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.