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Bernie Madoff, Anna Nicole Smith, and John Roberts Walk Into a Bar…

While Bernie Madoff serves out his 150-year sentence, the fight over how to satisfy his creditors rages on. Now, an infamous 2011 ruling by the Supreme Court limiting the power of bankruptcy courts may have a bizarre and unintended affect: many of the investors that recovered money when Madoff was first exposed may lose it (again) because the Bankruptcy Court may have overstepped its bounds by giving it to them in the first place. Confused yet?
Collateral Damage
Here’s the problem. Irving Picard, Trustee in the Madoff Bankruptcy, is now attempting to recoup funds lost to Madoff’s Ponzi schemes by means of fraudulent transfer suits. A Ponzi scheme is an illegal investment scheme that involves investors getting returns on their investment not based on profits but by subsequent investors. The enticement for new investors is usually short-term investments that offer an unnaturally high rate of return. Because it is not based on actual profits, it is destined for collapse. Madoff, on his way to becoming the largest financial fraud in U.S. history, created a Ponzi scheme that defrauded investors of billions of dollars. A fraudulent transfer suit is when in an effort to mislead creditors, the debtor transfers assets he knows he does not have. This is a fraudulent conveyance. The “suit” part is when a creditor, or a Bankruptcy Trustee, sues the recipients of the fraudulent conveyances demanding the funds back. In the case of Madoff and his Bankruptcy Trustee Picard, Picard is trying to augment the bankruptcy estate by suing people who originally invested in Madoff’s Ponzi scheme and received a “return” on that investment from Madoff. Picard wants the investors’ funds back, despite it being Madoff who created the fraudulent scheme in the first place. So if you are one of those investors, what do you do?

On June 12, defendants in the fraudulent transfer proceedings filed a brief arguing that the bankruptcy judge cannot rule or recommend rulings on fraudulent transfer suits by Picard, the liquidator of Madoff’s brokerage. The defendants, many of whom after receiving original returns from Madoff invested again only to eventually see that investment vanish, argued that attempts to “augment” a bankrupt estate are based on common law and must be heard in district court. In May, US District Judge Jed S. Rakoff ruled bankruptcy courts could not issue final rulings on claims of fraudulent transfers or unjust enrichment, but they could make recommendations or reports to federal district judges, citing the recent Supreme Court decision Stern v. Marshall. The defendants argued such recommendations by bankruptcy judges are not allowed, as Congress has “considered and rejected bankruptcy judges serving as magistrates, who would issues reports and recommendations.”
TMZ Meets the Supreme Court

Oddly enough, the fate of the fraudulent transfer suits and the collateral damage of Bernie Madoff rest with the fortunes of an ill-fated and questionably famous starlet, whose case ended at the doorstep of the supreme law of the land. The case of Stern v. Marshall, decided June 23, 2011, involved the estate of the late Anna Nicole Smith and her late husband. Her husband’s estate, worth a modest 1.6 billion, resulted in a protracted legal battle. The case, which outlived many of the original players, was in 2006 compared to “a Harlequin romance novel. It’s part Knots Landing, and part Shakespearean filial betrayal…the protagonists, shall we say, are not without flaws.” Ouch.

The Supreme Court’s ruling issued a stern warning to Congress not to leave judicial duties to anyone other than the judicial branch. With Chief Justice John Roberts writing the majority opinion, the court held unanimously that under a 1984 law, Congress had given the bankruptcy court the power to issue a final ruling in the debtor’s claim, but ruled 5-4 that Congress violated Article III by creating such power in the bankruptcy courts, thus shutting out Smith. The infamous, flaw-filled celebrity diva went home empty-handed. Tragic.

Roberts argued Congress had grossly overstepped its authority by creating such power in the bankruptcy courts. The ruling states bankruptcy judges cannot constitutionally decide debtor’s claims that are based solely on state law. Bankruptcy judges can still decide cases that are based on federal law or related to a federal regulatory scheme. According to the Court, issuing such decisions from a non-Article III court threatens the entire separation of powers, “…Article III would be transformed from the guardian of individual liberty and separation of powers we have long recognized into mere wishful thinking.” But why do the Madoff victims care about this?
Fight (in Bankruptcy Court) or Flight (out of Bankruptcy Court)
In response, hundreds of former Madoff investors, many of whom were unaware of Madoff’s unapologetic fraud, and facing fraudulent transfer suits in bankruptcy court, are trying to get their case before a federal judge and not a bankruptcy judge, arguing their claim is based solely on state law. Unclear in Stern v. Marshall is whether or not a bankruptcy court can issue recommendations to the relevant federal judges as Rakoff argued in May. Rakoff argued that the specialized expertise of bankruptcy court judges make them better suited to handle such claims and thus should issue recommendations to less experienced federal judges.

If you are concerned that you are a victim of a Ponzi scheme, or could be facing a fraudulent transfer suit, contact the offices of M. Hedayat & Associates. The firm has been expertly handling Bankruptcy proceedings of all kinds for nearly twenty years.

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