Attorney Fees At Risk in the Aftermath of Ponzi Schemes

Posted by Kathy Bazoian Phelps

Attorneys provide legal services, bill for them, and hope to get paid. Sometimes, they even get paid. When attorney fees meet up with Ponzi schemes, however, the game changes, and attorneys face a host of additional problems relating to their fees, even if the attorneys and the services they provided were not at all involved in or related to the Ponzi scheme. Two recent decisions in Ponzi cases highlight a few of the problems that can be encountered: one in trying to collect fees from a government forfeiture proceeding, and the other in defending the attempted disgorgement of fees already paid on fraudulent transfer theories.

In United States v. Madoff, 2012 U.S. Dist. LEXIS 48733 (S.D.N.Y. Apr. 3, 2012), the firm of Epstein, Becker & Green, P.C. (“EBG”) was forced to do battle with the government in seeking payment of fees earned from settlement proceeds that turned into forfeited funds. EBG had performed legal services for Ruth Madoff that were unrelated to her husband’s Ponzi scheme. Those services resulted in settlement of a suit in her favor in the amount of $61,993. EBG’s fees for this were $24,790.86. In the meantime, however, Bernard Madoff was arrested and convicted, and the district court entered a forfeiture order against most of the Madoffs’ property, including the proceeds of Ruth’s suit.

EBG’s then took the only recourse that was available to it at that point - to submit a claim in the forfeiture action under 21 U.S.C. § 853(n). Specifically, it asserted that it held a legal interest superior to that of the government under § 853(n)(6)(A) and that it was a bona fide purchaser for value, under § 853(n)(6)(B).

The court, however, dismissed these claims, holding, “To have a claim in the specific property, a creditor, therefore, must secure a judgment or perfect a lien against a particular item.” The court further held, “To enforce a lien under the [applicable New Jersey] Act, an attorney must file an application with the court; otherwise, the attorney will lose the right to assert an attorney's lien against any proceeds derived from his services.” Because EBG had not filed such an application, it was merely a general creditor without a legal interest superior to that of the government.

The court further noted that even if EBG had a valid claim to the lawsuit proceeds, it would not have been a superior interest because of the relation back doctrine. Under that doctrine, the government’s interest in the Madoff’s property arose when his crimes were committed beginning at least as early as the 1980s, well before Ruth’s lawsuit was settled.

Finally, the court also rejected EBG’s claim that it was bona fide purchaser for value. It held that as a general creditor without a legal interest in the settlement funds, EBG had no standing to assert such a claim under § 853(n)(6)(B).

Third party claims in forfeiture actions are increasingly common, given the rise in Ponzi cases. These types of claims are extensively covered in § 16.04 of The Ponzi Book: A Legal Resource for Unraveling Ponzi Schemes.

In the second case, Silverman v. Meister Seelig & Fein, LLP (In re Agape World, LLP), 2012 Bankr. LEXIS 911 (Bankr. E.D.N.Y., Feb. 21, 2012), the law firm (“MSF”) provided legal services to Agape during a time when Agape was conducting a Ponzi scheme. It billed and collected $400,000 in fees and expenses. After his appointment as trustee in Agape’s bankruptcy, Silverman filed a lawsuit against MSF, including claims to recover the attorney fees paid on theories of actual and constructive fraudulent transfer, as well as a claim for malpractice, and many other claims.

MSF moved to dismiss the entire suit, and the court granted much of the motion on standing grounds. However, the court denied the motion as to the fraudulent transfer claims.

On the actual fraudulent transfer claim, the court held that the “Ponzi presumption” worked “to establish fraudulent intent on the part of the transferor as a matter of law.” In support of its motion, MSF asserted there was no allegation of its fraudulent intent, but the court rejected this argument, holding that MSF’s intent was irrelevant. MSF also argued that it was entitled to the good faith defense under § 548(c), but the court also rejected this defense, holding, “it is only sufficient to dismiss these claims at this stage if it appears from the face of the Complaint that the Defendant took the funds in good faith and for fair consideration.” The court found that Silverman’s complaint adequately alleged MSF’s knowledge of Agape’s wrongdoing and that Agape received less than fair value.

The court’s more notable holding was on Silverman’s constructive fraudulent transfer claim. MSF argued that as the recipient of its legal services, Agape received sufficient consideration as a matter of law. But the court rejected that argument, holding that Silverman had “adequately pleaded that the Defendant provided less than fair consideration in exchange for the [payments that it received] because the Defendant acted negligently in its representation of Agape.” At the same time, the court dismissed Silverman’s direct malpractice claim on several grounds, including lack of standing and the in pari delicto doctrine.

Therefore, under the court’s holding, even if a trustee’s malpractice claim against a Ponzi perpetrator’s attorney is barred by the in pari delicto doctrine, that same malpractice claim can be sufficient to show a lack of reasonably equivalent value on a constructive fraudulent transfer claim. This holding effectively creates a new and potentially important exception to the in pari delicto doctrine, or at least a significant narrowing of it. It will be interesting to see whether it gains traction among trustees and, more importantly, courts.

Actual and constructive fraudulent transfers and the defenses to these claims are fully covered in chapters 1, 2 and 3 of The Ponzi Book: A Legal Resource for Unraveling Ponzi Schemes.

Legislative Protection for Charities Caught by Ponzi Clawbacks

Posted by Kathy Bazoian Phelps   

On April 3, 2012, Minnesota Governor Mark Dayton signed a new law, Chapter 151, House File 1384, designed to protect nonprofits from having to pay back donations made by Ponzi perpetrators and other fraudulent sources.  The new law actually restricts a trustee’s recovery in three distinct ways.

First, it amends Minnesota Statutes § 513.41 to exempt charitable organizations from returning transfers made outside of a two year statute of limitations.  The current statute of limitation on fraudulent transfer lawsuits is six years.  The new statute effectively shortens the statute of limitations by amending the definition of a “transfer” to exclude any transfer more than two years before the commencement of the action, as follows:

“Transfer” does not include a contribution of money or an asset made to a qualified charitable or religious organization or entity unless the contribution was made within two years of commencement of an action under sections 513.41 to 513.51 against the qualified charitable or religious organization or entity and [the transfer was either an actual or a constructive fraudulent transfer].

Second, even within the two years before the action is commenced, recovery of constructive fraudulent transfers is restricted in amount according to a formula that further narrows the definition of a “transfer,” as follows:

A transfer of a charitable contribution to a qualified charitable or religious organization or entity is not considered a [constructive] transfer . . . if the amount of that contribution did not exceed 15 percent of the gross annual income of the debtor for the year in which the transfer of the contribution was made; or the contribution exceeded that amount but the transfer was consistent with practices of the debtor in making charitable contributions.

Those familiar with the Bankruptcy Code will recognize that this precise limitation applies to a trustee’s recovery under § 548(a)(2).  As a result, substantial case law is available that should assist in interpreting and applying this new Minnesota restriction.  This case law is thoroughly reviewed in § 3.02[5] of The Ponzi Book: A Legal Resource for Unraveling Ponzi Schemes, by Kathy Bazoian Phelps and Hon. Steven Rhodes.

The third way in which the new Minnesota statute restricts a trustee’s recovery is that these limits are given immediate effect and are applied to existing lawsuits, as follows:

This section is effective the day following final enactment and applies to a cause of action existing on, or arising on or after, that date.

Reactions to the new law have been as expected.  Doug Kelley, the trustee in the Thomas Petters bankruptcy case pending in Minnesota, had sued several charities, including the Minnesota Teen Challenge for $2.3 million and the College of St. Benedict for $2 million.  He has been quoted as saying that the new law could possibly bar him from collecting between $200 million and $450 million.  He also reportedly expressed concern that the law will turn Petters’ investors into two-time victims by reducing their recoveries.

 

On the other side, the College of St. Benedict told the Minneapolis Star Tribune that it “accepted and spent the donations in good faith from 2003 to 2006 to further its mission,” and added,  “We are gratified that a bill recently passed by the 2012 Minnesota Legislature and awaiting the governor’s signature recognizes the position of nonprofits in such situations.”

It will be interesting to whether other states follow Minnesota’s lead on this important question. The new Minnesota law is available here.

Podcast on Bank Liability in Ponzi Schemes

Posted by Kathy Bazoian Phelps

To hear about issues relating to the liability of banks in Ponzi scheme cases, listen to my podcast - “Bankers That Bank Fraudsters Could Face Costly Liability to Victims” - presented by the Association of Certified Financial Crime Specialists, available here.  Banks have faced substantial claims in many Ponzi cases, including the Rothstein and Madoff cases, and were held liable in some actions but not in others. The podcast also includes discussion of some of the things that banks can and should be doing to protect themselves against potential liability in these cases.   

 Issues relating to bank liability in Ponzi cases and the many contexts in which such claims can arise are discussed in The Ponzi Book: A Legal Resource for Unraveling Ponzi Schemes by Kathy Bazoian Phelps and Hon. Steven Rhodes.

The "In Pari Delicto" Battle in Ponzi Cases Rages On

Posted by Kathy Bazoian Phelps

Although the Seventh Circuit recently vacated the dismissal of the trustee’s claim for negligence against an accounting firm, that court did not do the trustee any favors. In fact, the language in Peterson v. McGladrey & Pullen, 2012 U.S. App. LEXIS 6608 (7th Cir. April 3, 2012), is solidly against excusing a trustee from the in pari delicto doctrine. It is a backhanded slap against all trustees seeking to recover funds for the benefit of creditors of their estates where the debtor was a crook. The dismissal of the trustee’s claims was vacated, but the Seventh Circuit made clear that this was not because the in pari delicto doctrine did not apply to the trustee. The Seventh Circuit joined many other circuits in holding that a trustee’s claims are subject to the in pari delicto defense, even though a trustee acts for the benefit of the defrauded victims and not the wrongdoer.

The trustee in Peterson v. McGladrey & Pullen, joined by an amicus brief filed by the National Association of Bankruptcy Trustees, sought a ruling that the trustee is not barred by the in pari delicto doctrine. The Seventh Circuit restated the trustee’s position and summarily dismissed it as follows:

Section 541(a) provides that an estate in bankruptcy includes all of the debtor's "property", a word that comprises legal claims such as the one against McGladrey. "Property" normally is defined by state law--and in Illinois a claim for damages is limited by defenses such as in pari delicto. The Trustee and the Association want us to hold that a bankruptcy estate includes rights of recovery, stripped of their defenses. If in pari delicto is out, presumably the statute of limitations would be out too, or maybe even the defense of accord and satisfaction. As the Trustee and the Association see things, "public policy" favors greater recoveries for estates in bankruptcy, so that more money is available for distribution and so that wrongdoing by a corporation's "gatekeepers" (the accountants as well as Bell) may be deterred more effectively.

***

Neither the Trustee nor the Association identifies any provision of the Code that overrides state-law limits on the legal claims created by state law against the debtor's auditors. "Public policy" is not a ground on which the federal judiciary may create such a limit--not unless the Supreme Court first overrules Butner, Raleigh, and similar decisions. We therefore agree with the conclusion of every other court of appeals that has addressed this subject and hold that a person sued by a trustee in bankruptcy may assert the defense of in pari delicto, if the jurisdiction whose law creates the claim permits such a defense outside of bankruptcy.

The court remanded the action to the district court to determine whether the debtors’ principal knew of the Ponzi scheme during the time that the defendant auditor allegedly committed malpractice.

The debate over whether the in pari delicto doctrine should apply to an innocent trustee acting for the benefit of defrauded investors in a Ponzi scheme arises frequently in these cases. In my blog posted on February 22, 2012, I discussed the issues as they arose in the Madoff case when Irving Picard’s claims against JP Morgan and other banks were dismissed on these grounds, among others. JP Morgan just filed its brief in opposition to Irving Picard’s appeal to the Second Circuit asking the Second Circuit to affirm the lower court’s ruling that Picard’s claims are barred by the doctrine of in pari delicto, among other things. A copy of JP Morgan’s brief is available here.

On the issue of in pari delicto, JP Morgan relies heavily on the Wagoner Rule in the Second Circuit in asking the court to affirm the lower court’s ruling dismissing Picard’s claims. JP Morgan argues in its opposition:

Under this doctrine - known as the “Wagoner rule” - “when a bankrupt corporation has joined with a third party in defrauding its creditors, the trustee cannot recover against the third party for the damage to the creditors.” Id. at 118; accord Kirschner v. Grant Thornton LLP, 2009 WL 1286326, at *10 (S.D.N.Y. Apr. 14, 2009) (Lynch, J.), aff’d, 626 F.3d 673 (2d Cir. 2010) (applying Wagoner rule to dismiss fraud and breach of fiduciary claims where the debtor “participated in, and benefitted from, the very wrong for which it seeks to recover”); Breeden v. Kirkpatrick & Lockhart LLP (In re Bennett Funding Grp., Inc.), 336 F.3d 94, 99- 100 (2d Cir. 2003) (applying Wagoner rule to prevent trustee for Ponzi scheme operator from bringing malpractice claims); Hirsch, 72 F.3d at 1094-95 (same).

The Wagoner rule is related to the state-law doctrine of in pari delicto. The rule “derives from the fundamental principle of agency that the misconduct of managers within the scope of their employment will normally be imputed to the corporation.” Wight v. BankAmerica Corp., 219 F.3d 79, 86-87 (2d Cir. 2000). “[B]ecause a trustee stands in the shoes of the corporation, the Wagoner rule bars a trustee from suing to recover for a wrong that he himself essentially took part in.” Id. at 87; see also Kirschner v. KPMG LLP, 15 N.Y.3d Case: 11-5044 Document: 110 Page: 35 04/05/2012 572673 91 -23- 446, 464 (2010) (“The doctrine of in pari delicto mandates that the courts will not intercede to resolve a dispute between two wrongdoers.”).

In this case, the Wagoner rule and the doctrine of in pari delicto plainly prevent the Trustee from bringing claims as successor to BMIS.

The Ponzi Book: A Legal Resource for Unraveling Ponzi Schemes dedicates an entire chapter to the subject of in pari delicto, which is an important defense to block multi-million and multi-billion dollar claims in Ponzi cases.

Ponzi Victims Pitted Against Each Other: Madoff Trustee v. California Attorney General

Posted by Kathy Bazoian Phelps

“An under-appreciated evil of substantial frauds . . . is how they pit their victims against one another.”  United States v. Dreier, 682 F. Supp. 2d 417, 418 (S.D.N.Y. 2010).

In the typical Ponzi case, some victims may employ strategies to seek advantage over other victims. These may include asserting: (1) equitable claims such as constructive trust to take the entirety of an asset rather than a pro rata share; (2) restitution claims in forfeiture proceedings; (3) a variety of legal claims to recover damages on theories such as breach of fiduciary duty or aiding and abetting against insiders and professionals; (4) the good faith defense to clawback suits in an effort to hold on to money already paid; and (5) in equity receivership actions, a more advantageous distribution scheme to one category of creditors over another.

Now, however, the Attorney General of California, Kamala D. Harris, has found a new and creative way to seek an advantage for some of Madoff’s victims. Not surprisingly, the victims for whom she seeks an advantage are her constituents in California. She filed a civil enforcement action against Stanley Chais and his probate estate in the California Superior Court in Los Angeles, seeking restitution and damages of $270 million. Chais ran a major feeder fund for Madoff which she contends violated state securities laws. Her amended complaint is available here.

At the same time, for the benefit of Madoff’s customers, Irving Picard, the trustee of Bernard L. Madoff Investment Securities, LLC, has a clawback suit against the estate of Chais pending in the bankruptcy court in New York. Picard contends that Chais acquired all of his assets through fraudulent transfers from Madoff. Picard’s complaint against the Chais defendants is here.

And so Harris and Picard are competing for the same assets – Chais’s assets – and it’s hundreds of millions of dollars. Who will win?

This high-stakes issue is squarely presented to the bankruptcy court in New York in a suit that Picard recently filed against Harris. Picard contends that Harris’s suit in Los Angeles violates the automatic stay of bankruptcy, and he has requested a preliminary injunction to enforce the stay. Harris has filed a forceful opposition. As of this writing, the motion has not yet been set for hearing. Picard’s complaint against Harris is here and his motion for a preliminary injunction is here. Harris’s opposition is here.

Picard’s brief in support of his motion for a preliminary injunction argues:

· The bankruptcy court in New York has subject matter jurisdiction over Harris’s claim.

· Because of the nature of Picard’s requested relief to preserve and protect property of the Madoff estate, Harris cannot raise a sovereign immunity defense and the court can enter an injunction against her action.

· Her action violates the stay of 11 U.S.C. § 362(a).

· Her action is a disguised fraudulent transfer action that violates § 362(a)(1).

· Her action seeks to obtain customer property in violation of § 362(a)(3).

· Her action is not excepted from the automatic stay by the police and regulatory power exception in § 362(b)(4).

· Her action seeks to recover on the trustee’s claim in violation of § 362(a)(6).

· The court should stay the Harris’s action under § 105 to allow for the fair and equitable administration of the bankruptcy estate.

· The injunction would avoid unnecessary proceedings because if Harris were to prevail in her action, the trustee will in any event pursue any transfers of customer property from the Chais defendants to the subsequent transferees.

In her brief in opposition, Harris argues:

· The automatic stay does not apply to an enforcement action against a non-debtor like Chais.

· Her enforcement action does not seek to recover a claim against the debtor and thus is not barred by § 362(a)(1) or (6).

· Her action does not seek or seek to control property of the estate or customer property and thus is not barred by § 362(a)(3).

· There is no justification to extend the stay under § 105.

· Her action is excepted from the stay by § 362(b)(4), the police and regulatory power exception.

· Because of that exception, the trustee is not entitled to a stay under § 105.

The tough question that Picard will have to answer is why he should be permitted to block the victims of Chais’s fraud from collecting against his probate estate while at the same time refusing under SIPA to recognize the claims of those very victims who invested, not directly with Madoff, but instead in feeder funds like that of Chais. Picard previously argued, and the bankruptcy and district courts held, that investors in Madoff’s feeder funds do not qualify as “customers” under SIPA. SIPC v. Bernard L. Madoff Investment Securities, LLC, 454 B.R. 285 (Bankr. S.D.N.Y. 2011), aff’d sub nom. Aozora Bank Ltd. v. SIPC, 2011 U.S. Dist. LEXIS 150753 (S.D.N.Y. Jan. 4, 2012).

The tough questions that Harris will have to answer are the slippery slope questions: If a state enacts a law making failure to pay a debt illegal, with enforcement by the state’s attorney general, would § 362(b)(4) except such an “enforcement” action from the automatic stay? And if that action is not excepted from the stay because it is only an attempt to collect a debt, how is her present enforcement action any different?  Also, what if every state attorney general filed a similar action against Chais’s probate estate?

This litigation is immensely important to Madoff’s victims because of its potential impact on how Chais’s assets will be distributed. We will watch it closely and continue to report on it for you. In The Ponzi Book: A Legal Resource for Unraveling Ponzi Schemes, automatic stay issues are addressed in §§13.02[2][f] and 20.06[5] and issues of competing victims’ claims are addressed in § 16.07.

A Treasure Trove of Ponzi Pleadings

Posted by Kathy Bazoian Phelps

Access to sample complaints asserting relevant claims and briefs asserting cogent legal arguments would be a dream come true when handling a complex fraud case, especially a Ponzi case. Remarkably, many such samples are readily available on the internet.  These pleadings are real-life examples of filings in some of the biggest and most complex Ponzi cases ever.

While writing The Ponzi Book: A Legal Resource for Unraveling Ponzi Schemes, we compiled a list of all of the websites that we could locate on pending and recent Ponzi cases. Trustees and receivers have established these sites to keep investors and others advised of the status of their cases, and they post all relevant complaints, motions, and other pleadings on a current basis. These websites provide valuable access to their legal theories and the arguments raised in response. 

Whether you are looking for forms of pleadings to assist you in your own Ponzi case, or for briefs on issues that you are facing, or for information that you need regarding an existing Ponzi case, this information can be found in the websites of these infamous Ponzi cases.  Rather than trolling the dockets of individual cases in bankruptcy or district courts, you can access all of the links to these websites on one page for your convenience.  Check it out at:

www.theponzibook.com/PonziCaseWebsites.html

Also, please let me know if you are aware of any other trustee or receiver websites in Ponzi cases that should be added to the list. 

Charities: Proper Clawback Targets in Ponzi Scheme Cases?

Posted by Kathy Bazoian Phelps

To gain valuable recognition, Ponzi perpetrators often make handsome contributions to charities. But those contributions create political difficulties for the trustees and receivers in evaluating whether to seek the return of those contributions on fraudulent transfer theories for the benefit of the defrauded investors whose money was used to make the contributions.  On the one hand, who wants to sue a do-good charity?  On the other hand, how to explain the refusal to seek the return of investor funds that were paid to bring attention and recognition to the wrongdoer? 

Trustees, receivers, and courts vary in their analyses of these fraudulent transfers, depending on whether the claim is for an actual or constructive fraudulent transfer.  Additionally, the results are further confused if the transfer was made to a religious organization because of the Religious Freedom Restoration Act (“RFRA”).   The cases are split on the impact of RFRA on fraudulent transfer claims against religious organizations under the Bankruptcy Code.  Some cases find no impact, while others find that RFRA does preclude fraudulent transfer claims against religious organizations under the Bankruptcy Code.  See The Ponzi Book: A Legal Resource for Unraveling Ponzi Schemes by Kathy Bazoian Phelps and Hon. Steven Rhodes at  § 3.02[5].

Even in cases involving non-religious charities, however, the avoidance of contributions is problematic, as demonstrated recently by The American Cancer Society v. Cook, 2012 U.S. App. LEXIS 5769 (5th Cir. Mar. 20, 2012).  In the fraudulent scheme of Giant Operating, Inc. and its related entities and individuals, the SEC-appointed receiver, Karen L. Cook, sought to recover $240,000 that the perpetrators paid to The American Cancer Society.  Cook asserted theories of fraudulent transfer and constructive trust, and argued that the perpetrators’ actual fraud justified disgorgement of the contributions. 

The district court relied on the Ponzi presumption, as permitted by the Fifth Circuit in Warfield v. Byron, 436 F.3d 551, 558-59 (5th Cir. 2006), and found that the payments to The American Cancer Society were recoverable as fraudulent transfers.  It found that because defendants were operating a “Ponzi-like scheme,” the debtors’ transfers to the charity were “presumptively made with fraudulent intent.”  SEC v. Harris, 2010 U.S. Dist. LEXIS 99118  (N.D. Tex. Sept. 7, 2010), Magistrate’s report and recommendation adopted, 2010 U.S. Dist. LEXIS 99146 (N.D. Tex., Sept. 22, 2010).  For a discussion of the Ponzi presumption, see The Ponzi Book at § 2.03[1][a].

However, the Fifth Circuit reversed, holding that the evidence did not support a “Ponzi scheme finding.”  Writing for the court, Judge Edith Jones held that the receiver’s affidavit was conclusory and insufficient.  Judge Jones described the evidence that Cook presented as follows:

Cook attested that (1) investor funds constituted virtually all of Giant's revenue; (2) those funds were commingled and used for personal and unauthorized expenses; (3) Giant did not operate a profitable business outside of money received from new investors; (4) investor funds were used to pay "returns" to some investors; and (5) Giant used some of its funds to procure new investors. Thus, the affidavit concluded, “Giant was a fraudulent Ponzi-type scheme.” Attached to the affidavit were three exhibits that purported to support her conclusions.

The exhibits included the following: a summary of Giant's profitability, a list of payments made by Giant Operating to DSSC, and what appears to be a checkbook registry of an account of DSSC at Comerica Bank.

Then, in the key holding, Judge Jones held, “Nothing in these documents demonstrates that investor funds were used to issue ‘returns’ to other investors - a sine qua non of any Ponzi scheme. Judge Jones further noted, “at oral argument, Cook’s counsel failed to identify in those exhibits any instance in which a single payment was made to an investor. The absence of even a single investor ‘payout’ - which would be, by its nature, easy to show - convinces us the district court erred in placing determinative weight on Cook’s declaration that Giant operated as a Ponzi scheme.”  The American Cancer Society v. Cook, at *7. For a discussion of the factors to establish the existence of a Ponzi scheme, see The Ponzi Book at § 2.03[1][b].

Cook also sought recovery of the funds on a theory of constructive trust “on ACS’s assets, arguing that the funds at issue rightfully belong to the defrauded investors of Giant.”  Id., at *11.  Judge Jones noted that this remedy is entrusted to the discretion of the court, but stated:

In this case, the equities militate against a constructive trust on Giant’s charitable contributions to ACS. As noted above, there is no evidence that Giant’s contributions furthered any fraudulent scheme or were otherwise made with intent to defraud investors.

It must also be noted that Cook’s original motion for turnover also asserted a constructive fraudulent transfer claim on the basis that the perpetrators received no reasonably equivalent value for their contributions and that they were insolvent. However, neither the magistrate, the district judge, nor Judge Jones dealt with this claim. Under such a claim, the perpetrators’ fraudulent intent would have been irrelevant, and the lack of reasonably equivalent value would have been clear. The Supreme Court has stated that: “The sine qua non of a charitable contribution is a transfer of money or property without adequate consideration.”  United States v. Am. Bar Endowment, 477 U.S. 105, 118, 106 S. Ct. 2426, 2433, 91 L. Ed. 2d 89 (1986).  Unfortunately, the record of the case does not disclose how this important claim got lost.

For a discussion of the case law on whether charitable contributions are avoidable as constructive fraudulent transfers, see The Ponzi Book at § 3.02[5].

This case could have gone either way.  The district court, reviewing the evidence, decided that avoiding the contributions to the ACS was appropriate in the context of what it concluded was a Ponzi-like scheme.  The Fifth Circuit, however, found the evidence insufficient and declined to exercise equitable powers to take the contributions away from the charity. 

Stockbroker Safe Harbor Defense in Ponzi Schemes Remains Unresolved Following Picard v. Katz Settlement

Posted by Kathy Bazoian Phelps

The stockbroker defense in § 546(e) of the Bankruptcy Code creates a safe harbor for recipients of certain types of transfers and can bar fraudulent transfer claims brought by a trustee.  In Picard v. Katz, this was a $1 billion issue, and one that will now not go up on appeal due to the settlement in that case.

The statute, in relevant part, states that “the trustee may not avoid . . . [a] settlement payment . . . made by or to (or for the benefit of) a . . . stockbroker . . . in connection with a securities contract.”  11 U.S.C. § 546(e).

In Picard v. Katz, District Judge Rakoff found that § 546(e) is a defense to all of the claims except the actual fraudulent transfer claims.  “Because Madoff Securities was a registered stockbrokerage firm, the liabilities of customers like the defendants here are subject to the ‘safe harbor’ set forth in section 546(e) of the Bankruptcy Code.”  Picard v. Katz, 462 B.R. 447 (S.D.N.Y. 2011).  The court found that the plain meaning of the statute barred the claims:  “By its literal language, therefore, the Bankruptcy Code precludes the Trustee from bringing any action to recover from any of Madoff's customers any of the monies paid by Madoff Securities to those customers except in the case of actual fraud.”  

And that was that.  One billion dollars of claims were struck from Picard’s case.  Picard attempted to appeal this ruling, and others, before a final judgment was entered in the adversary proceeding, but Judge Rakoff denied these attempts.  Picard v. Katz, 2012 U.S. Dist. LEXIS 5143 (S.D.N.Y. Jan. 13, 2011).

As of yesterday, we learned that the claims in the Picard v. Katz have been settled, so Judge Rakoff’s decision will stand without further review. 

However, Picard received more favorable results on this same issue in the bankruptcy court.  Judge Lifland, the bankruptcy judge presiding over the Madoff SIPA liquidation proceeding, has rejected the stockbroker defense on two occasions.  In Picard v. Merkin (In re Bernard L. Madoff Inv. Sec. LLC), 440 B.R. 243 (Bankr. S.D.N.Y. 2010), leave to appeal denied, 2011 U.S. Dist. LEXIS 97647 (S.D.N.Y. Aug. 31, 2011), Judge Lifland held that § 546(e) is inapplicable in fraudulent schemes:

Section 546(e) was intended to promote stability and instill investor confidence in the commodities and securities markets. . . .   Courts have held that to extend safe harbor protection in the context of a fraudulent securities scheme would be to “undermine, not protect or promote investor confidence . . . [by] endorsing a scheme to defraud SIPC,” and therefore contradict the goals of the provision. . . .  Simply stated, the transfers sought to be avoided emanate from Madoff’s massive Ponzi scheme, and the safe harbor provision “does not insulate transactions like these from attack.”

Judge Lifland also found that there was no support for the position that “a Ponzi scheme operator, who allegedly did not execute any trades, was deemed, at the pleading stage, to be a ‘stockbroker’ for purposes of Section 546(e).”         

Judge Lifland reached the same result in Picard v. Madoff (In re Bernard L. Madoff Inv. Sec. LLC), 458 B.R. 87 (Bankr. S.D.N.Y. 2011), leave to appeal denied, 464 B.R. 578 (S.D.N.Y. 2011):

     [T]he Court cannot find as a matter of law that [the § 546(e) safe harbor] applies to the transactions at issue. Whether Madoff, through BLMIS, was a stockbroker “engaged in the business of effecting transactions in securities” is dubious. Courts have held that Ponzi scheme operators do not affirmatively “make securities transactions happen” on behalf of legal “customers,” and thus do not fit the definition of “stockbroker” for purposes of section 546(e). . . .  As asserted in the Complaint, Madoff, through BLMIS, "never in fact purchased any of the securities he claimed to have purchased for customer accounts.”

Id. at 116 (citations omitted).

On the issue of whether the payments made were “settlement payments,” Judge Lifland found:

For the same reason, it is doubtful whether the payments from BLMIS to the Defendants are settlement payments as contemplated by the statute.  Settlement payments subject to the safe harbor of section 546(e) must be made in the context of a “securities transaction.”  . . . While the Second Circuit recently defined “transaction in securities” broadly, In re Enron Creditors Recovery Group, 651 F.3d 329, 2011 U.S. App. LEXIS 13177, 2011 WL 2536101, at *6-7 (holding settlement payment does not require change in ownership of the security and limiting the requirement of “commonly used in the securities trade” in connection  with settlement payments), it suggested that “settlement payments” must be made in relation to an actual securities transaction . . . Here, where securities may never have been bought, sold, or otherwise existent at BLMIS, withdrawals from IA Accounts may not constitute “settlement payments” under section 546(e) of the Code.

Id. (citations omitted).

On the other hand, two weeks ago, the bankruptcy court presiding over a proceeding related to the Thomas Petters Ponzi case held that § 546(e) is applicable and granted summary judgment to the defendants.  Peterson v. Enhanced Investing Corp. (Cayman) Ltd. (In re Lancelot Investors Fund L.P.), 2012 Bankr. LEXIS 914, at *26-27 (Bankr. N.D. Ill. Mar. 7, 2012).  Judge Cox concluded:

The court cannot accept the Trustee's position that the redemption payments herein are not settlement payments eligible for safe harbor protection because they may be tainted by fraud. Congress did not exempt all fraudulent transfers from safe harbor protection, only those involving actual fraud, claims that allege and prove that a debtor acted “with actual intent to hinder, delay or defraud any entity" to which the debtor was indebted. 11 U.S.C. § 548(a)(1)(A). Congress' judgment call on this matter is clear from the opening language of Section 546(e) . . .  Section 741(8) of the Code defines settlement payment as “a preliminary settlement payment, a partial settlement payment, an interim settlement payment, a settlement payment on account, a final settlement payment, or any other similar payment commonly used in the securities trade . . .” 11 U.S.C. § 741(8). (emphasis added).

Plainly the application of § 546(e) is a big-money issue in Ponzi cases.  We will continue to follow it closely.

Same Ponzi Case, Same Bank Defendant, Same Result? No!

Posted by Kathy Bazoian Phelps    

To hear a live discussion on these issues and issues relating to bank liability in Ponzi scheme cases, register for the March 15, 2012 webinar, “The Costly Collision of Financial Institutions with Ponzi Schemes” at http://www.nomoneylaundering.com/ described below.

On the heels of a jury’s $67 million verdict against TD Bank for aiding and abetting Scott Rothstein’s fraud, Platinum Estates’ aiding and abetting claim against TD Bank has been dismissed for failing to state a claim.  On March 7, 2012, District Judge Kenneth A. Marra found, “[T]he Complaint fails to include sufficient facts which would support a finding of actual knowledge, only facts that support an insufficient finding that Defendant ‘should have known’ about the alleged fraud. Accordingly, Count II fails for failing to satisfy the actual knowledge requirement of aiding and abetting fraud.” The judge also found, “Count II also fails under the ‘substantial assistance’ prong of aiding and abetting fraud.”  Platinum Estates, Inc. v. TD Bank, N.A., 2012 U.S. Dist. LEXIS 30684 (S.D. Fla. Mar. 7, 2012).

Unfortunately for those of us who follow these matters closely, the opinion contains little more than these conclusory findings and does not review or analyze what Platinum Estates’ complaint did allege.  In addition, the opinion makes no effort to address why its result should be different than the result that District Judge Marcia Cooke of the same court reached on TD Bank’s motion to dismiss Coquina’s aiding and abetting claim.  See Coquina Investments v. Rothstein, 2011 U.S. Dist. LEXIS 7062 (S.D. Fla. Jan. 20, 2011).

Was Platinum Estates’ complaint inadequate?  Judge for yourself.  Here are the key aiding and abetting allegations in the complaint:

22. TD Bank was the financial nucleus of the Rothstein Ponzi scheme as hundreds of millions of Ponzi scheme dollars flowed through RRA's TD Bank trust and operating accounts.

23. Rothstein’s scheme was entirely dependent on the legitimacy TD Bank bestowed upon him. Indeed, TD Bank treated Rothstein as a VIP customer and afforded him unprecedented privileges and access.

24. For example, TD Bank lulled investors, including Plaintiffs, into a false sense of security by providing written assurances that settlement funds existed in separate accounts and could only be disbursed directly to the investor(s).

25. TD Bank further legitimized Rothstein by permitting him to use conference rooms at its branches to have meetings with the very investors he was defrauding and by TD Bank participating in staged procedures during those meetings such that the investor would be led to believe that their investment would be safe with TD Bank's involvement.

* * *

27. TD Bank misrepresented to investors that the settlement funds for Rothstein's clients were “irrevocably locked” in special accounts.

28. Senior officers of TD Bank also met with investors to reassure them about the investments.

29. TD Bank supposedly opened separate accounts for each investor's funds. TD Bank represented to Plaintiffs that settlement funds existed and could only be disbursed directly to the investor.

* * *

57. Defendant knew or should have known that Rothstein was engaged in fraud.

58. Defendant knowingly joined, participated in, and/or ratified Rothstein’s fraud in the following ways:

     (a) Defendant permitted hundreds of millions, of Ponzi dollars to flow through RRA’s TD Bank escrow, trust, and operating accounts in violation of applicable laws, regulations and internal policies and procedures.

     (b) Defendant lulled investors, including Plaintiffs, into false senses of security by providing verbal and/or written assurances that settlement funds existed and could only be disbursed directly to the investor;

     (c) Defendant permitted Rothstein to use conference rooms at its branches to have meetings with investors and TD Bank employees assisted RRA in arranging meetings with investors;

     (d) Defendant mobilized employees to participate in “presentations” or “shows” for Rothstein investors at TD Bank branches;

     (e) Defendant misrepresented to investors that the settlement funds for Rothstein's clients were “irrevocably locked” in special accounts;

     (f) Senior officers of TD Bank frequently met with investors to reassure them about the investments;

     (g) TD Bank represented to Plaintiffs that settlement funds existed and could only be disbursed directly to the investor.

59. Defendant substantially and materially assisted Rothstein in committing fraud.

Fortunately for the plaintiffs, Judge Marra did grant an opportunity to amend the complaint, so it remains to be seen whether the aiding and abetting claim will get past the pleading stage.  As can be seen from the recent jury verdict against TD Bank in the same Ponzi scheme case, a jury can have a very different assessment of the facts than can a judge on a motion to dismiss.

A copy of the Platinum Estates' complaint against TD Bank is available here.

On March 15, 2012, 12:00–1:00 pm EDT, I will be speaking at an AML Services International Training Web Seminar, “The Costly Collision of Financial Institutions with Ponzi Schemes.”  Register to hear me speak about topics such as: how to do due diligence to detect Ponzi schemes, red flag warnings, and liability exposures of the bank. You will get critical insights from recent real life cases, and see court documents showing missteps made by banks involved in costly lawsuits because they were allegedly banking Ponzi fraudsters. There is  a special discount code for my Ponzi Blog readers: 15% off (only $85). Code: TEMP232. Register at: http://www.nomoneylaundering.com/.

Not Surprisingly, Bank Settlements Follow the Big Verdict Against TD Bank

Posted by Kathy Bazoian Phelps

The Ponzi Blog by Kathy Bazoian Phelps on February 16, 2012, analyzed on the jury verdict of $67 million in favor of Coquina Investments against TD Bank for its participation in the Rothstein Ponzi scheme in Florida.  Now two more bank settlements are being reported in the news.

First, TD Bank has settled with the Razorback Group of 55 investors for $170 million.  Second, Gibraltar Private Bank & Trust Co. of Coral Gables has settled with the Razorback Group for an additional $10 million.  The total of these two settlements - $180 million - is just what the plaintiffs had requested in damages, but the investors will not likely be paid in full because a large chunk of the settlements is most certainly designated for attorney fees.

It is likely that TD Bank settled because it had no reason to believe that the result of a jury trial on the Razorback Group’s claims would turn out any better than the  clobbering it just suffered on the Coquina claims. 

But why did Gibraltar Bank settle?  Perhaps the answer lies in Scott Rothstein’s deposition testimony of December 12, 2011:
     

Q:  Now, was [Gibraltar] bank important for your Ponzi scheme?

Rothstein:  Critical.

Q:  And why?

Rothstein:  Because I had [Gibraltar’s Fort Lauderdale market manager] John Harris in my pocket and later had [Gibraltar Chairman and CEO] Steve Hayworth in my pocket, and they were essential for me being able to do what I needed to do without having interference with the federal or state authorities...

(Rothstein Deposition Transcript, 12/12/12 p.m. session, pp. 134-35).

When asked to explain what he meant by "in your pocket," Rothstein responded in part:

Rothstein:  Harris was in my pocket by me supplementing his lifestyle to the extent that I changed his lifestyle. He received gifts from me. He traveled with me extensively. He was on our permanent guest list for all of our sporting events including Dolphin's [sic] stadium and the Heat. Traveled with me on charter private aircraft to all kinds of sporting events. I took him to several thousand dollar a plate smokers for the various charities I was involved in. . .

Q:  How about Mr. Hayworth?

Rothstein:  Hayworth was simple. He needed an investor for the bank, and I invested $5 million...

(12/12/12 p.m. Transcript, pp. 137-38).

Rothstein also testified about his tactics to end questioning by Gibraltar’s compliance officers by purchasing stock in the bank.

Q:  Was there ever a conversation or any conversation with any of those folks concerning your regulatory problems, compliance problems, vis-a-vis become a major shareholder in the bank?

Rothstein:  Yes. I was told by Harris and by Steve Hayworth that we don't investigation [sic] shareholders of the bank.

Q:  That gave you some insensitive [sic] to become a shareholder?

Rothstein:  That's the one and only reason I invested...

(12/12/12 p.m. Transcript, pp. 139).

Rothstein acknowledged in his deposition that he would not provide “real answers” to questions asked by the Bank.

Rothstein:  I never provided real answers to any of these questions.

Q:  If in fact they had gotten the real answers to these questions, what would that have done to your Ponzi scheme?

Rothstein:  It would have exploded.

(12/12/12 p.m. Transcript, pp. 168-69).

Q:  As a matter of fact, was the success of the Ponzi based in part on your ability to keep this bank at bay?

Rothstein:  Absolutely.

(12/12/12 p.m. Transcript, pp. 147-48).

This is potentially strong evidence that these agents of Gibraltar Bank facilitated Rothstein’s fraud and protected it from disclosure, for their personal financial gain.  From this evidence, a jury certainly could find that the bank aided and abetted the fraud and is, therefore, liable for the resulting damages.  Despite questions about Rothstein’s credibility, this, along with the TD verdict, quite likely motivated Gibraltar Bank to settle.

The transcripts of Rothstein’s deposition taken December 12-23, 2011 are available here.