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From Securities Regulation Daily, August 25, 2014

ERISA plan participants, trustees not Madoff “customers” under SIPA

By Amy Leisinger, J.D.

The federal bankruptcy court in Manhattan has determined that neither investors in four benefit plans regulated under ERISA nor the trustees of the plans qualify as “customers” of the failed broker-dealer Bernard L. Madoff Investment Securities LLC (BLMIS) under the Securities Investor Protection Act (SIPA). According to the court, the objecting individuals had no direct financial or transactional relationship with BLMIS, and, therefore, the bankruptcy trustee was justified in disallowing their claims (Securities Investor Protection Corporation v. Bernard L. Madoff Investment Securities LLC, August 22, 2014, Bernstein, S.).

Background. The objecting investors sought to be recognized as BLMIS customers in order to obtain coverage under SIPA, which would potentially provide compensation for uncompensated losses of up to $500,000 per customer. However, the claimants did not invest directly with BLMIS but instead invested with ERISA plans that, in turn, invested their assets in accounts maintained at BLMIS. The bankruptcy trustee served discovery requests on each of the claimants, and the claimants from one ERISA plan admitted that the plan’s account was not titled in their own names but stated that the plan’s account at BLMIS indicated that it was a profit sharing plan belonging to employees. Further, employee claimants serving as trustees of the plan noted that they communicated directly with BLMIS concerning BLMIS accounts. According to the objectors, these facts should have resulted in a determination by the bankruptcy trustee that they qualify for protection as “customers” under SIPA.

“Customers” under SIPA. The court noted that SIPA defines a “customer” as any person with a claim on securities received or held by the debtor in the ordinary course of its business as a broker or dealer for the account of the person. The term specifically includes those that have “deposited cash with the debtor for the purpose of purchasing securities” and that have a claim arising out of “sales or conversion” of those securities, the court explained, and “[j]udicial interpretations of ‘customer’ status support a narrow interpretation of SIPA’s provisions.”

Citing an earlier decision denying “customer” status to persons invested in feeder funds that invested assets in BLMIS (covered in the Securities Regulation Daily Wrap Up for February 22, 2013), the court explained that the “critical aspect” of this status is “the entrustment of cash or securities to the broker-dealer for the purposes of trading securities.” According to the court, the objectors’ ability to control the size of their investments and withdrawals and to choose investment alternatives is not equivalent to having a direct financial relationship with BLMIS, and their minimal contact with the organization does not represent the kind of “repeated business dealings” associated with “customer” status. Further, the court stated, the objectors did not maintain accounts with BLMIS in their own names, and there is no record showing that BLMIS directly received any funds from them. They “made no purchases, transacted no business, and had no dealings whatsoever” with BLMIS so as to qualify for protection as “customers” under SIPA, and the bankruptcy trustee’s motion for an order affirming his determinations disallowing the claims must be granted, the court concluded.

The case is No. 08-01789 (SMB).

Attorneys: Kevin H. Bell for Securities Investor Protection Corp. David J. Sheehan, Esq. (Baker & Hostetler LLP) for Irving H. Picard, Trustee for the SIPA Liquidation of Bernard L. Madoff Investment Securities LLC. Helen Davis Chaitman, Esq. (Becker & Poliakoff LLP) for Elizabeth Cavanaugh and Laura Hallick.

Companies: Bernard L. Madoff Investment Securities, LLC

MainStory: TopStory FraudManipulation NewYorkNews

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