By Frank G. Runyeon

Law360, New York (March 31, 2020, 8:48 PM EDT) -- Investors who profited off Bernie Madoff's multibillion-dollar fraud scheme told a wary Second Circuit panel on Tuesday that they should be able to keep the tens of millions in proceeds, arguing that bankruptcy law dictates the money is rightfully theirs.

The investors, including Turtle Cay Partners and South Ferry Building Co. LP, argued that their gains from Madoff's firm were not fraudulent transfers because they were "good faith withdrawals from brokerage accounts and the withdrawals satisfied a debt," which shields them from having to cough up $41 million in Ponzi scheme proceeds sought by the liquidating estate of Bernie L. Madoff Investment Securities LLC in four clawback cases filed in 2010.

Madoff pled guilty in March 2009 to orchestrating a $65 billion Ponzi scheme and is serving a 150-year federal prison term. The trustee of the estate for Madoff's defunct firm has recovered more than $13.3 billion and distributed $12.4 billion, according to court filings.

"Even if Madoff secretly intended to defraud his customers and even if Madoff stole the money from another client, those contract rights were obligations and the broker's payments of those obligations satisfied the debt," said investor counsel Richard A. Kirby of RK Invest Law PBC.

"The defendants are therefore entitled to keep what they received," he said.

"You have an account. You take money out in good faith, relying on the statement. And years later — out of the blue — you get sued," Kirby said, depicting his clients' plight. "Why does the law penalize an innocent customer who got what was due? It does not."

The panel cast skepticism on the investors' posture.

"Did you say — I'm sorry, but did you say that your clients got what they were due?" Judge José A. Cabranes asked.

"That's exactly right," Kirby replied.

"They were due the money that other people were putting in?" Judge Cabranes replied, chuckling briefly. "It's a Ponzi scheme!"

Kirby fumbled for words for a moment before reasserting that his clients were protected under bankruptcy law.

The litigants argued in a virtual appeals court via teleconference due to new rules enacted since the start of the coronavirus pandemic to avoid gatherings for public health reasons; the grand courtroom on the 17th floor of the Thurgood Marshall Courthouse in Foley Square stood silent and dark on Tuesday afternoon as the arguments were broadcast over a streaming audio link.

The circuit judges appeared remotely from three different states: Judge Cabranes in Connecticut, Judge John M. Walker Jr. in Florida and Judge Robert D. Sack in New York.

Judge Walker also questioned Kirby's line of argument that this group of Madoff investors was specifically protected as customers under the Securities Exchange Act of 1934.

"What about the customers who were defrauded and got no money out? Aren't they also protected?" Judge Walker asked.

"They are, but they're protected by a different statute. That's SIPA," Kirby said, referencing the 1970 Securities Investor Protection Act, which helps investors recover equity claims through a trustee. "That is not an issue before the court."

Judge Walker pushed back, asking if this entire matter wasn't really all about customer accounts that are a part of an effort to recover equity.

"The fundamental answer to that is that SIPA looks to bankruptcy code to recover property that was transferred before the petition. These were all transfers that occurred long before there even was a SIPA estate," Kirby said, arguing that if the trustee wants the investors' profits, he would need to go through a standard bankruptcy claim, not via the SIPA actions he's undertaken.

The investors have faced an uphill battle ever since 2018, when U.S. Bankruptcy Judge Stuart M. Bernstein said Madoff trustee Irving Picard should prevail on his claims. U.S. District Judge Jed Rakoff and later U.S. District Judge Paul A. Engelmayer in February 2019 each ruled that because the investors have recovered their initial investment, "their claims to recoup more would not qualify as antecedent debts in the first place."

"In SIPA, Congress made 'the policy decision ... to attempt to treat each investor equitably by providing for recovery of customer property and pro rata distributions based on each customer's net-equity claim, rather than merely letting those who came out ahead retain the amounts obtained,'" Judge Engelmayer wrote, adopting the bankruptcy court's recommendations and entering judgment against the investors.

Arguing for the trustee fund on Tuesday, Seanna R. Brown of BakerHostetler touted her side's long string of victories in the matter.

"All three judges that considered the value question have recognized that every single circuit court to consider this issue has concluded that an investor's profits from a Ponzi scheme are not for value under the bankruptcy code," she said.

"The prevailing view in this district and bankruptcy courts of this circuit is the same: Investors don't get value for their Ponzi profits," Brown argued. "So, the appellants lose under the bankruptcy code, which is the regime that they're arguing applies here."

The judges did not push back on any of Brown's arguments. The panel reserved judgment on the matter.

Judges José A. Cabranes, John M. Walker Jr. Robert D. Sack sat on the panel for the Second Circuit.

The investors are represented by Richard A. Kirby and Beth-ann Roth of R K Invest Law PBC.

The trustee is represented by Seanna R. Brown of BakerHostetler.

The cases are In re: Bernard L. Madoff Investment Securities LLC, case numbers 19-429, 19-443, 19-501 and 19-510, in the U.S. Court of Appeals for the Second Circuit.

--Editing by Adam LoBelia.

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