoff Trustee also lacked standing to pursue claims on behalf of the customers of BLMIS, the court relied primarily on Caplin v. Marine Midland Grace Trust Co., 406 U.S. 416 (1972), which held that bankruptcy trustees (and, by analogy, SIPA trustees) asserting claims brought on behalf of creditors cannot satisfy the prudential standing requirement that a plaintiff must rest its claim on its own legal rights and interests and not on those of others.  Although the Second Circuit acknowledged that its prior decision in Redington v. Touche Ross & Co., 592 F.2d 617 (2d Cir. 1978), rev’d, 442 U.S. 560 (1979) – which found a SIPA Trustee to be a real party in interest with standing to pursue customer claims – would appear to “favor Picard’s case,” it concluded that Redington “has no precedential effect” and, in any event, that it “would not decide this case.”  The Second Circuit held that the Supreme Court’s reversal of Redington on other grounds “drained the Second Circuit Redington opinion of force on other questions.”  The Second Circuit acknowledged that Redington “has enjoyed something of a half-life, with several courts (including this one) assuming without deciding that [it] retains residual force,” but ultimately held that Redington “should be put to rest.”

The Second Circuit similarly rejected the arguments of the Madoff Trustee that one passage in another Second Circuit case, St. Paul Fire & Marine Insurance Co. v. PepsiCo, Inc., 884 F.2d 688 (2d Cir. 1989) – noting that a trustee may bring a creditor claim if the “claim is a general one, with no particularized injury arising from it, and if that claim could be brought by any creditor of the debtor” – vested the Madoff Trustee with standing to bring tort-based claims against the bank defendants.  The Second Circuit clarified that the passage in St. Paul was intended to convey only that claims belonging to the estate, which are “general” as to all creditors because they are truly claims arising from harm to the debtor, may be brought by a trustee.  Accordingly, the Court held that St. Paul did not give the Madoff Trustee standing to bring claims on behalf of BLMIS customers.

Finally, the Court rejected the arguments of the Madoff Trustee that the common law of bailments and subrogation afforded him standing to assert claims on behalf of customers.  The Court found the Madoff Trustee’s argument that he had been entrusted with customer property as bailee to be unpersuasive, as any damage to that property would have predated Mr. Picard’s appointment as trustee.  Thus, the bailed property (the customer investments) would have been impaired prior to the bailment, precluding any claim for damages by the Madoff Trustee, as bailee.  With respect to subrogation, the Court acknowledged that SIPA provides SIPC with a right to recover funds advanced to customers upon a liquidation of a broker-dealer on a theory of subrogation.  The court concluded, however, that this subrogation right is limited, and that it permits SIPC only to access the funds held by the estate – after complete satisfaction of customer net equity claims – not to advance claims against third parties on a subrogation theory.  Although the Court noted that a different approach might have some advantages, it also recognized that the subrogation theory advanced by the Madoff Trustee raised a host of practical problems, and ultimately concluded that “it is better to leave these intractable policy judgments to Congress.”


The Second Circuit’s decision in In re Bernard L. Madoff Investment Securities LLC significantly clarifies the scope of a SIPA trustee’s (and by analogy, a bankruptcy trustee’s) rights to bring common law claims against third parties.  In particular, questions regarding the precedential value of Redington and the meaning of the “generalized” vs. “particularized” claims referenced in St. Paul have caused confusion among litigants and other courts for many years.  In In re Bernard L. Madoff Investment Securities LLC, the Second Circuit has taken meaningful steps to reduce confusion regarding the proper parties to bring common law claims arising in a bankruptcy or SIPA proceeding, and has taken a strong stance that creditor claims belong to creditors.

*  *  *

Gibson Dunn represents UBS AG and its affiliates in In re Bernard L. Madoff Investment Securities LLC.

Gibson, Dunn & Crutcher’s lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact the Gibson Dunn lawyer with whom you usually work or the authors:

Marshall R. King – New York (212-351-3905, [email protected])
Keith R. Martorana – New York (212-351-3991, [email protected])
Gabriel Herrmann – New York (212-351-3974, [email protected])

Please also feel free to contact any of the following members of the Securities Litigation Practice Group or the Business Restructuring and Reorganization Practice Group:

Securities Litigation Group:
Jonathan C. Dickey – Co-Chair, New York/Palo Alto (212-351-2399, 650-849-5370, [email protected])
Robert F. Serio – Co-Chair, New York (212-351-3917, [email protected])
Meryl L. Young – Co-Chair, Orange County (949-451-4229, [email protected])
Thad A. Davis – Co-Chair, San Francisco (415-393-8251, [email protected])
Paul J. Collins – Palo Alto (650-849-5309, [email protected])
George B. Curtis – Denver (303-298-5743, [email protected])
Ethan Dettmer – San Francisco (415-393-8292, [email protected])
Gareth T. Evans – Orange County (949-451-4330, [email protected])
Joel A. Feuer – Los Angeles (310-551-8808, [email protected])
Daniel S. Floyd – Los Angeles (213-229-7148, [email protected])
Barry R. Goldsmith – New York (212-351-2440, [email protected])
Mark A. Kirsch – New York (212-351-2662, [email protected])
Monica K. Loseman – Denver (303-298-5784, [email protected])
John C. Millian – Washington, D.C. (202-955-8213, [email protected])
John H. Sturc – Washington, D.C. (202-955-8243, [email protected])
Robert C. Walters – Dallas (214-698-3114, [email protected])
Additional Securities Litigation Partners

Business Restructuring and Reorganization Group:
Craig H. Millet – Co-Chair, Orange County (949-451-3986, [email protected])
Michael A. Rosenthal – Co-Chair, New York (212-351-3969, [email protected])
David M. Feldman – Co-Chair, New York (212-351-2366, [email protected])

© 2013 Gibson, Dunn & Crutcher LLP

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.