BEACON ASSOCIATES MGMT. v. BEACON ASSOCIATES LLC I

Investment Securities LLC ("BLMIS");

(c) the individual member's capital accounts and pro-rata share of Net Asset Value shall be computed based upon the financial statements of Beacon I as certified by Beacon I's certified public accountants for each such year, or portion thereof.

2. A declaratory judgment that none of the "sharing ratios" or capital accounts of any member of Beacon I for any year prior to 2008 is required to be restated to reflect the fact that BLMIS was engaged in a Ponzi scheme in those prior years, which involved the theft or other diversions of assets and fabrication of investment results in such years, but which was not discovered to have existed until December 2008.

3. Beacon Management and Beacon I are ordered to distribute to the members of Beacon I, all of the remaining assets of the Beacon I in accordance with the computation of each member's sharing ratio and capital account computed as specified above, less any existing holdbacks as previously determined or as otherwise ordered by the Court.

(Dkt. No. 24: Fastenberg Notice of Motion ¶¶ 1-3; see also Fastenberg Intervenor Compl. ¶¶ 5, 31 Wherefore ¶ 2, seeking a mandatory injunction.)

Beacon conducted a survey of its members to determine their preferred accounting methodology (see Dkt. No. 40: 5/4/10 Jakoby Aff. Ex. C: 1/26/10 Jakoby Ltr.; id. Ex. D: 3/5/10 Jakoby Ltr.;id. Ex. F: 3/11/10 Jakoby Ltr.). Each member was advised of their "estimated distribution amounts under each method" (1/26/10 Jakoby Ltr. at 2; 3/5/10 Jakoby Ltr. at 2), and was given a copy of: (1) the complaint; (2) Beacon's answer; (3) the Citrin Report; (4) the Roberts Holland opinion letter; and (5) letters from investors "who would receive larger distributions under a restatement method, but are willing to accept the [V]aluation method in order to potentially expedite a distribution to the Beacon Fund's investors." (1/26/10 Jakoby Ltr. at 1-4.)

Tabulation of the completed "Valuation Methodology Form[s]" revealed that, out of 329 total members, 270 (82%) preferred the Valuation Method; thirty-four (10%) preferred a Restatement Method; and twenty-five (8%) did not make a selection. (6/16/10 Jacoby Ltr. at 1-2.) If funds are allocated under the Valuation Method, members favoring that method represent approximately 69% of Beacon's assets whereas those favoring a Restatement Method represent just 10%. (6/16/10 Jakoby Ltr. at 1-2.) If funds are allocated using one of the various Restatement Methods, members favoring the Valuation Method represent approximately 57% of Beacon's remaining assets compared to just 16% favoring Restatement. (6/16/10 Jakoby Ltr. at 1-3.)

Five (1.5%) chose the first Restatement Method; four (1.2%) chose the second Restatement Method; twenty-two (6.7%) chose the third Restatement Method; and three (0.9%) chose Restatement but did not specify which Restatement Method they preferred. (Dkt. No. 59: 6/16/10 Jakoby Ltr.)

Fifteen investors (4.5%) did not respond to the survey and ten (3%) chose to abstain. (6/16/10 Jakoby Ltr.)

The ratio of members favoring the Valuation Method versus Restatement under each of the three Restatement Methods is: (1) 57.6% to 16.2%, (2) 57.7% to 15.9% and (3) 55.7% to 17%, respectively. (6/16/10 Jakoby Ltr.)

On May 20, 2010, this Court held a hearing to discuss the proper methodology to be adopted in distributing Beacon's remaining assets. (Dkt. No. 53: 5/20/10 Hearing Transcript ("H").) The Court heard impassioned testimony from several investors, including Dr. Robert Decker (H. 8-10, 80-81), Bradley Tolkin (H. 10-11, 73-76) and Howard Siegel (H. 13-14, 34-35, 78-80), and argument from counsel for Management (H. 18-19, 58-65), Beacon (H. 6-7, 17-20, 33-37, 65-67,), the Fastenberg Invervenors (H. 37-58, 67-69, 77-78), Petronella (H. 12-13, 14-15, 69-73) and Jordan (H. 21-34).

The Court also received letters from several Beacon members including: Dr. Robert E. Decker; Howard M. Siegel, CPA, JD, LLM; Ironworkers Local No. 6 Pension Fund; Ironworkers Local No. 6 Supplemental Medical and S.U.B. Pay Plan; Bradley J. Tolkin; SALI Fund Services; Holly Weisman; LJMMJ Investors, LLC; Robert Winikoff; Luana Alesio; and Howard Karawan. (5/4/10 Jakoby Aff. Ex. E: Investor Ltrs.)

The Parties' Arguments

The Fastenberg Intervenors maintain that Beacon's Operating Agreement "[r]equires [d]istribution [b]ased [u]pon the Valuation Method." (Dkt. No. 25: Fastenberg Br. at 7.) First, they argue, the Operating Agreement provides that Beacon's assets are to be divided in "`accordance with accounting principles consistently applied from year to year employed under the method of accounting adopted by the Company.'" (Fastenberg Br. at 9; H. 41-42.) In issuing the 2008 financial statements, Management "determine[d] to account for the Madoff theft losses when discovered." (Fastenberg Br. at 9.) Thus, the Fastenberg Intervenors assert, "[t]hat determination . . . should be consistently applied in the 2009 financial statements, and in the financial statements to be prepared in connection with the distribution of assets in 2010." (Fastenberg Br. at 9.)

Secondly, the Fastenberg Intervenors argue, the Agreement requires that profits and losses be allocated in conformity with "Section 704(b) of the Internal Revenue Code." (Fastenberg Br. at 9-10.) "Since the Section 704(b) regulations require that the BLMIS loss must be recognized as of December 2008," they contend, Beacon "must distribute the remaining funds . . . on that basis." (Fastenberg Br. at 10.)

Even if Management had the authority to restate the financial statements, the Fastenberg Intervenors argue, doing so would be unfair because it would "unsettl[e] a whole series of transactions previously engaged in on the basis of [the] certified financial statements." (Fastenberg Br. at 11; H. 39-42, 54.) In any event, they argue, accurately restating the financial statements would be impossible because no one knows "exactly what occurred when, and how [it] occurred" (H. 44; Fastenberg Br. at 13-16), and uncertainty as to when the Madoff losses actually occurred is precisely why Citrin "did not stand behind any of th[e] restatement calculations" (H. 45; Fastenberg Br. at 14-16).

Beacon members Howard Siegel and Dr. Robert Decker also favor use of the Valuation Method. According to Siegel, each of the proposed accounting "methods has pros and cons," but the Valuation Method has been employed "over the 14 or 15 years of the fund" and is the best method to provide an "expeditious" distribution. (H. 79.) Like Siegel, Decker prefers the Valuation Method because it was the method used throughout the life of the fund and would lead to the quickest distribution. (H. 9-10, 80-81.)

The Fastenberg Intervenors' motion is opposed by the Estate of P. Neill Petronella, a Beacon member since 2006. (Dkt. No. 41: Re Aff.; Dkt No. 42: Petronella Br.) Petronella opposes use of the Valuation Method because it "recognizes fictitious gains and unfairly requires more recent investors to give up a share of their actual dollar investment to subsidize earlier investors, whose only claim to such additional funds are the fabricated profits Madoff put on paper." (Petronella Br. at 8.) If the Valuation Method were adopted, Petronella argues, the only measure taken

to reconcile the Beacon Funds investors' account with the economic reality of the fraud perpetrated by the Madoff Ponzi scheme is a single write off in late 2008; thereby, incorporating and necessarily endorsing all of the fictitious profits previously reported by BLMIS up to the December 2008 write off.

(Petronella Br. at 6)

Instead, Petronella proposes that capital account balances be recalculated based upon an "investor's cash contributions, less withdrawals." (Petronella Br. at 1.) While recognizing that this so called "Net Investment" Method is not perfect, Petronella claims that it is preferable to the Valuation or Restatement Methods because it does not give "credence to `profits' that everyone now knows to be a fiction." (Petronella Br. at 1.) Moreover, Petronella argues, because courts routinely apply the Net Investment Method "when a Ponzi scheme collapses[] and there are insufficient assets to repay all of the investments," and because "the overwhelming majority of Beacon's funds are subject to the B[LM]IS Ponzi scheme," the Net Investment Method should be applied here. (Petronella Br. at 7-10; H. 69.)

Similarly, investor Bradley Tolkin argues that because the only facts known, or knowable, "are cash in and cash out," the Net Investment Method is the only accounting method not based upon a "fiction." (H. 74-76; Dkt. No. 40: 5/4/10 Jakoby Aff. Ex. E: 3/11/10 Tolkin Email.)

Conversely, the Fastenberg Intervenors argue that the Net Investment Method should not be used because Beacon made real profits through non-BLMIS investments, and the Net Investment Method ignores those legitimate gains. (H. 50-51.)

Although Beacon takes no position on the proper accounting methodology, it opposes the Fastenberg Inervenors' motion to the extent that it calls for distribution of all Beacon's remaining assets. (Dkt. No. 39: Beacon Br. at 9.) According to Beacon, a "litigation reserve of 9% was established in early 2009 and should at this time be maintained." (Beacon Br. at 9; Dkt. No. 38: Rosenfeld Aff. ¶ 9.) Also, Beacon was informed in August 2009 that the Madoff Bankruptcy Trustee is "asserting claw back claims" against Beacon totaling $28,310,000. (Beacon Br. at 9; see Rosenfeld Aff. ¶ 9.) Accordingly, Beacon requests that an appropriate amount of money be set aside in the event it is required to pay those claims. (Beacon Br. at 9-10.)

ANALYSIS I. THE VALUATION METHOD SHALL BE USED TO DISTRIBUTE BEACON'S REMAINING ASSETS

A. Beacon's Operating Agreement Mandates Use of the Valuation Method

The Fastenberg Intervenors assert that Beacon's Operating Agreement "[r]equires" that Management make distributions using the Valuation Method. (See page 14 above.) The Court agrees.

Pursuant to Article XIV of Beacon's Operating Agreement, upon dissolution, Beacon's remaining assets are to be distributed to "Members in accordance with their positive Capital Account balances taking into account all Capital Account adjustments for the Company's taxable year in which the dissolution occurs." (Dkt. No. 1: Compl. Ex. A: Operating Agmt. Art. XIV ¶ 2.1(iii).) As mentioned above, each member's capital account balance is "equal to [their] proportionate share of the Net Worth of" Beacon, which includes "all cash and cash equivalents . . ., accrued interest and the market value of all securities and other assets of" Beacon. (See page 3 n. 4 above.)

The Operating Agreement, therefore, clearlymandates that each member's distribution equal their proportionate share of Beacon's remaining assets. What is at issue here, however, is whether the Operating Agreement requires that each members' interest equal their capital account balance as stated on Beacon's books as of December 2008, or whether Beacon's books should be restated to eliminate the fictitious profits reported to Beacon by BLMIS.

Interestingly, although approximately 10% of Beacon's investors indicated that they preferred one of the Restatement Methods (see page 13 above), no party appearing before the Court has argued for its application. Instead, the dispute before the Court is between those preferring the Valuation Method and those preferring the Net Investment (cash in less cash out) Method. (See pages 14-17 above.)

According to Beacon's Offering Memorandum:

Net Worth and Net Worth per Interest will be calculated as of the closing of business on the last business day of each month in each year, on each Withdrawal Date, and such other date(s) as the Managing Member determines (each, a "Valuation Date"). Securities held by the Company are valued by the Managing Member at their fair market value as of the Valuation Date. . . . Investments in Investment Pools are valued pursuant to the valuations submitted to the Company by the Managers of the Investment Pools, which valuations the Company expects to accept. All values assigned by the Managing Member are final, binding and conclusive on all of the Members.

(Dkt. No. 51: Jordan Intervenor Compl. Ex. 1: Offering Mem. at 35, emphasis added.)

While this provision suggests that historical computations of member interests should not, or cannot, be disturbed, Petronella argues that the Operating Agreement, while correctly reflecting "the agreement between the investors as to profits and losses due to market fluctuations, investment risks, [and] volatility of market," is inapplicable here because "there was no agreement as to how to divvy up the remaining assets after a fraud." (Dkt. No. 53: H. 69-70.) While it is undoubtedly true that no one anticipated the extent of Madoff's fraud, the Offering Memorandum clearly states that "[t]he Managing Member relies on the Managers of Investment Pools for the valuations of these vehicles for purposes of calculating the Company's Net Asset Value," and further warns that "[t]here is no assurance that these valuations will be accurate." (Offering Mem. at 24.) In a section entitled "Company Risks," the Offering Memorandum is explicit: "Although the Managing Member endeavors to verify the integrity of its Managers and broker it utilizes, there is always the risk that they could mishandle or convert the securities or assets under their control." (Offering Mem. at 21-22.)

These provision demonstrate that it was an understood risk that investment managers, such as Madoff, might misappropriate Beacon's assets, resulting in false Beacon financial statements. Nonetheless, the members agreed that once adopted by Management, those financial statements would become "final, binding and conclusive on all of the members." (Offering Mem. at 35.) Because the financial statements upon which each member's final capital account balance is based were adopted by Management, the Operating Agreement requires that each member's interest equal their capital account balance as stated on Beacon's books as of December 2008.

Moreover, as discussed in the May 27, 2009 Roberts Holland letter (Compl. Ex. B: Roberts Holland Op. Ltr. at 3-6), Beacon intended "to be taxed as a partnership for federal income tax purposes" (Offering Mem. at 7, 23, 35). Accordingly, the provisions of the Operating Agreement dealing with the maintenance of capital accounts were

intended, and shall be construed, and if necessary, modified to cause the allocations of profits, losses, income, gain and credit . . . to have substantial economic effect under the Regulations promulgated under Section 704(b) of the [Internal Revenue] Code.

(Operating Agmt. Art. VIII ¶ 5.)

Pursuant to Treasury Regulation 1.704-1, promulgated under section 704(b) of the Code, "an allocation of income, gain, loss, or deduction," has "substantial economic effect" if "there is a reasonable possibility that the allocation (or allocations) will affect substantially the dollar amounts to be received by the partners from the partnership, independent of tax consequences," 26 C.F.R. §§ 1.704-1(b)(2)(i) 1.704-1(b)(2)(iii), and if "the partnership agreement provides . . . [f]or the determination and maintenance of the partners' capital accounts in accordance with the rules of paragraph (b)(2)(iv) of this section. . . ." 26 C.F.R. § 1.704-1(b)(2)(ii)(b)(1).

Although the Robert's Holland letter indicates that Beacon's capital accounts were "maintained in accordance with GAAP" rather than "in accordance with the rules of Treasury Regulation section 1.704(b)(2)(iv)" (Roberts Holland Op. Ltr. at 5), the language in Beacon's Operating Agreement tracks closely that of section 1.704-1(b)(2)(iv), compare, e.g., Operating Agmt. Art. VIII ¶¶ 1-4, with 26 C.F.R. § 1.704-1(b)(2)(iv)(b), and Beacon's accountants advised that the capital account balances would be "substantially equal" under either standard (Roberts Holland Op. Ltr. at 5-6). In this regard, Treasury Regulation 1.704-1(b)(2)(iv) provides that:

Discrepancies between the balances in the respective capital accounts of the partners and the balances that would be in such respective capital accounts if they had been determined and maintained in accordance with this paragraph (b)(2)(iv) will not adversely affect the validity of an allocation, provided that such discrepancies are minor and are attributable to good faith error by the partnership.

26 C.F.R. § 1.704-1(b)(2)(iv)(p).

Treasury Regulation 1.704-1(b)(2)(iv) states, in relevant part, that

the capital accounts of the partners will not be considered to be determined and maintained in accordance with the rules of this paragraph (b)(2)(iv) unless adjustments to such capital accounts in respect of partnership income, gain, loss, deduction . . . are made with reference to the Federal tax treatment of such items. . . .

26 C.F.R. § 1.704-1(b)(2)(iv)(n) (emphasis added).

On March 17, 2009, the IRS issued Revenue Ruling 2009-9, holding that a "loss from criminal fraud or embezzlement in a transaction entered into for profit is a theft loss, not a capital loss, under § 165." 2009-14 I.R.B. 735, 2009 WL 678990 (IRS RRU). In turn, Treasury Regulation 1.165-8 mandates that:

A loss arising from theft shall be treated under section 165(a) as sustained during the taxable year in which the taxpayer discovers the loss. Thus, a theft loss is not deductible under section 165(a) for the taxable year in which the theft actually occurs unless that is also the year in which the taxpayer discovers the loss.

26 C.F.R. § 1.165-8(a)(2) (citation omitted); see also 2009-14 I.R.B. 735 ("A theft loss in a transaction entered into for profit is deductible in the year the loss is discovered. . . ."). Moreover, Revenue Ruling 2009-9 permits the investor to "claim a theft loss deduction not only for the net amount invested, but also for the so-called `fictitious income' that the promoter of the scheme credited to the investor's account and on which the investor reported as income on his or her tax returns for years prior to discovery of the theft." Prepared Testimony of Doug Shulman, Commissioner, IRS, Before the Senate Finance Committee on Tax Issues: Related to Ponzi Schemes and an Update on Offshore Tax Evasion Legislation (Mar. 17, 2009), at http://www.irs.gov/newsroom/article/0,id=205374,00.html; see also 2009-14 I.R.B. 735 at *8 ("Where an amount is reported to the investor as income prior to discovery of the [fraudulent] arrangement and the investor includes that amount in gross income and reinvests this amount in the arrangement, the amount of the theft loss is increased by the purportedly reinvested amount.").

Because Beacon's Operating Agreement requires that capital accounts be maintained in accordance with Federal Treasury rules, and because the IRS has ruled that losses attributable to Ponzi schemes be reported in the year they are discovered, Beacon's Operating Agreement must be read as requiring that Madoff theft losses, including those losses owing to "fictitious profits," be allocated among its members' capital accounts in proportion to their interest in Beacon as recorded in December 2008, when Madoff's fraud was discovered.

B. Beacon's Members Overwhelming Selected the Valuation Method

On January 26, 2010, counsel for Beacon surveyed all members to determine which, if any, of the methodologies they preferred. (See pages 12-13 above.) The survey results show that an overwhelming majority of Beacon's members favor the Valuation Method. (See page 13 above.)

According to the Operating Agreement: "All Members . . . who have not withdrawn pursuant to Article XII hereof shall be entitled to vote on any matter submitted to a vote of the Members." (Dkt. No. 1: Compl. Ex. A: Operating Agmt. Art. VI ¶ 1, emphasis added.)

Unless specifically provided otherwise herein, whenever the Members are entitled to vote on any matter under . . . this Operating Agreement . . ., such matter shall be considered approved or consented to upon the receipt of the affirmative approval or consent . . . of Members whose combined Sharing Ratios aggregate at least fifty-one percent (51%) of the Sharing Ratios.

(Operating Agmt. Art. VI ¶ 2, emphasis added.)

The only events which the Operating Agreement "specifically provided" for a larger majority are: (1) "the continuation of the Company after a Dissolution Event" (75%) (Operating Agmt. Art. VI ¶ 1.1 Art. XIV ¶ 1.1(i)); (2) the "Removal of [a] Managing Member" (75%) (Operating Agmt. Art. Art. VII ¶ 7); (3) "the election of a Managing Member to fill a vacancy" (75%) (Operating Agmt. Art. VI ¶ 1.2 Art. VII ¶ 8); and (4) "Amendment or Modification of [the] Operating Agreement" (66%) (Operating Agmt. Art. XV ¶ 2).

Here, the issue of which methodology should be used to allocate the Madoff losses effectively was "submitted to a vote of the Members" (see page 12-13 above) and does not involve any of the issues requiring a super-majority vote. Accordingly, consent by a simple majority is all that the Operating Agreement requires. The result of Beacon's survey-vote shows that members owning 51% or more of Beacon's assets (irrespective of which methodology is used to calculate the members' interest) favor the Valuation Method. (See page 13 above.) Thus, by exercising the rights provided to them by the Operating Agreement, Beacon's members have affirmed that the Fund's remaining assets be distributed in the proportion that each member's capital account bears to all other capital accounts, as calculated by applying the Valuation Method. The members' selection shall be honored.

C. The Cases Employing the Net Investment Method of Distribution are Inapplicable Because Beacon Itself Was Not a Ponzi Scheme

Beacon members Petronella and Tolkin assert that Beacon's remaining assets should be distributed in accordance with the Net Investment Method, i.e., cash in less cash out. (See pages 15-16 above.) Petronella argues that while the Valuation Method "recognizes fictitious gains and unfairly requires more recent investors to give up a share of their actual dollar investment to subsidize earlier investors," the Net Investment Method "ties the value of the account to the economic reality of the underlying transactions." (Dkt. No. 42: Petronella Br. at 8-9; see pages 15-16 above.) According to Petronella, because of the inequity that would result from "legitimizing the fictitious profits" (Petronella Br. at 9), the Court should follow those cases, including Judge Lifland's opinion in the Madoff bankruptcy proceedings,In Re Bernard L. Madoff Inv. Sec. LLC, 424 B.R. 122 (Bankr. S.D.N.Y. 2010), that hold that "when a Ponzi scheme collapses, and there are insufficient assets to repay all of the investments, the victims of the fraud should recover

proportionately in accordance with their actual losses and not their fictitious profits." (Petronella Br. at 7, 8.)

Although it may well be true, as Judge Lifland reasonably articulated, that in Ponzi scheme cases "equity and practicality favor the Net Investment method," In Re Bernard L. Madoff Inv. Sec. LLC, 424 B.R. at 140-42, the present case is distinguishable because Beacon itself was not a Ponzi scheme.

Petronella's argument that, "[b]ecause the overwhelming majority of Beacon's funds are subject to the B[LM]IS Ponzi scheme, Beacon's members are now in a similar position to those who invested directly with BLMIS" (Petronella Br. at 8; see page 16 above), is unavailing. First, unlike BLMIS, where every dollar invested was subject to Madoff's fraud, Beacon invested approximately thirty percent of its assets with legitimate managers who consistently made profits. (See page 5 above; Dkt. No. 53: H. 38-39, 71-72, 76-77.) Thus, while application of the Valuation Method allows Madoff-related "fictitious profits" to inflate member interests, application of the Net Investment Method would strip investors of legitimate gains from Beacon's significant non-Madoff investments.

Even if Beacon's accountants were capable of netting out each members BLMIS investments while properly allocating the legitimate profits gained from other investment managers (which the Court has no way of knowing), attempting to do so would be very "timeconsuming" and "expensive." (H. 76-77.) While Citrin calcualted each member's shares under the Valuation and Restatement Methods, Citrin did not recommend or calcualte member's shares under the Net Investment Method. (See pages 6-7 above.) Because Beacon has a finite amount of resources and its members have waited close to two years to receive their money, spending more investor money while tying up the funds for an indefinite period would be counterproductive.

Second, and more importantly, whereas BLMIS was subject to the Securities Investor Protection Act ("SIPA") requiring that "customers share pro rata in customer property to the extent of their net equities, as defined in SIPA," In Re Bernard L. Madoff Inv. Sec. LLC, 424 B.R. at 124-25, Beacon is governed by its Operating Agreement which requires that Beacon's assets be distributed in accordance with the Valuation Method. (See Section I.A above.) The Court is not aware of any legal authority that would allow it to upset this contract between and among Beacon's members, and is unpersuaded that equity demands it. See, e.g.,Lanier v. Bowdoin, 282 N.Y. 32, 38 (1939) ("In the absence of prohibitory provisions of the statutes, or of rules of the common law relating to partnerships, or considerations of public policy, the partners of either a general or limited partnership, as between themselves, may include in the partnership articles any agreement they wish concerning the sharing of profits and losses, priorities of distribution on winding up of the partnership affairs and other matters. If complete, as between the partners, the agreement so made controls. The agreement here is not barred by law and furnishes a complete and legal scheme for distribution of assets and participation in profits and losses as between the partners and must control.") (citation omitted), reargument denied, 282 N.Y. 611 (1940).

II. JORDAN AND MCBRIDE'S CONTESTED CONTRIBUTIONS WERE FULLY INVESTED PRIOR TO DISCOVERY OF THE MADOFF FRAUD

Beacon members Jordan Group LLC and Donna McBride made substantial capital contributions to Beacon after it made its "last placement" with BLMIS in July 2008. They contend that those investments should be returned in full rather than be included in the pool of assets to be

distributed to Beacon's members. For the reasons set forth below, Jordan and McBrides' request for relief is DENIED.

A. Additional Facts Regarding Jordan and McBride's Contributions

Beacon members Jordan and McBride also intervened in this action. (See Dkt. No. 29: 3/15/10 McBride Ltr.; Dkt. No. 36: 4/30/10 Order; Dkt No. 51: Jordan Intervenor Compl.) Jordan, a member of Beacon since 2003, made a $700,000 capital contribution to Beacon on September 1, 2008. (Jordan Intervenor Compl. ¶¶ 1-2, 40.) McBride made a $200,000 capital contribution on December 2, 2008, which was received by Beacon on or about December 4, 2008. (3/15/10 McBride Ltr. at 1 Ex. B: Fidelity Check Image.) Because Beacon "`made its last placement of funds with Madoff in July of 2008'" (Jordan Intervenor Compl. ¶ 46), Jordan and McBride contend that it is impossible that their late contributions were stolen by Madoff (Jordan Intervenor Compl. ¶¶ 10, 46-49; 3/15/10 McBride Ltr. Ex. C: 12/15/08 McBride Ltr.). Accordingly, Jordan and McBride demand that their contributions be returned in full and not included in their "capital account balance for the purpose of calculating [their] respective distributive share." (Jordan Intervenor Compl. ¶¶ 11, 53-58 Wherefore ¶¶ 2-3; Dkt. No. 55: Jordan Br. at 2-5; 3/15/10 McBride Ltr. at 1.)

McBride's investment was accepted and deemed effective as of December 1, 2008. (3/15/10 McBride Ltr. at 1 Ex. A: 12/4/08 Beacon Ltr.) According to McBride, her capital contribution should be returned in full because it "obviously could not have been invested before December 11, 2008 when Mr. Madoff announced the fraud." (3/15/10 McBride Ltr at 1 Ex. C: 12/15/08 McBride Ltr.) Moreover, McBride argues, because Beacon's Operating Agreement "clearly states that you can only make an investment before the 1st of the month" and "[i]t is against the law for Beacon (or anyone else) to back date an investment into [an] investment account" (Dkt. No. 56: 6/2/10 McBride Ltr.), her contribution should not have been deemed effective as of December 1, 2008, and her funds should be returned. (6/2/10 McBride Ltr.; 3/15/10 McBride Ltr. at 1.)

According to Jordan, "Federal law is clear [that] when the wrongdoer does not take legal possession of a client's funds, the client is entitled to a full return of those funds." (Jordan Br. at 2-3.) Since Jordan's contribution "was effectively separated from funds which were transferred to the legal possession of Madoff," Jordan argues, "law and equity dictate" that it not "be included among Beacon's losses sustained by Madoff's activities." (Jordan Br. at 2-4; Jordan Intervenor Compl. Wherefore Clause ¶ 2.) Finally, Jordan argues, Beacon's Operating Agreement "[d]oes [n]ot [p]reclude" the return of its funds and equitable principles militate in favor of granting the requested relief. (Jordan Br. at 5-8.)

Beacon opposes Jordan and McBride's position that money invested after its last placement with BLMIS should be returned. (Dkt. No. 53: H. 17-20, 24-25; Dkt. No. 58: 6/11/10 Jakoby Aff.) According to Beacon, Jordan's $700,000 contribution became effective on September 1, 2008. (6/11/10 Jakoby Aff. ¶ 4; H. 19.) In fact, Jordan's October 21, 2008 capital account statement reflects "that the September 1, 2008 $700,000 investment was already earning profit just like all other pre-July 2008 investments." (6/11/10 Jakoby Aff. ¶ 20.) With respect to McBride's December 2008 contribution, Beacon maintains that it became effective on December 1, 2008 because McBride "specifically requested that [it] be deemed effective" on that date (6/11/10 Jakoby Aff. ¶ 27; H. 18-19), and it was within Management's discretion to grant her request (6/11/10 Jakoby Aff. ¶ 26). Thus, Beacon argues, Jordan and McBride were "fully invested . . . before it was made public that Bernard Madoff was running a Ponzi scheme" (6/11/10 Jakoby Aff. ¶ 28), and once

accepted, they became "pro rata investor[s] in all of the funds' interests" regardless of when, or whether, their capital contribution was actually invested with BLMIS (H. 17). Accordingly, Beacon reasons, Jordan and McBride are not entitled to the requested relief but must bear their share of Beacon's loss. (6/11/10 Jakoby Aff. ¶ 28; H. 17-24.)

B. Analyses

It is undisputed that at the time of their contested contributions, Jordan and McBride were members of Beacon. Accordingly, determination of how to treat those contributions is controlled by the terms of Beacon's Operating Agreement. See NCAS Realty Mgmt. Corp. v. Nat'l Corp. for Hous. P'ships, 143 F.3d 38, 45 (2d Cir. 1998) ("When a partnership agreement contains clear and unambiguous terms, New York courts enforce the plain meaning of those terms. . . ."); Furman v. Cirrito, 828 F.2d 898, 901 (2d Cir. 1987) ("The rights and obligations of partners, as between themselves, are fixed by the terms of the partnership agreement."); Greenwald v. Friedman, 147 B.R. 5, 8 (Bankr. S.D.N.Y. 1992) ("The rights and obligations of partner are fixed as between themselves, by the terms of the partnership agreement and not by the operation of law."); Lanier v. Bowdoin, 282 N.Y. 32, 38 (1939) ("If complete, as between the partners, the agreement so made controls."); Corr v. Hoffman, 256 N.Y. 254, 272 (1931) ("The rights and obligations of the partners as between themselves arise from, and are fixed by, their agreement."); Levy v. Leavitt, 257 N.Y. 461, 466 (1931) (same).

Pursuant to Article VIII of Beacon's Operating Agreement, investors receive a membership interest in Beacon in exchange for their capital contribution. (See pages 3-5 above; Dkt. No. 1: Compl. Ex. A: Operating Agmt. Art. VIII ¶ 1; Dkt. No. 51: Jordan Intervenor Compl. Ex. 1: Offering Mem. at 30.) Thereafter, Beacon "establish[es] and maintain[s] [a] Capital Account[] for each Member" (Operating Agmt. Art. VIII ¶ 2; see page 3 above), the balance of which is "equal to [their] proportionate share of the Net Worth of the Company" (see page 3 above). Existing members may "make additional investments in $25,000 increments on the first day of any month, or in such other amounts or at such other times as the Managing Member, in its discretion, may determine" (see page 4 n. 5 above, emphasis added), thereby increasing their interest in Beacon (see page 4 above).

Once made, member contributions are pooled and collectively invested for Beacon's benefit. (See page 4 above.) Similarly, those monies not invested in securities or other financial instruments are "deposited in a bank or money market account maintained by the Managing Member . . . in the name of and for the benefit of" Beacon. (See page 4 above.) "[F]or financial and tax purposes," Beacon's profits and losses are apportioned among its members' capital accounts "in the proportion that [their] Capital Account bears to all other Capital Accounts on the last day of each applicable accounting period" (Offering Mem. at 5; see page 19 above), with allocated profits constituting "additional Capital Contribution[s] . . . to the Company" (see page 4 above).

Thus, member contributions to Beacon secure a percentage interest in Beacon's net assets and a correlative right to share proportionately in Beacon's profits and losses. If Beacon's investments performed well, the value of each members' interest increased; if, on the other hand, the investments performed poorly, the value of their interest decreased proportionately.

It is irrelevant that particular contributions by Jordan and McBride were made after Beacon's last placement with BLMIS, and Jordan's argument that its contribution was "effectively separated from funds which were transferred to the legal possession of Madoff" (see page 27 above) is misplaced. Once Jordan and McBride's contributions were accepted by Beacon, the money became a Beacon asset and they received an incrementally larger "share of the Net Worth of the Company," including "all cash and cash equivalents . . ., accrued interest and the market value of all securities and other assets of" Beacon. (See page 3 n. 4 above.) The funds were not segregated in Jordan's and McBride's accounts, but were part of Beacon's general assets.

The cases cited by Jordan are inapposite. In Anderson v.Stephens, government regulators filed suit against the "Futures Investment Group (`FIG')," an unregistered "commodity pool operator" that lost approximately seventy five percent of its investors' funds. Anderson v. Stephens, 875 F.2d 76, 77 (4th Cir. 1989). Following the issuance of a court order freezing FIG's bank account, several checks were deposited into the account.Anderson v. Stephens, 875 F.2d at 77. Rather than allow the funds to be added to other monies already in the account for purposes of a prorata distribution to all FIG investors, the Fourth Circuit ruled that checks deposited after the freeze order was issued should be returned in full. Anderson v. Stephens, 875 F.2d at 78, 81. In so ruling, the Fourth Circuit found "that the freeze order implicitly prohibited any banking activity with regard to the FIG account . . . [and] funds deposited after cessation of business rightfully can be retrieved." Anderson v.Stephens, 875 F.2d at 79-80.

In SEC v. Black, the president of a registered investment advisor (Devon Capital Management) began operating a Ponzi scheme after suffering "massive trading losses." SEC v. Black, 163 F.3d 188, 191 (3d Cir. 1998). Upon discovery of the fraud, the SEC obtained a temporary restraining order "whereby all assets `presently held by [Devon], under their control or over which they exercise actual or apparent investment of other authority' . . . were to be immediately frozen."SEC v. Black, 163 F.3d at 191-92. Among those assets frozen by the SEC were: (1) securities held "in a pooled account in the name of [Devon] in its principal depository bank"; (2) securities held in custodial accounts at Devon's bank for the benefit of Devon's individual investors; and (3) securities held in individual investor accounts at the investors' own banks. SEC v. Black, 163 F.3d at 192. The Third Circuit upheld a District Court order releasing funds held in the individual and custodial accounts because none of those funds were "assets of the defendants" and the "investors themselves were [not] implicated as `wrongdoers.'" SEC v. Black, 163 F.3d at 196. The funds in the pooled account, however, were properly frozen because "th[o]se accounts were not . . . in the names of individual investors, but, rather, were commingled funds in a pooled account . . . over which the defendants had control." SEC v. Black, 163 F.3d at 196 n. 6. Importantly, the Third Circuit did not "determine claims . . . or in any way resolve disputes or final distributions among the parties." SEC v.Black, 163 F.3d at 198.

The Court fails to see the factual similarity between Anderson or Black and the present case, or how the legal principal for which those cases are purportedly offered, i.e., investors are entitled to "take a full recovery of invested funds from remaining available assets when . . . the wrongdoer never obtained legal title or possession of the . . . investment" (Jordan Br. at 2-5), applies. First, unlike Anderson, Beacon's accounts were never frozen and Jordan and McBride's capital contributions were received and accepted before discovery of the Madoff fraud. (See pages 27-28 above.) Second, unlike the accounts released in Black, Jordan and McBride's capital contributions were not segregated from other investor's funds, but were pooled and commingled in a single account held in Beacon's name. (See pages 4, 28 above; H. 24-25.) To the extent Jordan and McBride urge that funds never legally in Madoff's possession should be returned, it is clear that they misapprehend how Beacon operated. The money was not in a separate account in Jordan or McBride's name, but was part of Beacon's general assets, available to pay Beacon's expenses or to pay Beacon members who were withdrawing money invested in Beacon (including invested through Beacon in Madoff).

Even as Jordan and McBride were putting money into Beacon, member Howard Siegel requested a "substantial withdrawal" from Beacon. (H. 34.) Siegel never received his withdrawal, however, because Beacon's Operating Agreement mandated a sixty day waiting period between a withdrawal request and dispersal, and by the time that period had ended, Management learned of Madoff's fraud and denied Siegel's request out of "fairness and equity to all the investors." (H. 34-35.) Accordingly, it would be inequitable to side-step the terms of the Operating Agreement in favor of Jordan and McBride while simultaneously upholding the Agreement to deny the release of Siegel's funds.

Neither does equity dictate that Jordan and McBride's late contributions be returned in full. As was pointed out at the hearing, once accepted, each investor stood to reap the benefits of membership. (H. 24-27.) Accordingly, had Beacon's investments gained in value, Jordan and McBride would have benefitted from the gain, and would not now argue that their investments should not have been deemed effective until a later date.

Indeed, Jordan's October 2008 capital account report shows that Jordan's September contribution earned profits. (See page 27 above.)

Equally unavailing is McBride's contention that Management acted improperly by retroactively accepting her investment. (See page 26 n. 23 above.) Although McBride's contribution was dated December 2, 2008, and was not received until December 4, 2008, she specifically requested that her investment be deemed effective on December 1, 2008. (See pages 27-28 above.) Pursuant to the terms of Beacon's Offering Memorandum, Management had the authority to accept McBride's contribution on the "first day of [the] month, or at such other time as the Managing Member, in its discretion, may determine" (see page 3 n. 3 above, emphasis added), and decided to exercise its discretion to accommodate McBride's request (see pages 27-28 above; H. 18-19, 36-37; 6/11/10 Jacoby Aff. ¶ 27). While the Offering Memorandum also states that no investment will be effective until the contribution is "credited to the Company's account" (Offering Memo, at 8, 31), McBride's own records show that the funds were withdrawn from her bank account on December 5, 2008, before discovery of Madoff's Ponzi scheme. (See Dkt. No. 29: 3/15/10 McBride Ltr. Ex. B: Fidelity Check Image.)

For the reasons stated above, Jordan and McBride's requests areDENIED, and their capital contributions, dated as of September 1, 2008 and December 1, 2008 respectively, shall be included in the assets to be distributed amongst Beacon's remaining members.

CONCLUSION

For the reasons stated above, the Fastenberg Intervenors' motion is GRANTED. A mandatory injunction is granted directing Beacon's Management to distribute, by August 31, 2010, Beacon's remaining assets, including Jordan and McBride's contested contributions, in accordance with the Valuation Method (i.e., in the proportion that each member's capital account bears to all other capital accounts, as stated in Beacon's books as of December 2008). Management, however, is ordered to maintain the previously established litigation reserve; to withhold an amount sufficient to cover the claims asserted against Beacon by the Madoff Trustee; and to refrain from distributing any monies to either Managing Member, Joel Danziger or Harris Markhoff, until further Court order.

SO ORDERED.