When the Bezzle Bursts: Restitutionary Distribution of Assets After Ponzi Schemes Enter Bankruptcy
When the Bezzle Bursts: Restitutionary Distribution of Assets After Ponzi Schemes Enter Bankruptcy
Mallory A. Sullivan 0
0 -John Kenneth Galbraith , The Great Crash
To the economist embezzlement is the most interesting of crimes. Alone among the various forms of larceny it has a time parameter. Weeks, months, or years may elapse between the commission of the crime and its discovery. (This is a period, incidentally, when the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss. There is a net increase in psychic wealth.) At any given time there exists an inventory of undiscovered embezzlement inor more precisely not in-the country's business and banks. This inventory-it should perhaps be called the bezzle-amounts at any moment to many millions of dollars. It also varies in size with the business cycle. In good times people are . . . trusting  and money is plentiful[, b]ut . . . there are always many people who need more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression all this is reversed. . . . Commercial morality is enormously improved. The bezzle shrinks. . . . Just as the boom accelerate[s] the rate of growth, so the crash enormously advance[s] the rate of discovery. . . . One of the uses of depression is the exposure of what auditors fail to find. Bagehot once observed: "Every great crisis reveals the excessive speculations of many houses which no one before suspected." ∗ Candidate for J.D., Washington and Lee University School of Law, May 2012; B.S. Wake Forest University, 2009. I would like to thank Professor Doug Rendleman for introducing me to this topic, serving as my advisor, and helping shape and guide my writing throughout the drafting process. I also would like to express my gratitude to Professor Margaret Howard for sharing her insights on the Bankruptcy Code and for her assistance in polishing my multiple drafts. 1. JOHN KENNETH GALBRAITH, THE GREAT CRASH 137-40 (Houghton Mifflin Co. 3d ed. 1972) (1954).
I. Introduction ................................................................................ 1590
Surprising to all, but perhaps those familiar with Galbraith’s critique
of the 1929 stock market crash, the 2008 banking crisis revealed prolific
investment fraud. Among those exposed was "a former chairman of the
NASDAQ Stock Market and a force in Wall Street trading for nearly 50
years," Bernard L. "Bernie" Madoff, who was thought to have a sterling
reputation.2 In today’s market, financial fraud is increasingly
2. See Amir Efrati, Tom Lauricella & Dionne Searcey, Top Broker Accused of $50
Billion Fraud, WALL ST. J., Dec. 12, 2008, at A1, available at
http://online.wsj.com/article/SB122903010173099377.html (noting that prior to his arrest,
prevalent,3 and just as Galbraith foreshadowed, fraudulent financial
schemes are collapsing more frequently given the current economy.4 Ponzi
schemes5 are no exception. According to the Associated Press, the number
of Ponzi schemes uncovered nearly quadrupled from 2008 to 2009 alone.6
Though the Securities and Exchange Commission (SEC) denies that there
has been a "dramatic upswing in terms of the number of [Ponzi scheme]
cases,"7 the agency’s deputy director of public affairs, John Heine, admits
that the SEC does not keep official statistics on Ponzi schemes.8 Instead,
Madoff was a "longstanding leader in the financial-services industry with an unblemished
3. See Page Perry LLC, Financial Scams Are Becoming More Common as the
Economy Deteriorates, INVESTMENT FRAUD LEGAL BLOG (Apr. 13, 2009), http://www.
Aug. 8, 2011)
("The Federal Bureau of Investigation reported that corporate fraud more than
doubled from 279 cases in 2003 to 529 in 2007 . . . . The financial frauds include various
forms of theft, such as Ponzi Schemes and embezzlement.") (on file with the Washington and
Lee Law Review).
4. See id. ("The down market ‘exposes more of those frauds’ . . . ."); David A.
Gradwohl & Karin Corbett, Equity Receiverships for Ponzi Schemes, 34 SETON HALL LEGIS.
J. 181, 189 (2010) ("With Madoff, the engine of fraud churned on until the collapse of the
securities markets caused new investors to stop feeding the scheme and made it impossible
for Madoff to continue.").
5. Gradwohl & Corbett, supra note 4, at 183–84 ("The term ‘Ponzi scheme’ has
achieved an established position of instant recognition in American jurisprudence and a
certain degree of infamy in everyday English parlance."). The term "Ponzi scheme" is
derived from Charles Ponzi, the operator of a fraudulent investment program, which
collapsed in the 1920s. See Cunningham v. Brown, 265 U.S. 1, 7–9 (1924) (discussing the
collapse of Ponzi’s fraudulent investment program). In the legal context, a Ponzi scheme is
defined by Black’s Law Dictionary as "[a] fraudulent investment scheme in which money
contributed by later investors generates artificially high dividends or returns for the original
investors, whose example attracts even larger investments. Money from the new investors is
used directly to repay or pay interest to earlier investors . . . ." BLACK’S LAW DICTIONARY
(9th ed. 2009).
6. See Gary D. Halbert, Record Year For Ponzi Schemes, INVESTOR INSIGHT (Jan. 19,
(last visited Aug. 8, 2011)
("According to recent research by
the Associated Press (AP) . . . more than 150 Ponzi and other fraudulent investment schemes
were exposed in 2009, compared to only 40 or so such scams uncovered in 2008.") (on file
with the Washington and Lee Law Review).
7. U.S. SEC Says Magnitude of Ponzi Schemes Growing, DALJE.COM (Feb. 6, 2009,
6:10 PM), http://dalje.com/en-economy/us-sec-says-magnitude-of-ponzi-schemes-growing/
(last visited Aug. 8, 2011)
(quoting a speech by Donald Hoerl, director of the SEC’s
Denver office, given at Practising Law Institute’s annual SEC Speaks conference) (on file
with the Washington and Lee Law Review).
8. See Robert Chew, Beyond Madoff, Ponzi Schemes Proliferate, TIME MAG. (Jan.
23, 2009), http://www.time.com/time/business/article/0,8599,1873639,00.html
Aug. 8, 2011)
(explaining that official statistics are not kept because "[t]here are too many
what SEC officials have observed as different is "the magnitude of the
Ponzi schemes" being perpetrated.9 While Madoff is certainly the most
notorious of the Ponzi scheme operators,10 other high dollar operations have
been discovered in his wake.11 Given the proliferation and growing
magnitude of Ponzi schemes, it is important that possible avenues of
investor recovery be examined.
This Note first examines the increasing prevalence of financial fraud
and the proliferation of Ponzi schemes. Part II outlines the possible ways
that investors can recover when investments are lost in a Ponzi scheme:
SIPC coverage, restitution from the wrongdoer, or through tracing and
restitution from unjustly enriched third parties. Part II also explains that
recovery is uncertain due to the limited protection offered by the SIPC, the
likely inadequacy of any financial recovery from the erring fiduciary, and
the lack of coherently-developed tracing and restitutionary law. Part III
further expounds upon tracing, a tool utilized to identify assets that can be
claimed by the creditors (former investors) of the erring fiduciary. It then
analyzes the utilization of tracing fictions and the necessity of suspending
tracing in favor of pro rata distribution when commingled funds render
individual tracing impossible. Part IV details the avoidance powers of the
bankruptcy trustee through fraudulent transfers, both actual and
constructive, and through preferential transfers. Part V contemplates the
variations . . . [i]t’s hard to categorize a Ponzi vs. a pyramid scheme vs. something else") (on
file with the Washington and Lee Law Review).
U.S. SEC Says Magnitude of Ponzi Schemes Growing, supra note 7.
10. See Gradwohl & Corbett, supra note 4, at 188 ("While the Ponzi scheme
engineered by Bernard L. Madoff Investment Securities LLC may end up being the largest
fraud in terms of dollars lost, it is not unique."); see also Danny King, JPMorgan Faces
Lawsuit over Madoff Fraud, DAILY FIN.
(Dec. 2, 2010, 6:30 PM)
(last visited Aug. 8, 2011)
(noting that Madoff’s $65 billion dollar fraud
was the largest Ponzi scheme in U.S. history) (on file with the Washington and Lee Law
11. In February 2009, the SEC charged Robert Allen Stanford with running an $8
billion fraudulent investment scheme. See U.S. Securities and Exchange Commission, Press
Release: SEC Charges R. Allen Stanford, Stanford International Bank for Multi-Billion
Dollar Investment Scheme (Feb. 17, 2009),
(last visited Aug. 8, 2011)
(detailing the charges against "Stanford and three of his
companies," which centered around his operation of an "$8 billion [fraudulent] CD
program") (on file with the Washington and Lee Law Review); see also Leslie Wayne,
Troubled Times Bring Mini-Madoffs to Light, N.Y. TIMES, Jan. 28, 2009, at B1, available at
(noting, among other Ponzi
schemes uncovered in 2009, a $380 million Ponzi scheme run by Nicholas Cosmo, a $23
million scheme run by George L. Theodule, and a $25 million scheme operated by James G.
shortcomings of the current statutory scheme of fraudulent and preferential
transfers. It considers how courts have misapplied the fraudulent transfers
statute as written by abrogating the good faith defense and how the
preferential transfer statute simply reallocates where an arbitrary line
regarding the ability to recover is drawn. Part V also looks at the discretion
given to the trustee and the resulting inequity and increased uncertainty in
Last, Part VI gives an overview of possible ways to promote
predictability in the law. It examines proposed legislation limiting
clawbacks and extending SIPC protection, the ability of Congress to amend
the fraudulent or preferential transfer statutes, and the introduction of
contractual clawback provisions into investment agreements. Part VI then
suggests an amalgam of the current proposals, in addition to other actions,
as a practicable solution. By allowing pro rata distribution only when
tracing is unworkable, traditional property and restitution rules will be
observed. By affirming a subjective good faith standard, and introducing
"change of position" as an affirmative defense from clawbacks, the
reachback period can be statutorily extended back to the inception of the
Ponzi scheme while still protecting good faith investors. The introduction
of pecuniary protection for whistleblowers promotes investor diligence and
makes frauds more likely to be caught in the earlier stages. These changes
will promote predictability in the distribution of assets after Ponzi schemes
enter bankruptcy while effectuating a more equitable distribution between
all investors, promoting the underlying equal-treatment goal of the
Bankruptcy Code, and upholding traditional restitutionary principles.
II. Avenues of Investor Recovery After Ponzi Schemes Enter Bankruptcy
A. SIPC Coverage
Ponzi schemes are rarely perpetrated by "legitimate" brokers, but in
Madoff’s case, he was a licensed broker, and his brokerage firm was a
member of the Securities Investor Protection Corporation (SIPC).12 The
SIPC touts itself as "the investor’s first line of defense in the event a
12. See Jerry J. Campos, Avoiding the Discretionary Function Rule in the Madoff
Case, 55 LOY. L. REV. 587, 591–92 (2009) (noting that Madoff’s firm, Bernard L. Madoff
Investment Securities LLC, "was a broker-dealer and investment advisor firm registered
under the SEC which conducted investment advising services, market making services, and
proprietary trading services").
brokerage firm fails owing customers cash and securities that are missing
from customer accounts," and investors assumed that the SIPC would step
in to cover part of their stolen funds.13
Through the Securities Investor Protection Act (15 U.S.C. §§
78aaalll),14 Congress created SIPC in 197015 as a "response to the financial crisis
in the securities industry in the late 1960s."16 The SIPC purports "to protect
customers of broker-dealers and maintain confidence in the United States
securities markets."17 It does not account for losses due to market
fluctuations or the decline in value of securities.18 Instead, its purpose is to
"insure brokerage firms just as the FDIC ensures bank accounts, but . . .
only against theft or misappropriation," bringing Madoff’s behavior exactly
within the confines of the SIPC’s intended purpose.19 The legislative
history of the Act and its subsequent amendments clarify that investors
were intended to be protected, even if the securities were "hypothecated,
misappropriated, never purchased, or even stolen . . . ."20
However, the SIPC does not cover all types of investments,21 nor does
it cover victims who invested indirectly through a feeder fund as they fail to
13. Securities Investor Protection Corporation, Our 39-Year Track Record for
(last visited Aug. 8, 2011)
with the Washington and Lee Law Review). The SIPC provides $500,000 in protection per
investor, which includes a $250,000 maximum allowance for cash claims. See Securities
Investor Protection Corporation, Brochure, http://www.sipc.org/how/brochure.cfm
visited Aug. 8, 2011)
(outlining the protection provided to customers) (on file with the
Washington and Lee Law Review).
WILLIAM L. NORTON, JR., 4 NORTON BANKR. L. & PRAC. 3D § 87:9 (2011).
17. See Sec. Investor Prot. Corp. v. BDO Seidman, L.L.P., 746 N.E.2d 1042, 1045
(N.Y. Ct. App. 2001) (holding that the SIPC did not have a valid cause of action for
negligent misrepresentation against accounting firm BDO Seidman because the SIPC was a
non-privy third party).
18. All Things Considered: SIPC May Rescue Madoff Victims, NPR, Dec. 31, 2008,
available at http://www.npr.org/templates/story/story.php?storyId=98913273 (explaining
that the SIPC does not "cover market risk or the simple decline of the value of securities").
S. REP. NO. 95-763, at 2 (1978); H.R. REP. NO. 95-746, at 21 (1978).
21. See Securities Investor Protection Corporation, What SIPC Covers . . . What it
Does Not, http://www.sipc.org/how/covers.cfm
(last visited Aug. 8, 2011)
(noting that the
SIPC does not cover currencies, commodity futures contracts, investment contracts, or fixed
annuity contracts that have not been registered with the SEC) (on file with the Washington
meet the definition of "customer" in section 78lll(2) of SIPA.22 Many of
Madoff’s victims do not qualify for reimbursement from the SIPC due to
regulatory restrictions, particularly the third party limitation.23 Even those
investors whose claims are accepted may only recover up to the modest
statutory limit, and only after agreeing to substantial conditions.24
The SIPC was severely underfunded to cover the losses resulting from
Madoff’s scheme25 and has limited claims to the amount actually invested,
not the amount shown on the victim’s most recent statement.26 This
approach, "referred to as the ‘net principal’ theory or the ‘equity theory,’
espouses the idea that the measure of bankruptcy claims should be a matter
of equity where illegal contracts or massive fraud [are] involved."27
and Lee Law Review). While individuals who invest in these exchanges certainly do not
expect their investments to fuel a Ponzi operation, such investors did not rely on SIPC
coverage and presumably were aware of and accepted the higher-risk nature of their
22. Trustee’s Fourth Interim Report for the Period Ending September 30, 2010, at 8,
Securities Investor Protection Corp. v. Madoff (In re Madoff), Adv. Pro. No. 08-1789 (BRL)
, available at http://www.madofftrustee.com/documents/FourthInterim
23. See Bernard L. Madoff Investment Securities LLC Liquidation Proceeding, Claims
& Recovery Status
(Aug. 9, 2011)
Aug. 9, 2011)
(noting that as of August 5, 2011, only 14.64% of claims had been approved
and 66.45% were denied as third party claims)
(on file with the Washington and Lee Law
24. See Campos, supra note 12, at 602 (noting that investors "are capped in what they
can receive from the organization and face a labyrinth of conditions and strictures on
actually getting money from the organization").
25. See Rachelle Younglai, Madoff Victims Seek Help from Congress, REUTERS (Dec.
9, 2009, 6:07 PM) http://www.reuters.com/article/idUSN0912808120091209
Aug. 8, 2011)
("SIPC is underfunded and has never had to deal with a liquidation the size of
Madoff’s brokerage.") (on file with the Washington and Lee Law Review); see also Fourth
Interim Report, supra note 22, at 11:
As of September 30, 2010, the Trustee . . . committed to pay approximately
$728 million in cash advances from SIPC. This is the largest commitment of
SIPC funds in any one SIPA liquidation proceeding and greatly exceeds the total
aggregate payments made in all SIPA liquidations to date. . . . The total
overthe-limits claim amount—the amount by which allowed customer claims exceed
the committed SIPC advances—is $4.9 billion.
26. See Younglai, supra note 25 (noting that the SIPC, SEC, and bankruptcy trustee all
agree that "customer claims should be based on how much money the victim invested, not
the amount the victim thought he had made from Madoff’s fictitious investments").
27. John Clemency & Scott Goldberg, Ponzi Schemes and Claims Allowance, 19-9
AM. BANKR. INST. J. 14, 14 (2000). On March 1, 2010, the bankruptcy court handling
Madoff’s liquidation adopted the Trustee’s determination that customer claims be calculated
using the "equity theory." In re Bernard L. Madoff Inv. Sec. LLC, 424 B.R. 122, 141, 143
However, prior to Madoff, the SIPC took the position that the appreciated
value of the investment was protected. The "reasonable and legitimate
claimant expectations on the filing date are controlling even where
inconsistent with transactional reality."28 The president of the SIPC, Steven
Harbeck, testified at a trial "that SIPC covers appreciation in customer
accounts . . . ‘even if the securities were never purchased.’"29 This change in
approach is particularly troublesome because a primary benefit of investing
with an SIPC certified broker is to be insured against malfeasance.30 The
SIPC-certified broker is also subject to regulation by the SEC, which should
prevent, and at a minimum catch, fraudulent schemes early.31 The SEC failed
investors on both counts, due to its underfunding and inability to cover losses,
as well as its failure to follow up on Madoff, despite receiving multiple
credible tips that his business venture was not legitimate.32 Consequently,
even investors who believed that they acted prudently by investing with a
licensed brokerage firm are minimally, if any, better off than those who
invest in programs outside of SIPC protection and SEC regulation.
Because the SIPC, the supposed "first line of defense," has failed to
make investors whole,33 defrauded victims have turned to restitutionary
remedies. Though restitution scholarship has, at least arguably, "been out of
fashion for nearly one hundred years,"34 its ability to adapt to contemporary
(Bankr. S.D.N.Y. 2010)
, aff’d, 09-5122-bk, 2011 WL 3568936
(2d Cir. Aug. 16, 2011)
("[E]quity dictates that the Court implement the Net Investment Method."). The bankruptcy
court certified an immediate appeal to the Second Circuit Court of Appeals. In re Bernard L.
Madoff Inv. Sec. LLC, 09-5122-bk, 2011 WL 3568936, at *4 (2d Cir. 2011). On August 16,
2011, the Second Circuit affirmed the decision of the bankruptcy court and upheld the
Trustee’s method of determining customer claims in the context of a Ponzi scheme. Id. at *8
("The extraordinary facts of this case make the Net Investment Method appropriate, whereas
in many instances, it would not be.").
Chaim Saiman, Restating Restitution: A Case of Contemporary Common Law
needs35 has placed restitutionary law at the forefront of recovering the
misappropriated funds that are making today’s headline news.36
B. Restitution from the Erring Fiduciary
Although the remedy of rescission37 is typically available in instances of
fraud,38 this does not hold true in the context of a bankrupt Ponzi scheme.39
Conceptualism, 52 VILL. L. REV. 487, 528 (2007).
Peter and Paul have both been victims of [an investment scheme] fraud. Because
he remitted funds to Ponzi just before the swindle was exposed, Peter is able to
trace his money into Ponzi’s bank account; Paul’s funds were remitted earlier
and are untraceable. Ponzi is now in bankruptcy and Peter wants restitution of
the traceable funds from the bankrupt estate. He offers the usual argument about
second-order restitution: Ponzi’s trustee should not be distributing Peter’s
property (the traceable portion of Peter’s investment, Peter having rescinded the
transfer for fraud) to pay Ponzi’s creditors. But Ponzi’s creditors are defrauded
investors just like Peter. Because Peter cannot properly differentiate his claim
against Ponzi from that of the other creditors, his claim to priority fails. . . . [I]n
the Ponzi scenario, neither Peter nor Paul has voluntarily extended credit to the
debtor. Both were defrauded; each asserts a right to rescind. Instead of a
problem in second-order restitution between a dispossessed owner and a creditor
of the transferee, the contest is between conflicting claims of ownership—that is
to say, between competing restitution claims. Between claimants similarly
situated, the equities of restitution (like the equities of bankruptcy) favor ratable
Nonetheless, it is fundamental that a "person who is unjustly enriched at
the expense of another is subject to liability in restitution."40 The right of
the individual creditors to recover from the wayward fiduciary is
indisputable.41 However, it is likely that the scheme collapsed due to
insufficient assets,42 and the typical "perpetrator lack[s] the financial
wherewithal to repay the victims of the scheme. . . . [T]he
[misappropriated] money dissipates for a variety of reasons."43 In
Madoff’s case, for example, his personal assets account for less than 5%
of the actual losses, and an even more trivial percentage of the paper
losses.44 Though investors are entitled to restitution from the erring
fiduciary, the insolvency of the scheme and its operator precludes
meaningful recovery and forces the former investors to pursue other
C. Restitution Through Tracing
The only viable remaining option available to defrauded creditors is
tracing,46 an option that is often misunderstood within the context of
restitutionary law.47 The lack of clarity is not surprising given the
40. RESTATEMENT (THIRD) OF RESTITUTION & UNJUST ENRICHMENT § 1 (2011).
41. See RESTATEMENT (FIRST) OF RESTITUTION § 1 (1937) ("A person who has been
unjustly enriched at the expense of another is required to make restitution to the other.").
42. See Mark A. McDermott, Ponzi Schemes and the Law of Fraudulent and
Preferential Transfers, 72 AM. BANKR. L.J. 157, 158 (1998) ("[I]t is not uncommon for the
estates of bankrupt Ponzi schemes to have very few physical or liquid assets."). For
example, Madoff was candid about his lack of financial resources when his scheme
unraveled, stating that his business had "absolutely nothing" in terms of assets. Bureau of
National Affairs, SEC, DOJ Charge Wall St. Veteran Over Multi-Billion Dollar Ponzi
Scheme, 40 SRLR 2049 (Dec. 15, 2008) ("Madoff said his business was insolvent and had
been so for years.").
Gradwohl & Corbett, supra note 4, at 205.
44. See Miriam A. Cherry & Jarrod Wong, Clawbacks: Prospective Contract
Measures in an Era of Excessive Executive Compensation and Ponzi Schemes, 94 MINN. L.
REV. 368, 394 (2009) ("[T]he shortfall is staggering given that authorities have located only
about $830 million in assets belonging to Madoff . . . .").
45. See id. at 395 ("[A]lthough the losing investors can turn to the courts to hold the
operator of the fraud accountable, they are often forced to look elsewhere because the
scheme and the operator are insolvent.").
46. BLACK’S LAW DICTIONARY (9th ed. 2009) (defining tracing as "[t]he process of
tracking property’s ownership or characteristics from the time of its origin to the present").
47. See ANDREW BURROWS & EWAN MCKENDRICK, CASES AND MATERIALS ON THE
LAW OF RESTITUTION 663 (1997) ("It is extremely difficult to pinpoint precisely what tracing
nuances (and resulting misapplication) of restitutionary law,48 as well as
the lack of scholarly attention restitutionary law receives as a whole.49
Judges and practitioners simply are not well versed in restitutionary law.50
The interplay between the common law of restitution and the statutory
law of bankruptcy is particularly cloudy; in the words of Andrew Kull, the
reporter for the American Law Institute’s (ALI) recently published
Restatement (Third) of Restitution & Unjust Enrichment: "The
contemporary treatment of restitution in bankruptcy has become confused
and haphazard because the subject is not addressed by the Bankruptcy
is concerned with and what its role is within the law of restitution.").
48. See Doug Rendleman, Restating Restitution: The Restatement Process and Its
Critics, 65 WASH. & LEE L. REV. 933, 936 (2008) ("Restitution is an essential and nuanced
common law area. But many smaller American states lack a decision on particular restitution
points. States, large and small, have muddled restitution analysis or have made just plain
incorrect restitution decisions. Many lawyers, judges, and professors misunderstand and
misstate basic restitution principles.").
50. Kull, supra note 39, at 267 ("Most law schools gave up teaching restitution a
generation ago, and many judges and practitioners are not familiar with its general principles.
Lack of familiarity with the restitutionary elements of the background rules results in a
predictable distortion of commercial law.").
Id. at 265–66. Kull further explains:
Scarcely anyone in the United States understands what restitution is about, to
begin with, and the particular role of restitution in bankruptcy is further obscured
by the way in which American commercial law has been codified. Unlike the
comprehensive framework of a continental legal code . . . the Bankruptcy Code
[was] drafted as [a] common-law statute. In theory, at least, [it] displace[s] the
preexisting common law only to the extent [it] alter[s] it, and [it] presume[s] the
continued existence of this background law to govern every question not otherwise
resolved. In practice it does not work quite like that. Lawyers and judges who
deal regularly with commercial materials come to expect that any problem worth
arguing about has been made the subject of an express statutory provision, their
usual task being to locate and explicate the relevant statutory language. In
consequence, the neglected background law recedes still further—until we reach a
point at which the most orthodox legal proposition, if not tied to a specific code
section, may actually be challenged as spurious.
Id. at 266–67.
Though tracing is described as both a tool52 and a remedy,53 it is best
understood as a restitutionary tool.54 Tracing comes into play when a
pyramid scheme enters bankruptcy (or an equivalent dissolution).55 A trustee
is appointed to collect assets.56 The assets available to be distributed to
investors are pinpointed and identified through tracing. Tracing allows the
defrauded investor to find, and thus recover, assets that are no longer held by
the wrongdoer and are now held by third parties. Once the assets are returned
to the estate, the court is given broad powers to rule on a plan of distribution,
subject only to the requirement that the court "use its discretion in a logical
way to divide the money."57 Though tracing is often suspended in favor of
pro rata distribution in Ponzi schemes,58 lower courts are given great
discretion in deciding whether to apportion funds based on tracing fictions59
or to distribute funds pro rata.60 The hands-off standard of review has led to a
52. See RESTATEMENT (THIRD) OF RESTITUTION & UNJUST ENRICHMENT § 58 cmt. a
(2011) ("Tracing is neither a source of liability nor a distinct restitutionary remedy. Rather,
tracing is an adjunct remedial device or technique . . . .").
53. See Dale A. Oesterle, Deficiencies of the Restitutionary Right to Trace
Misappropriated Property in Equity and in UCC § 9-306, 68 CORNELL L. REV. 172, 184 (1983)
("[T]racing is viewed as a remedy . . . implemented through a number of more specific
remedial devices . . . ."). It is worth noting that the amended Article 9 of the Uniform
Commercial Code no longer addresses tracing in § 9-306. See U.C.C. § 9-306 (2005). U.C.C.
§ 9-315(b)(2) does allow a secured party to trace proceeds "by a method of tracing, including
application of equitable principles, that is permitted under law other than this article." U.C.C.
§ 9-315 (2005).
54. See LIONEL D. SMITH, THE LAW OF TRACING 13 (Oxford University Press 1997)
("The distinction between tracing and claiming is obscured when tracing is referred to as a
‘right’ or ‘remedy.’ When the exercise of tracing is properly distinguished from the making of
claims, it is clear that the exercise of tracing is neither right nor remedy."); Peter Birks, Trusts
in the Recovery of Misapplied Assets: Tracing, Trusts, and Restitution, in COMMERCIAL
ASPECTS OF TRUSTS AND FIDUCIARY OBLIGATIONS 149, 157 (Ewan McKendrick ed., 1992)
("[T]racing should be understood as a process of identification and no more. It is not in itself a
remedy."); BURROWS & MCKENDRICK, supra note 47, at 664 ("[T]racing is a technique . . . it
follows that it is neither a ground for restitution nor a remedy.").
55. See Cramer & Pilmer, supra note 36, at 24 ("Failed Ponzi schemes often end up in
bankruptcy, SEC receivership, Securities Investor Protection Corporation (SIPC) liquidation, or
other formal dissolution proceedings. . . . Depending on the circumstances, the personal estates
of Ponzi operators and related business entities may file for liquidation in a bankruptcy or
through a receiver . . . .").
56. See id. ("Trustees and receivers share the same objective—namely, to return as much
money as possible to the victims of the scheme.").
Saiman, supra note 49, at 1011 (citations omitted).
58. See infra notes 94–118 and accompanying text (explaining the justifications for and
operation of pro rata distribution).
See infra notes 85–93 and accompanying text (discussing the use of tracing fictions).
See Saiman, supra note 49, at 1013 ("[A] number of [appealed] cases have expressed
lack of consistency in "cases pitting the interests of competing claimants to a
limited pool of assets."61 Due to the emphasis on the trial court’s equitable
powers to decide the proper remedy, developed case law is limited.62
Similarly, the power of the bankruptcy trustee to recover transfers to earlier
investors, and the defenses available to those earlier investors, continue to
develop and remain a source of confusion.63 In particular, recent
applications of the trustee’s avoidance power have been alleged to be
"grossly inequitable and inconsistent with existing . . . law."64 Because the
law is not settled,65 the bankruptcy court’s approval of the trustee’s formula
is often appealed, making the recovery process longer and more costly for
the victims of the fraud.
III. Tracing, Tracing Fictions, and Suspension of Tracing in Favor of
Ratable Distribution of Commingled Funds
When a pyramid scheme collapses and the operator "becomes a debtor
under the Bankruptcy Code, the bankruptcy trustee must collect whatever
assets are available in order to pay both the investors who lost money and
near-total agnosticism . . . candidly stating that the district court would be within its rights to
apportion the funds using either the ‘tracing fictions’ or pro rata method, so long as the net
result was reasonable.").
61. Id. at 1003.
Id. at 1013–14. As explained by Chaim Saiman:
[I]nstead of presenting arguments for specific distribution plans on the basis of
the law of restitution, [most] cases [regarding tracing and restitution] argue for a
hands-off standard of review. As a result, the analytic heavy lifting and virtually
all the citation of legal authorities relate to the law of the standard of review
rather than to the law of restitution. To the extent there is any "law" in these
cases, it is the law governing when a court is within its rights to exercise its
63. See Kathy Bazoian Phelps, Hon. Steven W. Rhodes, Brenda Moody Whinery &
Daniel R. Williams, Fraudulent Transfer Claims and Defenses in Ponzi Schemes, in
FRAUDULENT CONVEYANCE CLAIMS: OFFENSE AND DEFENSE, 091009 ABI-CLE 209
("[C]ourts are continuing to refine the rules which arise in unwinding these tangled financial
webs. In particular, the law regarding fraudulent transfer claims to recover funds paid by the
Ponzi debtor to investors as a return of principal or payment of fictitious profits and defenses
which can be asserted to those claims continue to evolve.").
65. See supra notes 49, 63 (explaining that this area of the law has historically been
unanalyzed and is still developing).
any other creditors of the estate."66 The assets available to be distributed to
investors are pinpointed and identified through tracing. Tracing is typically
suspended as between equally innocent investors in cases of commingled
funds,67 but to understand the reasons for and necessity of suspension, an
understanding of tracing and the development of the pertinent law is
Tracing is most easily understood in the context of constructive trusts
or equitable liens. Both are considered traditional equitable remedies to
prevent unjust enrichment.68 In the words of Justice Cardozo, "[a]
constructive trust is the formula through which the conscience of equity
finds expression."69 Under a constructive trust theory, the wrongdoer is
deemed to hold the absconded property "in trust" for the claimant.70 An
equitable lien secures the value of the misappropriated property by
attaching to property owned by the wrongdoer.71 Constructive trusts and
equitable liens "are similar in that they are available only when the plaintiff
can establish some connection between the benefit conferred and an
identifiable asset held by the defendant at the time restitution is sought."72
Often the claimant can choose which remedy to pursue:
Where a person wrongfully disposes of property of another knowing that
the disposition is wrongful and acquires in exchange other property, the
other is entitled at his option to enforce either (a) a constructive trust of
the property so acquired, or (b) an equitable lien upon it to secure his
claim for reimbursement from the wrongdoer.73
McDermott, supra note 42, at 158.
See infra notes 94–118 and accompanying text (discussing pro rata sharing).
68. Jeffrey Davis, Equitable Liens and Constructive Trusts in Bankruptcy: Judicial
Values and the Limits of Bankruptcy Distribution Policy, 41 FLA. L. REV. 1, 4 (1989)
("Constructive trusts and equitable liens are equitable remedies available to vindicate
69. Beatty v. Guggenheim Exploration Co., 122 N.E. 378, 380 (N.Y. 1919),
superseded by statute as stated in Israel v. Chabra, 906 N.E.2d 374, 378 (N.Y. 2009)
(holding that oral consent to waive or amend a contract gives protection to the agent and
acquits him of a breach of contract).
70. See RESTATEMENT (FIRST) OF RESTITUTION § 160 (1937) ("Where a person holding
title to property is subject to an equitable duty to convey it to another on the ground that he
would be unjustly enriched if he were permitted to retain it, a constructive trust arises.").
71. See id. § 161 ("Where property of one person can by a proceeding in equity be
reached by another as security for a claim on the ground that otherwise the former would be
unjustly enriched, an equitable lien arises.").
See Davis, supra note 68, at 4. 73. RESTATEMENT (FIRST) OF RESTITUTION § 202 (1937).
The remedies differ in that a constructive trust grants the plaintiff title to the
asset while an equitable lien only places a lien upon the asset.74 Though the
remedies vary in some significant respects, courts recognize their
similarities as equitable remedies,75 and the precise differences are not
important for this Note. For either remedy, to recover the asset, the
claimant must prove a restitutionary right and identify his rightful property
among the wrongdoer’s holdings.76 If the wrongdoer still holds the exact
property that was wrongfully taken from the claimant, specific
identification is easy and tracing is not necessary.77 Instead, the claimant
simply ascertains the current physical location of a tangible asset in a
process most aptly described as "following."78 However, this is rarely the
case as the wrongdoer is likely to have converted the asset or otherwise
disposed of it.79
Tracing is the substitution process80 that allows the claimant "to follow
his property through various forms and transactions and establish his
equitable claim."81 For example, the wrongdoer may have sold the
misappropriated property for cash. Proceeds of the sale identifiable in the
wrongdoer’s bank account belong to the claimant; the change in form is
immaterial.82 In these direct tracing situations, "[t]he claimant . . . is
effectively arguing that his ownership rights should be transferred to
74. See Davis, supra note 68, at 4 ("The difference between them is that imposition of
a constructive trust . . . gives the plaintiff title to the asset, whereas imposition of an
equitable lien merely gives the plaintiff a lien on the asset.").
75. See id. at 17 n.65 ("Some courts do not bother to characterize the claim as one or
the other, referring to the claim instead simply as an ‘equitable right.’").
See Davis, supra note 68, at 4.
77. See RESTATEMENT (THIRD) OF RESTITUTION & UNJUST ENRICHMENT § 58 cmt. a
(2011) ("[I]f A’s claim is that B obtained X from A by fraud, and A seeks specific restitution
of X via constructive trust, there is no need to ‘trace’ if A can still identify X in B’s
78. SMITH, supra note 54, at 6; see also Robert Chambers, Tracing and Unjust
Enrichment, in UNDERSTANDING UNJUST ENRICHMENT 263, 263 (Jason W. Neyers et al. eds.,
2004) ("We follow assets, trace value, and claim rights.").
79. See supra notes 42–45 and accompanying text (explaining that misappropriated
assets are exhausted for a number of reasons).
SMITH, supra note 54, at 6 ("[T]he context of tracing is substitution.").
property that has been substituted for his property, or is the product of his
property."83 Simply put, "[t]racing is the process of tracking the location of
value when one asset is exchanged for another."84
Presumptive tracing, also known as tracing fictions,85 comes into play
when "indistinguishable property is combined in an undifferentiated mass
or fund (as when money belonging to two people is deposited in the same
bank account)."86 Because of the fungible nature of the property "it may be
impossible to specify the ownership of any particular asset within the fund,
or of an asset acquired with withdrawals from the fund, except by [tracing]
rules designed to answer these questions."87 In this scenario, all
presumptions are drawn in favor of the innocent investor as against the
wrongdoer. If the wrongdoer simply deposited the money in a personal
bank account, the victim will recover the full amount.88
Recipient wrongfully takes $100 belonging to Claimant and uses it to
open an account with Bank. Recipient then deposits $200 of his own in
the same account. There are no other transactions in the account. After
Recipient’s wrongdoing comes to light, Bank attempts to set off the
$300 balance of the account against Recipient’s unsecured debt to Bank.
Claimant is entitled to payment of $100 from the account in priority to
If the wrongdoer removed any money, it is presumed that the wrongdoer
withdrew his own funds prior to the funds of the victim.90
83. Rosa, supra note 81, at 1342.
Chambers, supra note 78, at 263.
85. See RESTATEMENT (THIRD) OF RESTITUTION & UNJUST ENRICHMENT § 59 cmt. b
(2011) ("The rules for tracing through a commingled fund are often called ‘tracing
fictions’ . . . .").
87. Id.; see also SMITH, supra note 54, at 1 ("[T]racing should be regulated by
principles which make sense, and which are supported not just by reason of authority, but by
the authority of reason. It should not be regulated by irrational fictions.").
88. See RESTATEMENT (THIRD) OF RESTITUTION & UNJUST ENRICHMENT § 59 cmt. c
(2011) ("The traceable product of the claimant’s assets is readily identifiable in the fund
itself, or in property acquired with the whole of a commingled fund, if there are no
intermediate transactions and (consequently) no need for a rule to determine whose money is
89. Id. illus. 1.
90. See id. § 59(2)(a) ("If property of the claimant has been commingled by a recipient
who is a conscious wrongdoer or a defaulting fiduciary (§ 51) or significantly at fault in
dealing with the claimant’s property (§ 52): (a) Withdrawals that yield a traceable product
and withdrawals that are dissipated are marshaled so far as possible in favor of the
Acting without authorization, Recipient deposits $1000 of Claimant’s
funds in a bank account that already contains $1000 of Recipient’s
funds. Recipient later withdraws $1500 from the account, using this
money for current expenditures. Claimant is entitled to recover the $500
remaining in the account via constructive trust or equitable lien, and
Claimant has an unsecured claim for the balance of the misappropriated
If there are multiple subsequent withdrawals and deposits, the victim’s
claim is limited to the lowest intermediate balance.92
On July 1, acting without authorization, Recipient deposits $1000 of
Claimant’s funds in a bank account that already contains $1000 of
Recipient’s funds. Recipient files for bankruptcy on December 31;
Claimant seeks restitution from the traceable product of his $1000 in
Recipient’s bankruptcy estate. Between July 1 and December 31,
Recipient has made numerous withdrawals from the bank account and
numerous deposits of his own funds; the final balance in the hands of
the bankruptcy trustee is $3000. Because Claimant is unable to identify
the product of any of the withdrawals, Claimant seeks to identify some
portion of this $3000 as the product of his initial $1000. From July 1 to
December 31, the balance of Recipient’s account fluctuated between a
high of $5000 and a low of $200. The bankruptcy trustee holds $200 of
the account in constructive trust for Claimant, and Claimant has an
unsecured claim in restitution for $800.93
Although tracing works when there are limited claimants, in Ponzi
schemes, where the funds of many victims are comingled, individual
tracing often becomes impossible.94 This problem was recognized at
common law, when multiple claimants could follow their asset into a
91. Id. illus. 4.
92. See id. at § 59(2)(b)–(c) ("Subsequent contributions by the recipient do not restore
property previously misappropriated from the claimant . . . . After one or more withdrawals
from a commingled fund, the portion of the remainder that may be identified as the traceable
product of the claimant’s property may not exceed the fund’s lowest intermediate balance.").
93. Id. illus. 10.
94. See id. § 59 (explaining that tracing rules are unequipped to deal with massive
fraud); Thomas R. Cox, Robert J. Morad & Clarence L. Pozza, Jr., A Review of Recent
Investor Issues in the Madoff, Stanford and Forte Ponzi Scheme Cases, 10 J. BUS. & SEC. L.
113, 130 (2010) ("The legal principles often utilized in the Ponzi scheme cases were not
originally developed to address Ponzi scheme victim fairness issues and create somewhat
extreme arguments and results.").
mixture, but the exact items belonging to each were unidentifiable.95
Because each claimant had a commensurate right to follow into the mixture,
but the assets were insufficient to satisfy fully the claims and the claimants
could not identify their specific assets, the rule became "where there has
been a diminution of the mixture, the loss will be born by the contributors
in proportion to their contribution."96 Similarly, under Section 59 of the
Restatement (Third) of Restitution & Unjust Enrichment, if "the court
[cannot] distinguish the interests of multiple restitution claimants by
reference to actual transactions, such claimants recover ratably from the
fund and any product thereof in proportion to their respective losses."97
Charles Ponzi persuades thousands of victims to entrust their savings to
him by issuing promissory notes, redeemable in 90 days at $150 for
each $100 invested. Notes presented for payment are redeemed with the
proceeds of the notes subsequently issued. During the eight-month life
of the scheme, from December to August, Ponzi issues $15 million in
promissory notes at an aggregate price of $10 million . . . . Ponzi has no
income apart from the sale of the notes, and he is at all relevant times
insolvent. Disclosure of the fraud on August 1 provokes a panic. At the
close of business on this date Ponzi’s bank balance . . . stands at $6
million. . . . Notes presented are redeemed at par until August 9, when
Ponzi’s account is overdrawn, leaving another $5 million in notes
unpaid. Braving the crowds in the streets, certain fraud victims (the
‘Diligent Creditors’) manage to obtain payment of their notes on August
4, when the balance of Ponzi’s account—although rapidly declining—
remains positive. In the ensuing bankruptcy proceedings, Ponzi’s
Trustee seeks restitution of the payments made to Diligent Creditors on
the grounds that they constituted an unlawful preference. . . . Instead,
Diligent Creditors defend on the ground that they obtained payment on
August 4 as a result of their own rescission for Ponzi’s fraud (§§ 13,
54). On this reasoning they were not paid as creditors from Ponzi’s
assets: rather they reclaimed, identified, and retook their own money,
which they identified by the tracing rules of § 59(2). The argument fails
to recognize that the relevant dispute over priority is not between
Diligent Creditors and Ponzi, but rather between Diligent Creditors and
competing restitution claimants whose equitable position is identical to
their own. The presumptions of § 59(2) do not serve to distinguish the
95. See SMITH, supra note 54, at 70–72 ("The principles are invoked whenever there is
no practicable way to determine who contributed what.").
96. Id. at 73.
97. RESTATEMENT (THIRD) OF RESTITUTION & UNJUST ENRICHMENT § 59 (2011).
interests of the fraud victims inter se. Holders of notes outstanding on
August 1 share ratably in Ponzi’s closing balance on that date.98
In these situations, the individual victimized investors are pitted against one
another—not against the erring fiduciary—to recover their investments.
This is problematic because the Ponzi scheme operator, not the co-victims,
acted wrongfully. Any remedy imposed should be against the wrongdoer.99
However, the investors are competing over a limited fund that is
insufficient to satisfy all their claims. In practice, the remedies essentially
do run against other investors and tracing "has nothing to be said for it as a
principle governing conflicting claims to restitution by equally wronged
In the first Ponzi scheme case, Cunningham v. Brown,101 the Supreme
Court held that because none of the claimants could directly trace their
money, all the victims should share in the fund ratably, each in proportion
to his own loss.102 The Cunningham Court relied on its inherent equitable
power to "disregard the rules of restitution and tracing to arrive at an
‘equitable’ answer"103 that yielded a more just result.104 Cunningham is
credited with developing the concept that "equity is equality" when there
are multiple similarly situated fraud victims,105 and it is the paramount case
cited when tracing is suspended.106
The Bankruptcy Code "was created for the express purpose of treating
equally situated creditors equally."107 Because "[a]ll investors in a Ponzi
scheme are creditors of the same class . . . [that] in theory . . . should be
treated equally,"108 the Bankruptcy Code aims to attain equal treatment
through avoidance. Avoidance of transfers received by earlier investors is
premised on the belief that early investors are unfairly (though innocently)
enriched at the expense of later investors.109 The Ponzi scheme operator
can only attract new investors so long as his scheme appears profitable, a
feat which is accomplished by meeting payout demands of early investors.
To meet the demands, the operator solicits new investments, and because
the early investors achieve a return on investment, additional new investors
are drawn into the scheme.110 This circular pattern makes the earlier
investors unwitting accomplices in continuing the fraud.111 "[T]o allow any
investor to recover promised returns in excess of the original amount
invested would be to further the Debtor’s fraudulent scheme at the expense
of other investors, particularly newer investors."112 From this perspective,
pro rata distribution is appropriate because the returns given to the early
redeemers are simply the principal investments of newly solicited
In order to increase the pool of funds to distribute pro rata, and in the
interest of equity, the Bankruptcy Code allows the trustee to recapture, or
U.S. 1, 13 (1924) ("[T]he principle that equality is equity . . . this is the spirit of the bankrupt
Merrill v. Abbott (In re Indep. Clearing House Co.), 77 B.R. 843, 871 (D. Utah
109. See infra note 119 and accompanying text (explaining that most of the traceable
assets are held by early redeemers, as payouts to early investors are necessary to perpetuate
See In re Indep. Clearing House Co., 77 B.R. at 860.
A Ponzi scheme cannot work forever. The investor pool is a limited resource
and will eventually run dry. The perpetrator must know that the scheme will
eventually collapse as a result of the inability to attract new investors. The
perpetrator nevertheless makes payments to present investors, which, by
definition, are meant to attract new investors.
111. See In re Taubman, 160 B.R. 964, 981 (Bankr. S.D. Ohio 1993) (authorizing the
bifurcation of investors’ claims against debtor into actual pecuniary losses and other claimed
losses in order to treat claimants more equitably). The Taubman Court noted that "[a]n
investor in a [P]onzi scheme is not only a victim but at the same time is a perpetrator." Id.
113. See S.E.C. v. Credit Bancorp, Ltd., 290 F.3d 80, 89 (2d Cir. 2002) (upholding the
equitable authority of the District Court to authorize a pro rata distribution plan). As the
court noted, "earlier investors’ returns are generated by the influx of fresh capital from
unwitting newcomers rather than through legitimate investment activity." Id.
instances where other courts "held that inquiry notice . . . preclude[d] a
finding of good faith, including inquiry notice of the: fraudulent purpose of
the transfer; underlying fraud; unfavorable financial condition for the
transferor; insolvency of the transferor; improper nature of the transaction;
[and] voidability of the transfer."178 However, the court noted that these
factors were not dispositive, and questions of good faith must be decided on
a case-by-case basis.179 Although the factors constituting inquiry notice are
quite broad, the district court reversed an even more expansive
interpretation approved by the bankruptcy court.180
In regards to the "diligent investigation" requirement, the Bayou
bankruptcy court embraced a high standard:
"[D]iligent investigation" must ameliorate the issues that placed the
transferee on inquiry notice in the first place. In other words, if the
diligent investigation aggravates, rather than allays, the concerns placing
the transferee on inquiry notice, then no "good faith" defense is
supported. Moreover, a transferee cannot satisfy the "diligent
investigation" prong of the good faith test merely by inquiring with the
transferor itself, even were the transferor to provide a plausible
explanation of the issues. . . . [A] "diligent investigation" requires more
than merely asking the transferor about the suspicious circumstances. In
other words, a transferee cannot put his head in the sand in the face of
unusual or suspicious circumstances and then take advantage of the
"good faith" defense afforded by section 548(c). . . . [O]nce on inquiry
notice, "taking no steps at all would . . . amount to ‘willful ignorance,’
which would . . . defeat the good faith defense."181
In theory, "[a]n objective, reasonable investor standard applies to both the
inquiry notice and the diligent investigation components of the good faith
test."182 Despite the intended uniform application, in practice, courts hold
investigation is triggered. Id.
178. In re Bayou Grp., LLC, 396 B.R. 810, 845–46 (Bankr. S.D.N.Y. 2008) aff’d in
part, rev’d in part, 439 B.R. 284
(denying the investors’ good faith
defenses and granting summary judgment).
179. Id. at 846.
180. See In re Bayou Grp., LLC, 439 B.R. 284, 290
Bankruptcy Court broadly held that information suggesting some potential infirmity in the
investment or some infirmity in the integrity of its management is a sufficient trigger. The
Bankruptcy Court’s expansion of the scope of information sufficient to trigger inquiry notice
is not supported by . . . case law and requires reversal . . . .").
181. In re Bayou Grp., LLC, 396 B.R. 810, 846–47 (Bankr. S.D.N.Y. 2008) aff’d in
part, rev’d in part, 439 B.R. 284
182. In re Bayou Grp., LLC, 439 B.R. 284, 313
educated parties to a higher standard of due diligence.183 Accordingly,
"courts have generally been willing to find that knowledgeable investors
did not act in objective good faith if their investment program showed
significant signs of irregularity."184 For example, in one of the rare cases
where the court did not grant summary judgment against the defendants on
the matter of good faith, it specifically noted the defendants’ lack of
sophistication, their smaller investments, and their less-prestigious jobs.185
Institutional investors are also held to a more rigorous standard as they are
presumably more sophisticated and have more resources to investigate,
adding yet another standard of "reasonable" to the determination of good
Also problematic with the good faith defense is that savvy investors
are presumably held to a higher standard than governmental monitoring
agencies.187 The SEC was informed of the fraudulent nature of Madoff’s
firm yet never uncovered the massive fraud.188 If the SEC was unable to
183. See id. ("Some courts have held that the standard . . . requires a specific focus on
the class or category of the transferee. . . . [W]hether a transferee is on inquiry notice is
informed by the standards, norms, practices, sophistication, and experience generally
possessed by participants in the transferee’s industry or class.").
McDermott, supra note 42, at 179.
The record shows certain facts from which the bankruptcy court might have
drawn an inference that the defendants took in good faith. . . . [The] court
may . . . have concluded that the undertakers generally were unsophisticated in
investment matters, from the modest amounts some of the defendants advanced,
by the jobs some held (as reflected in their answers to interrogatories) and by the
fact that many of the defendants appeared pro se, suggesting either that they
could not afford a lawyer or did not realize the need for one.
catch schemes like Madoff’s, despite receiving tips on its probable
fraudulent nature189 and conducting at least five investigations over nearly
two decades,190 individual investors with substantially fewer resources and
more limited access to financial data should not be charged with having a
reason to suspect the integrity of the investment necessitating further
investigation. If anything, an SEC investigation revealing no evidence of
fraud should have relieved any investor concerns. The SEC also failed to
vet Madoff when he registered as an investment advisor in 2006.191
Moreover, the "red flags" obvious with hindsight might not have been
sufficient to put the investor on notice. Indeed, the appearance of
legitimacy is what makes Ponzi schemes so damaging.192 For example, the
consistency of Madoff’s returns was remarkable, but the percentage of
returns was not necessarily unparalleled in the market.193 Madoff’s
investment strategy also seemed plausible.194 The split-strike conversion
strategy195 he claimed to employ does minimize downside risk and tends to
lead to more consistent, if less lucrative, returns on investment.196 The
189. See id. (discussing the failure of the SEC to uncover Madoff’s scheme despite
receiving tips on its fraudulent nature).
190. See Debra Cassens Weiss, SEC Lawyer Warned About Madoff in 2004, A.B.A. J.
(July 2, 2009, 7:06 AM), http://www.abajournal.com/news/article/sec_lawyer_warned_
(last visited on Aug. 9, 2011)
("The SEC investigated Madoff’s
firms at least five times over nearly 20 years, including in 2007 after rival Harry Markopolos
complained that Madoff’s improbable returns were likely the result of a Ponzi scheme . . . .")
(on file with the Washington and Lee Law Review).
191. See Campos, supra note 12, at 593 ("Traditionally, when an investment adviser
registers with the Agency, the Office of Compliance, Inspections, and Examinations
scrutinizes and examines the investor—in this case the SEC did not.").
193. See Efrati, Lauricella & Searcey, supra note 2 (noting that one fund averaged a
10.5% annual return).
194. See Gradwohl & Corbett, supra note 4, at 217 ("The successful schemes make the
tale told by the perpetrator appear reasonable.").
195. See Assessing the Madoff Ponzi Scheme and Regulatory Failure: Hearing Before
the H. Comm. on Financial Services, 111th Cong. 6 (2009) (testimony of Harry Markopolos,
Chartered Financial Analyst, Certified Fraud Examiner) [hereinafter Hearings], available at
(explaining the split-strike conversion strategy and outlining its three main parts). "Part I is
a . . . grouping of stocks that you purchase. . . . Part II consists of the call options that you
are selling to generate income. Part III consists of the put options that you will be buying to
protect your stock portfolio from market price declines . . . ." Id.
196. See Carole Bernard & Phelim P. Boyle, Mr. Madoff’s Amazing Returns: An
Analysis of the Split-Strike Conversion Strategy, 17 J. DERIVATIVES 62, *2 (2009), available
at SSRN: http://ssrn.com/abstract=1371320 ("This strategy involves taking a long position in
complex transactions generate confusion even among trained market
professionals.197 Judge Richard Posner of the Seventh Circuit opined that
Madoff’s scheme did not have the hallmarks of a typical Ponzi scheme:
The strategy . . . attributed to Madoff is the opposite of that of the
typical Ponzi schemer: it [wa]s to obtain investments from well-off
people far more financially sophisticated than the average Ponzi victim,
including genuine financial experts such as hedge fund managers and
bank officials. And therefore it require[d] different tactics from that of
the ordinary Ponzi scheme, such as offering returns only moderately
above average, satisfying redemption requests promptly, turning down
some would-be investors . . . , and trading on a reputation earned in a
legitimate business (Madoff’s business of market making).198
An objective good faith standard contravenes congressional intent,
confuses the goals of fraudulent and preferential transfer law, unfairly
penalizes savvier investors with actual good faith based on their status
alone, demands investors to be more diligent than the SEC itself, and
assumes (with the benefit of hindsight) that investors saw the "red flags."
B. Preferential Transfers: Reallocation of an Arbitrary Line
In practice, by voiding the "preference" of investors who withdraw
money within three months (90 days) of bankruptcy, investors who fall
outside the three-month statute of limitations receive preferential
treatment.199 In In re Independent Clearing House Co.,200 the court
explained that § 547 simply reallocates where the arbitrary line is drawn:
equities together with a short call and a long put on an equity index to lower the volatility of
197. See Hearings, supra note 195, at 7 (testimony of Harry Markopolos) ("[T]he
strategy is complex enough . . . that even market professionals without derivatives
experience would have trouble keeping track . . . and understanding . . . fully.").
198. See Richard Posner, Bernard Madoff and Ponzi Schemes—Posner’s Comment,
BECKER-POSNER BLOG (Dec. 21, 2008, 3:45 PM),
Aug. 9, 2011)
("Madoff’s scheme . . . is not a classic Ponzi scheme.") (on file with the
Washington and Lee Law Review).
199. See In re Indep. Clearing House Co., 77 B.R. 843, 871
(D. Utah 1987)
that the application of § 547 is limited and the transfers that cannot be reached are thus
treated more favorable).
200. Id. at 875 (holding in part that the trustee was not entitled to a judgment as a
matter of law on the preferential transfer claims).
For a Ponzi scheme that lasts more than three months, the statute . . .
does not go far enough. By definition, an enterprise engaged in a Ponzi
scheme is insolvent from day one. Thus, all transfers to investors in a
Ponzi scheme are preferential, not just those made within the three
months before bankruptcy. Every transfer prefers the transferee to those
investors at the end of the line. The evil of a preferential transfer is that
it "unfairly permit[s] a particular creditor to be treated more favorably
than other creditors of the same class." All investors in a Ponzi scheme
are creditors of the same class, so in theory all should be treated equally.
In effect, though, applying section 547 to a Ponzi scheme . . . favors
some creditors over others. Under section 547 the creditors who are
most preferred are allowed to keep their preferential payments because
the transfers were made outside the statutory period . . . . The statute
simply does not reach the early investors. Thus, applying the statute as
written, the court is "compelled to take part in a farce whose result is . . .
to take away from those who have little, the little that they have." The
equitable solution would be either to apply the statute to all transfers to
investors in a Ponzi scheme—without regard to when the transfers were
made—or to apply the statute to none of the transfers.201
The preferential transfer statute applies to a small fraction of transfers in the
context of a multiple decade fraud. Investors who redeemed prior to the
90day period are simply outside its scope. Because earlier investors are likely
the ones that received substantial fictitious profits, the preferential transfer
statue does little to redistribute assets. Its limited scope is likely why courts
have read the fraudulent transfer statutes so broadly202 and, as discussed in
this Note, it unfairly penalizes investors who act in actual good faith.203
C. Trustee Discretion: Increased Uncertainty and Prolonged Litigation
The trustee is given great discretion in deciding which clawback
claims to pursue,204 which injects a subjective element into the application
of the law and is likely to lead to prolonged litigation.205 For example, the
201. Id. at 871 (citations omitted).
202. See supra notes 172–73 and accompanying text (explaining that the abrogation of
the good faith defense treats fraudulent transfers like preferential transfers).
See Part V.A (discussing the consequences of the narrowing good faith defense).
204. See Barasch & Chestnut, supra note 64, at 926 ("The trustee or receiver in a Ponzi
scheme has a fair amount of discretion in whether to pursue claims against investors and
205. See Alain Leibman, Revisiting Madoff and His Stakeholders—Is Trustee Picard
Pursuing Hadassah and Other Charities as Candidates for "Clawback"?—Installment 32,
WHITE COLLAR DEFENSE AND COMPLIANCE, Fox Rothschild LLP (Aug. 2, 2010),
http://whitecollarcrime.foxrothschild.com/2010/08/articles/bernard-madoff/revisitingtrustee in Madoff’s bankruptcy, Irving Picard, has said that he will not seek
the return of funds from "net losers,"206 and he will not file lawsuits against
"net winners"207 who are financially destitute. He "recognizes that many
people are not going to be in a position to pay anything back."208 As a
result, a hardship program has been implemented.209 Picard assesses
whether investors, who would otherwise be subject to avoidance actions,
qualify for hardship based on factors including inability to pay for
necessary living expenses (including loss of home to foreclosure),
necessary medical expenses, or the care of dependents.210 "Declaring
personal bankruptcy . . . [or o]therwise suffering from extreme financial
hardship as demonstrated by other circumstances" are also grounds for
hardship exception.211 Although it seems patently unfair to force those with
limited means to pay back funds, it essentially means that wealthy investors
are the only parties targeted, simply because they are in a position to pay.
Prudent investors who saved the money that they withdrew can "afford" to
return those funds and are forced to do so, while those who spent the money
lavishly can claim hardship. This promotes irresponsible spending over
saving and disfavors generally wealthier investors with the financial
stability to return what they withdrew. Although there is some sense of
fairness in the notion of only forcing those to pay who are able to do so, the
law should at least attempt to treat all parties similarly, and an exception
that promotes poor financial management should be against public policy.
(last visited Aug. 9, 2011)
that Mr. Picard will use to separate those from whom he will seek clawback and those . . .
from whom he will not raise fundamental questions of fairness, size[,] and relative value that
will likely lead to much more controversy and potential litigation.") (on file with the
Washington and Lee Law Review).
206. See Assessing the Limitations of the Securities Investor Protection Act: Hearing
Before the Subcomm. on Capital Markets, Insurance, and Government Sponsored
Enterprises of the H. Comm. on Financial Services, 111th Cong. 1 (2010) (testimony of John
C. Coffee, Jr., Adolf A. Berle Professor of Law, Columbia University Law School),
available at http://financialservices.house.gov/Media/file/hearings/111/Coffee092310.pdf
(defining net losers as investors who withdrew less than the amount of their principal).
207. See id. (explaining that net winners are investors who withdrew their principal and
any fictitious profits).
208. Untangling Madoff’s "Winners" And Losers, supra note 187.
209. See Bernard L. Madoff Investment Securities LLC Liquidation Proceeding,
Hardship Program, http://www.madofftrustee.com/HardshipProgram.aspx
(last visited Aug.
(outlining the hardship program) (on file with the Washington and Lee Law
Instead of filing lawsuits against all people who withdrew more than
their principal, Picard’s lawsuits are being filed primarily against those who
he deems "should have known," which incidentally coincides with deeper
pockets.212 This sentiment of perceived unfairness is well-reflected by the
statements of Fred Wilpon and Saul Katz, owners of the New York Mets,
who were recently sued for $1 billion,213 $300 million of which reflects
profits and $700 million of which is principal withdrawn over the years.214
The men allege that the claims against them are "abusive, unfair[,] and
untrue," and that the lawsuit is nothing more than "an outrageous
strongarm effort to try to force a settlement by threatening to ruin our reputations
and businesses."215 "[T]he lawsuit seeks to hold them responsible for the
indirect benefits they derived from the apparent success of their many
investments in Mr. Madoff’s firm, which allowed them to flourish in other
areas, including buying the Mets."216 In the words of one Wall Street
The Wilpon-Katzes are accused of taking out $300 million in "fictitious
profits," but the family is also worth much more than that, which makes
them irresistible targets for the fatal "or"—they knew or should have
known that Madoff was a fraud. Hence the Picard lawsuit’s demand of
an additional $700 million in principal the family had withdrawn over
Picard’s aggressive stance towards the Mets’ owners must be contrasted
with his approach toward some charities. Cognizant that many charities
"are struggling with materially reduced contributions because of the
economy, increased demands by individuals who are unemployed and
suffering financially, losses in endowment funds from the substantial
market declines and increased regulatory activity," he has taken a less
aggressive approach towards such organizations.218 For example,
Hadassah, a Jewish charitable organization, was allowed to voluntarily
settle by repaying $45 million, even though it faced a potential clawback
claim, for fictional profits alone, of $97 million.219 This is approximately a
mere 58% of the fictitious profits.220 It is worth noting that "Hadassah had
sophisticated investment advisers over the period of their Madoff
investments," so the disparity in treatment cannot be based on level of
financial acumen.221 "While the [more lenient] position . . . by Picard as to
charities may be humanitarian and emotionally appealing, there is little
basis in the law for the disparity in treatment between charities and
forprofit entities."222 By evaluating the relative worth of investors, and
subjectively determining the amount for which the party should be held
accountable, Picard exacerbates the uncertainty in terms of prospective
liability and makes investors more likely to feel they were treated unfairly
and seek judicial review.223
Predictably, the suggestion that Picard’s disparate treatment will lead
to litigation has already proven true.224 Wilpon and Katz succeeded in
having the lawsuit against them moved from federal bankruptcy court to
218. Alain Leibman, The Madoff Profit Game: Will the Mets End up Losers Off the
Field While Charity Stakeholders Become Winners?—Installment 17, WHITE COLLAR
DEFENSE AND COMPLIANCE, Fox Rothschild LLP (Oct. 26, 2009), http://white
(last visited Aug. 9, 2011)
(on file with the Washington and Lee Law Review).
219. Alain Leibman, Picard Chases Madoff "Winners" in Inconsistent Fashion—
Contrasting Treatment of the Wilpon Family Versus Hadassah—Installment 45, LEXOLOGY
(Feb. 9, 2011)
(last visited Aug. 9, 2011)
(on file with the Washington and Lee Law
220. Michael J. Kline, Picard Crusades Against the Wilpon/Katz Family Charitable
Foundations While He Moves to Settle with Hadassah, LEXOLOGY (Feb. 21, 2011),
(last visited Aug. 9, 2011)
("Picard is willing to settle for approximately 58% of the
Fictitious Profits reported for Hadassah, presumably because they may be a worthier
charitable vehicle in his eyes than the [charities of Wilpon and Katz].") (on file with the
Washington and Lee Law Review).
Leibman, Picard Chases Madoff "Winners" in Inconsistent Fashion, supra note
223. See id. ("This inequality of approach will more likely than not lead to protracted
litigation and uncertainty in the Madoff matter.").
See, e.g., Picard v. Katz, 11-cv-03605, 2011 WL 4448638 (S.D.N.Y. Sept. 27,
district court.225 On September 27, 2011, U.S. District Judge Jed Rakoff
dismissed nine of the eleven claims against the Mets owners.226 Rakoff
found that Picard could only maintain claims under federal bankruptcy law
and could not take advantage of the longer time period provided under state
law.227 The main claim remaining alleges actual fraud under Bankruptcy
Code § 548(a)(1)(a).228 This limits the financial exposure of Wilpon and
Katz to withdrawals made within two years of the bankruptcy filing by
Madoff’s firm.229 Judge Rakoff noted that Picard could not recover
withdrawals of principal made within the two years preceding the filing of
the bankruptcy petition under § 548(c) "absent bad faith."230 Significantly,
Rakoff rejected the "inquiry notice" approach taken by the Bayou court in
determining "good faith" under § 548(c).231 Instead, in the "context of a
SIPA trusteeship," Rakoff found that scienter was required to prove a lack
of good faith: Only "‘willful blindness’ to the truth is tantamount to a lack
of good faith."232 Rakoff elaborates:
The difference between the inquiry notice approach and the willful
blindness approach is essentially the difference between an objective
standard and a subjective standard. . . .
A securities investor has no inherent duty to inquire about his
stockbroker, and SIPA creates no such duty. If an investor, nonetheless,
intentionally chooses to blind himself to the "red flags" that suggest a
high probability of fraud, his "willful blindness" to the truth is
tantamount to a lack of good faith. But if, simply confronted with
suspicious circumstances, he fails to launch an investigation of his
broker’s internal practices—and how could he do so anyway?—his lack
of due diligence cannot be equated with a lack of good faith, at least so
226. Picard v. Katz, 2011 WL 4448638, at *3 ("[T]he Court grants the defendants’
motion to dismiss all claims predicated on principles of preference or constructive fraud
under the Bankruptcy Code.").
227. Id. at *2–3. This decision was based on the "safe harbor" in Bankruptcy Code
§ 546(e), which limits fraudulent conveyance claims to two years when it involves a
"settlement payment" that is "made by or to (or for the benefit of) a . . . stockbroker, in
connection with a securities contract." Id. at *2; see also 11 U.S.C. § 546(e) (2006).
228. Id. at *3.
229. Id. at *4–5.
230. Id. at *3.
231. Id. at *5.
far as section 548(c) is concerned as applied in the context of a SIPA
However, Rakoff’s ruling is tempered by a footnote in which he states:
"[T]he Court does not resolve on this motion whether the Trustee can avoid
as profits only what defendants received in excess of their investment
during the two year look back period specified by Section 548 or instead
the excess they received over the course of their investment with
Madoff."234 While the decision purports to clarify the bounds of Picard’s
reach, it does not provide the clarity necessary to facilitate out of court
settlements. Additionally, Picard has already filed an appeal.235
In the Madoff liquidation, mediation is mandatory for all parties
against whom an avoidance action is brought.236 If Picard seeks $20
million or less, he will pay for the mediation expenses, but for all claims
over $20 million, the expense falls on the investor.237 If individual
investors disagree with Picard’s assessment, the investor does have the
option to proceed to court instead of settling with the trustee. However, in
the words of Steve Harbeck, the president of SIPC, Picard "has the
resources to conduct a serious and intense legal campaign."238 The investor
must also keep in mind that the trustee is appointed by the presiding judge.
"As a result, you’ll get a fair hearing, but it will be subjectively biased in
favor of the trustee [and m]ost bankruptcy judges tend to be as pro-trustee
as federal judges tend to be pro-prosecutor . . . ."239 Moreover, the party
must cover its own litigation costs, which can be substantial.240 The party
would also have its finances publicly vetted.241
In terms of recapturing the greatest amount of assets from the fewest
number of individuals, an approach of targeting wealthier individuals
makes sense. However, it unfairly penalizes wealthier parties, who are
forced to pay back considerably more than just the "fictitious profits"
withdrawn during the reachback period in order to avoid a costly and
reputation-damaging trial.242 Even the SEC has "argued that it would be
inequitable to pursue disgorgement of principal payments from a select few
investors when there are hundreds—maybe even thousands—of investors
who have received principal payments yet are not being sued or are beyond
the court’s jurisdiction."243
Picard’s largest settlement of $7.2 billion, which notably is "the largest
single forfeiture in American judicial history," came from the estate of
Jeffery Picower.244 His estate agreed to repay not just the $2.4 billion
withdrawn within the six-year reachback period, but the entire $7.2 billion
withdrawn by "Picower, his charitable foundation[,] and related entities . . .
over 20 years."245 This decision was presumably made to avoid a lifetime
240. See id. ("In addition to the emotional and physical cost of going to trial, Wilpon
and Katz would probably face legal bills of about $1 million a month, given the number of
complaints and entities involved.").
241. See id. ("[T]here is the likelihood that every corner of their financial lives would
be publicly explored.").
242. See Joshua Gallu, David Voreacos & Bob Van Voris, Picower Estate Said to Pay
$7.2 Billion in Biggest Madoff Fraud Settlement, BLOOMBERG
(Dec. 17, 2010, 10:33 AM)
(last visited Aug. 9, 2011)
(noting that the Picower
settlement required the estate to pay back all the profits ever received, a time frame which
spanned over two decades) (on file with the Washington and Lee Law Review).
243. Cox, Morad & Pozza supra note 94, at 121 (citing Brief of Securities and
Exchange Commission, Amicus Curiae, in Support of Appellees, at 11–12, Janvey v.
Adams, 588 F.3d 831 (5th Cir. 2009) (No. 09-10761)), available at http://www.
244. Diana B. Henriques, Deal Recovers $7.2 Billion for Madoff Fraud Victims, N.Y.
(Dec. 17, 2010, 9:51 AM)
(last visited Aug. 9, 2011)
(on file with the
Washington and Lee Law Review).
Gallu, Voreacos & Van Voris, supra note 242.
246. See Diana B. Henriques, Madoff Investor Said to Have Drowned, N.Y. TIMES, Oct.
27, 2009, at B1, available at http://www.nytimes.com/2009/10/27/business/27madoff.html
(noting that the Picower’s have found the litigation to be "emotionally and physically"
Picard has also taken advantage of the possibility of treble damages or
putative damages. Picard has filed a lawsuit against JPMorgan Chase
seeking approximately $1 billion in bank profits and an additional $5.4
billion in damages.247 He is also seeking $9 billion from HSBC, a
Londonbased financial institution,248 and $2 billion from USB AG, a Swiss bank.249
He has "sued Bank Medici AG and its founder, Sonja Kohn, as well as
Bank Austria, UniCredit SpA and [additional] parties . . . seeking $19.6
billion from them, which could triple to $58.8 billion under the Racketeer
Influenced and Corrupt Organizations Act (RICO)."250 Given the
substantial claims already filed against financial institutions,251 even
Madoff has commented that Picard is pursuing individual investors too
aggressively.252 While some of Picard’s claims have been dismissed for
lack of standing he has filed a notice of appeal.253
247. Martha Neil, Madoff Trustee Sues JPMorgan Chase, Seeks $6B for Alleged Blind
Eye to Massive Swindle, A.B.A. J.
(Dec. 2, 2010, 3:31 PM)
(last visited Aug. 9, 2011)
(on file with the Washington and Lee Law Review).
249. Ashby Jones, Picard Goes Big, Sues UBS for $2 Billion in Madoff Case, WALL ST.
J. L. BLOG
(Nov. 24, 2010, 8:19 AM)
(last visited Aug. 9, 2011)
(on file with the
Washington and Lee Law Review).
Gallu, Voreacos & Van Voris, supra note 242.
251. See Norris, supra note 238, at B1 ("It now appears that . . . [investors] might . . .
get it all back, particularly if the banks agree to substantial settlements. If that happened, it
is possible that the net winners, who were victims of a fraud since they were told they had
money that did not exist, might also get some money.").
[Madoff was] critical of the trustee’s reach, claiming that . . . Picard was seeking
far more money than was needed to resolve valid investor claims. . . . Madoff
calculated that the lawsuits against major banks and hedge funds would produce
more than enough to cover the rest of the cash losses without . . . Picard having
to pursue "clawback" litigation . . . .
However, some bankruptcy trustees are even more aggressive than
Picard. Doug Kelley, the trustee who is overseeing the bankruptcy of
convicted Ponzi schemer Thomas Petters, has asserted that the reachback
period applicable to clawbacks is "suspended by reason of the schemer’s
concealment of the fraudulent Ponzi scheme."254 This would allow Kelley
to recoup not only the profits and principal withdrawn in the last six years,
but every withdrawal ever made since the inception of the Ponzi scheme.255
He has stated that he will "reach back for money from the start of the Ponzi
scheme, more than a decade ago."256 Although Kelley’s theory of
concealment remains untested in the courts,257 it evidences the lack of
predictability facing investors. In Kelley’s own words, "[w]e are making
law day by day."258 The bankruptcy judge handling the Petters case has
reserved ruling on the statute of limitations issue.259 Because investors are
unable to calculate how much they may be liable for, it will presumably
make mediation less successful, or force them to settle because they fear the
aggressive stance that the trustee will pursue in court and cannot predict the
court’s ruling due to the lack of coherent case law.
VI. Proposed Solutions to Promote Predictability in Asset Distribution
Given the broad discretion afforded to bankruptcy trustees in pursuing
clawback claims selectively and the wide latitude of the bankruptcy or
district court to craft remedies as it deems fit, the asset distribution plan in
essentially all bankruptcy cases likely does comport with law. However,
that does not prevent litigation, mean that the results were reached in a
principled manner, or suggest that equitable principles actually prevailed.
Moving forward, there are several options to promote predictability in
situations where Ponzi schemes enter bankruptcy. The proposals range
from legislative action to contractual measures, and from preventing
clawbacks to substantially increasing their reach, but either extreme would
introduce much-needed consistency into the law.
New Jersey Representative Scott Garrett has introduced legislation to
prevent the trustee representing Madoff’s victims from pursuing additional
clawback claims.260 Garrett introduced a similar bill last session, and he
believes that ordinary investors who were unaware of the fraud should not
have to forfeit any portion of profits that were recorded on their monthly
statements: "I introduced this legislation because I am increasingly
concerned that the trustee in the Madoff case is ignoring the law and failing
to provide prompt assistance to those who have been thrust into financial
chaos."261 Garrett’s bill would protect investors who withdrew fictitious
profits in good faith.262
New York Representative Gary Ackerman has introduced similar
legislation to prevent trustees from clawing back money from investors in
Ponzi schemes.263 Ackerman’s proposal was offered in conjunction with
several other members of the House Financial Services Committee, and it
limits clawbacks to being filed only against those who were "complicit or
negligent in their participation in the Ponzi scheme."264 It also extends
$100,000 in SIPC protection to indirect investors who are currently
excluded from coverage.265 A co-sponsor of the bill, Peter King, stated:
"While [Congress] unfortunately cannot return the full amount of funds that
were greedily stolen in these Ponzi schemes, this legislation will put in
protections that will provide some financial relief to the victims, restrict
clawbacks, and restore investor confidence in the market."266
Both proposals protect good faith investors and are supported by
compelling arguments, one of which is reliance: Investors who withdrew
money and enjoyed its use for as many as six years were doing so in
reasonable reliance. Moreover, financial investments always carry some
risk, and those with funds still invested were presumably less risk-adverse
or more willing to take a chance based on changing market conditions, or
were at least better prepared for the shock of losing their investment.
Ackerman’s bill would also help parties with pressing monetary needs.
Although providing $100,000 of protection to all defrauded investors, even
those who invested through a hedge fund, may be nominal to heftier
investors, it would go a long way towards helping those who need
immediate financial assistance. However, neither proposal adequately
protects investors against the narrowing of the good faith defense or sets
forth a uniform approach by which trustees and courts must abide.
B. Congress Amending Preferential or Fraudulent Transfer Statutes
As suggested in this Note, the good faith defense is construed narrowly
to allow the court to treat fraudulent transfers as preferences.267 This allows
avoidance of the transfers, and redistribution in a pro rata manner that the
court deems more equitable. There is nothing inherently wrong with this
approach. The problem resides in the fact that a narrowed good faith
(last visited Aug. 9, 2011)
with the Washington and Lee Law Review).
265. See id. ("Under the measure, SIPC would be required to provide up to $100,000
worth of insurance coverage to indirect investors in Ponzi schemes—those investors who
invested through feeder funds and/or other indirect sources. Presently, SIPC only provides
coverage to direct investors . . . .").
267. See supra note 172 and accompanying text (noting that courts purposefully
construe the defense narrowly).
defense is a misapplication of the current law as written,268 and inconsistent
application of the law leads to uncertainty and disparate results. Although
courts have inherent equitable power, "a bankruptcy court may not use its
equitable powers to ignore the specific dictates of a bankruptcy statute."269
Specific to Ponzi schemes that enter bankruptcy, Congress can certainly
amend the preferential transfer statute to cover a more expansive amount of
time or amend the fraudulent transfer statutes to abrogate the good faith
defense. Uniform changes in the law need to be promulgated from the
legislative branch, as opposed to being derived by individual judges in
C. Contractual Measures in Investment Contracts
An interesting proposal by one group of commentators basically
replicates the contractual corporate compensation clawback idea in the
Dodd-Frank Act and applies it to investment contracts.271 Instead of relying
on courts to avoid transfers "at the back end—a remedy whose reach . . . is
generally limited" to no recovery by the statute of limitations and to only
profits by operation of the good faith defense, "the investor could in theory
better protect herself prospectively by including a provision in the
investment contract that would clawback all amounts paid out to investors
contingent on the fund becoming insolvent as a result of the fraud."272 Such
a provision would have the effect of treating all transfers as preferential:
No matter when the transfer was made, the entire amount—principal and
fictitious profits—would be returned. It would operate like a rule of strict
liability, as there would be no good faith defense. This proposal would
treat all investors similarly because exact pro rata distribution would be
possible.273 The authors also suggest that such a provision would better
reflect the expectations of investors:
268. See supra notes 158, 160 (suggesting that Congress intended the good faith
determination to be subjective).
269. Carlos J. Cuevas, Bankruptcy Code Section 544(a) and Constructive Trusts: The
Trustee’s Strong Arm Powers Should Prevail, 21 SETON HALL L. REV. 678, 679 (1991).
270. See supra note 173 and accompanying text (noting that it is Congress, not the
courts, who should amend fraudulent transfer law.).
271. See generally Cherry & Wong, supra note 44 (proposing the inclusion of
contractual measures in investment agreements to address multiple victim fraud).
272. Id. at 406.
Such a risk distribution arguably reflects more accurately what the
reasonable investor would have expected in the first instance, but which
expectation turns out to be false and can be restored post facto only to a
limited extent. Clawbacks in investment contracts therefore operate to
ensure that investors’ expectations concerning risk allocation are not
There are potential problems with this proposal, a major one being the
lack of contractual privity between investors.275 The typical investment
structure consists of individual contracts between the individual investor
and the investment operator or fund.276 Investors would be wary of signing
a clawback agreement under which they would be bound "to surrender all
funds received without the assurance other investors would do the same."277
Essentially, such a provision would benefit co-investors while possibly
serving to the detriment of the individual investor.278 One way to overcome
such a shortcoming is through a requirement of reciprocity: "[O]nly
investors with similar provisions in their investment contracts would be
permitted to enforce the clawback."279 The authors also suggest that such
terms might become standard in investment contracts over time because the
risk is reallocated among investors while having no impact on the
investment firm’s liability.280
There is a strong public policy argument in favor of such contractual
provisions. As the law currently stands, an investor has no incentive to
discover a fraud, at least not until he recoups his principal (and possibly
waits for the expiration of the reachback period to ensure he cannot be
disgorged of his withdrawals).281 "[B]ecause an investor subject to a
contractual clawback will generally stand to recover more the earlier the
275. See id. at 407 (noting that the lack of contractual privity is a "potential
278. See id. (explaining that if the lack of contractual privity among the investors was
not addressed, the clawback agreement "would function as a third-party beneficiary
280. See id. at 408 (suggesting that an "investment fund would . . . have little incentive
to remove . . . [default] clawback [terms] since the provision[s] [would] reallocate the risk
of loss only as among the investors, and ha[ve] no impact on its bottom line").
281. See Jenkins, supra note 214 ("[T]he law is certainly a powerful disincentive to
discovering ex post facto that you’ve invested in a Ponzi scheme, for reasons that the
[current clawback] lawsuit[s] make obvious.").
fraud is discovered, the incentive structure is reversed in favor of disclosure
at the earliest possible time."282
Courts should uniformly utilize tracing principles when it is feasible to
do so and only turn to pro rata distribution when tracing is not viable. As
noted by the Restatement (Third) of Restitution & Unjust Enrichment, pro
rata distribution should only occur when tracing is impossible.283 Given the
recent trend of courts allowing pro rata distribution, despite the ability of
claimants to trace individually,284 either Congress or the Supreme Court
needs to mandate a return to traditional principles. Although the
Restatement views these cases as anomalies,285 it is hard to imagine that
subsequent courts would not follow their precedent, especially given the
confusion surrounding restitutionary principles.286 The idea that tracing is
Cherry & Wong, supra note 44, at 409.
283. See RESTATEMENT (THIRD) OF RESTITUTION & UNJUST ENRICHMENT § 59 reporter’s
note (g) (2011) ("[T]he orthodox approach to multiple-fraud cases returns identifiable assets
to their owners, turning to pro rata distribution only when specific identification or
transactional tracing is impossible.").
284. See, e.g., cases discussed supra note 117 (noting that the district court had the
authority to distribute assets pro rata). The Restatement (Third) of Restitution & Unjust
Enrichment states that:
The rule that is effectively being applied in cases like Durham imposes a
liability for contribution between victims of a common fraud—though a liability
imposed in the court’s "discretion" . . . when the court sees fit . . . . Such a
power has been asserted, without being identified, in a number of recent cases.
Of the foregoing cases it can generally be observed—as the trial court [did] in
United States v. Durham —that "all claimants stand equal in terms of being
victimized by the defendant defrauders. The ability to trace the seized funds to
[particular claimants] is the result of the merely fortuitous fact that the
defrauders spent the money of the other victims first." But that is not a basis for
imposing a rule of contribution or "general average" between fraud victims—at
least without a theory to explain how one set of victims becomes liable to
another. The necessary principle is apparently one of loss-sharing between
unrelated victims of a common casualty, but the decisions . . . do not purport to
establish, delimit, or justify the principle necessary to explain the results, which
appears inconsistent with fundamental rules of property.
RESTATEMENT (THIRD) OF RESTITUTION & UNJUST ENRICHMENT § 59 reporter’s note (g)
285. See RESTATEMENT (THIRD) OF RESTITUTION & UNJUST ENRICHMENT § 59 reporter’s
note (g) (2011) ("Until these results are forthrightly explained and adequately justified, it
seems safer to regard them as the product of error and inattention.").
See supra notes 48–51 and accompanying text (discussing the confusion
appropriate whenever it is practicable needs to be reiterated before more courts
break with tradition and order pro rata distribution. As the Supreme Court
stated in Pearlman v. Reliance Insurance Co.:287 "The Bankruptcy Act simply
does not authorize a trustee to distribute other people’s property among a
Congress should clarify that the good faith standard in the Bankruptcy
Code is subjective289 and that fraudulent transfers should not be treated as
preferential transfers. Just as courts often disregard tracing in favor of ratable
distribution, courts also construe the good faith defense narrowly because it
allows more transfers to be avoided and a resulting higher corpus to be
distributed pro rata.290 If Congress reaffirms a subjective standard, which
would protect the principal of those who withdrew funds in actual good faith,
extending the reachback period to cover the entire length of the Ponzi scheme
becomes less problematic. Extending the reachback period would allow all
profits received over the course of the Ponzi scheme to be avoided and
redistributed from the estate on a pro rata basis. Only investors who knowingly
participated or acquiesced in the fraud would be subject to returning all
withdrawals—principal and profits—made over the course of the fraud. The
modern push is towards achieving at least a rough parity between early and late
investors, so extending the reachback period helps effectuate this goal.
If the reachback period is extended, the traditional equitable defense of
"change in position" should be recognized: "If receipt of a benefit has led an
innocent recipient to change position in such manner that an obligation to make
restitution of the original benefit would be inequitable to the recipient, the
recipient’s liability in restitution is to that extent reduced."291 This defense
would function like the hardship defense by protecting early investors who are
not in a position to repay the withdrawn funds. However, change in position
would be applicable to all investors, not just those who are financially destitute.
Even wealthy investors could benefit from the defense if they were able to
surrounding restitution, especially within the bankruptcy context).
287. See Pearlman v. Reliance Ins. Co., 371 U.S. 132, 136 (1962) (reaffirming that
"property rights existing before bankruptcy in persons other than the bankrupt must be
recognized and respected in bankruptcy").
288. Id. at 135–36.
289. See supra notes 158, 161 and accompanying text (postulating that Congress
intended a subjective standard).
290. See supra notes 172–73 and accompanying text (suggesting that the narrow
reading of the good faith defense is an intentional effort by courts to put all investors at
291. RESTATEMENT (THIRD) OF RESTITUTION & UNJUST ENRICHMENT § 65 (2011).
prove that they used the withdrawn proceeds to fund an endowment or make
charitable donations that they would not have otherwise made.292
If Congress extended the reachback period, reaffirmed that the good faith
defense has a subjective standard, and recognized "changed circumstances" as
a defense, the courts could reach all of the "phantom profits" while still
protecting individual investors from excessive clawbacks that include their
principal (so long as they acted in good faith). Only investors with actual
knowledge of the fraud would be penalized with having to return withdrawn
principal as well as profits. Such an approach balances the interests of early
and late investors and mitigates the prejudice currently bestowed on wealthier
or savvier investors.
Congress should also enact a provision protecting the investment of
whistleblowers in order to encourage diligence on the part of investors and
encourage earlier discovery of fraudulent schemes. Currently, the avoidance
laws discourage investors from investigating the investment fund because if the
investor finds it is fraudulent, he is subject to having his withdrawals reclaimed.
"[T]he law is certainly a powerful disincentive to discovering ex post facto that
you’ve invested in a Ponzi scheme, for reasons that the [current clawback]
lawsuit[s] make obvious."293 A possible solution would be to enact a
whistleblower provision that allows the discovering investor to recover his
entire principal, or that specifically exempts such a party from clawback
lawsuits. This approach would presumably have minimal impact on the overall
value of the estate and the recovery of the numerous other defrauded investors,
but it would certainly provide a substantial incentive for the individual investor
to reveal the fraud as soon as it is discovered. Even if the amount set aside for
the whistleblower is substantial, by revealing the scheme earlier, the erring
fiduciary will have dissipated fewer assets, which should more than offset any
decrease in the corpus of the estate.
By limiting pro rata distribution to situations when tracing is impossible,
traditional property and restitution rules will not be contravened.294 A
292. See id. § 65 cmt. c (explaining the defense of change in position).
Restatement comment states:
[T]he fact that the recipient has spent the money is not of itself a defense to
liability in restitution, because an expenditure of funds—without more—does
not constitute a change of position. . . . [T]he recipient must demonstrate a
causal relationship between receipt and expenditure: in other words, that the
expenditure is one that would not have been made but for the payment or
transfer for which the claimant seeks restitution.
293. Jenkins, supra note 214.
294. See supra notes 284–72 (discussing that pro rata distribution in cases where
subjective good faith defense protects all investors equally and makes an
extension of the reachback period to encompass the entire Ponzi scheme
reasonable because only parties with actual knowledge are forced to repay
principal in addition to fictitious profits. Although the principal of innocent
investors certainly should be protected (especially since they are likely to
reasonably rely on funds that they have held possibly for decades), there is no
comparable argument for parties who knowingly participated in a fraud.
Finally, a whistleblower provision would transform the current disincentive of
discovering fraudulent schemes into a powerful incentive for investors to vet
funds and brokers before investing, remain diligent throughout the duration of
their investment, and follow up on all "red flags."
As noted by multiple commentators, the financial culture which allowed
Madoff to flourish "largely remains in place today."295 Given that Picard has
already collected about half of the deficit, Madoff suggests that the "net losers"
of his scheme are arguably in a better position than the investors who otherwise
lost money in the 2008 financial decline.296 Regardless of the relative recovery
amount, it is apparent that the SEC is unequipped to catch fraud and is likely
facing budget cuts that will only further hurt its efficiency.297 Unless changes
are made, "the fact remains that the time couldn’t be riper for the next
tracing is feasible is not supported by developed law).
295. Frank Rich, Op-Ed., At Last, Bernie Madoff Gives Back, N.Y. TIMES, Feb. 12,
2011, at WK8, available at
296. Steve Fishman, The Madoff Tapes, N.Y. MAG., Mar. 7, 2011, at 93, available at
http://nymag.com/news/features/berniemadoff-2011-3/ (quoting a phone interview with
Bernie Madoff). It is interesting to note that Madoff’s victims might actually recover more
than individuals invested in the stock market who sold at a loss. Madoff points out that the
recovery is already at "50 cents on the dollar" and that many investors "probably would’ve
lost all that money in the market" anyway. Id. Madoff may be correct. The S&P 500,
which tracks the stock movement of the NYSE and NASDAQ, and is considered a
bellweather for the U.S. economy, "lost about 56% of its value from the October 2007 peak
to the March 2009 trough." Kiran Manda, Stock Market Volatility During the 2008
Financial Crisis, STERN SCHOOL OF BUSINESS, Apr. 1, 2010, at 2, available at
297. See Sarah N. Lynch, SEC Watchdog Tells of Waste but Is Cautious of Budget Cuts,
WESTLAW NEWS & INSIGHT
(Feb. 10, 2011)
(last visited Aug. 9, 2011)
("Many Republicans unhappy with key provisions in
the Dodd-Frank financial reform law have said they might try to keep the [SEC] from
implementing them by starving its budget.") (on file with the Washington and Lee Law
Madoff . . . to get in the game."298 While we might be unable to predict or
prevent the next Madoff,299 we can at least have a consistent framework for
working out restitution questions afterwards.
In the aftermath of a failed Ponzi scheme, some investors will inevitably
be shortchanged. There is no easy answer when the losses resulting from fraud
exceed the amount available for restitution. However, there is too much
variance in the current law due to the discretion afforded to the court presiding
over the distribution as well as to the trustee charged with recovering assets.
Courts are given too much leeway in deciding whether to employ tracing or
order pro rata distribution. The Reporter’s Notes to the Restatement note that
"the diminished familiarity of some courts with traditional equity techniques
appears to have fostered a basic misconception: that the property rights of
fraud victims may either be recognized or disregarded as a court may elect, to
achieve a result the court views as desirable in a particular case."300 By treating
fraudulent transfers as preferences, the abrogation of the good faith defense has
led to pro rata distribution in situations where it might not be justified. The
lack of certainty leads to expensive, time-consuming litigation and delays the
recovery of defrauded investors. The current concept of what is "equitable"
burdens wealthy investors more heavily in that they are more likely to be
targeted by the trustee, are ineligible for the hardship exception, must cover
mediation costs, and are less likely to prevail under a good faith defense.
Clarification of the law has the potential to streamline the recovery process, cut
costs, and restore the equitable principles underlying the Bankruptcy Code.
The newly published Restatement (Third) of Restitution & Unjust Enrichment
is hopefully a good start in bringing clarity into an unwieldy area of the law,301
and further action by Congress can help achieve parity between Ponzi scheme
victims while protecting innocent investors and promoting the early discovery
of fraudulent schemes.
A. SIPC Coverage ....................................................................1593
B. Restitution from the Erring Fiduciary .................................1597
C. Restitution Through Tracing ...............................................1598
IV. Avoidance Under the Bankruptcy Code.....................................1610
A. Actual Fraudulent Transfers................................................1610
B. Constructive Fraudulent Transfers ......................................1613
C. Preferential Transfers ..........................................................1614
V. Shortcomings of the Current Statutory Scheme .........................1615
A. Actual Fraud: Abrogation of the Good Faith Defense .......1615
A. Proposed Legislation ...........................................................1633
C. Contractual Measures in Investment Contracts...................1635
D. Amalgamated Proposal ....................................................... 1637 14. Securities Investor Protection Corporation, SIPC Statute and Rules,
http://www.sipc.org/who/statute. cfm (last visited Aug. 8 , 2011 ) ( on file with the Washington
and Lee Law Review) . 15 . Securities Investor Protection Corporation , The SIPC Mission,
http://www.sipc.org/who/sipcmission. cfm (last visited Aug. 8 , 2011 ) ( on file with the
Washington and Lee Law Review). 28 . Paul Sinclair & Brendan McPherson , The Sad Tale of Multiple Overlapping
Fraudulent Transfers: Part IV , 29 - 4 AM. BANKR. INST. J. 18 , 69 ( 2010 ) (citations omitted) . 29. Id. at 69 (quoting Hearing Transcript at 37-38 , In re New Times Sec. Servs., Inc.,
371 F.3d 68 ( Bankr. E.D.N .Y. 2000 )). 30 . See Younglai, supra note 25 ( "'We have a mess on our hands . We have a large
system into thinking they were insured , ' said Democratic Representative Gary Ackerman.") . 31 . See Campos, supra note 12 , at 604 ( "[T]he SEC is concerned with providing
and most importantly protecting against fraud." (emphasis added)) . 32 . See infra notes 188-91 and accompanying text (discussing the inconsistencies
reported to the SEC and the agency's failure to investigate ). 33 . Campos, supra note 12, at 602 ( "[R]estrictions on the SIPC fund's disbursements
and the reality of large Ponzi schemes often dictate an insufficient recovery . ") . 35 . See Doug Rendleman, When Is Enrichment Unjust? Restitution Visits an Onyx
Bathroom , 36 LOY. L. A. L. REV . 991 , 1001 ( 2003 ) ("[C]ourts use common law techniques to
decide unprovided-for disputes and shape restitution doctrines to contemporary needs . . . .") . 36 . See Mark T. Cramer & R. Alexander Pilmer , Swindlers' List: Formal Dissolution
32 L.A. LAW. , June 2009 , at 22 ( "Thanks to Madoff, Ponzi schemes are now part of the
also late-night talk shows . . . .") . 37 . See BLACK'S LAW DICTIONARY (9th ed. 2009 ) (defining rescission as "[a] party's
unilateral unmaking of a contract for a legally sufficient reason" ). 38. See 73 AM. JUR. 2D Support of Persons § 35 ( 2010 ) ("[C]ancellation is not
accordance with what is reasonable and just under the particular circumstances . " Id . 39. See Andrew Kull, Restitution in Bankruptcy: Reclamation and Constructive Trust ,
72 AM. BANKR . L.J. 265 , 285 - 86 ( 1998 ) (explaining why rescission is not an appropriate
49. See Chaim Saiman, Restitution and the Production of Legal Doctrine , 65 WASH. &
LEE L. REV . 993 , 994 ( 2008 ) ("[I]n American legal discourse restitution sits at the backwaters
of the academic and judicial consciousness . . . .") . 64 . Spencer C. Barasch & Sara J. Chesnut , Controversial Uses of the "Clawback"
Remedy in the Current Financial Crisis , 72 TEX. B.J. 922 , 923 ( 2009 ). 81 . Claire Seaton Rosa, Note, Should Owners Have to Share? An Examination of
Forced Sharing in the Name of Fairness in Recent Multiple Fraud Victim Cases , 90 B.U. L.
REV. 1331 , 1338 ( 2010 ). 82 . See George Gleason Bogert, George Taylor Bogert & Amy Morris Hess,
BOGERT'S TRUSTS AND TRUSTEES § 921 ( 2010 ) ("It is a fundamental principle in the English
ownership.") . 98 . Id. illus. 23 . 99. See , e.g., DAN B . DOBBS, DOBBS LAW OF REMEDIES: DAMAGES-EQUITY-
RESTITUTION 27 (2d ed. 1993 ) ("[I]f the right is a right against A, then the remedy must not
run against B when B has violated no rights.") . 100 . Ruddle v. Moore , 411 F.2d 718 , 719 (D.C. Cir . 1969 ) (concluding that pro rata
distribution of the recovered commingled funds was proper ). 101 . See Cunningham v. Brown , 265 U.S. 1 , 13 ( 1924 ) (finding that the claimants were
of the same class and equity dictated pro rata distribution ). 102. Id. at 11-13 . 103 . Saiman, supra note 49, at 1008 . 104. See Doug Rendleman, Irreparability Irreparably Damaged, 90 MICH. L. REV.
1642 , 1653 ( 1992 ) (reviewing DOUGLAS LAYCOCK, THE DEATH OF THE IRREPARABLE INJURY
RULE ( 1991 )) ("One of the ways the legal profession uses the word equity is to describe
when inflexible rules would create harsh results . ") . 105 . Cunningham , 265 U.S. at 13 . 106. A Westlaw query reveals that Cunningham v. Brown is cited in 208 subsequent
cases as well as in hundreds of other briefs, memoranda, and supplemental sources . 107. Clemency & Goldberg, supra note 27, at 14; see also Cunningham v. Brown , 265 185 . See Merrill v. Abbott (In re Indep. Clearing House Co.) , 77 B.R. 843 , 862 n.29 (D.
Utah 1987 ) (denying summary judgment) . The court stated: 186 . See Jeff F. Freidman & Anthony L. Paccione , Clawback of Fraudulent Transfers
from Investors-"Good Faith" Defense Update , LEXOLOGY (Sept. 30 , 2010 ),
http://www.lexology.com/library/detail.aspx?g= 218b746c - 3690 - 4378 -a4f6-c0bfe02d3bf1
(last visited Aug. 9 , 2011 ) (noting that the Bayou district court "found that the nature of the
Review) . 187 . See Untangling Madoff's "Winners" And Losers , NPR (July 27 , 2010 ),
https://www.npr.org/templates/story/story.php?storyId= 128802589 ( "[I]t [is] hard to believe
Madoff's claims.") (on file with the Washington and Lee Law Review) . 188 . See Ralph A. Midkiff , Recovering Losses When Schemes Are Exposed , 2009
ASPATORE SPECIAL REP . 4 ("The SEC had been tipped that [Madoff's firm] was a Ponzi
charges seriously, and never issued formal subpoenas to Madoff for his books and records.") . 192 . See S.E.C. v . Forte, CIV. 09 - 63 , 2009 WL 4809804, *1 ( E.D. Pa . Dec. 15 , 2009 )
("Ponzi schemes are pernicious because they masquerade as legitimate investments . ") . 212 . Untangling Madoff's " Winners" And Losers, supra note 187 . 213. Bob Van Voris, Madoff Trustee May Do What Bernie Didn't: Give Victims Profit,
BLOOMBERG (Feb. 11 , 2011 , 12 :01 AM), http://www.bloomberg.com/news/2011-02-
visited Aug. 9 , 2011 ) ( on file with the Washington and Lee Law Review) . 214 . Holman W. Jenkins , Jr., Madoff and the Mets: How the " Extremely Wealthy"
Allowed the Madoff Fraud to Endure, WALL ST . J. (BUSINESS WORLD) (Feb. 8 , 2011 , 9 : 12
130. html (last visited Aug. 9 , 2011 ) ( on file with the Washington and Lee Law Review) . 215 . Voris, supra note 213 . 216. Peter J. Henning , Mets Owners Face Novel Claim in Madoff Clawback, N.Y.
TIMES (DEALBOOK) (Feb . 7, 2011 , 2 :49 PM), http://dealbook.nytimes.com/ 2011 /02/07/mets-
owners-face-novel-claim-in-madoff-clawback/ (last visited Aug. 9 , 2011 ) ( on file with the
Washington and Lee Law Review). 217 . Jenkins, supra note 214 . 225. Richard Sandomir, Ruling Limits Financial Exposure of Mets' Owners, N.Y.
TIMES , Sept. 28 , 2011 , at B11, available at http://www.nytimes.com/ 2011 /09/28/sports/
baseball/parts-of-suit-against-mets-owners-are-dismissed . html. 233. Id. 234. Id. at *4 n.6 . 235. See Bernard L. Madoff Investment Securities LLC Liquidation Proceeding , Court
Filings , http://www.madoff.com/CourtFilings.aspx (last visited Oct. 15 , 2011 ) ( on file with
the Washington and Lee Law Review) . On October 7 , 2011 , Picard filed a Memorandum of
Law in which he seeks an interlocutory appeal . Id . 236 . See Howard R. Elisofon & Steven D. Feldman , Bankruptcy Judge Approves
(Nov. 24 , 2010 ), http://www.lexology.com/library/detail.aspx?g= 16b4c512 -cc52- 4130 -9387-
a9cf28d08300 (last visited Aug. 9 , 2011 ) (noting that under the court-approved procedures,
Law Review) . 237 . Id . 238 . Floyd Norris , A Blank Check for Cleaning Up Madoff's Mess , N.Y. TIMES , Feb.
25, 2011 , at B1, available at http://www.nytimes.com/ 2011 /02/25/business/25norris.html. 239. Ken Belson , For Mets' Owners, Court Fight Could Be Costly, N.Y. TIMES , Feb. 8 ,
2011, at B10, available at http://www.nytimes.com/ 2011 /02/08/sports/baseball/08picard-
mets.html. 248. Diana B. Henriques , Madoff Suit Cites HSBC as a Helper , N.Y. TIMES , Dec. 6 ,
2010, at B1, available at http://www.nytimes.com/ 2010 /12/06/business/06madoff.html?
adxnnl=1&hpw= &adxnnlx= 1291637114 - YRNcApCkYWOOTpOSUkE0SQ #. 252. See Diana B. Henriques , From Prison, Madoff Says Banks "Had to Know" of
Fraud , N.Y. TIMES , Feb. 16 , 2011 , at B1, available at http://www.nytimes.com/ 2011 /02/16/
business/madoff-prison-interview.html?pagewanted=1&hp . 253. See , e.g., Linda Sandler , Madoff Trustee Appeals $9 Billion Ruling in HBSC Case,
BLOOMBERG (Aug. 30 , 2011 10:17 AM), http://www.bloomberg.com/news/2011-08-
30/madoff-trustee-picard-appeals-judge-s-ruling-in-hsbc-case . html (last visited Oct . 9 , 2011 )
Review) . 254 . Sidney Goldstein , The Search For A "Deep Pocket" in a Period of Economic
Uncertainty , LEXISNEXIS , 2011 Emerging Issues 5478 (Jan. 11 , 2011 ). 255 . See id. (noting that suspension of the limitations period will allow the "recovery of
periods") . 256 . Martin Moylan , Attorney Works to Claw Back Profits from Petters Fraud,
MINNESOTA PUBLIC RADIO (Sept. 30 , 2010 , 6 :15 PM), http://m.mprnews.org/
2 (last visited Aug. 9 , 2011 ) ( on file with the Washington and Lee Law Review) . 257 . Goldstein, supra note 254 . 245. Dave Beal , Clawback Incorporated, TWINCITIES BUSINESS ( Jan . 2011 ),
http://www.tcbmag.com/industriestrends/law/133625p1.aspx (last visited Sept . 13 , 2011 ) (on
file with the Washington and Lee Law Review) . 259 . See Jake Anderson , Attorneys Gather for Petters Clawback Hearing , TWINCITIES
BUSINESS (Jan. 19 , 2011 , 12 :39 PM), http://tcbmag.blogs.com/daily_developments/ 2011 /01/
attorneys-gather-for-petters-clawback-hearing . html (last visited Aug. 9 , 2011 ) (noting that
Lee Law Review) . 260 . See Jessica Holzer, Bill Seeks to Shield Madoff Investors from Clawbacks , WALL
ST. J. (METROPOLIS ) ( Feb . 18, 2011 , 10 :18 AM), http://blogs.wsj.com/metropolis/2011/02/18
/bill-seeks-to-shield-madoff-investors-from-clawbacks (last visited Aug. 9 , 2011 )
investors") (on file with the Washington and Lee Law Review) . 261 . Id . (quoting New Jersey Representative Scott Garrett) . 262 . See id. ("[O]rdinary investors who didn't know about the fraud shouldn't have to
forfeit any portion of profits that were recorded on their monthly statements . ") . 263 . Bill May Spare Mets' Owners in Madoff Clawback, N.Y. TIMES (DEALBOOK ) (May
14, 2010 , 4 :04 PM), http://dealbook.nytimes.com/ 2010 /05/14/bill-may -spare-mets-owners-
in-madoff-clawback/ (last visited Aug. 9 , 2011 ) ( on file with the Washington and Lee Law
Review) . 264 . Perlmutter & Members of Congress Introduce Legislation to Improve Relief for
Victims of Madoff & All Ponzi Schemes , CONGRESSMAN ED PERLMUTTER (Apr. 15 , 2010 ),