Baker & Hostetler LLP 45 Rockefeller Plaza New York, NY 10111€¦ · Baker & Hostetler LLP 45 Rockefeller Plaza New York, NY 10111 Telephone: (212) 589-4200 Facsimile: (212) 589-4201

Baker & Hostetler LLP

45 Rockefeller Plaza

New York, NY 10111

Telephone: (212) 589-4200

Facsimile: (212) 589-4201

Attorneys for Irving H. Picard, Esq., Trustee for the

Substantively Consolidated SIPA Liquidation of

Bernard L. Madoff Investment Securities LLC

and the Estate of Bernard L. Madoff

UNITED STATES DISTRICT COURT

SOUTHERN DISTRICT OF NEW YORK

SECURITIES INVESTOR PROTECTION

CORPORATION,

Adv. Pro. No. 08-01789 (BRL)

Plaintiff,

SIPA LIQUIDATION

v.

(Substantively Consolidated)

BERNARD L. MADOFF INVESTMENT

SECURITIES LLC,

Defendant.

In re:

MADOFF SECURITIES, 12 Misc. 115 (JSR)

Debtor.

IRVING H. PICARD, Trustee for the Liquidation

of Bernard L. Madoff Investment Securities LLC,

PERTAINS TO Case No. 12 Civ. 6733 (JSR)

Plaintiff, REPLY MEMORANDUM OF LAW IN

FURTHER SUPPORT OF TRUSTEE’S

v. APPLICATION FOR ENFORCEMENT

OF AUTOMATIC STAY AND ISSUANCE

ERIC T. SCHNEIDERMAN, as successor to

ANDREW M. CUOMO, Attorney General of the

State of New York; BART M. SCHWARTZ, as

Receiver for ARIEL FUND LTD. and GABRIEL

CAPITAL, L.P.; DAVID PITOFSKY, as

Receiver for ASCOT PARTNERS, L.P. and

ASCOT FUND, LTD.; J. EZRA MERKIN; and

GABRIEL CAPITAL CORPORATION,

OF PRELIMINARY INJUNCTION

REDACTED

Defendants.

Case 1:12-cv-06733-JSR Document 24 Filed 02/21/13 Page 1 of 49

TABLE OF CONTENTS

Page

-i-

PRELIMINARY STATEMENT ................................................................................................... 1

STATEMENT OF FACTS ............................................................................................................ 3

I. THE MERKIN DEFENDANTS WERE WARNED THAT MADOFF WAS A FRAUD .................................................................................................... 4

A. Early Warnings that Madoff Was Engaged in Fraud ................................. 4

B. Later Warnings and Red Flags Regarding the ............. 5

II. THE MERKIN DEFENDANTS’ STATEMENTS AND ACTIONS SHOW THAT THEY HAD KNOWLEDGE OF MADOFF’S FRAUD .............. 7

A. The Merkin Defendants Ignored Evidence of Fraud ................................. 7

B. Merkin Kept His Own Money Away From the Madoff Fraud .................. 8

III. THE MERKIN DEFENDANTS WERE ANYTHING BUT DILIGENT AND SO HAVE NO GOOD FAITH DEFENSE .................................................. 9

A. Merkin Fails to Conduct Meaningful Due Diligence on Madoff’s Operations .................................................................................................. 9

B. Merkin Fails to Conduct Meaningful Due Diligence into the Numbers ................................................................................................... 12

ARGUMENT ............................................................................................................................... 12

I. THE SETTLEMENT DISSIPATES ASSETS SUBJECT TO SIPA .................. 12

A. A Section 105 Injunction Is Necessary to Prevent the Dissipation of Estate Assets ........................................................................................ 12

B. The Trustee May Obtain a Stay or Injunction Prior to Final Judgment .................................................................................................. 15

II. THE CODE AND SIPA REQUIRE AN INJUNCTION ..................................... 16

A. SIPA Displaces Laws That Conflict with Its Purpose of Rapidly Returning Funds to Customers of Failed Brokerages .............................. 17

B. The Settlement Resolves State Law Claims in a Manner that Would Defeat and Prove an Obstacle to the Return of Funds to Customers ................................................................................................ 18

III. THE COURT HAS AMPLE SUBJECT MATTER JURISDICTION TO ISSUE A SECTION 105(a) INJUNCTION ........................................................ 21

A. The District Court Has Jurisdiction Over Third Party Actions That Have a Conceivable Effect on the Estate ................................................. 21

B. Grupo Mexicano is Inapplicable .............................................................. 21


TABLE OF CONTENTS

(continued)

Page

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C. The Barton Doctrine Does Not Deprive the Court of Subject-Matter Jurisdiction ................................................................................... 23

D. Rule 65 Injunction Standards Do Not Apply ........................................... 25

E. The Trustee’s Application Satisfies the Rule 65 Standards ..................... 27

1. Absent an Injunction, the BLMIS Estate Will Suffer Irreparable Harm .......................................................................... 28

(a) Dissipation of Assets Constitutes Irreparable Harm ........ 28

(b) The Merkin Defendants’ Arguments to the Contrary Are Premised on Demonstrably False Assumptions ........ 29

2. The Trustee Has Established a Likelihood of Success on the Merits ..................................................................................... 32

3. The Public Interest and Balance of Hardships Favor the Trustee.......................................................................................... 33

IV. DEFENDANTS’ EQUITABLE ARGUMENTS ARE WITHOUT MERIT ....... 35

CONCLUSION ............................................................................................................................ 37


TABLE OF AUTHORITIES

Page(s)

-iii-

CASES

Adams v. Hartconn Assocs., Inc. (In re Adams), 212 B.R. 703 (Bankr. D. Mass. 1997) .....................................................................................36

In re Adelphia Commc’ns Corp., 298 B.R. 49 (S.D.N.Y. 2003) ...................................................................................................25

Adelphia Commc’ns Corp. v. Am. Channel, LLC (In re Adelphia Commc’ns Corp.), No. 06-10528; 2006 WL 1529357 (Bankr. S.D.N.Y. June 5, 2006) .......................................28

Adelphia Commc’ns Corp. v. Rigas (In re Adelphia Commc’ns Corp.), 323 B.R. 345 (Bankr. S.D.N.Y. 2005) .....................................................................................23

Adelphia Commc’ns Corp. v. Rigas (In re Adelphia Commc’ns Corp.), No. 02 Civ. 8495, 2003 WL 21297258 (S.D.N.Y. June 4, 2003) ......................................21, 22

Altria Grp., Inc. v. Good, 555 U.S. 70 (2008) ...................................................................................................................18

AP Indus., Inc. v. SN Phelps & Co. (In re AP Indus., Inc.), 117 B.R. 789 (Bankr. S.D.N.Y. 1990) .....................................................................................14

Astor Holdings, Inc. v. Roski, 325 F.Supp.2d 251 (S.D.N.Y. 2003) ........................................................................................18

In re Baldwin–United Corp., 770 F.2d 328 (2d Cir. 1985).....................................................................................................26

Barton v. Barbour, 104 U.S. 126 (1881) .....................................................................................................23, 24, 25

Begier v. IRS, 496 U.S. 53 (1990) .............................................................................................................16, 32

Berkman v. Rust Craft Greeting Cards, Inc., 454 F. Supp. 787 (S.D.N.Y. 1978)...........................................................................................33

In re Bernard L. Madoff Inv. Sec. LLC, 654 F.3d 229 (2d Cir. 2011).....................................................................................................17

In re Bernard L. Madoff Inv. Sec. LLC, No. 11 CV 2392, 2011 WL 7975167 (S.D.N.Y. Nov. 17, 2011) ............................................14

In re Best Prods. Co., 168 B.R. 35 (Bankr. S.D.N.Y. 1994) .......................................................................................31



(continued) Page(s)

-iv-

Best Prods. Co. v. Resolution Trust Corp. (In re Best Prods. Co.), No. 93 Civ. 1115, 1994 WL 141970 (S.D.N.Y. Apr. 20, 1994) ..............................................24

Blanchard v. Landis, No. 02-0053, 2002 WL 1933819 (S.D.N.Y. Aug 20, 2002) ....................................................24

Boles v. Turner (In re Enivid), 364 B.R. 139 (Bankr. D. Mass 2007) ......................................................................................14

Brennan v. Poritz (In re Brennan), 198 B.R. 445 (D.N.J. 1996) .....................................................................................................15

C & J Clark Am., Inc. v. Carol Ruth, Inc. (In re Wingspread Corp.), 92 B.R. 87 (Bankr. S.D.N.Y. 1988) ...................................................................................26, 27

California v. ARC Am. Corp., 490 U.S. 93 (1989) .......................................................................................................18, 19, 20

Casse v. Key Bank N.A. (In re Casse), 198 F.3d 327 (2d Cir. 1999).....................................................................................................26

Cent. Va. Cmty. Coll. v. Katz, 546 U.S. 356 (2006) .................................................................................................................24

Citigroup Global Mkts., Inc. v. VCG Special Opportunities Master Fund Ltd., 598 F.3d 30 (2d Cir. 2010).......................................................................................................27

Class Five Nev. Claimants v. Dow Corning Corp. (In re Dow Corning Corp.), 280 F.3d 648 ............................................................................................................................22

In re Commonwealth Oil Refining Co., 805 F.2d 1175 (5th Cir. 1985) .................................................................................................32

Coscill Inc. v. Gabriel Capital, L.P. (In re Merkin), 817 F.Supp.2d 346 (S.D.N.Y. 2011) ....................................................................................9, 15

CSC Holdings, Inc. v. Redisi, 309 F.3d 988 (7th Cir. 2002) ...................................................................................................23

E. Air Lines, Inc. v. Rolleston (In re Ionosphere Clubs, Inc.), 111 B.R. 423 (Bankr. S.D.N.Y. 1990), aff’d in part,124 B.R. 635 (S.D.N.Y. 1991) ........26, 32

E. Equip. & Servs. Corp. v. Factory Point Nat’l Bank, Bennington, 236 F.3d 117 (2d Cir. 2001).....................................................................................................19



(continued) Page(s)

-v-

eBay Inc. v. MercExchange, L.L.C., 547 U.S. 388 (2006) .................................................................................................................27

Erti v. Paine Webber Jackson & Curtis, Inc. (In re Baldwin-United Corp. Litig.), 765 F.2d 343 (2d Cir. 1985).....................................................................................................25

FDIC v. Hirsch (In re Colonial Realty), 980 F.2d 125 (2d Cir. 1992.)....................................................................................................16

In re Feit & Drexler, Inc., 760 F.2d 406 (2d Cir. 1985).....................................................................................................22

Fischer v. Am. United Life Ins. Co., 314 U.S. 549 (1942) .................................................................................................................25

Fisher v. Apostolou, 155 F.3d 876 (7th Cir. 1998) .......................................................................................13, 14, 27

Fisher v. Hamilton (In re Teknek LLC), 343 B.R. 850 (Bankr. N.D. Ill. 2006) ......................................................................................29

FPSDA v. Larin (In re FPSDA), No. 12-08032, 2012 WL 6681794 (Bankr. E.D.N.Y. Dec. 21, 2012) .....................................32

Freedom Holding, Inc. v. Spitzer, 408 F.3d 112 (2d Cir. 2005).....................................................................................................29

Garrity v. Leffler (In re Neuman), 71 B.R. 567 (S.D.N.Y. 1987) .............................................................................................25, 26

Gazes v. DeArakie (In re DeArakie), 199 B.R. 821 (Bankr. S.D.N.Y. 1992) .....................................................................................35

In re Gen. Motors Corp., 407 B.R. 463 (Bankr. S.D.N.Y. 2009) .....................................................................................14

Geron v. Schulman (In re Manshul Constr. Corp.), 2000 WL 1228866 (S.D.N.Y. Aug. 30, 2000) .........................................................................31

Grupo Mexicano de Desarrollo, S.A. v. Alliance Bond Fund, Inc., 527 U.S. 308 (1999) .....................................................................................................21, 22, 23

Hamilton v. Atlas Turner, Inc., 197 F.3d 58 (2d Cir. 1999).......................................................................................................35



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-vi-

Hasset v. Far West Fed. Sav. & Loan (In re OPM Leasing Servs., Inc.), 40 B.R. 390 (Bankr. S.D.N.Y.) ................................................................................................31

Henderson v. Burd, 133 F.2d 515 (2d Cir. 1943).....................................................................................................26

Hudson Tire Mart, Inc. v. Aetna Cas. & Sur. Co., 518 F.2d 671 (2d Cir. 1975).....................................................................................................29

Jackson Dairy, Inc. v. H.P. Hood & Sons, Inc., 596 F.2d 70 (2d Cir. 1979).......................................................................................................29

Johns-Manville Corp. v. Asbestos Litig. Grp. (In re Johns-Manville Corp.), 26 B.R. 420 (Bankr. S.D.N.Y. 1983) .......................................................................................29

JSC Foreign Econ. Assoc. Technostroyexport v. Int’l. Dev. & Trade Servs, Inc., 295 F. Supp. 2d. 366 (S.D.N.Y. 2003).....................................................................................23

Kagan v. Saint Vincents Catholic Med. Ctrs. of N.Y. (In re Saint Vincents Catholic Med.

Ctrs. of N.Y.), 449 B.R. (S.D.N.Y. 2011) ........................................................................................................27

Katchen v. Landy, 382 U.S. 323 (1966) .................................................................................................................32

In re Keene Corp., 168 B.R. 285 (Bankr. S.D.N.Y. 1994) .....................................................................................22

Keene Corp. v. Acstar Ins. Co. (In re Keene Corp.), 162 B.R. 935 (Bankr. S.D.N.Y.1994) ......................................................................................26

Kramer v. Sooklall (In re Singh), 434 B.R. 298 (Bankr. E.D.N.Y. 2010) .....................................................................................31

LaMonica v. N. of Eng. Protecting & Indemn. Ass’n (In re Probulk Inc.), 407 B.R. 56 (Bankr. S.D.N.Y. 2009) .....................................................................25, 27, 28, 32

Lautenberg Found. v. Picard (In re Bernard L. Madoff Inv. Sec., LLC), No. 11-5421, 2013 WL 616269 (2d Cir. Feb. 20, 2013) ................................................. passim

In re Lee, 465 B.R. 469 (Bankr. W.D. Ky. 2012) ....................................................................................36

In re Lines, 81 B.R. 267 (Bankr. S.D.N.Y. 1988) .......................................................................................28



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-vii-

Loewi Realty Corp. v. Chanticleer Assocs., Ltd. (In re Chanticleer Assocs., Ltd.), 592 F.2d 70 (2d Cir. 1979).......................................................................................................25

LTV Steel Co., Inc. v. Bd. of Educ. (In re Chateaugay Corp.), 93 B.R. 26 (S.D.N.Y. 1988) ...............................................................................................25, 26

Lurie v. Blackwell, No. 98-35553, 2000 WL 237965 (9th Cir. Mar. 2, 2000)........................................................24

Lyondell Chem. Co. v. CenterPoint Energy Gas Servs. Inc. (In re Lyondell Chem. Co.), 402 B.R. 571 (Bankr. S.D.N.Y. 2009) .....................................................................................25

MacArthur Co. v. Johns-Manville Corp., 837 F.2d 89 (2d Cir. 1988).........................................................................................................2

Malm v. Goldin, No. 92–Civ–8012 (LJF), 1993 WL 330489 (S.D.N.Y. Aug. 27, 1993) ..................................26

Marrama v. Citizens Bank of Mass., 549 U.S. 365 (2007) .................................................................................................................25

Maryland v. Louisiana, 451 U.S. 725 (1981) .................................................................................................................24

Matthew v. Rosene, 739 F.2d 249 (7th Cir. 1984) ...................................................................................................36

Maxam v. Picard, 474 B.R. 76 (S.D.N.Y. 2012) .............................................................................................24, 26

Merrill Lynch Inv. Managers v. Optibase, Ltd., 337 F.3d 125 (2d Cir. 2003).....................................................................................................36

Mishkin v. Siclari (In re Adler, Coleman Clearing Corp.), 277 B.R. 520 (Bankr. S.D.N.Y. 2002) .....................................................................................30

Motorola Credit Corp. v. Uzan, 202 F. Supp. 2d 239 (S.D.N.Y. 2002) ......................................................................................23

N.Y. SMSA Ltd. P’ship v. Town of Clarkstown, 612 F.3d 97 (2d Cir. 2010).......................................................................................................19

New England Dairies, Inc. v. Dairy Mart Convenience Stores, Inc. (In re Dairy Mart

Convenience Stores, Inc.), 351 F.3d 86 (2d Cir. 2003).......................................................................................................14



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Old Carco Motors LLC v. Suthers (In re Old Carco LLC), 470 B.R. 688 (S.D.N.Y. 2012) .................................................................................................19

Patco Energy Express, LLC v. Lambros, 353 F. App’x 379 (11th Cir. 2009) ..........................................................................................24

Pfizer Inc. v. Law Offices of Peter G. Angelos (In re Quigley Co.), 676 F.3d 45 (2d Cir. 2012).................................................................................................12, 21

Picard v. Katz, 462 B.R. 447 (S.D.N.Y. 2011) .............................................................................................4, 33

Picard v. Merkin, 440 B.R. 243 (Bankr. S.D.N.Y. 2010) .....................................................................................15

Picard v. Stahl, 443 B.R. 295 (Bankr. S.D.N.Y. 2011) .........................................................................16, 28, 32

President Casinos, Inc. v. Columbia Sussex Corp. (In re President Casinos, Inc.), 419 B.R. 394 (E.D. Mo. 2009) .................................................................................................22

Quantum Corporate Funding, Ltd. v. Assist You Home Health Care Servs. of Va., 144 F. Supp. 2d 241 (S.D.N.Y. 2001) ......................................................................................23

Queenie, Ltd. v. Nygard Int’l, 321 F.3d 282 (2d Cir. 2003).....................................................................................................13

United States ex rel. Rahman v. Oncology Assocs., P.C., 198 F.3d 489 (4th Cir. 1999) ...................................................................................................23

Random House, Inc. v. Rosetta Books LLC, 283 F.3d 490 (2d Cir. 2002)...............................................................................................27, 33

In re Reliance Acceptance Grp., 235 B.R. 548 (D. Del. 1999) ..............................................................................................14, 32

Ressler v. Liz Claiborne, Inc., 75 F. Supp. 2d 43 (E.D.N.Y. 1999) .........................................................................................33

Sealink Funding Ltd. v. Bear Stearns & Co., No. 12 Civ. 1397, 2012 WL 4794450 (S.D.N.Y. Oct. 9, 2012) ..............................................21

Sec. Investor Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC (In re Madoff), 454 B.R. 285 (Bankr. S.D.N.Y. 2011) .....................................................................................34



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Sec. Investor Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, 12 Misc. 115, 2013 WL 67605 (S.D.N.Y. Jan. 4, 2013) .........................................................30

Sec. Investor Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, 477 B.R. 351 (Bankr. S.D.N.Y. 2012) .....................................................................................16

Sec. Investor Prot. Corp. v. Wise (In re Stalvey & Assocs., Inc.), 750 F.2d 464 (5th Cir. 1985) ...................................................................................................17

SEC v. F.O. Baroff Co., 497 F.2d 280 (2d Cir. 1974).....................................................................................................30

SEC v. Mgmt. Dynamics, Inc., 515 F.2d 801 (2d Cir. 1975).....................................................................................................26

SEC v. N. Am. Planning Corp., No. 72 Civ. 3158, 1975 U.S. Dist. LEXIS 14183 (S.D.N.Y. Jan. 24, 1975) ...........................30

SEC v. Packer, Wilbur & Co., Inc., 498 F.2d 978 (2d Cir. 1974)...............................................................................................17, 30

Seitz v. Freeman (In re CitX Corp.), 302 B.R. 144 (Bankr. E.D. Pa. 2003) ......................................................................................23

Serio v. Black, Davis & Shue Agency Inc., No. 05-15, 2005 U.S. Dist. LEXIS 39018 (S.D.N.Y. Jan. 11, 2006) ......................................23

Singer Co. B.V. v. Groz-Beckert KG (In re Singer Co. N.V.), No. 99-10578, 2000 WL 33716976 (Bankr. S.D.N.Y. Nov. 3, 2000) .....................................14

Sosne v. Reinert & Duree, P.C. (In re Just Brakes Corporate Sys., Inc.), 108 F.3d 881 (8th Cir. 1997) ...................................................................................................14

Touche Ross & Co. v. Redington, 442 U.S. 560 (1979) .................................................................................................................17

U.S. v. Broccolo, No. 06-CV-2812, 2006 WL 3690648 (S.D.N.Y. Dec. 13, 2006) ............................................26

In re United Health Care Org., 210 B.R. 228 (S.D.N.Y. 1997) .................................................................................................28

In re VistaCare Grp., LLC, 678 F.3d 218 (3d Cir. 2012).....................................................................................................24



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Wildermuth v. Pious, 21 A.D.2d 912 (N.Y. Sup. Ct. App. Div. 1964) ......................................................................24

Winter v. Natural Res. Def. Council, Inc., 555 US. 7 (2008) ......................................................................................................................27

Wishnatzki & Nathel, Inc. v. H.P. Island-Wide, Inc., No. 00 Civ. 8051, 2000 WL 1610790 (S.D.N.Y. Oct. 27, 2000) ............................................23

STATUTES

11 U.S.C. § 105 ...................................................................................................................... passim

11 U.S.C. § 105(a) ................................................................................................................. passim

11 U.S.C. § 362 ..................................................................................................................16, 24, 29

11 U.S.C. § 362(a)(1) .....................................................................................................................16

11 U.S.C. § 362(b) .........................................................................................................................14

11 U.S.C. § 502(d) ...................................................................................................................30, 31

11 U.S.C. § 502(h) .........................................................................................................................31

11 U.S.C. § 510(c) .........................................................................................................................30

11 U.S.C. § 542 ..............................................................................................................................15

11 U.S.C. § 550 ..............................................................................................................................31

15 U.S.C. § 78fff-1 ........................................................................................................................17

15 U.S.C. § 78fff-2(c)(1)(B) ..........................................................................................................19

15 U.S.C. § 78fff-2(c)(3) .........................................................................................................19, 20

15 U.S.C. § 78fff-3(a)(5) ...............................................................................................................17

15 U.S.C. § 78fff(a) .......................................................................................................................20

15 U.S.C. § 78fff(a)(1)(B) .............................................................................................................18

28 U.S.C. § 1651 ............................................................................................................................26



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RULES

Fed. R. Civ. P. 65 .........................................................................................................25, 26, 27, 32

OTHER AUTHORITIES

H.R. Rep. 91-1613 (1970), reprinted in 1970 U.S.C.C.A.N. 5254 ...............................2, 17, 18, 20

Pub. L. 91-598, § 6(c)(1), 84 Stat. 1636 (1970) .............................................................................17

U.S. Const. Art. VI, cl. 2 ................................................................................................................18


The Trustee respectfully submits this reply memorandum of law in further support of his

Application.1

PRELIMINARY STATEMENT

The $410 million Settlement struck by the NYAG, the Merkin Defendants, and the

Merkin Funds implicates estate property that the Trustee seeks to recover, as it represents the

(Sealed Sheehan Dec. ¶ 11, Ex. A.)2

Defendants made this bargain with full knowledge that the Trustee has pending fraudulent

conveyance claims seeking in excess of $500 million against the Merkin Defendants and Merkin

Funds. Merkin’s assets are limited, and he cannot satisfy both the Settlement terms and any

judgment obtained by the Trustee. Contrary to public statements, millions of dollars of the

Settlement money will not be going to the Merkin Defendants’ investors, but to the NYAG, a

Merkin defense “war chest,” and to administer a complicated claims process. More to the point,

that money will not be going to BLMIS customers as mandated by SIPA and the Bankruptcy

Code (“Code”).

SIPA and the Code provide a comprehensive statutory scheme that prohibits third-party

actions from interfering with the orderly administration of a debtor’s estate. The Settlement

would impermissibly elevate the NYAG’s state law claims over the Trustee’s federal statutory

claims, and is therefore preempted as an impediment to Congress’ mandate to equitably

1 Capitalized terms not otherwise defined herein shall have the meaning ascribed to them in the Trustee’s Opening Brief, Adv. Pro. No. 12-1778 (Bankr. S.D.N.Y. Aug. 1, 1012), ECF No. 3 (“Tr. Op. Br.”).

2 To aid the Court’s review, the Trustee has provided the Court with a redacted copy of the Settlement Agreement under seal pursuant to a stipulation as directed by the Court, along with the Sealed Declaration of David J. Sheehan, dated February 21, 2013 (“Sealed Sheehan Dec.”). The Trustee is also submitting another declaration from Mr. Sheehan (“Sheehan Dec.”) that attaches pertinent non-confidential documents.


2

distribute customer property to BLMIS customers with valid claims. Otherwise, third parties

could race to the courthouse and evade the statutory mandate, appropriating to themselves estate

assets that Congress intended to be equitably distributed according to Congress’s statutory

priorities.

The NYAG himself sees his action as a race to the courthouse: “the Attorney General of

the State of New York . . . beat Mr. Picard to the courthouse or beat him to a settlement.”

(Sheehan Dec., Ex. A.) The Second Circuit has recognized that a section 105 preliminary

injunction is precisely what is necessary to prevent such races to the courthouse, which harm the

integrity of the estate by appropriating assets sought by the Trustee:

Appellants pursue the Third-Party Actions against defendants whose every asset (or the vast majority thereof) is claimed by the Trustee as a fraudulent transfer from BLMIS. Under these circumstances, we conclude that the Preliminary Injunction serves the legitimate purpose of “preserving the debtor’s estate for the creditors and funneling claims to one proceeding in the bankruptcy court,” MacArthur Co. v. Johns-Manville Corp., [837 F.2d 89, 93 (2d Cir. 1988)]. Were it not for the Preliminary Injunction, there would ensue a chaotic rush to the courthouse—or rather, multiple courthouses—of those seeking assets that the trustee claims are properly part of the BLMIS estate. This would run counter to SIPA’s objective of furthering “the prompt and orderly liquidation of SIPC members.” H.R. Rep. No. 91-1613 (1970), reprinted in 1970 U.S.C.C.A.N. 5254, 5262.

Summary Order, Lautenberg Found. v. Picard (In re Bernard L. Madoff Inv. Sec., LLC), No. 11-

5421, 2013 WL 616269, at *2 (2d Cir. Feb. 20, 2013) (“Lautenberg Summary Order”).

(Sheehan Dec., Ex. F.)

Defendants contend that their Settlement should be allowed to proceed because the

Trustee is both “too early” (because he has yet to prove that the Settlement funds are estate

property) and “too late” (because the parties have expended resources reaching the Settlement) to

stop it. Both arguments are wrong. As in the Second Circuit’s holding in Lautenberg, the

Trustee need not prevail on his claims before an injunction may issue. Nor is the Trustee too late


3

in seeking to enjoin a settlement immediately after it was announced that the monies he sought to

recover for the estate would be dissipated.

The Trustee seeks a narrowly tailored injunction, fully consistent with the mandates of

the Code and SIPA, to prevent dissipation of potential estate assets until his avoidance action is

resolved. Accordingly, the Trustee’s Application should be granted.

STATEMENT OF FACTS

The brief filed by the Merkin Defendants joins in the arguments contained in the separate

brief filed collectively by the NYAG and the Funds, but its primary argument is that the Trustee

would not succeed in his underlying case. Although a determination concerning the underlying

action is unnecessary for the injunctive relief sought by the Trustee, the self-serving and

incorrect assumptions and statements of the Merkin Defendants are easily rebutted.

The defenses argued by the Merkin Defendants to the Trustee’s action to avoid and

recover more than $500 million in avoidable transfers are without support. The Merkin

Defendants do not dispute the dates and the amounts of the transfers set forth in the Trustee’s

Complaint. (See Second Am. Compl., Ex. B, Picard v. Merkin, Adv. Pro. No. 09-1182 (Bankr.

S.D.N.Y. Mar. 16, 2010), ECF No. 68; see also Sheehan Dec., Ex. B. at 94–97.) Evidence

developed in the case to date supports the Trustee’s allegations that the Merkin Defendants knew

or should have known of fraud at BLMIS because they had actual knowledge of fraud by

BLMIS—in particular, knowledge that it was a Ponzi scheme. The Merkin Funds are charged

with the knowledge, actions, and lack of actions of the Merkin Defendants. And because Merkin

had ultimate responsibility and was the sole decision maker for the Merkin Funds, he is

responsible for the amount of the avoidable transfers. (See Second Am. Complaint ¶¶ 34, 42–43;

see also Sealed Sheehan Dec., Ex. B at BS00022361, 2368, 2378; Ex. C. at BS00096674, 6681,

6691; Ex. D at BS00024248, 4258, 4277.)


4

I. THE MERKIN DEFENDANTS WERE WARNED THAT MADOFF WAS A

FRAUD

The Merkin Defendants were repeatedly warned that BLMIS was a fraudulent operation,

both by facts suggesting and confirming that fraud. Aware of these facts,

(Sealed Sheehan Dec., Ex. E at CON00000058.) The collective warnings and

Merkin’s continued investment with Madoff at a minimum demonstrate willful blindness. See

Picard v. Katz, 462 B.R. 447, 455 (S.D.N.Y. 2011). Viewed in their entirety, the facts will

demonstrate that the Merkin Defendants had actual knowledge of the fraud at BLMIS.

A. Early Warnings that Madoff Was Engaged in Fraud

Merkin was first warned of Madoff’s Ponzi scheme by his initial money manager, Victor

Teicher. As early as 1991,






9

0492877, 878.) If Merkin had truly been interested in investing with Madoff he would have

placed his money in Ascot Fund, .6

III. THE MERKIN DEFENDANTS WERE ANYTHING BUT DILIGENT AND SO

HAVE NO GOOD FAITH DEFENSE

The Merkin Defendants claim, while ignoring critical evidence of fraud, that they

performed “extensive due diligence,” and therefore, the Trustee cannot demonstrate a likelihood

of success in proving that they lacked good faith. But, this, too, is wholly inaccurate.7

A. Merkin Fails to Conduct Meaningful Due Diligence on Madoff’s Operations

Significantly, the Merkin Defendants rely upon the fact that Madoff honored their

redemption requests as their primary due diligence on Madoff. (Merkin Br. 8.) Of course,

honored redemptions are no protection against fraud, and in fact are a prerequisite for the

successful continuation of a Ponzi scheme. A responsible manager cannot assume an investment

will not “blow up,” simply because it has not yet done so. This is evidence of nothing.

Merkin also relies upon his meetings and telephone calls with Madoff and others as proof

6 Merkin maintains that his and his family’s personal investments with BLMIS exceeded $110 million, and this fact evinces his belief that BLMIS was a legitimate enterprise. (Merkin Br. 3, 8.) But Merkin fails to provide any support for his $110 million figure. In reality, the figure is significantly composed of fictitious paper profits that Merkin knew were the result of fraud at BLMIS.

7 The Merkin Defendants appear to argue that the standard for scienter in a section 10(b) action is applicable to the good faith standard. (Merkin Br. 10, 16.) These issues are currently pending before the Court and the Trustee’s position is articulated in the Trustee’s Memorandum of Law in Opposition to (1) BLMIS Customers’ Consolidated Brief Responding to Good Faith Issues; and (2) Consolidated Brief on Behalf of Subsequent Transferee Defendants Responding to the Good Faith Standard Issues and incorporated here by reference. Sec. Investor Prot. Corp. v.

Bernard L. Madoff Sec. LLC, No. 1:12-mc-00115 (S.D.N.Y. Aug. 31, 2012), ECF No. 324. Similarly, Judge Batts did not rule that Merkin’s due diligence practices were proper, but simply found that the “alleged failure to conduct due diligence generally does not give rise to a securities fraud claim.” See Coscill Inc. v. Gabriel Capital, L.P. (In re Merkin), 817 F.Supp.2d 346, 356 (S.D.N.Y. 2011).


10

of his due diligence. Yet, even after purportedly meeting with Madoff dozens of times,

For example,

Similarly, Merkin was well aware of concerns over Madoff’s supposed option volume.

Madoff purportedly told Merkin that he executed his option trades over-the-counter. (Merkin Br.

11.) Yet, despite a duty to do so,

A simple

review of the trade confirmations would have revealed that Madoff was lying. Madoff’s trade

confirmations for options included a CUSIP number, indicating an exchange traded transaction

and not an option traded over-the-counter.

Merkin’s purported reliance on the SEC’s clearance of Madoff in 1992, 2006 and 2007 is

belied by the fact that Madoff was the sole source of this information. Merkin never sought any

information on the SEC’s investigation or findings. The single newspaper article referring to the

SEC’s investigation into Avellino & Bienes relied upon by the Merkin Defendants never even

states that the SEC investigated and inspected Madoff. (Declaration of Kristine A. Moon in

Support of Merkin Defendants’ Opposition to the Trustee’s Injunction Application (“Moon


11

Dec.”), Ex. 12.)

(Sealed Sheehan Dec., Ex. H at GCC-P 0492986.)

Next, the Merkin Defendants stress that Merkin had complete transparency into Madoff’s

trading based on their receipt and review of Madoff’s trade confirmations. Yet, there is no

evidence that the Merkin Defendants ever checked to see if the listed prices were possible in

light of the reported daily highs and lows. Rather, the record reveals that the Merkin Defendants

did nothing more than enter the prices and amounts listed in Madoff’s confirmations into their

portfolio management system and reconcile their daily entries with the monthly statements also

generated by Madoff. These activities are general accounting functions, not due diligence.

(Sheehan Dec., Ex. H.)

The Merkin Defendants’ reliance on BDO’s audits of the funds also misses the mark.8

Merkin almost never spoke to his auditors; in fact, it happened only once in almost 12 years.

(Sheehan Dec., Ex. I at 39–40.) The Merkin Defendants also misstate the role their auditors

played in auditing their funds. BDO had no duty to audit Madoff or to detect fraud. (Id. at 51–

52, 56, 134, 169.) The BDO audit was limited to inspecting the trade confirmations and

brokerage statements issued by Madoff and given to BDO by the Merkin Defendants. (Id. at

116, 134, 169.)

8 The Merkin Defendants’ claim that “BDO referred investors to Ascot” is not supported by the

evidence. The Merkin Defendants never identified who made the referrals, and BDO’s corporate

representative testified that he was not aware of anyone of BDO’s audit team recommending the

defendant funds as an investment to anyone. (Sheehan Dec., Ex. I at 142) Moreover, Michael

Andreola, a BDO tax partner mentioned in Moon Declaration, Ex.16, denied making any

referral. (Sheehan Dec., Ex. J at BDO_T_0043035.)


12

B. Merkin Fails to Conduct Meaningful Due Diligence into the Numbers

Notably absent from the Merkin Defendants’ recitation of their due diligence activities is

any type of quantitative analysis of the kind routinely conducted by sophisticated fund managers.

More than a failure of due diligence, this is effectively breach of fiduciary duty for a fund

manager.

ARGUMENT

I. THE SETTLEMENT DISSIPATES ASSETS SUBJECT TO SIPA

A. A Section 105 Injunction Is Necessary to Prevent the Dissipation of Estate

Assets

As the Second Circuit has recognized, a “suit against a third party alleging liability not

derivative of the debtor’s conduct but that nevertheless poses the specter of direct impact on the

res of the bankruptcy estate may just as surely impair the bankruptcy court’s ability to make a

fair distribution of the bankrupt’s assets as a third-party suit alleging derivative liability.” Pfizer

Inc. v. Law Offices of Peter G. Angelos (In re Quigley Co.), 676 F.3d 45, 57–58 (2d Cir. 2012).

9 Importantly, evidence is still being gathered in the Trustee’s Action. Ezra Merkin has not yet been deposed by the Trustee, nor have Victor Teicher and several other witnesses believed to have warned Merkin about Madoff’s fraud. And additional critical documents are yet to be produced, as Defendants have not completed their productions in response to the Trustee’s requests, and deficiencies in the productions to date are the subject of an omnibus discovery dispute pending before the discovery arbitrator.


13

The Defendants do not dispute that the Trustee’s Application should be granted if estate property

is implicated by the Settlement—nor could they. (See NYAG Br. 8–9; Merkin Br. 1.)

They do argue that neither a stay nor an injunction is necessary because the Settlement

will not have an adverse economic impact on the BLMIS estate. (NYAG Br. 14–15.) But the

NYAG and Receivers also do not dispute that they seek to recover funds that allegedly were

transferred by BLMIS to the Merkin Funds and the Merkin Defendants—the very same funds

that the Trustee seeks to recover in his litigation. (See Tr. Op. Br. 14–16) (the NYAG seeks to

recover management fees from the Merkin Defendants, which the Trustee also seeks to recover

in his avoidance action, and the Schwartz Action seeks a constructive trust over all assets,

property, and/or cash in the custody and control of the Merkin Defendants.)

That concession is fatal to their argument against an injunction. As the Second Circuit

held in Lautenberg:

[T]he Third-Party Actions would have an “immediate adverse economic consequence for the debtor’s estate” if allowed to proceed, Queenie, Ltd. v.

Nygard Int’l, [321 F.3d 282, 287 (2d Cir. 2003)], inasmuch as, if successful, they would draw down assets almost all of which would otherwise be expected to return to the BLMIS estate as a consequence of the Trustee’s fraudulent transfer action. Injunctive relief was therefore properly granted to avoid impeding the SIPA liquidation.

Lautenberg, 2013 WL 616269, at *2.

That Defendants purport to have independent claims is of no moment. Under SIPA and

the Code, the Trustee must be allowed to recover from a limited pool of assets before competing

actions may go forward. Indeed, the same argument urged by Defendants here was made and

rejected in Lautenberg: “§ 105(a) is properly used to enjoin creditors’ lawsuits against third

parties where the injunction plays an important part in the debtor’s reorganization plan or where

the action to be enjoined will have an immediate adverse economic consequence for the debtor’s

estate.” Id. (internal quotations and citations omitted); see also Fisher v. Apostolou, 155 F.3d


14

876 (7th Cir. 1998); Sosne v. Reinert & Duree, P.C. (In re Just Brakes Corporate Sys., Inc.), 108

F.3d 881 (8th Cir. 1997).10

To allow otherwise would reward the Injunction Defendants’ “race to the courthouse,”

which, as the Second Circuit recognized, is contrary to SIPA and the Code. Lautenberg, 2013

WL 616269, at *2 (“Were it not for the Preliminary Injunction, there would ensue a chaotic rush

to the courthouse. . . .”).11

The NYAG asserts in a footnote that the police powers exception set forth in section

362(b) of the Code to the automatic stay applies, and hence injunctive relief is not proper.

(NYAG Br. 11 n.6.) But the NYAG Action is not a proper exercise of police or regulatory

10

New England Dairies, Inc. v. Dairy Mart Convenience Stores, Inc. (In re Dairy Mart

Convenience Stores, Inc.), 351 F.3d 86 (2d Cir. 2003), relied on by the Defendants, is not on point. In Dairy Mart, the Second Circuit considered whether a creditor that could not adequately protect its interest in a letter of credit was entitled to relief from the automatic stay. 351 F.3d at 90–92. Unlike the circumstances here, there was no third party action at issue and no injunctive relief of any kind was sought. In re General Motors Corp., 407 B.R. 463 (Bankr. S.D.N.Y. 2009), is likewise irrelevant. In General Motors, the bankruptcy court declined to exercise equitable powers to force the purchaser in a sale of liens to assume liability to clean a superfund site in circumvention of the Code. Here, Trustee seeks injunctive relief to protect his property interest under the Code.

11 Moreover, that a state court held that claims could proceed against the Merkin Defendants does not mean that these claims can be separated from those of the Trustee. (See NYAG Br. 4.) As with the claims asserted in Lautenberg, Defendants’ claims are inextricably intertwined and related to the underlying SIPA proceeding, making an injunction of the Settlement and underlying action appropriate. See In re Bernard L. Madoff Inv. Sec. LLC, No. 11 CV 2392, 2011 WL 7975167, at *13 (S.D.N.Y. Nov. 17, 2011) (Hellerstein, J.); see also Apostolou, 155 F.3d at 882; AP Indus., Inc. v. SN Phelps & Co. (In re AP Indus., Inc.), 117 B.R. 789, 802 (Bankr. S.D.N.Y. 1990); Singer Co. B.V. v. Groz-Beckert KG (In re Singer Co. N.V.), No. 99-10578, 2000 WL 33716976 (Bankr. S.D.N.Y. Nov. 3, 2000); (Tr. Op. Br. 6, 22, 34, 37.) Defendants’ reliance on Boles v. Turner (In re Enivid), 364 B.R. 139 (Bankr. D. Mass 2007) and In re Reliance Acceptance Grp., 235 B.R. 548 (D. Del. 1999) is misplaced. Enivid stands only for the uncontroversial proposition that third party claims that do not significantly impact the bankruptcy estate may proceed, and Reliance addressed whether non-debtor directors’ and officers’ lack of deep pockets and probability of indemnification claims warranted a permanent injunction. By contrast, here, the Settlement will have an immediate adverse impact on the estate by seeking to recover a limited pool of assets also pursued by the Trustee.


15

powers; instead, it is an attempt to vindicate private rights and to fill New York State’s coffers by

allotting $5 million to pay the NYAG’s costs. (See Tr. Op. Br. 27–31; Declaration of Marc D.

Powers ¶ 4, Adv. Pro. No. 12-1778 (Bankr. S.D.N.Y. Aug. 1, 1012), ECF No. 4 (“Powers Dec.”)

¶ 4.) The NYAG does not dispute this point. The case relied upon by the NYAG, Brennan v.

Poritz (In re Brennan), 198 B.R. 445 (D.N.J. 1996), is inapposite, and, in fact, recognizes that

injunctions of state police powers or regulatory actions are “clearly” authorized when the state

action would “effectively contravene a specific bankruptcy code section.” Id. at 451; see also

infra § II.B (NYAG’s claims are preempted).

B. The Trustee May Obtain a Stay or Injunction Prior to Final Judgment

Defendants’ assertions that the Trustee must actually recover the estate property in his

avoidance action before the automatic stay can be enforced or an injunction can issue are wrong.

The Second Circuit’s Lautenberg ruling demonstrates this. There, as here, the Trustee had not

completed his avoidance actions.

Indeed, the Trustee must show only that the property at issue is a “conceivable interest”

of BLMIS. (Tr. Op. Br. 26.) Defendants fail to address this argument, instead arguing that

under the bankruptcy court’s decision in Picard v. Merkin, 440 B.R. 243 (Bankr. S.D.N.Y.

2010)—which had nothing to do with the automatic stay or an injunction—the Trustee cannot

seek to enjoin an action implicating property sought by the estate. But the court held only that

the Trustee could not rely on section 542 to recover transfers until they are avoided. Id. at 272–

73. This is a far cry from a finding that the Trustee does not have any legally cognizable interest

at stake in an avoidance action prior to the time the action is determined and the transfers

avoided. Indeed, subsequent to the Merkin decision, the bankruptcy court enforced the automatic

stay and issued or enforced injunctions in Lautenberg—now affirmed by the Second Circuit—


16

and AG Goldman, thus belying Defendants’ arguments.12 See Lautenberg, 2013 WL 616269;

Stahl, 443 B.R. 315; Sec. Investor Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC, 477 B.R. 351

(Bankr. S.D.N.Y. 2012).

II. THE CODE AND SIPA REQUIRE AN INJUNCTION

Defendants contend that their state law claims can be recovered prior to the Trustee’s

federally-mandated claims. But if Defendants were correct that the bankruptcy court could not

use sections 362 and 105 of the Code to protect estate assets and enjoin the Settlement, state law

claims would be resolved in a manner that plainly conflicts with the requirements of federal law.

This is because the Settlement will have an immediate adverse impact on the estate, an outcome

that is prohibited by federal law. The Code’s fundamental purpose is to protect the debtor’s

estate for equitable distribution. See Begier v. IRS, 496 U.S. 53, 58 (1990) (the Code’s central

policy is the equitable distribution of a debtor’s assets among its creditors). That principle is

significantly reinforced by SIPA, which creates a statutory priority scheme entitling the Trustee

to recover and distribute to BLMIS customers the very property that would be dissipated by the

Settlement. The Settlement, if allowed to proceed, will dissipate property in conflict with

SIPA’s liquidation process, which Congress intended to rapidly and equitably recover and return

property to the customers of failed brokerages. SIPA must control here because that is what

12 Defendants similarly misconstrue FDIC v. Hirsch (In re Colonial Realty), 980 F.2d 125 (2d Cir. 1992.) In Colonial Realty, the Second Circuit concluded that the automatic stay applied to a third party action brought by the FDIC because the action sought property fraudulently transferred by the debtor, and thus it was an “action . . . to recover a claim against the debtor” within the meaning of § 362(a)(1). 980 F.2d at 132. It did not suggest that a trustee must first prove that the property he seeks to protect is recoverable before moving to protect that property. Such a reading of the Code would defeat its plain language and would frustrate the intent and purpose of the statute.


17

Congress commanded. The Settlement must be enjoined until the Trustee’s claims against the

Merkin Defendants have been resolved.

A. SIPA Displaces Laws That Conflict with Its Purpose of Rapidly Returning

Funds to Customers of Failed Brokerages

“Congress specifically enacted SIPA in 1970 to afford customers . . . protection against

losses they might incur as a result of the financial failure of their broker-dealer.” Touche Ross &

Co. v. Redington, 442 U.S. 560, 574 n.16 (1979). To that end, SIPA establishes “a

comprehensive statutory scheme governing the rights of creditors and brokers,” Sec. Investor

Prot. Corp. v. Wise (In re Stalvey & Assocs., Inc.), 750 F.2d 464, 468 & n.3 (5th Cir. 1985),

mandating that the Trustee recover transferred property for equitable distribution to customers

and other creditors in accordance with the statutory priority scheme. 15 U.S.C. § 78fff-1; In re

Bernard L. Madoff Inv. Sec. LLC, 654 F.3d 229, 231 (2d Cir. 2011) (describing the SIPA

Trustee’s “additional duties, specified by the Act”).

Two provisions, in particular, demonstrate Congress’s intention to supplant the normal

operation of law when it conflicts with that task. First, Congress expressly contemplated that

federal courts would use their injunctive powers to temporarily stay outside claims while the

Trustee’s primary task of recovering and distributing property to customers was under way.

While barring a court from abrogating “rights of setoff” and “the right to enforce a valid, non-

preferential lien,” Congress allowed that it “may stay enforcement of such rights” pending the

resolution of customer claims. H.R. Rep. 91-1613 (1970), reprinted in 1970 U.S.C.C.A.N. 5254,

5264; Pub. L. 91-598, § 6(c)(1), 84 Stat. 1636, 1647 (1970). Second, Congress put other broker-

dealers at the back of the line in any SIPA recovery, no matter their seniority under state law,

except to the extent that their claims are derivative of those of their customers. 1970

U.S.C.C.A.N. at 5264; 15 U.S.C. § 78fff-3(a)(5); see also SEC v. Packer, Wilbur & Co., Inc.,


18

498 F.2d 978, 984 (2d Cir. 1974). In these ways, Congress manifested its intentions that

(1) nothing stand in the way of a SIPA proceeding to recover and return funds to “customers,” as

defined in the statute, and (2) all claims relating to a broker’s failure be channeled into that single

proceeding, at least as an initial matter.

Indeed, a primary impetus for SIPA was the proliferation of lawsuits after the “Salad Oil

Swindle” of 1963 ruined the Ira Haupt & Co. brokerage, which impeded efforts to equitably

satisfy customer claims. 1970 U.S.C.C.A.N. at 5256–57. Congress established SIPA’s

comprehensive liquidation process to prevent another morass of competing claims following a

brokerage failure. The whole point was to displace laws that impeded a prompt distribution of

customer property to “satisfy net equity claims of customers[.]” 15 U.S.C. § 78fff(a)(1)(B).

B. The Settlement Resolves State Law Claims in a Manner that Would Defeat

and Prove an Obstacle to the Return of Funds to Customers

Defendants’ argument that a section 105 injunction cannot issue ignores the fundamental

principle that federal law preempts contrary state law. U.S. Const. Art. VI, cl. 2. Even when

Congress has not expressly preempted state law or occupied the field, “state law is nevertheless

preempted to the extent it actually conflicts with federal law, that is, when compliance with both

state and federal law is impossible, or when the state law stands as an obstacle to the

accomplishment and execution of the full purposes and objectives of Congress.” California v.

ARC Am. Corp., 490 U.S. 93, 100–01 (1989) (internal quotation marks and citations omitted).

The Settlement’s resolution of state law claims fails both tests.

Congressional purpose is the “ultimate touchstone” in preemption. Altria Grp., Inc. v.

Good, 555 U.S. 70, 76 (2008). Congress enacted SIPA to supplement the already “broad scope

of bankruptcy preemption.” Astor Holdings, Inc. v. Roski, 325 F.Supp.2d 251, 262 (S.D.N.Y.

2003). “The United States Bankruptcy Code provides a comprehensive federal system of


19

penalties and protections to govern the orderly conduct of debtors’ affairs and creditors’ rights.”

E. Equip. & Servs. Corp. v. Factory Point Nat’l Bank, Bennington, 236 F.3d 117, 120 (2d Cir.

2001). As a result, “even a minor incursion into federal bankruptcy [is] tantamount to state

courts, in effect, interfering with the whole complex, reticulated bankruptcy process itself.” Old

Carco Motors LLC v. Suthers (In re Old Carco LLC), 470 B.R. 688, 703 (S.D.N.Y. 2012)

(internal quotation marks omitted). SIPA goes even further to carry out its highly specific

purpose.

Federal law mandates that the BLMIS estate must be protected, which is the fundamental

purpose of a section 105 injunction. Because the Settlement conflicts with that federal purpose,

it is preempted. First, the Settlement would prevent the Merkin Defendants from complying with

the requirements of federal law. See ARC Am., 490 U.S. at 100–01. The settlement of

Defendants’ state law claims would dissipate funds wrongfully transferred to the Merkin

Defendants, depleting their assets so they could not satisfy the Trustee’s federal law claims.

These state law claims are premised on the same fraudulent enterprise as the SIPA liquidation

proceedings, concern proceeds of that enterprise, and are for the preferential benefit of persons

who may already benefit from the Merkin Funds’ customer claims on the BLMIS estate.

Whether the Trustee can assert the Defendants’ precise claims himself is irrelevant to the

question whether those claims are compatible with the requirements of federal law. See, e.g.,

N.Y. SMSA Ltd. P’ship v. Town of Clarkstown, 612 F.3d 97, 107 (2d Cir. 2010).

They are not. SIPA specifically authorizes the Trustee’s action against the Merkin

Defendants to avoid wrongful transfers of property from the estate. 15 U.S.C. § 78fff-2(c)(3).

They must return any property found to have been wrongfully transferred. The Trustee must

then distribute such property according to the statutory priority scheme. 15 U.S.C. §§ 78fff-


20

2(c)(1)(B), (c)(3). The Settlement clashes with those federal obligations, relying on state law to

deny the Trustee possession of property that federal law mandates. Compliance with both

federal law and the Settlement’s execution of state law is not possible unless and until the

Trustee’s claims against the Merkin Defendants are resolved. Accordingly, the Settlement is

preempted and must be enjoined at this time.

Second, the Settlement is preempted because it is plainly “an obstacle to the

accomplishment and execution of the full purposes and objectives of Congress.” ARC Am., 490

U.S. at 101. Congress’s avowed purpose was to end the pre-SIPA litigation free-for-all, which

undermined investor confidence in securities markets, by establishing a comprehensive and

orderly liquidation process that would rapidly and equitably recover and return property to the

customers of failed brokerages. 15 U.S.C. § 78fff(a); see also 1970 U.S.C.C.A.N. at 5255

(describing purpose and need for SIPA). Congress expected that this process would be used to

simplify the resolution of massive fraud cases involving numerous parties in complex

arrangements by putting a single trustee at the helm of the recovery process and placing

“customers” (as defined in the statute) at the front of the line for distributions.

The NYAG brought his claims under state law for his benefit and the benefit of select

investors, and the Merkin Defendants, whose liability exceeds their assets, are essentially

indifferent to which creditors are paid first, fully, or at all. This is precisely the type of multiple

recovery proceedings and arbitrary distributions Congress meant to end. Failure to enjoin the

Settlement, at least until the Trustee’s action against the Merkin Defendants is resolved, would

permit state law impermissibly to override congressionally mandated priorities.


21

III. THE COURT HAS AMPLE SUBJECT MATTER JURISDICTION TO ISSUE A

SECTION 105(a) INJUNCTION

A. The District Court Has Jurisdiction Over Third Party Actions That Have a

Conceivable Effect on the Estate

Again basing their argument on the false premise that property of the estate is not

implicated in the Settlement, Defendants assert that this Court lacks subject matter jurisdiction to

enjoin the Settlement. However, the jurisdictional standard is well-settled and easily satisfied

here. (See Tr. Op. Br. at 19–20.) As recognized by the Second Circuit in Quigley, the

bankruptcy court has jurisdiction to enjoin even independent claims that “pose[] the specter of

direct impact on the res of the bankruptcy estate.” See Quigley, 676 F.3d at 57–58.13

B. Grupo Mexicano is Inapplicable

Defendants are wrong that Grupo Mexicano de Desarrollo, S.A. v. Alliance Bond Fund,

Inc., 527 U.S. 308 (1999), prohibits issuance of a section 105(a) injunction. In Grupo Mexicano,

the U.S. Supreme Court held that a district court lacks the inherent authority to issue a

preliminary injunction preventing a defendant from disposing of its assets prior to disposition of

a plaintiff’s claim for money damages. The court, however, specifically juxtaposed that holding

against the availability of such relief in the bankruptcy context, where there is a statutory scheme

providing for injunctive relief. Id. at 322, 325.

Accordingly, in Adelphia Communications Corp. v. Rigas (In re Adelphia

Communications Corp.), No. 02 Civ. 8495, 2003 WL 21297258, at *4–5 (S.D.N.Y. June 4,

13 This Court’s decision in Sealink Funding Ltd. v. Bear Stearns & Co., No. 12 Civ. 1397, 2012 WL 4794450 (S.D.N.Y. Oct. 9, 2012) (Swain, J.), is not to the contrary. There, the court held that defendants’ speculative indemnification claims against the bankrupt originators of mortgage-backed securities loans did not confer related-to jurisdiction over a fraud action against financial institutions related to the sale of mortgage-backed securities, given that the defendants had not filed proofs of claim or scheduled such debt in the debtors’ chapter 11 proceedings. Id. at *3. That scenario differs from the instant case, where estate property is at risk.


22

2003), Judge George Daniels of this Court held that Grupo Mexicano does not apply to a request

for injunctive relief under section 105(a). Judge Daniels reasoned that section 105(a) conferred

on the bankruptcy court a “broad range of equitable powers,” including powers to issue all orders

“necessary or appropriate to carry out the provisions of [the Code.]” See Adelphia, 2003 WL

21297258, at *4–5. The Court held that section 105(a) authorized the bankruptcy court to issue a

prejudgment order preventing a party from disposing of assets. Id. (citing In re Keene Corp.,

168 B.R. 285, 292 (Bankr. S.D.N.Y. 1994).) Grupo Mexicano’s holding, the Court concluded,

“is inapplicable in the bankruptcy court context.” Id.

Indeed, numerous courts have recognized that a bankruptcy court’s statutory authority to

issue section 105(a) injunctions falls outside Grupo Mexicano’s limitation on courts’ inherent

authority. See Class Five Nev. Claimants v. Dow Corning Corp. (In re Dow Corning Corp.), 280

F.3d 648, 657–58 (Grupo Mexicano does not apply to exercise of statutory grant of power to

issue injunctions under section 105(a)); In re Feit & Drexler, Inc., 760 F.2d 406, 414–15 (2d Cir.

1985) (affirming a pre-judgment freeze of assets under section 105(a)); President Casinos, Inc. v.

Columbia Sussex Corp. (In re President Casinos, Inc.), 419 B.R. 394, 406 (E.D. Mo. 2009) (a

section 105(a) injunction to facilitate the court’s administration of the debtor’s bankruptcy estate

was not improper under Grupo Mexicano because the Grupo Mexicano Court “specifically

exempted from its holding cases where jurisdiction to issue such injunctions is conferred, as

here, by statute.”)14 So too here.

Moreover, Grupo Mexicano does not apply to the Trustee’s complaint against the Merkin

Defendants, because it asserts fraudulent transfer claims and an equitable claim for constructive

14 In the argument before this Court on the motion to withdraw the reference, this Court recognized that Grupo Mexicano would be “irrelevant” to the extent that property of the estate is implicated. (See Sheehan Dec., Ex. A at 23:1–4; 25:12–13.)


23

trust. Courts have “repeatedly (and uniformly, to date) held that Grupo Mexicano is inapplicable

to requests for asset-freezing injunctions where plaintiffs seeking that relief have also made

equitable claims.” Adelphia Commc’ns Corp. v. Rigas (In re Adelphia Commc’ns Corp.), 323

B.R. 345, 360 n.18 (Bankr. S.D.N.Y. 2005) (collecting cases, including Motorola Credit Corp. v.

Uzan, 202 F. Supp. 2d 239, 250 (S.D.N.Y. 2002) (Rakoff, J.); CSC Holdings, Inc. v. Redisi, 309

F.3d 988, 996 (7th Cir. 2002); United States ex rel. Rahman v. Oncology Assocs., P.C., 198 F.3d

489, 496–97 (4th Cir. 1999); Quantum Corporate Funding, Ltd. v. Assist You Home Health Care

Servs. of Va., 144 F. Supp. 2d 241, 249–50 & n. 9 (S.D.N.Y. 2001); Wishnatzki & Nathel, Inc. v.

H.P. Island-Wide, Inc., No. 00 Civ. 8051, 2000 WL 1610790, at *1 (S.D.N.Y. Oct. 27, 2000).)

Grupo Mexicano poses no obstacle to this Court’s jurisdiction to issue the injunctive relief

sought by the Trustee.15

C. The Barton Doctrine Does Not Deprive the Court of Subject-Matter

Jurisdiction

Defendants are incorrect that the Barton doctrine bars the Trustee from proceeding with

his Application against the two Receivers. (NYAG Br. 15‒16 (citing Barton v. Barbour, 104

U.S. 126 (1881)).) The Trustee was not required to seek leave from the state court that appointed

them prior to bringing this Application. Defendants’ reasoning fails for two main reasons.

First, the Receivers waived any immunity Barton might afford by participating in the

claims process before the bankruptcy court. See Seitz v. Freeman (In re CitX Corp.), 302 B.R.

144, 158–59 (Bankr. E.D. Pa. 2003) (denying immunity to bankruptcy suit on any actions

15 The cases cited by the NYAG provide no additional support, as they do not involve preliminary injunctions issued under section 105(a) of the Code. (See NYAG Br. 12–13 (citing Serio v. Black, Davis & Shue Agency Inc., No. 05-15, 2005 U.S. Dist. LEXIS 39018, at *19 (S.D.N.Y. Jan. 11, 2006) (Donahil, Mag. J.); JSC Foreign Econ. Assoc. Technostroyexport v.

Int’l. Dev. & Trade Servs, Inc., 295 F. Supp. 2d. 366, 386 (S.D.N.Y. 2003)).)


24

“related to the claim [the state-appointed receiver] asserted” where receiver had filed a proof of

claim); Best Prods. Co. v. Resolution Trust Corp. (In re Best Prods. Co.), No. 93 Civ. 1115,

1994 WL 141970 (S.D.N.Y. Apr. 20, 1994) (denying motion to withdraw the reference brought

by receiver sued by bankruptcy trustee where receiver was found to have submitted itself to the

equitable jurisdiction of the bankruptcy court by submitting a proof of claim.)

Second, 11 U.S.C. § 362 expressly authorizes enforcement of the automatic stay, as well

as injunctive relief as “necessary or appropriate to carry out the provisions of this title.” 11

U.S.C. § 105(a). The Stay Action therefore preempts the state court receivership order. See

Maryland v. Louisiana, 451 U.S. 725, 746 (1981) (holding that under the Supremacy Clause of

the United States Constitution, if state law conflicts with federal law, the state law is preempted

and “without effect.”); Cent. Va. Cmty. Coll. v. Katz, 546 U.S. 356, 362–63 (2006) (holding that

adversary proceeding brought by Chapter 11 trustee to set aside alleged preferential transfers that

debtor had made to state agencies was not barred by agencies’ sovereign immunity). The

bankruptcy court has the explicit injunctive power to enforce the automatic stay against entities

subject to its in personam jurisdiction. See Maxam v. Picard, 474 B.R. 76, 82 (S.D.N.Y. 2012).

Accordingly, neither the Barton doctrine nor the receivership order immunizes the receiver from

the Stay Action. And to the extent SIPA preempts Defendants’ state-law claims, it also pre-

empts the state court receivership order.16

16 The cases cited by Defendants do not support them. (See NYAG Br. 15–16.) None of the cases involved enforcement of a federal bankruptcy court’s exclusive jurisdiction over property of a debtor’s estate. Rather, these cases involved a private plaintiff seeking to sue a state-court receiver or bankruptcy trustee, in abrogation of the Barton doctrine. See In re VistaCare Grp.,

LLC, 678 F.3d 218 (3d Cir. 2012); Blanchard v. Landis, No. 02-0053, 2002 WL 1933819, *2 (S.D.N.Y. Aug 20, 2002) (Duffy, J.); Patco Energy Express, LLC v. Lambros, 353 F. App’x 379, 382 (11th Cir. 2009); Lurie v. Blackwell, No. 98-35553, 2000 WL 237965 (9th Cir. Mar. 2, 2000); Wildermuth v. Pious, 21 A.D.2d 912 (N.Y. Sup. Ct. App. Div. 1964). The Supreme

(continued on next page)


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D. Rule 65 Injunction Standards Do Not Apply

As recently recognized by the Second Circuit in Lautenberg, section 105(a) confers broad

equitable powers on a bankruptcy court to preserve its jurisdiction, including powers to enjoin

proceedings. See, e.g., Lautenberg, 2013 WL 616269, at *2; Marrama v. Citizens Bank of

Mass., 549 U.S. 365 (2007); Erti v. Paine Webber Jackson & Curtis, Inc. (In re Baldwin-United

Corp. Litig.), 765 F.2d 343, 348 (2d Cir. 1985); Loewi Realty Corp. v. Chanticleer Assocs., Ltd.

(In re Chanticleer Assocs., Ltd.), 592 F.2d 70, 74 (2d Cir. 1979).

Defendants’ argument that Federal Rule of Civil Procedure 65 standards apply to section

105(a) requests for injunctive relief is mistaken. Notably, the Second Circuit did not look to the

Rule 65 standards in affirming the issuance of a 105 injunction in Lautenberg. Lautenberg, 2013

WL 616269, at *2; see Appellate Briefs, Lautenberg Found. v. Picard (In re Bernard L. Madoff

Inv. Sec., LLC), No. 11-5421 (2d. Cir. July 11, 2012), ECF Nos. 54, 55, 58, 74, 82–84 (raising

the issue of the application of Rule 65 to 105(a) injunctions before the Second Circuit). The

majority of courts in this Circuit recognize that the analysis applied in other injunctive contexts

is not pertinent to section 105(a) requests. See, e.g., In re Adelphia Commc’ns Corp., 298 B.R.

49, 54 (S.D.N.Y. 2003) (Baer, J.); LTV Steel Co., Inc. v. Bd. of Educ. (In re Chateaugay Corp.),

93 B.R. 26, 29 (S.D.N.Y. 1988) (Leval, J.); Garrity v. Leffler (In re Neuman), 71 B.R. 567, 571–

72 (S.D.N.Y. 1987) (Sweet, J.); LaMonica v. N. of Eng. Protecting & Indemn. Ass’n (In re

Probulk Inc.), 407 B.R. 56, 63 (Bankr. S.D.N.Y. 2009); Lyondell Chem. Co. v. CenterPoint

Energy Gas Servs. Inc. (In re Lyondell Chem. Co.), 402 B.R. 571, 588 n.37 (Bankr. S.D.N.Y.

Court’s decision in Fischer v. American United Life Insurance Co., 314 U.S. 549 (1942), is likewise not to the contrary, and in fact, found that the district court properly exercised jurisdiction where the state court was not in possession of the property in question. 314 U.S. at 555. Here, where Merkin himself is not in receivership and his assets are not in possession of the state court, the Barton doctrine presents no obstacle to the injunctive relief sought by the Trustee.


26

2009); Keene Corp. v. Acstar Ins. Co. (In re Keene Corp.), 162 B.R. 935, 944 (Bankr.

S.D.N.Y.1994); E. Air Lines, Inc. v. Rolleston (In re Ionosphere Clubs, Inc.), 111 B.R. 423, 431

(Bankr. S.D.N.Y. 1990), aff’d in part,124 B.R. 635 (S.D.N.Y. 1991); C & J Clark Am., Inc. v.

Carol Ruth, Inc. (In re Wingspread Corp.), 92 B.R. 87, 92 (Bankr. S.D.N.Y. 1988).

The Second Circuit has recognized that “the legislative history of section 105 reflects

congressional intent that the section be similar in effect to the All Writs Act, 28 U.S.C. § 1651.”

Casse v. Key Bank N.A. (In re Casse), 198 F.3d 327, 336 (2d Cir. 1999) (internal quotation

marks and citations omitted.) It has also made clear that “Rule 65 does not apply to injunctions

issued under the All-Writs Act against non-parties whose actions would impair the court’s

jurisdiction.” In re Baldwin–United Corp., 770 F.2d 328, 339 (2d Cir. 1985).

Section 105(a) injunctions also are exempt from traditional Rule 65 requirements because

they are authorized by statute. See Neuman, 71 B.R. at 571; Chateaugay, 93 B.R. at 29;

Ionosphere, 111 B.R. at 431. In such circumstances, the court applies the statutory conditions

instead. See SEC v. Mgmt. Dynamics, Inc., 515 F.2d 801, 808–09 (2d Cir. 1975); Henderson v.

Burd, 133 F.2d 515, 517 (2d Cir. 1943); U.S. v. Broccolo, No. 06-CV-2812, 2006 WL 3690648,

at *1 (S.D.N.Y. Dec. 13, 2006).

Even where courts have considered Rule 65 factors, a threat to the bankruptcy court’s

jurisdiction or to a debtor’s reorganization is recognized as a “limited exception” to a showing of

irreparable harm, as the Injunction Defendants concede. (NYAG Br. 18.) However

characterized, courts agree that a bankruptcy court may enjoin third party proceedings if it finds

that such proceedings would “defeat or impair its jurisdiction with respect to a case before it.”

Chateaugay, 93 B.R. at 29; Neuman, 71 B.R. at 571; Malm v. Goldin, No. 92–Civ–8012 (LJF),

1993 WL 330489, at *3 (S.D.N.Y. Aug. 27, 1993); Maxam, 474 B.R. at 85; Ionosphere, 111


27

B.R. at 431; see also Probulk, 407 B.R. 56; In re Wingspread Corp., 92 B.R. 87; Apostolou, 155

F.3d 876; Kagan v. Saint Vincents Catholic Med. Ctrs. of N.Y. (In re Saint Vincents Catholic

Med. Ctrs. of N.Y.), 449 B.R. at 215‒16 (S.D.N.Y. 2011)17 In identical fashion, SIPA imbues the

operation of section 105(a) with a specific purpose: recovery and distribution of assets to

customers. The statute must be construed and applied so as to further, rather than defeat, this

purpose.

E. The Trustee’s Application Satisfies the Rule 65 Standards

In any case, Rule 65’s requirements are satisfied here. Under Rule 65, courts consider

the following factors: (1) whether plaintiff will suffer irreparable harm in the absence of the

relief requested; and (2) whether there is either (a) a likelihood of success on the merits or (b)

sufficiently serious questions going to the merits to make them a fair ground for litigation, with a

balance of the hardships tipping in favor of the moving party. Random House, Inc. v. Rosetta

Books LLC, 283 F.3d 490, 491 (2d Cir. 2002). The impingement on the bankruptcy court’s

jurisdiction over potential estate property, coupled with the imminent threat of substantial or

complete dissipation of the Merkin Defendants’ assets, constitutes irreparable harm. Similarly,

there is a likelihood that the Trustee will succeed on the merits, and the public interest (as

defined by Congress) and balance of hardships weigh heavily in the Trustee’s favor.

17 The Supreme Court’s decisions in Winter v. Natural Resources Defense Council, Inc., 555 US. 7 (2008), and eBay Inc. v. MercExchange, L.L.C., 547 U.S. 388 (2006), and the Second Circuit’s decision in Citigroup Global Markets, Inc. v. VCG Special Opportunities Master Fund Ltd., 598 F.3d 30 (2d Cir. 2010), relied on by the Merkin Defendants, are not to the contrary. (See Merkin Br. 17–18 n.10.) These cases do not involve injunctions against third-party actions that would impair a court’s jurisdiction. Likewise, Winter and eBay stand for the unremarkable principle that courts may not adopt more lenient or categorical interpretations of the traditional equitable factors concerning Rule 65 injunctions.


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1. Absent an Injunction, the BLMIS Estate Will Suffer Irreparable

Harm

(a) Dissipation of Assets Constitutes Irreparable Harm

Effectuating the Settlement will cause the Trustee irreparable harm because it will

(i) interfere with the Bankruptcy Court’s jurisdiction over the administration of the estate, and

(ii) preclude the equitable distribution of estate property pursuant to SIPA. See Picard v. Stahl,

443 B.R. 295, 318-20 (Bankr. S.D.N.Y. 2011); Adelphia Commc’ns Corp. v. Am. Channel, LLC

(In re Adelphia Commc’ns Corp.), No. 06-10528; 2006 WL 1529357, at *5 (Bankr. S.D.N.Y.

June 5, 2006) (“infringement on this Court’s jurisdiction constitutes irreparable harm”). The

Settlement would also allow parties without direct customer claims to recover ahead of statutory

customers and could allow for “double recoveries” because the Merkin Funds’ investors are the

ultimate beneficiaries of customer claims filed by the Merkin Funds. It would also inequitably

benefit primarily residents of New York State, where most of the Merkin Funds’ investors reside.

This alone constitutes irreparable harm. See Stahl, 443 B.R. at 318 n.24 (“The Third Party

Actions threaten irreparable harm to the estate by seeking potentially preferential and double

recoveries from the same limited pool targeted by the Trustee in his avoidance actions”).

In this Circuit, bankruptcy courts have routinely found “irreparable harm” where, as here,

the third party action interferes with recovery of assets by the estate. See, e.g., In re United

Health Care Org., 210 B.R. 228, 233–34 (S.D.N.Y. 1997) (third-party claims against debtor’s

non-debtor officers posed threat to officers’ ability to obtain liquid assets to fund settlement

agreement and hence constituted irreparable harm to the estate); Probulk, 407 B.R. at 63

(termination of insurance that would possibly cause loss of debtor’s vessels constituted

irreparable harm); In re Lines, 81 B.R. 267, 270 (Bankr. S.D.N.Y. 1988) (“the premature piecing

out of property involved in a foreign liquidation proceeding constitutes irreparable injury”);


29

Johns-Manville Corp. v. Asbestos Litig. Grp. (In re Johns-Manville Corp.), 26 B.R. 420, 436

(Bankr. S.D.N.Y. 1983), aff’d, 40 B.R. 219 (S.D.N.Y.), vacated on other grounds, 41 B.R. 926

(S.D.N.Y. 1984) (“Pursuant to § 105(a), the Bankruptcy Court may extend the automatic stay

under § 362 of the Code and enjoin proceedings or acts against non-debtors where such actions

would interfere with, deplete or adversely affect property of Manville’s estates . . . .”).

Here, effectuation of the Settlement would substantially dissipate the Merkin Defendants’

limited assets, to the detriment of BLMIS customers. This threat to the bankruptcy court’s

jurisdiction and the administration of the estate constitutes irreparable harm.18

(b) The Merkin Defendants’ Arguments to the Contrary Are

Premised on Demonstrably False Assumptions

The Merkin Defendants argue that the Trustee will be unable to establish irreparable

harm based on calculations suggesting that any recovery the Trustee obtains in the Merkin

Litigation will be offset by the Merkin Funds’ SIPA claims and distributions on such claims.

(Merkin Br. 18–20.) This argument is based on a number of mistaken assumptions.

First, the Merkin Defendants incorrectly assume that the customer claims filed by the

Merkin Funds in the BLMIS liquidation will be allowed and that any payments made by the

18 The cases cited by Defendants provide them no support. Freedom Holding, Inc. v. Spitzer, 408 F.3d 112 (2d Cir. 2005), addressed whether a requirement under New York state law that cigarette importers to make annual payments to states pursuant to a settlement of multi-state tort litigation constituted irreparable harm. Jackson Dairy, Inc. v. H.P. Hood & Sons, Inc., 596 F.2d 70 (2d Cir. 1979), addressed whether money damages constituted adequate compensation for an alleged breach of an exclusive distributorship agreement. Hudson Tire Mart, Inc. v. Aetna

Casualty & Surety Co., 518 F.2d 671 (2d Cir. 1975), addressed whether money damages adequately compensated a corporation for discovery under a cooperation clause in a fire insurance policy. Likewise, in Fisher v. Hamilton (In re Teknek LLC), 343 B.R. 850, 868, 872 (Bankr. N.D. Ill. 2006), defendant was a solvent going concern and the court found that there was no evidence that the assets in question were at risk. None of these cases has any bearing on the issue here: whether the risk that the Settlement will dissipate limited assets that are potential property of the estate constitutes irreparable harm to the BLMIS bankruptcy estate.


30

Merkin Funds to satisfy the Trustee’s fraudulent transfer claims would be added to the Merkin

Funds’ customer claims. Defendants contend that this calculation should be used to determine

the risk of the Trustee’s eventual judgment not being satisfied. This is incorrect because the

Trustee has alleged that the Merkin Defendants knew or should have known of fraud at BLMIS,

that Merkin directed the investments of the Merkin Funds into BLMIS, and that Merkin, as

general partner of Ascot (which is insolvent), is liable for improper transfers to Ascot.

(Complaint ¶¶ 2, 3, 34, 37, 43, 44.) The Trustee has further alleged that BLMIS did not receive

fair consideration for the fraudulent transfers to the Merkin Funds, and that the Merkin Funds did

not provide true value to BLMIS. (Id. ¶¶ 74, 86, 91, 96.) Under these circumstances, the Merkin

Funds are not entitled to any payment on their claims.19

Second, this Court’s recent decision upholding section 502(d)’s application in this SIPA

proceeding permits the Trustee to disallow the Merkin Defendants’ claims until the Trustee’s

action against them is resolved. See Sec. Investor Prot. Corp. v. Bernard L. Madoff Inv. Sec.

LLC, 12 Misc. 115, 2013 WL 67605 (S.D.N.Y. Jan. 4, 2013). In other words, the Merkin

Defendants are improperly according themselves a dollar for dollar offset of their fraudulent

19 Simply because a claimant fits within the four corners of the definition of “customer” does not mean that he will be entitled to the benefits of customer status. See SEC v. F.O. Baroff Co., 497 F.2d 280, 282 (2d Cir. 1974) (although claimant fell within the literal meaning of customer, he was not entitled to customer status because it was contrary to patent legislative purpose.) Specifically, SIPA was only intended to protect the innocent investor. “One who engages in a fraudulent transaction cannot reap the benefits of the Act’s intended protection.” Packer, Wilbur

& Co., 498 F.2d at 984; SEC v. N. Am. Planning Corp., No. 72 Civ. 3158, 1975 U.S. Dist. LEXIS 14183, at *6 (S.D.N.Y. Jan. 24, 1975); Mishkin v. Siclari (In re Adler, Coleman Clearing

Corp.), 277 B.R. 520, 558 (Bankr. S.D.N.Y. 2002) (providing assistance under SIPA to anyone other than an innocent investor “‘would be a gratuitous, indeed, counterproductive gesture”) (quoting Packer, Wilbur & Co., 498 F.2d at 985.) Furthermore, to the extent any claim is allowed, the Trustee may seek to equitably subordinate that claim pursuant to Bankruptcy Code section 510(c).


31

transfer liability based on claims that are presently disallowed and may never be allowed if the

Merkin Defendants fail to pay the judgment that the Trustee recovers at trial.

Third, any prepetition claims that the Merkin Defendants could assert against the estate

cannot, as a matter of law, provide them with a setoff of that “debt” against the Trustee’s

fraudulent transfer claims. See Hasset v. Far West Fed. Sav. & Loan (In re OPM Leasing

Servs., Inc.), 40 B.R. 390, 402 (Bankr. S.D.N.Y.), aff’d, 44 B.R. 1023 (S.D.N.Y. 1984); Geron v.

Schulman (In re Manshul Constr. Corp.), 2000 WL 1228866, at *56–57 (S.D.N.Y. Aug. 30,

2000); Kramer v. Sooklall (In re Singh), 434 B.R. 298, 308 (Bankr. E.D.N.Y. 2010).

Finally, the Merkin Defendants are not entitled to any claim under section 502(h) that

could reduce their fraudulent transfer liability. To the extent applicable here at all, a potential

future section 502(h) claim is just that—a potential future claim—which is irrelevant in

evaluating irreparable harm to the BLMIS estate because the claim does not presently exist. See

11 U.S.C. § 502(h) (claim under § 502(h) accrues after, rather than before or even during, a

successful avoidance action, and such claim, pursuant to 11 U.S.C. § 502(d), does not even

accrue until property is actually recovered by avoidance action plaintiff pursuant to § 550). In

any event, any such section 502(h) claim would be treated as a prepetition claim, which—

again—cannot be used as an offset against liability to the Trustee as a transferee of a fraudulent

transfer.20 See id.; In re Best Prods. Co., 168 B.R. 35, 58 (Bankr. S.D.N.Y. 1994).

20 The Merkin Defendants also suggest that, to the extent the Trustee obtains a judgment against the Merkin Funds and such a judgment is satisfied, he cannot seek recovery from Merkin as a general partner of the Ascot Fund or as a subsequent transferee of transfers to the Merkin Funds. (Merkin Br. 18–19.) Given that the Merkin Funds are in receivership, and that the Ascot Fund—against which the Trustee has asserted hundreds of millions of dollars in liability—is effectively insolvent, any judgment the Trustee receives is highly unlikely to be satisfied without seeking recovery from Merkin himself.


32

2. The Trustee Has Established a Likelihood of Success on the Merits

As the district court held in Lautenberg, “there is a substantial ‘likelihood of success on

the merits’ of the Trustee’s claims for relief on the bases that the Third Party Actions violate the

automatic stay and interfere with the administration of the estate.” Lautenberg, 443 B.R. at 318

n.24.

Contrary to Defendants’ claims, the Trustee need not also show a likelihood of success

on his underlying avoidance action against the Merkin Defendants. Where courts have applied a

Rule 65 analysis, they have considered the likelihood of success on the injunction application,

not related adversary proceedings commenced by the trustee. See Probulk, 407 B.R. at 63;

Ionosphere, 111 B.R. at 431–37; In re Reliance Acceptance Grp., Inc., 235 B.R. 548, 553–63 (D.

Del. 1999) (looking to estate’s probability of success on merits of its claim seeking declaratory

judgment that shareholder-plaintiffs’ claims violate the automatic stay and for a preliminary

injunction). A section 105(a) injunction serves to protect the bankruptcy court’s jurisdiction and

preserve the bankruptcy estate.21 This approach is wholly consistent with the Code’s text,

structure, and purpose. Begier, 496 U.S. at 58 (the Code’s central policy is the equitable

distribution of a debtor’s assets among its creditors); Katchen v. Landy, 382 U.S. 323, 328–29

(1966) (another objective of the Code is to accomplish a prompt and efficient administration of

the bankruptcy estate).

21 Defendants mistakenly rely on FPSDA v. Larin (In re FPSDA), No. 12-08032, 2012 WL 6681794 (Bankr. E.D.N.Y. Dec. 21, 2012). In that case, the court considered the likelihood of success in the action seeking an injunction, not in the related action. Id. at *7. The other cases relied upon by Defendants are similarly unavailing. In In re Commonwealth Oil Refining Co., 805 F.2d 1175 (5th Cir. 1985), the Fifth Circuit observed that the party seeking the injunction had conceded that there was no likelihood of success on the merits of the underlying action but did not discuss whether such a finding was necessary.


33

Regardless, the Trustee has demonstrated that he is likely to prevail in his proceeding

against the Merkin Defendants or, at a minimum, has demonstrated serious questions going to

the merits, making them fair grounds for litigation.22 As set forth at length above, the amount

and dates of the transfers from BLMIS to the Merkin Defendants are not disputed. The

transferred funds constitute potential estate assets and should be returned. The issue is whether

the Merkin Defendants lacked good faith in their receipt of the transfers. The Trustee submits

that the Merkin Defendants not only had warnings of fraud, but knew that Madoff was a fraud

and even a Ponzi scheme— —and yet continued to invest with Madoff.

This is actual knowledge or at a minimum, the very definition of willful blindness articulated by

this Court: a conscious, willful avoidance of facts that not only suggested a high probability of

fraud, but facts that confirmed a fraud. See Picard v. Katz, 462 B.R. at 454–55.23 Accordingly,

the Trustee has sufficiently demonstrated likelihood of success on the merits.

3. The Public Interest and Balance of Hardships Favor the Trustee

The public interest favors the Trustee for the same reasons the Defendants’ claims are

pre-empted. Congress has already decided that it is in the public interest to recover assets and

return them to a statutorily-defined group of “customers” through a SIPA proceeding.

Defendants maintain that the public interest is served by the Settlement because it facilitates

22 As the Trustee has shown likelihood of success on the merits of the claim, he has a fortiori shown that there are “‘serious questions’ going to the merits [and] that ‘the balance of hardships tips decidedly’” in the Trustee’s favor. Random House, 283 F.3d at 491; Berkman v. Rust Craft

Greeting Cards, Inc., 454 F. Supp. 787, 794 (S.D.N.Y. 1978).

23 The Merkin Defendants’ cases do not support their contention that Merkin’s personal holdings with BLMIS somehow evidence his good faith. (Merkin Br. 15.) Instead, those cases merely stand for the proposition that the pattern of an insider’s sales and purchases of stock is only a part of the scienter analysis. See Ressler v. Liz Claiborne, Inc., 75 F. Supp. 2d 43, 59–60 (E.D.N.Y. 1999) (“large proceeds alone are not suspicious per se, . . . and other relevant facts may undermine any inference of fraud arising from them”).


34

enforcement of New York State regulatory law, permits the Defendants to obtain a consensual

resolution of their disputes, and enables the Receivers to liquidate the Merkin Funds. (NYAG

Br. 18; Merkin Br. 21–22.) But the NYAG is not acting in a regulatory capacity; instead, he

seeks to vindicate the private interests of a select group of investors—most residing in New

York—and to divert millions of dollars of Settlement money into New York State’s coffers. (See

Tr. Op. Br. 27–31.) That result is perfectly incompatible with what Congress identified as the

public interest: protecting the assets of statutory customers by putting them at the front of the line

in the liquidation of a collapsed brokerage.

That purpose also speaks to the balance of harms. As Defendants concede, the Merkin

Funds and (indirectly) their investors are beneficiaries of the Trustee’s recovery efforts. Sec.

Investor Prot. Corp. v. Bernard L. Madoff Inv. Sec. LLC (In re Madoff), 454 B.R. 285 (Bankr.

S.D.N.Y. 2011); see also Schwartz Dec. ¶13 (stating that Mr. Schwartz has represented to

investors that they stand to benefit when the Merkin Funds’ customer claims are resolved).

Indeed, the NYAG maintains that investors who would benefit from the Settlement “are likely to

receive additional payments at a future date when the Madoff Estate is able to distribute moneys

recovered by Irving Picard.” (Powers Dec., Ex. A.) BLMIS customers, however, would not

share in the proceeds of the Settlement; to the contrary, the pool of funds available to make them

whole would be permanently dissipated.

Nor does the injunctive relief sought by the Trustee in any manner impede the Receivers

from liquidating the Merkin Funds, as Defendants suggest. The Receivers have been liquidating,

and are continuing to liquidate, assets of the Funds not related to their investments in BLMIS,

and making distributions to the Funds’ investors from the liquidation of such non-Madoff


35

investments under the auspices of the Trustee and the bankruptcy court. (See Schwartz Dec.

¶ 8.) The injunctive relief will not alter this process in any manner.

IV. DEFENDANTS’ EQUITABLE ARGUMENTS ARE WITHOUT MERIT

Defendants argue that the Trustee was both too early and too late to protect against the

dissipation of the Merkin Defendants’ assets, contending, on the one hand, that such applications

cannot be brought until a trustee succeeds in an avoidance action, (NYAG Br. 8‒11), and that on

the other hand, the Trustee’s Application should be denied on the basis of laches, waiver and

equitable estoppel, because he moved too late for the enforcement of the automatic stay and

issuance of an injunction. (NYAG Br. 2, 19‒22; Merkin Br. 2.) Both arguments are wrong.

Laches and equitable estoppel are similar doctrines under which a party is estopped from

taking a certain action if that party made a material misrepresentation that was relied upon by

another party, who was damaged as a result. See, e.g., Gazes v. DeArakie (In re DeArakie), 199

B.R. 821, 827–28 (Bankr. S.D.N.Y. 1992). Waiver is an equitable doctrine pursuant to which a

party may give up its right to relief if it intentionally relinquishes that right. Hamilton v. Atlas

Turner, Inc., 197 F.3d 58, 61 (2d Cir. 1999). None of these equitable arguments carry any

weight in these circumstances.

Defendants were always aware of the probability of an injunction. Trustee’s counsel

notified the NYAG’s counsel as early as November 2009 of the Trustee’s position that the

NYAG’s action violated the automatic stay and that he would seek to enjoin the action against

Merkin. (Sheehan Dec., Exs. C, D). The NYAG conceded at oral argument on the motion to

withdraw the reference that, based on meetings with the Trustee in 2009, the NYAG was aware

of the Trustee’s intent to seek to enjoin the NYAG Action and the Settlement, if needed, and that

they proceeded at their peril absent a global settlement. (See Sheehan Dec., Ex. A at 10:21–25,

11:1–11.)


36

Prior to June 2012, the Trustee had good reason to believe that there was no imminent

threat of dissipation of assets or need to seek injunctive relief.

(See Sealed

Sheehan Dec. ¶ 4.)

(Powers Dec., Ex. A;

Sealed Sheehan Dec. ¶ 4.) No imminent threat to the estate existed until the Settlement was

reached,24 and there is no factual basis for Defendants’ equitable arguments.25

24 The NYAG urges that the Trustee’s decision to decline to seek to enjoin payments of judgments to certain third-party actions and arbitrations shows that the Trustee failed to promptly vindicate its rights. As set forth in the Trustee’s opening pages, he has reserved his rights with respect to these actions. (Tr. Op. Br. 4 n.2.)

25 The Second Circuit case cited by Defendants, Merrill Lynch Inv. Managers v. Optibase, Ltd.,

337 F.3d 125 (2d Cir. 2003), in fact, supports the Trustee. In Merrill, the Circuit Court affirmed a preliminary injunction on a finding that laches did not apply where a party immediately notified the investor of its objection to arbitration after the investor filed its statement of claim, even though the party did not seek the injunction until later. This is the case here, where the Trustee first notified the NYAG of its intent to seek injunctive relief promptly after the NYAG’s complaint against the Merkin Defendants was filed. Other cases cited by the defendants are inapposite because, unlike in Merrill and the instant case, the party against whom laches was being asserted had taken no action whatsoever to protect its rights prior to seeking to enforce the automatic stay. See Matthew v. Rosene, 739 F.2d 249, 251 (7th Cir. 1984); In re Lee, 465 B.R. 469, 470–71 (Bankr. W.D. Ky. 2012); Adams v. Hartconn Assocs., Inc. (In re Adams), 212 B.R. 703, 712 (Bankr. D. Mass. 1997).



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