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?
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.
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.
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[a].
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.
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
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.
is 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.
Kathy Bazoian Phelps is the
co-author of The Ponzi Book: A Legal
Resource for Unraveling Ponzi Schemes available for purchase at www.lexisnexis.com/ponzibook.
More information about The
Ponzi Book can be found at www.theponzibook.com.
Read more articles at The Ponzi Blog
For more information about LexisNexis
products and solutions connect with us through our corporate site.