You Can't Cheat an Honest Man (37 page)

Because of their broad language, these laws can be a useful tool for going after people who’ve taken money out of Ponzi schemes. However, courts don’t allow broad language to turn fairness upside down.

In one Illinois case, the receiver sifting through the wreckage of a commodities investment Ponzi scheme filed a suit which argued that fairness required a redistribution of the effects of the scheme “by recovering from those who received more than their investments and paying those who participated in the fraudulent investment schemes.”

However, to decide the question of fairness, the court noted it had to keep in mind whom the parties represent. It wrote:

The Receiver does not assert the rights or claims of any investors. Rather, the plaintiff stands in the shoes of [the Ponzi perp] and the various receivership entities. So, when asserting his equity claim, the Receiver cannot personally raise those equitable considerations of the later investors that lost their money.

The companies which were the “receivership entities” had been established to perpetrate fraud. Thus, to the extent that the receiver sought recovery in equity on behalf of the companies, “it is difficult to imagine a less deserving entity.”

The defendants in the case were “innocent investors” who had accepted their payments as legitimate returns on their investments. The court noted that the receiver had made no allegation that the defendants committed fraud or participated in the Ponzi scheme. “The evidence therefore supports the proposition that the defendants received these conveyances in good faith,” the court concluded.

If the investors had cited the “unjust enrichment” language in a suit against the receiver, the court might have been more inclined to agree.
The “Special Status” of Ponzi Schemes

Transfers made as part of Ponzi schemes have achieved a special status in fraudulent transfer law. Proof of a Ponzi scheme is sufficient to establish the perp’s intent to defraud creditors for purposes of actually fraudulent transfers. As one federal appeals court noted:

The fraud consists of funnelling proceeds received from new investors to previous investors in the guise of profits from the alleged business venture, thereby cultivating an illusion that a legitimate profit-making business opportunity exists and inducing further investment.

Smart Ponzi perps—or merchants who’ve dealt with perps—faced with fraudulent transfer claims from angry investors will usually make a so-called “good faith defense.” Basically, they will claim that they entered the business honestly and that whatever trouble followed was simply the unpredictable course of business.
Legally, the good faith claim places the burden of proof on the person making it. The main stumbling block: A person lacks the good faith essential to the defense if he or she possessed enough knowledge of the facts to induce a “reasonable person” to inquire further about the transaction.

Reasonable person standards can be complicated. But one court considering a collpased Ponzi scheme offered this common-sense guideline: “some facts suggest the presence of others to which a transferee may not safely turn a blind eye.”

A Ponzi perp who’s able to sustain the good-faith defense avoids claims of actually fraudulent transfer. The easiest way to avoid claims of constructively fraudulent transfer is to show that disputed deals involved reasonably equivalent value.

Reasonably equivalent value can be established in a number of ways. Two of the simplest: to show that the sale was made in a retail environment and to enlist a recognized expert to broker the sale. This is why smart Ponzi perps will be finicky sellers—it gives them credibility in the moment and deniability later.

Case Study: Stanley Cohen’s Bogus Benzes

Going after people who get money out of a Ponzi scheme can be difficult—especially if the people are vendors or creditors rather than investors. One colorful car scheme shows why this is.

Ponzi perps love driving Mercedes Benzes. Once in a while, a perp will try to make money from this passion. Stanley Cohen concocted a not very clever, I-can-get-it-for-you-wholesale Ponzi scheme in which he accepted money from prospective buyers of premium cars and used it to buy the things at full retail. Because he was losing money—in some cases, quite a bit—on each sale, the scheme headed for collapse more quickly than most.

Cohen’s investors were entertainment industry figures whom he reckoned were greedy enough to want the most expensive cars on the road...and not quite rich enough to afford them. There is no shortage of people like that in the entertainment industry.
In the typical transaction, Cohen would explain that he could get a Mercedes Benz 500SL for $80,000, even though the car had a retail sticker price of almost $115,000. He claimed that he had some heavy connections in the auto industry; but he remained vague about details. If a person wanted the hard-to-get model cheaply, he or she had to give Cohen the $80,000 quickly, in cash and up front.

Like in all Ponzi schemes, this promise was too good to be true. Several people would each pay Cohen $80,000. Cohen would then go to a dealer, say that he was an agent for some Hollywood high-roller, sign contracts to purchase as many vehicles as his funds allowed, and write checks for the full $114,500 for each vehicle.

The dealer, confirming that Cohen had sufficient funds on deposit to honor the check but not otherwise investigating Cohen’s bona fides, would prepare the cars for delivery. Cohen would then tell the dealer to whom to deliver (and place in title on) the vehicles.

Neither the numbers of vehicles involved nor the method of payment were, in the experience of the dealers, extraordinary. However, if the dealers had investigated Cohen’s creditworthiness in greater detail, they would have discovered that he had a checkered financial past— including at least one previous personal bankruptcy and involvement in financial frauds dating back to the 1940s.

Since Cohen was losing $34,500 per vehicle (or more, because he was also taking money for himself), the number of cars he bought was always lower than the number of people who’d paid him $80,000. Other people’s payments were used to make up the shortfall.

Cohen was no stranger to financial frauds. He knew that as he continued to buy high and sell low with the funds provided by the scheme participants that it was doomed to collapse. He knew that his “investors” were his creditors because he owed them either a vehicle or their money back. And he knew that when it collapsed there would be no vehicle and no money left for refunds.

The inevitable collapse landed Cohen in prison and left a number of burned customers—they didn’t think of themselves as scheme participants—who’d paid Cohen money and received nothing. The trustee who took over the pieces of Cohen’s operation sued the scheme participants (that’s what they were, no matter what they considered themselves) who’d taken possession of the cars and the dealers who’d gotten full retail price. He argued that a federal court should avoid all seventeen sales because they were fraudulent transfers.

The bankruptcy estate would recoup the difference between the price Cohen paid and the amount paid to Cohen by the scheme participants to whom the goods were transferred.

The trustee’s theory was that the act of delivering $114,500 vehicles to people who had paid Cohen $80,000 was a transfer distinct from the $114,500 purchase at the dealer.

This second transfer gave Cohen value only to the extent of extinguishing his $80,000 refund obligation to the person who took delivery. So, this did not qualify for the Bankruptcy Code safe harbor that protects transferees, including merchants, to the extent value is given in good faith “to the debtor.”

Seven of the deals had taken place within one year before Cohen filed bankruptcy, so the federal Bankruptcy Code gave the court the power to reverse them. California law and the Uniform Fraudulent Transfer Act (UFTA), which expanded the trustee’s range of options under so-called “strong arm” authority, allowed the court to reverse the other 10 deals.

However, the court chose not to reverse the sales—even though the various laws would have allowed it. It disagreed with the trustee’s theory, concluding instead that there were no fraudulent transfers because Cohen had received value from the dealers equal to the retail price that he paid.

The trustee appealed. The 1996 federal appeals court decision
In re Stanley Mark Cohen
considered the appeal. In that decision, a Bankruptcy Appellate Panel considered the technical details of the trustee’s argument and held that:

The Bankruptcy Code makes [Cohen’s] purchases from the merchants fraudulent transfers because [he] intended to hinder, delay, or defraud creditors when purchasing goods that were central to the Ponzi scheme. But the merchants have no ensuing liability because they qualify for the safe harbor that shelters transferees who give full value to the debtor in good faith.

UFTA, in contrast, makes the transfers not avoidable against the merchants because, although they were made with actual intent to hinder, delay, or defraud creditors, the merchants took debtor’s money in good faith for a reasonably equivalent value.

Under this concept, Cohen’s payment in full with checks that his bank honored limited any further duty the Mercedes dealers had. Cohen had what is known as “equitable title” in the cars.

When the lucky scheme participants received their cars, a separate transfer occured—in this case, Cohen handed his equitable title in the cars to the participants.

Evidence that the bankruptcy court considered had established that Cohen had the requisite intent to hinder, delay, or defraud creditors when he’d purchased vehicles in furtherance of his Ponzi scheme. So, the transfers were actually fraudulent. However, that didn’t answer everything.

The differences between the Bankruptcy Code and UFTA forced divergent analyses of the avoidability of Cohen’s transactions.

The seven vehicles purchased during the year before bankruptcy could be considered fraudulent transfers under the Bankrupcty Code. Under UFTA, though, the other 10 transfers could not be avoided because the dealers operated in “good faith and for a reasonably equivalent value” when they sold for a market price.

The appeals board upheld the bankruptcy court’s decision in favor of the dealers. The trustee would have to look elsewhere for deep pockets. It concluded:

None of the transfers are avoidable under the Uniform Fraudulent Transfer Act because the dealers took Cohen’s money in good faith for reasonably equivalent value. Although some of the transfers are avoidable under Bankruptcy Code, the dealers qualify for the safe harbor demarked by good faith and value given to the debtor and are entitled to retain the money they received.

Long story short: Cohen may have been stealing money from some of the scheme participants; but that didn’t mean the trustee could go after the dealers.
They
had operated in good faith. And they were probably the only characters in the story who had.

CHAPTER 20
Chapter 20: Go After the Lawyers and Accountants

Trusting someone who turned out to be a smarmy crook is bad enough. What’s even worse is realizing that a bunch of smarmy lawyers and CPAs ran up big fees advising the crooks, got paid and then claimed that they didn’t know what was going on the whole time.

This is why the second lawsuit filed by most burned Ponzi investors is against any yuppie scum who advised in the scam. Even though it’s usually the second suit filed, it’s usually the most successful. Why? Lawyers and CPAs usually have professional liability insurance.

In March 1993, a top-notch law firm found itself in legal hot water over work it did for Stockbridge Funding Corp., the New York mortgage-brokerage business that turned out to be a Ponzi scheme preying on Eastern European immigrants.

Court-appointed trustee David Kittay who was charged with liquidating what was left of Stockbridge claimed that New York-based Battle Fowler, the law firm which had advised Stockbridge’s management during its thieving heyday, should be held responsible for the ment during its thieving heyday, should be held responsible for the lawyer firm “aided and abetted” the fraud by “drafting, editing and supervising illegal and fraudulent advertising” placed in newspapers geared toward Eastern European immigrants.

Battle Fowler answered that it had been unaware of any wrongdoing. Spokesmen for the law firm said it had tried to ensure that Stockbridge abided by the law—but that its efforts had been sabotaged by Stockbridge’s owners. “There’s not a scintilla of evidence that any of the lawyers at Battle Fowler knew what these characters were doing. They didn’t know what these crooks were doing any more than anyone else [did],” the lawyers’ lawyer said.

Battle Fowler’s attorney said Kittay’s suit was a creative—but unjustifiable—attempt to search for deep pockets to repay investors. If anything, he said, Stockbridge owed Battle Fowler money. The law firm had only been paid $50,000 for the legal work it did; it was still owed another $40,000.

Apparently, Battle Fowler went too far in fighting Kittay’s claim. In an order, the judge presiding over the early stages of the dispute rebuked Battle Fowler’s lawyers for attempting to “terrorize” immigrant investors by sending out notices demanding that they bring immigration documents with them for pretrial questioning.

The pushy approach didn’t work. Battle Fowler ended up settling with Kittay in exchange for a quiet end to the suit.

The RICO Connection

Generally, the legal rule is that companies that were part of Ponzi schemes can’t sue under RICO. Only investors can. However, this leads to an inherent conflict: the receiver’s primary responsibility is to the corporation—not the burned investors.

This means that receivers aren’t usually good advocates for what most people would consider
justice
in the wake of a Ponzi scheme. Their proper role is to liquidate whatever assets are left as quickly and costeffectively as possible.

The 1995 federal appeals court decision
Hirsch v. Arthur Andersen & Co.
illustrates why receivers in Ponzi cases have so much trouble going after lawyers and accountants.