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Legal Update

Southern District of New York Dismisses $3 Billion Madoff Feeder-Fund Class Action

20 April 2011
Mayer Brown Legal Update

On March 30, 2011, Judge Deborah A. Batts of the US District Court for the Southern District of New York dismissed a $3 billion consolidated securities class action against two so-called “feeder funds” that channeled investments into Bernard L. Madoff Securities LLC (BMIS) in a case entitled In Re Kingate Management Ltd. Litigation, 1:09-cv-05386 (S.D.N.Y. Mar. 30, 2011). After the US Supreme Court’s decision in Morrison v. National Australia Bank Ltd., which found that Section 10(b) of the Securities Act of 1934 does not apply extraterritorially, the parties had voluntarily dismissed all federal claims under Section 10(b), leaving only the state common law claims intact.

In its decision, the district court concluded that the remaining claims were foreclosed by the Securities Litigation Uniform Standards Act of 1998 (SLUSA), which preempts certain categories of securities actions brought under state law, subjecting them instead to federal statutory standards. 

In In Re Kingate, the plaintiffs claimed that Kingate Global Fund Ltd. and Kingate Euro Fund Ltd., two divisions of US-based corporate parent Tremont Group Holdings, Inc., directed capital into Madoff’s fraudulent operations, acting essentially as cursory pass-through vehicles by which investors could place their assets. The funds’ investments, $963 and $767 million, respectively, were made through a total of 155 wire transfers, beginning in March 1994—the present value of which had purportedly grown to over $3 billion by December 2008. All of the monies were eventually lost. The plaintiffs sought damages based on the alleged failure of the Kingate funds to oversee, audit and otherwise ensure that covered securities were being purchased on behalf of the funds.   

In her dismissal order, Judge Batts concluded that the common law claims in plaintiffs’ consolidated action were “in connection with the covered securities” that Madoff claimed to have purchased, bringing them within the purview of SLUSA. As a result, the plaintiffs’ claims under state law alleging fraud, misrepresentation, material omission or the use of a deceptive device were barred. Although the plaintiffs argued that their purchases in overseas funds should not trigger SLUSA preemption, the district court found that under the statute’s broad construction, “it is enough that the fraud alleged ‘coincide’ with a securities transaction—whether by the plaintiff or by someone else.” 

The court further noted that Congress enacted SLUSA to prevent plaintiffs from seeking to evade the protections against abusive securities litigation codified in the Private Securities Litigation Reform Act (PSLRA) by filing class action fraud claims based on state law rather than on federal securities law. Because Judge Batts also denied leave for plaintiffs to amend their claims, SLUSA preemption proved fatal to the plaintiffs’ case. 

Other feeder-fund decisions have resulted in similar dismissals, though on different grounds. For instance, a recent decision in the Southern District of New York found that “red flags” were insufficient to allege scienter in a securities class action in the absence of evidence that defendants were actually aware of most of the warning signs related to the Madoff investments, and those of which they were aware were not so serious as to permit an inference of intent to defraud. Saltz v. First Frontier, LP, No. 10 Civ. 964 (S.D.N.Y. Dec. 23, 2010). For more information, see our January 13, 2011 Legal Update, “Southern District Court of New York Holds ‘Red Flags’ Insufficient to Allege Scienter in Madoff-Related Federal Securities Class Action.”

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