Kathy Bazoian Phelps
Senior Counsel in Ponzi Scheme Litigation
and Bankruptcy Matters
Kathy is a senior business trial attorney with more than 25 years experience prosecuting and defending claims for clients involved in Ponzi scheme matters and in bankruptcy proceedings. Kathy’s practice includes recovering assets for clients in complex fraud cases on under standard fee and alternative fee arrangements. Kathy also serves as a mediator in bankruptcy matters, in complex business disputes, and in matters requiring an expert on fraud or Ponzi schemes.
Kathy’s Clients in Ponzi Scheme Cases and Bankruptcy Matters
High Net Worth Investors
Debtors in Bankruptcy
Secured and Unsecured Creditors
Saturday, May 31, 2014
Monday, May 26, 2014
In a case arising out of the Bernard Madoff Ponzi scheme, the United States Tax Court recently considered whether federal estate tax must be paid on the amount identified on the Madoff account statement at the time of the death of the decedent account holder, or whether no tax is owed because the account really had nothing in it. Kessel v. Commissioner of Internal Revenue, 2014 Tax. Ct. Memo LEXIS 98 (May 21, 2014).
Although no definitive answers were provided because the court simply denied the IRS’s motion for summary judgment, the opinion is thought-provoking nonetheless. The facts are that Bernard Kessel, the decedent, had an account with Madoff that was valued at $4.8 million at the time of his death in 2006. We now know that the account was actually worthless at that time because Madoff never actually invested in any securities. Kessel’s estate paid about $1.9 million in federal estate tax, but then sought a refund after the Madoff fraud was revealed in 2008.
The executrix of Kessel’s estate had had the Madoff account appraised by an appraisal service and, based upon that report, the estate paid the tax owing. Following the demise of the Madoff scheme in 2008, however, the estate sought to recover the assets in the Madoff account. The Madoff trustee denied payment because Madoff had not actually purchased securities for the account and because about $2.7 million more than was originally invested had been withdrawn from the account, making Kessel a net winner.
The IRS filed a motion for summary judgment, asking the court to find that the Madoff account was subject to the federal estate tax and that a hypothetical willing buyer and willing seller of the Madoff account would not reasonably know or foresee that Madoff was operating a Ponzi scheme at the time that the decedent died. The court declined to make either finding, noting that there were disputed material facts.
On the first disputed issue, the court observed that the Court of Appeals for the State of New York “has held that the eventual discovery of Mr. Madoff’s Ponzi scheme did not dissolve a Madoff Investments account before Mr. Madoff’s Ponzi scheme began to unravel,” citing Simkin v. Blank, 968 N.E. 2d 459, 464 (N.Y. 2012). However, the court disagreed that “the Madoff account must be the property valued for Federal estate tax purposes” and reserved the issue for trial.
On the second disputed issue, the court noted that “the value of the property to be taxed must be determined as of the time the property was transferred.” The court defined “value” as “fair market value--what a willing buyer would pay to a willing seller, both having reasonable knowledge of the relevant facts.” But the court recognized that “later occurring events affecting the value of the property transferred” might be relevant to a determination of fair market value “if they were reasonably foreseeable at the time of transfer.” However, “later occurring events not affecting value may be relevant to the determination of fair market value regardless of their foreseeability at the time of transfer.” The court reserved the issue of whether the Madoff Ponzi scheme was reasonably knowable or foreseeable before its collapse in 2008 for trial.
The final rub in this case is that, while Kessel’s estate is fighting for a refund of the estate tax paid, it must also contend with the Madoff trustee’s fraudulent transfer claim to recover the net winnings of about $2.7 million paid to Kessel. To have paid tax on something that didn’t exist and then to get sued for more than that amount to return profits paid seems painful. If the IRS prevails, isn’t the government getting a windfall at the expense of a defrauded victim on account of Madoff’s fraud? Should investors really be required to pay a tax on nothing? We’ll have to wait and see what happens with this case at trial.
Wednesday, May 14, 2014
As reported in The Ponzi Scheme Blog, the Supreme Court recently issued an important decision further defining the boundaries of SLUSA – the Securities Litigation Uniform Standards Act of 1998. Chadbourne & Park LLP v. Troice, 2014 U.S. LEXIS 1644 (Feb. 26, 2014). Two new decisions attempt to interpret and apply Troice in other Ponzi scheme cases.
In Troice, the Court determined that a class action could proceed against two law firms, an insurance brokerage firm, and a financial services firm for their alleged assistance to R. Allen Stanford and Stanford Financial in connection with Stanford’s multi-billion Ponzi scheme. The thrust of the Troice opinion was that the Stanford certificates of deposits did not fall within the definition of “covered securities” as defined by SLUSA, and that the “in connection with” link was not met: “A fraudulent misrepresentation or omission is not made ‘in connection with’ such a ‘purchase or sale of a covered security’ unless it is material to a decision by one or more individuals (other than the fraudster) to buy or to sell a ‘covered security.’”
So the Stanford victims are now able to pursue their claims against alleged wrongdoing defendants, but does the type of distinctions drawn by SLUSA create unfairness to victims in other Ponzi schemes where the thing being sold to them (even though non-existent) falls within the definition of a “covered security”? Should SLUSA apply where victims thought they were buying covered securities but in fact were buying nothing at all?
So far, two courts have considered the issue in connection with Ponzi scheme cases. In the first case, Spectrum Select, L.P. v. Tremont Group Holdings, Inc. (In re Tremont Securities Law, State Law, and Insurance Litigation), 2014 U.S. Dist. LEXIS 52082 (S.D.N.Y. April 14, 2014), the allegations involve claims by victims who invested in funds that handed the assets over to Bernard Madoff. The plaintiffs allege that the funds did not conduct proper due diligence. The plaintiffs’ original state law claims against the defendants had been dismissed under SLUSA, causing the plaintiffs to amend their complaint to include federal securities laws claims. Following Troice, the plaintiffs asked the court to reconsider the dismissal of the state law claims.
Interpreting Troice, the Tremont court stated, “The Supreme Court held that the real issue was what the plaintiffs bought, not what the bank might buy.” The Tremont court further noted, “Essentially, the Court stated that the only ‘connection’ that matters under SLUSA was whether the plaintiffs themselves bought or sold an ‘an ownership interest’ covered securities.” The Tremont court reconsidered its prior order, observing that it had not “really analyzed” the “crucial issue” of whether the plaintiffs had “an ownership interest” in a “covered security.” Upon reconsideration, the court found that no such connection was present:
Plaintiffs did not buy an ownership interest in covered securities; they bought limited partnership interests in funds. There is no dispute that these limited partnership interests are not covered securities. Thus, like the plaintiffs in Troice, plaintiffs here did not acquire any ownership interest in covered securities, so there is not a sufficient connection between the material misrepresentations alleged and transactions in covered securities.The court also rejected the defendants’ argument that the plaintiffs knew that the funds in which they were investing were simply a conduit for investing in Madoff and that they knew Madoff traded in covered securities. “Knowledge that the fund would buy covered securities for itself does not create the required ownership interest in covered securities.”
In another decision, In re Harbinger Capital Partners Funds Investor Litigation, 2014 U.S. Dist. LEXIS 64504 (S.D.N.Y. April 30, 2014), the court was less certain how to interpret Troice and deferred a decision pending direction from the Second Circuit. The Harbinger court noted that the significance of the words “ownership interest” in Troice was unclear and the meaning of “in connection with” was subject to interpretation. Although the Harbinger court deferred its decision on a motion for reconsideration, it noted that in its original decision, “The fact that Plaintiffs themselves purchased interests in hedge funds, and not covered securities, was of no moment.”
The Harbinger court questioned the relevance of the distinction of “whether that investment involves owning actual covered securities, or instead buying into a vehicle whose sole purpose is to provide exposure to those securities.” The court further commented, “If the majority intended to make a distinction between transacting in ownership interests in covered securities and transacting in covered securities themselves--and to suggest that even the former would trigger SLUSA preclusion--it gave no guidance on what qualifies as an ownership interest.”
The Harbinger court chose to wait for the Second Circuit to rule on one of a few pending matters before resolving the reconsidered SLUSA question before it. “Given these difficulties, the Court will reserve decision pending guidance from the Second Circuit.”Pending before the Second Circuit are two Madoff related cases: the appeal in In re Kingate Management Limited Litigation, No. 11-1397, and the petition for rehearing in In re Herald, Primeo, and Thema Securities Litigation, 730 F.3d 112 (2d Cir. 2013).