Kathy Bazoian Phelps
Senior Counsel in Ponzi Scheme Litigation
and Bankruptcy Matters

Kathy is a senior business trial attorney with more than 30 years experience prosecuting and defending claims for high net worth clients involved in Ponzi scheme matters and in bankruptcy proceedings. Kathy’s practice includes recovering assets for clients in complex fraud cases under standard fee and alternative fee arrangements. She also handles SEC and CFTC whistleblower claims. Kathy also serves as a mediator in bankruptcy matters, in complex business disputes, and in matters requiring detailed knowledge about fraud or Ponzi schemes.

Kathy’s Clients in Ponzi Scheme Cases and Bankruptcy Matters
Equity Receivers
Bankruptcy Trustees
High Net Worth Investors
Debtors in Bankruptcy
Secured and Unsecured Creditors

Wednesday, June 12, 2013

Eleventh Circuit Hands Bankruptcy Trustee a Victory in Battle Over Ponzi Schemer Scott Rothstein's Assets

Posted by Kathy Bazoian Phelps

   The Eleventh Circuit issued its ruling today in the Scott Rothstein Ponzi scheme case in the ongoing battle between the bankruptcy trustee of Rothstein's law firm, Rosenfeldt and Adler P.A. ("RRA"), and the Department of Justice over assets of RRA. The trustee claims the funds are part of the RRA bankruptcy case to be administered by him, and the Government claims the assets are the subject of its forfeiture action to be administered by it. This conflict has led to multiple legal battles which have culminated in this Eleventh Circuit decision. The question presented to the Eleventh Circuit was whether the money in the bank accounts of RRA at the time that Rothstein was criminally charged is subject to forfeiture by the Government. The Eleventh Circuit handed the bankruptcy trustee a clear victory and held that the money is not subject to forfeiture. The decision is here.

The Facts

   Rothstein deposited crime proceeds from his Ponzi scheme along with his law firm's receipts from legitimate clients into commingled bank accounts in the name of RRA. RRA was placed into an involuntary bankruptcy, and the trustee was appointed. Meanwhile, Rothstein was charged with multiple counts relating to the allegation that he was operating a Ponzi scheme.

   In addition to the criminal charges, the Government sought to forfeit Rothstein's interest in a variety of properties, including RRA's bank accounts and property purchased using funds from those accounts. The Government's theory was that the money in those accounts constituted proceeds of Rothstein's Ponzi scheme or consisted of property that was acquired with proceeds of the fraud. Rothstein entered into a preliminary order of forfeiture with the Government.

   After that, the fighting began. In very summary fashion, here is what happened: the Government sought and obtained a restraining order relating to those assets; the Government attempted to seize the bank accounts; the bank rejected the attempt and went to court for direction; the court ordered the turnover of the funds to the Government; the RRA trustee filed an ancillary proceeding to assert his claim to the assets; and on and on the fighting went. Ultimately, the district court denied the RRA trustee's petition in the ancillary proceeding, finding that the funds in the bank accounts were more likely than not "proceeds of fraud."

The Oral Argument at the Eleventh Circuit

   The Eleventh Circuit then heard an appeal of the denial of the trustee's petition. At the oral argument, the court focused whether the Government had violated the automatic stay in seeking forfeiture of assets after the bankruptcy filing where those assets were in the name of RRA and arguably property of the bankruptcy. The court expressed concern that the forfeiture "is frustrating the bankruptcy law, and when you frustrate the bankruptcy law, you frustrate all of the creditors of the bankrupt estate." At the oral argument, the court only touched on whether the forfeited assets were "proceeds of crime." The transcript of the oral argument is here.

Eleventh Circuit's Use of Forfeiture Law to Deny Forfeiture

   The opinion issued today relies exclusively on forfeiture law to hand the assets to the bankruptcy trustee.

   The key to the Eleventh Circuit's decision is whether the funds in the RRA bank accounts constitute "proceeds" of Rothstein's Ponzi scheme. If so, under forfeiture law, proceeds of crime constitute a defendant's interest in property that can then be forfeited. If crime proceeds are commingled with legitimate funds, whether the commingled property constitutes "proceeds" is far less clear. The opinion focuses on this issue to deny forfeiture of the property as proceeds.

   The bankruptcy trustee had argued that the bank account funds were not in fact proceeds because they contained commingled funds, only some of which were tainted funds. The Eleventh Circuit pointed out that property is only forfeitable as "proceeds" where there is an established "nexus between the property and the offense." So the question became whether "property becomes so commingled that it may not be forfeited directly . . ." The court found that proceeds cannot be traced as a matter of law and that the Government can forfeit other assets through substitute asset provisions. Those provisions state, "the court shall order the forfeiture of any other property of the defendant" where "as a result of any act or omission of the defendant," forfeitable property, such as proceeds, "has been commingled with other property which cannot be divided without difficulty." 21 U.S.C. § 853(p). The court also endorsed the lower court's rejection of the use of the lowest intermediate balance rule ("LIBR") for purposes of trying to separate tainted and untainted funds, noting that the lower court called LIBR a "legal fiction."

   Acknowledging that the Eleventh Circuit had not previously considered this question of whether commingled property can be forfeited directly as proceeds, the court analyzed two Third Circuit decisions on this point. The Eleventh Circuit relied on U.S. v. Voigt, 89 F.3d 1050 (3rd Cir. 1996), noting that, "The sheer volume of financial information available and required to separate tainted from untainted monies in this case leads us to the conclusion that it is far more appropriate to apply the Third Circuit's rule in Voigt. . ."

   The Eleventh Circuit stated: "In sum, if ever there was a case where commingled proceeds 'c[ould not] be divided without difficulty' and that therefore required the Government to seek forfeiture pursuant to the statutes' substitute property provisions, §§ 1963(m) and 853(p), this is that case. For us to conclude otherwise would 'render the substitute asset provision a nullity,' Voigt, 89 F.3d at 1087, contrary to the time-honored canon of construction that we 'should disfavor interpretations of statutes that render language superfluous.'"

   In extending this rationale to property that was acquired with funds from RRA's bank accounts, the court remanded that aspect of the case to the district court for a factual finding of whether the property was purchased with commingled funds. If so, then the purchased property also would not be forfeitable.

Did the Eleventh Circuit Thumb Its Nose at the Government?

   The Eleventh Circuit acknowledged that the Government could still use the substitute asset forfeiture provisions of 18 U.S.C. § 1961 and 21 U.S.C. § 853 to attempt to forfeit a property interest held by Rothstein individually, such as his shareholder interest in RRA.

   The court suggested that, if the Government can succeed in obtaining an order from the district court in exercising in personam jurisdiction over Scott Rothstein, and that court orders Rothstein's shareholder interest in RRA forfeited as a substitute property interest, then "the Government standing in Rothstein's shoes, may appear in the Chapter 11 proceeding and lay claim to Rothstein's share of law firm assets that survive bankruptcy."

   While this may sound like a slight win for the Government, for those in the know about bankruptcy priority schemes, a shareholder will receive nothing in distribution from a bankruptcy proceeding until absolutely all creditors have been paid in full. With over $461 million in claims filed in the RRA case, according to published reports, the possibility of the Government ever seeing a dime in distribution on account of Rothstein's shareholder interest seems remote.
Was This the Right Analysis and Conclusion?

   As a matter of forfeiture law, was this the right conclusion? The Eleventh Circuit had a choice to make in what law to apply regarding the level of proof for tracing of proceeds in a commingled account. It applied a bright line rule – no tracing and therefore no finding that the property was "proceeds." Should there be discretion in this analysis, and should it matter what percentage of the money is tainted versus untainted?

Another question left hanging from this decision is whether the automatic stay should have prevented a forfeiture action after the bankruptcy had been filed. The court declined to opine on this issue. Was this because it concluded that this argument was a loser in light of the relation back doctrine, which the Government argued prevented the assets from ever becoming property of the bankruptcy estate in the first place?

   From the standpoint of Rothstein's victims, will they ultimately fare better if the bankruptcy trustee administers these assets as opposed to the Government? Should the administrative costs, tax consequences or distribution schemes of the two competing statutory structures of bankruptcy and forfeiture have any impact on who is better to administer the assets?

   This decision puts an explanation point at the end of a hard fought battle. While this one is a big win for bankruptcy estates, there are certainly others going in the other direction, where assets are forfeited by the Government despite a pending bankruptcy proceeding. We can only hope that bankruptcy trustees and the Government will maintain a sensitivity to the ultimate objective – getting money back to the defrauded victims – and handle these disputes in a manner that keeps their eyes on that objective.


  1. It's good to see a win like this. I know it was a huge inspiration to the bankruptcy trustees in Woodstock who are facing some similar problems. Way to go folks!

  2. I am looking for a Bankruptcy Trustee in Toronto. Does anyone have any idea where I can find one?