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The Second Circuit Court of Appeals vacated a preliminary
injunction secured by the SEC and the CFTC freezing the assets a spouse
received in a divorce settlement from her former husband who ran a massive
Ponzi scheme. The court held that the agencies are only entitled to obtain disgorgement
of ill-gotten funds to the extent a relief defendant "lacks a legitimate claim
to them." CFTC v. Walsh, Nos. 09-3742, 09-3787 (2nd Cir.
Decided Sept. 15, 2011).
Relief defendant Janet Schaberg (named in the action as
Janet Walsh) was married to Stephen Walsh for two decades. By the time of their
separation in 2004 Mr. Walsh had amassed a substantial fortune. Under the terms
of the final 2006 divorce settlement Mr. Walsh paid his former spouse $12.5
million in biannual installments through 2020. She also obtained nearly $5
million held in several checking accounts during the marriage as well as their
home in Port Washington, New York and other real estate.
In 2009 the SEC and the CFTC accused Mr. Walsh of
operating a Ponzi scheme. He and his partner supposedly fleeced investors out
of $554 million. Investor funds which were suppose to be put in a vehicle to
trade in equity index arbitrage were in fact used for the personal expenses of
Mr. Walsh. Both agencies filed enforcement actions and requested a preliminary
injunction freezing assets including those held by Ms. Schaberg. The district
court granted the motions of the SEC and CFTC.
Critical to a resolution of this case is the question of
whether Ms. Schaberg has a legitimate claim to the assets. To resolve this
issue the court certified two questions to the New York Court of Appeals for
resolution, rejecting the contention of each agency that it is one of federal
law. Question one focused on whether "marital property can include the proceeds
of a fraud." The second, which the New York court recast, is whether a spouse
paid fair consideration if all or part of the marital estate consists of the
proceeds of a fraud. The answer to the first question is yes while the response
to the second is no. The response to the second question is qualified however.
The court stated that a spouse cannot be viewed as having paid fair value for
the assets received by relinquishing a claim to a bigger share of the
fraudulently obtained assets where the marital estate is primarily or all the
proceeds of a fraud. Fair consideration giving the spouse a legitimate claim to
assets can be given the court held by relinquishing rights such as maintenance,
inheritance and child custody.
In this case the preliminary injunction was predicated on
the notion that Ms. Schaberg had no legitimate claim to the assets because the
estate was largely if not wholly the fruits of the Ponzi scheme. However, under
New York law it is clear from the ruling of the Court of Appeals that a "divorce
decree may cleanse such a taint [from a Ponzi scheme] where the innocent spouse
acts in good faith and gives fair consideration."
In reaching its conclusion that the preliminary
injunction had to be vacated the court rejected arguments by the SEC and CFTC
that the ruling could be affirmed on the basis that under the facts here valid
consideration was not paid. First, the Court of Appeals held that there could
be fair consideration under New York law. Second, at least some part of the
funds spent on the residence in Port Washington, appear to have come from
untainted sources. Third, Ms. Schaberg relinquished rights to maintenance and
inheritance which might not have been worth much at the time, but at some point
they may have value. Finally, it is possible that fair value may have been
given for at least some of the assets. Accordingly, the case had to be remanded
to the district court for further proceedings.
Program: ABA Seminar: Is the
DOJ and SEC War On Insider Trading Rewriting the Rules? ABA program, live in
New York City, webcast nationally. Friday September 23, 2011 from 12 - 1:30
p.m. at Dorsey & Whitney, 51 West 52 St. New York, New York 10019.
Co-Chairs: Thomas O. Gorman, Dorsey & Whitney LLP and Frank C.
Razzano, Pepper Hamilton LLP.
Panelists: Christopher L. Garcia, Chief, Securities and Commodities
fraud Task Force, Assistant U.S. Attorney, Southern District of New York;
Daniel Hawke, Chief, Market Abuse Unit, Securities and Exchange Commission;
Stuart Kaswell, Executive Vice President & Managing Director, General
Counsel, Managed Funds Association; Tammy Eisenberg, Chief Compliance Officer,
General Counsel and Senior Vice President, DIAM U.S.A., Inc.
For further information please click here.
For more cutting edge commentary on developing
securities issues, visit SEC Actions, a blog by Thomas
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