In this edition of the Commercial Fraud Committee Newsletter, we introduce a new feature: an interview with a Commercial Fraud Committee member. Our inaugural interviewee is Richard Lauter, Commercial Fraud Committee Chair. Rich is a partner at Freeborn & Peters LLP in Chicago, where he leads his firm’s Bankruptcy and Restructuring Group.
Over the past several years, creditors, bankruptcy trustees and receivers have used § 548 of the Bankruptcy Code and the Uniform Fraudulent Transfer Act (UFTA) to “claw back” amounts paid to winning investors in a Ponzi scheme (i.e., payments made to investors greater than their investment).
A series of recent Tenth Circuit decisions illustrate the potential pitfalls defendants face in relying on the good faith and subsequent transferee defenses in fraudulent transfer avoidance claims.[1] In both cases, law firms were required to return fees they had undisputedly earned.
Section 548(c) of the Bankruptcy Code provides a defense to a party found to have received a fraudulent transfer: If the transfer is received for value and in good faith, the transferee may retain the property to the extent value was given in exchange.[1]
In the recent case of Securities Investor Protection Corp. v. Bernard Madoff Inv. Sec. (“Securities”), the Second Circuit ruled that § 550[1] of the Bankruptcy Code does not apply extraterritorially to allow avoidance of fraudulent transfers that occur entirely outside of the United States.[2] Securities involved the efforts of Irving H. Picard, the trustee appointed under the Securities Investor Protection Act (SIPA)[3] to recover funds transferred from Madoff Investment Securities LLC[4] to foreign “feeder funds,” which then transferred those funds to other foreign persons or entities.
Ponzi schemes are increasingly in the news. Recently, the FBI released information about an $18 million Ponzi scheme based out of Nashville, Tenn., in which three men involved in the Hanover Corp. pled guilty to securities fraud, money laundering and conspiracy.[1] In that scheme, the three men offered clients the opportunity to invest in Hanover through promissory notes bearing high interest rates. In this classic Ponzi scheme, Hanover promised that the money would be invested in stock options and startup companies.
Since the enactment of the Fraudulent Conveyances Act of 1571, the law has prohibited transfers designed to hinder, delay, or defraud creditors.[1] Likewise, aiding-and-abetting and conspiracy are well-established bases for civil liability. Business lawyers live and breathe these concepts.
In a bankruptcy context, issues arising from the forced transfer of partnership or membership interests in a closely held business are a frequently encountered by the practitioner. The relevant focus is upon the value, or lack of value, given in consideration for the transfer of interest.
The unfortunate aftermath of a Ponzi scheme is that it leaves investors fighting amongst themselves over what remains and the competing interests of the “net losers” (those who lost money beyond the initial investment) trying to recover some of their losses and the “net winners” (those who made a profit) trying to hold onto distributions they received.
In Labourers’ Pension Fund of Central and Eastern Canada v. Sino-Forest Corporation[1], the Ontario court[2] approved Ernst & Young LLP’s (“Ernst & Young”) $117 million settlement relating to class action lawsuits commenced by jilted investors following the downfall of Sino-Forest Corporation (“SFC”), once the most valuable forestry company on the Toronto Stock Exchange. The $9.2 Billion class action (which is ongoing against certain defendants) contains significant allegations of fraud that call into question SFC's reported asset values and revenues, as well as the practices of SFC's auditors, underwriters and consultants.
