Legal Commentary

Whereas lots of attention has been paid to recovery from Madoff (and his wife), another source of funds may be from investors who redeemed shares before the Ponzi scheme fell apart.  (Although the investors would have to return money, presumably they would eventually get their pro-rata share.)  These investors may have an uphill battle.  

First, "good faith" is an affirmative defense to a fraudulent conveyance claim, but it doesn't necessarily have the same meaning as in other areas of the law.  As Bankruptcy Judge Hardin described "good faith" in In re Bayou:

"The test [for good faith] is whether the defendant requested redemption after learning of a 'red flag' which, under an 'objective' standard, should have put the defendant on 'inquiry notice' of some infirmity in Bayou or the integrity of its management.  The rule does not require that the 'red flag' be of such specificity as to put the recipient on 'inquiry notice' of the actual fraud, or embezzlement, or looting, or whatever ultimately proves to be the cause of loss.  It is sufficient if the red flag puts the investor on notice of some potential infirmity in the investment such that a reasonable investor would recognize the need to conduct some investigation."

And presumably (reasonably and without what we usually think of as "bad faith") to consider redemption....

Second, hat tip to Edward Hynes (Cardozo '10 and summer law clerk to Judge Hardin), who describes another fact that may support clawback in the Madoff cases:

"Bernard Madoff's admission in his plea allocution that he operated a Ponzi scheme is bad news for those who redeemed investments from his fund. Courts have found that criminal admissions of a fraudulent scheme to defraud investors made in plea allocutions are admissible as direct evidence of "actual intent" to defraud creditors. This is significant because under Section 548(a)(1)(A) of the Bankruptcy Code, a trustee may clawback the principal and fictitious profits of any redemption that was made with 'actual intent' to defraud creditors.

Madoff's allocution details how he operated the fraud. This will be good evidence for any forensic accounting expert to track down how accounts were fraudulently calculated and specific assets transferred. In the recent Bayou hedge fund case, Judge Adlai S. Hardin used the plea allocutions of the hedge fund officers to decide that investor redemptions were fraudulent and, therefore, subject to clawback."