Perkins v. Haines - S.E.C.'s Amicus Brief

Case: 10-10683
Date Filed: 07/08/2010
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No. 10-10683-BB __________________________________________________________________ UNITED STATES COURT OF APPEALS FOR THE ELEVENTH CIRCUIT __________________________________________________________________ WILLIAM F. PERKINS, PLAN TRUSTEE FOR INTERNATIONAL MANAGEMENT ASSOCIATES, LLC Appellant v. AENA Y. HAINES, ET AL, Appellees __________________________________________________________________ On Direct Appeal from the United States Bankruptcy Court for the Northern District of Georgia, Atlanta Division __________________________________________________________________ BRIEF OF THE SECURITIES AND EXCHANGE COMMISSION, AMICUS CURIAE, IN SUPPORT OF APPELLEES AND AFFIRMANCE OF THE ORDER OF THE BANKRUPTCY COURT __________________________________________________________________ DAVID M. BECKER General Counsel MARK D. CAHN Deputy General Counsel JACOB H. STILLMAN Solicitor KATHARINE B. GRESHAM Assistant General Counsel MORGAN BRADYLYONS Attorney Securities and Exchange Commission 100 F. Street, NE Washington, DC 20549 (202) 551-7926 (Bradylyons)
www.floridalegalblog.org
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William F. Perkins v. Haines, et al; Docket No. 10-10683-BB CERTIFICATE OF INTERESTED PERSONS AND CORPORATE DISCLOSURE STATEMENT The Certificate of Interested Persons and Corporate Disclosure Statement filed with the Brief of Appellant William F. Perkins, Plan Trustee for International Management Associates, LLC, as supplemented by the Certificate of Interested Persons and Corporate Disclosure Statement filed with the Brief of DefendantsAppellees, should also include: Becker, David M. Cahn, Mark D. Gresham, Katharine B. Stillman, Jacob H.
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TABLE OF CONTENTS Page CERTIFICATE OF INTERESTED PERSONS AND CORPORATE DISCLOSURE STATEMENT . . . . . . . . . . . . . . . . . . . . . . . . . . C-1 TABLE OF CITATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iii INTEREST OF THE SECURITIES AND EXCHANGE COMMISSION . . . . . 1 STATEMENT OF THE ISSUES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 FACTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 SUMMARY OF ARGUMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 ARGUMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 The bankruptcy court correctly determined that the general rule in Ponzi schemes applies whether an investment involves equity or debt. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 A. Investors with equity interests in an entity operated as a Ponzi scheme give value for transfers up to the amount of principal invested for purposes of the affirmative defense to a fraudulent transfer action. . . . . . . . . . . 9
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TABLE OF CONTENTS (Continued) Page B. Policy reasons support the view that there should be no distinction between debt and equity in the context of an action to recover principal payments in a Ponzi scheme case. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 C. The Trustees arguments about the differences between debt and equity are not persuasive in the Ponzi scheme context. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
CERTIFICATE OF COMPLIANCE CERTIFICATE OF SERVICE
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TABLE OF CITATIONS CASES Alexander v. Albright (In re Terry Manufacturing Co., Inc.), Nos. 03-32063, 05-3050, 2007 WL 274319 (Bankr. M.D. Ala. Jan. 25, 2007) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23-24 American Broadcasting Systems, Inc. v. Nugent (In re Betacom of Phoenix, Inc.), 240 F.3d 823 (9th Cir. 2001) . . . . . . . . 22 *Barclay v. Mackenzie (In re AFI Holding, Inc.), 525 F.3d 700 (9th Cir. 2008) . . . . . . . . . . . . . . . . . . . . . . . . . . 10, 13-15, 20 Bayou Superfund, LLC v. WAM Long/Short Fund II, L.P. (In re Bayou Group, LLC), 362 B.R. 624 (Bankr. S.D.N.Y. 2007) . . . 13, 20 Dicello v. Jenkins (In re International Loan Network, Inc.), 160 B.R. 1 (Bankr. D.D.C. 1993) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 *Donell v. Kowell, 533 F.3d 762 (9th Cir. 2008), cert. denied, 129 S. Ct. 640 (2008) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-13, 16, 19-20 Eby v. Ashley, 1 F.2d 971 (4th Cir. 1924), cert. denied, 266 U.S. 631 (1925) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15-16 Page
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TABLE OF CITATIONS (Continued) Page Fisher v. Sellis (In re Lake States Commodities, Inc.), 253 B.R. 866 (Bankr. N.D. Ill. 2000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 *Merrill v. Abbott (In re Independent Clearing House Co.), 77 B.R. 843 (D. Utah 1987) . . . . . . . . . . . . . . . . . . . . . . . . 10, 12, 17-18, 20 *Wyle v. C.H. Rider & Family (In re United Energy Corp.), 944 F.2d 589 (9th Cir. 1991) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16-17, 24 STATUTES AND RULES Bankruptcy Code, 11 U.S.C. 101, et seq. Section 101(5)(A), 11 U.S.C. 101(5)(A) . . . . . . . . . . . . . . . . . . . . . . . . . 12 Section 101(12), 11 U.S.C. 101(12) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Section 544(b)(1), 11 U.S.C. 544(b)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Section 548, 11 U.S.C. 548 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Section 548(a)(1)(A), 11 U.S.C. 548(a)(1)(A) . . . . . . . . . . . . . . . . . . 9-11 Section 548(a)(1)(B), 11 U.S.C. 548(a)(1)(B) . . . . . . . . . . . . . . . . . . . . . 10 Sections 548(a)(1)(B)(i)-(ii)(I), 11 U.S.C. 548(a)(1)(B)(i)-(ii)(I) . . . . . 10 Section 548(c), 11 U.S.C. 548(c) . . . . . . . . . . . . . . . . . . . 3, 5-6, 10-11, 13 Section 548(d)(2)(A), 11 U.S.C. 548(d)(2)(A) . . . . . . . . . . . . . . . . . 11-12 -iv-
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TABLE OF CITATIONS (Continued) Page Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L. No. 109-8, 1402(1), 119 Stat. 23 . . . . . . . . . . . . . . . . . . . . . . . . . 10 Sections 19 and 20 of the Securities Act of 1933, 15 U.S.C. 77s, 77t . . . . . . . . . . 1 Section 21 of the Securities Exchange Act of 1934, 15 U.S.C. 78u . . . . . . . . . . . . 1 Fed. R. App. P. 29(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Georgia Code Annotated Ga. Code Ann. 18-2-73(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Ga. Code Ann. 18-2-74(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Ga. Code Ann. 18-2-75(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Ga. Code Ann. 18-2-77(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Ga. Code Ann. 18-2-78 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Ga. Code Ann. 18-2-78(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Ga. Code Ann. 18-2-78(d) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Ga. Code Ann. 18-2-79 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
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INTEREST OF THE SECURITIES AND EXCHANGE COMMISSION The Securities and Exchange Commission is the agency principally responsible for the enforcement of the federal securities laws and the protection of the investing public. See Sections 19 and 20 of the Securities Act of 1933, 15 U.S.C. 77s, 77t; Section 21 of the Securities Exchange Act of 1934, 15 U.S.C. 78u. This appeal was taken from an order in the bankruptcy of International Management Associates, LLC (IMA), denying partial summary judgment with respect to fraudulent transfer actions brought by the Trustee, who had previously been the receiver in a Commission securities fraud enforcement action against IMA. The Trustee is seeking to recover payments made to investors by IMA prior to the collapse of IMA, which the Trustee alleges was operating a Ponzi scheme through several affiliated hedge funds. As a general rule, innocent investors in Ponzi schemes have a good faith-for value defense against fraudulent transfer actions to recover their investment principal. The Trustee contends, however, that because the IMA investors had worthless equity, rather than debt, interests in the hedge funds, they cannot establish that they gave value for payments they received. The bankruptcy court rejected the Trustees argument, holding that the existence of a fraud claim arising from the investment, not the form of the
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investment, is the relevant consideration in determining if investors gave value. (Order Den. Trustees Mot. for Partial Summ. J. 12, Dec. 1, 2009.) The Trustee appealed. The Commission submits this amicus curiae brief, pursuant to Fed. R. App. P. 29(a), to address the important legal question raised by the Trustees appeal: whether equity investors in a fraudulent scheme can establish that they gave value in exchange for payments up to their principal amounts because they held claims based on fraudulent inducement arising from their initial investment. The answer to this question will have a significant impact on the treatment of investors defrauded by Ponzi schemes purporting to offer equity investments. The Commission believes that the Trustees view is contrary to longestablished legal principles governing the recovery of payments received by investors prior to the collapse of a Ponzi scheme. Moreover, as a policy matter, it should make no difference whether investors are defrauded by Ponzi schemes that purport to offer debt securities or Ponzi schemes that purport to offer equity securities.
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STATEMENT OF THE ISSUES Section 548(c) of the Bankruptcy Code and similar state laws provide a defense to fraudulent transfer actions to those who took for value and in good faith. In the Ponzi scheme context, courts generally find that defrauded investors gave value for transfers up to their principal amounts because the investors had restitution or rescission claims that were satisfied to the extent of the transfers they received. For the purposes of this appeal, it is assumed that the investor defendants were fraudulently induced to invest as equity holders in a Ponzi scheme and that they received transfers purportedly in exchange for tendering their equity interests to IMA. The question presented is whether they gave value for purposes of this defense.
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FACTS A. The Commissions Enforcement Action
In February 2006, the Commission filed a complaint alleging a fraudulent offering involving investments in a group of hedge funds run by promoter Kirk Wright and two investment advisers he controlled International Management Associates, LLC and International Management Associates Advisory Group, LLC. 1/ The complaint alleged that, over a period of about nine years, the defendants raised approximately $150 million from about 500 investors in the hedge funds, which were organized as limited liability companies and limited partnerships. B. The Bankruptcy Filing and the Fraudulent Transfer Actions
A month after the Commission filed its complaint, IMA and its affiliated funds filed voluntary petitions for relief under the Bankruptcy Code. Thereafter, the Trustee filed 108 adversary proceedings in the bankruptcy court, seeking to recover certain transfers made to investors in the form of the return of amounts they had invested i.e., the principal of their investments and, in some cases, purported profits, as fraudulent transfers under the Bankruptcy Code and
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The court entered a default judgment as to Wright after he failed to answer the complaint, enjoining him from committing further violations and ordering him to pay $17,019,510 in disgorgement, $2,786,399 in prejudgment interest, and a $120,000 penalty.
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comparable state fraudulent transfer statutes. 2/ Under the liquidation plan confirmed by the bankruptcy court in August 2008, it appears that the main assets that would be available for distribution to the defrauded IMA investors are the assets the Trustee hopes to recover through the fraudulent transfer actions. The Trustee moved for partial summary judgment, seeking a ruling that, assuming he were able to establish a prima facie case for the recovery of the payments as fraudulent transfers, the investors could not assert a defense under Section 548(c) of the Bankruptcy Code, 11 U.S.C. 548(c), and comparable state law fraudulent transfer statutes, that they received the payments for value and in good faith. The general rule with respect to investors in Ponzi schemes is that good faith investors give value, and can assert the Section 548(c) affirmative defense to a fraudulent transfer action, for transfers up to the amount they invested, but not for transfers of additional funds. 3/ The Trustee does not address whether the investors had the requisite good faith; at this stage of the proceedings, he is seeking a ruling that, as a matter of law, the investors did not give value and
2/ 3/
The Trustee has since dismissed or settled with some of the defendants. For the purposes of this appeal, it is assumed that Wright used IMA and its affiliated hedge funds to operate a Ponzi scheme at all material times. (Trustees Br. 6.)
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therefore cannot establish the affirmative defense under Section 548(c) or comparable state law regardless of their good faith. The Trustee argued in his summary judgment motion that this general rule should not apply to investors holding equity interests, such as the interests in the limited liability companies and partnerships sold to the investors in the IMA hedge funds. Because equity interests in an insolvent enterprise are essentially worthless, he contended, transfers on account of those equity interests are not exchanges for value within the meaning of the Bankruptcy Code or state law. C. The Decision Below
The bankruptcy court rejected the Trustees analysis and denied the motion for partial summary judgment. In so ruling, it cited the general rule in Ponzi schemes that the victim of a Ponzi scheme has a claim for the return of the principal it invested based on fraud and that payments up to the amount of the invested principal are made in exchange for value because the payments satisfy the fraud claim (Order 10) and concluded that no principled basis exists for a different result depending on the technical form of the fraudulent investment (Order 12). The determining factor, it explained, is the substance, not the form, of the transaction, and [t]he substance of a Ponzi scheme transaction is the
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acquisition and use of funds through a fraudulent scheme, not the particular manner in which the perpetrator carried it out. (Order 12.) The bankruptcy court certified its order for direct interlocutory appeal by the Trustee to this Court.
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SUMMARY OF ARGUMENT The bankruptcy courts denial of the Trustees motion should be affirmed. The bankruptcy court correctly concluded that there is no basis, simply because the scheme in this case involved purported equity interests, for a result contrary to the general rule in Ponzi schemes that good faith investors can retain transfers up to the principal amounts they invested. The substance of a Ponzi scheme is the fraud perpetrated on investors; the form of the so-called investment should not be controlling. Further, in light of the hardship that would be inflicted on defrauded investors if they were now forced to disgorge funds received years ago and likely already spent, the equitable balance should be struck in favor of allowing innocent investors to keep their principal amounts.
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ARGUMENT THE BANKRUPTCY COURT CORRECTLY DETERMINED THAT THE GENERAL RULE IN PONZI SCHEMES APPLIES WHETHER AN INVESTMENT INVOLVES EQUITY OR DEBT. Investors in Ponzi schemes who become defendants in fraudulent transfer actions are, as a general rule, deemed to have given value, for purposes of the defense to a fraudulent transfer action, for any payments they received prior to a bankruptcy or receivership that represent a return of the initial amount they invested. The Trustees view that there should be a different rule for equity investments finds no support in the extensive case law addressing Ponzi schemes. This view is also at odds with the Commissions policy of generally not seeking recovery of investment principal received by innocent investors in Ponzi schemes. The policy arguments advanced by the Trustee in support of his position did not convince the bankruptcy court and should similarly fail to persuade this Court. A. Investors with Equity Interests in an Entity Operated as a Ponzi Scheme Give Value for Transfers Up to the Amount of Principal Invested for Purposes of the Affirmative Defense to a Fraudulent Transfer Action.
Under Section 548(a)(1)(A) of the Bankruptcy Code, a trustee may avoid any transfer made within two years before the filing of a bankruptcy petition if the debtor made the transfer with actual intent to hinder, delay, or defraud any entity
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to which the debtor was ... indebted. 11 U.S.C. 548(a)(1)(A). 4/ The existence of a Ponzi scheme is sufficient to establish that a transfer was made with the requisite fraudulent intent. Barclay v. Mackenzie (In re AFI Holding, Inc.), 525 F.3d 700, 704 (9th Cir. 2008). Under Section 548(a)(1)(B) of the Bankruptcy Code, a trustee may avoid any transfer made within two years before the filing of a bankruptcy petition if the debtor received less than a reasonably equivalent value in exchange for such transfer or obligation; and ... was insolvent on the date that such transfer was made[.] 11 U.S.C. 548(a)(1)(B)(i)-(ii)(I). 5/ Section 544(b) of the Code allows trustees to bring actions under state law, which typically provides longer reach-back periods. 11 U.S.C. 544(b)(1). The Trustee is seeking to avoid transfers to the investors under both the Bankruptcy Code and
4/
The time period was extended from one year to two years by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub. L. No. 109-8, 1402(1), 119 Stat. 23, but the extension was made applicable only to bankruptcy cases that commenced more than one year after April 20, 2005. IMA filed for bankruptcy relief on March 16, 2006. The concept of value is material to both the Section 548(c) defense and the Trustees claim for recovery of payments as constructively fraudulent transfers. See Merrill v. Abbott (In re Indep. Clearing House Co.), 77 B.R. 843, 861 (D. Utah 1987) (en banc) (in examining a defendants Section 548(c) defense, the court explained that [t]he extent to which a defendant gave value for a particular transfer is essentially the flip side of the question we have already discussed ... [] namely, whether the debtor received a reasonably equivalent value in exchange for the transfer).
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the fraudulent transfer provisions of the Georgia Code, which have a four-year statute of limitations. See GA. CODE ANN. 18-2-74(a), 18-2-75(a), 18-2-77(a), 18-2-79. The Trustee asks this Court to rule that the investors cannot assert the good faith-for value defense under the Bankruptcy Code and comparable state law fraudulent transfer statutes because they did not provide value for the transfers they received. Section 548(c) of the Code provides, in pertinent part, that a transferee ... that takes for value and in good faith ... may retain any interest transferred ... to the extent that such transferee ... gave value to the debtor in exchange for such transfer or obligation. 11 U.S.C. 548(c). See also GA. CODE ANN. 18-2-78. 6/ Value for the purposes of this defense to a fraudulent transfer action includes the satisfaction ... of a present or antecedent debt of the debtor[.] 11
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A transfer or obligation is not voidable under [the Georgia Code provision comparable to 11 U.S.C. 548(a)(1)(a)] against a person who took in good faith and for a reasonably equivalent value or against any subsequent transferee or obligee. GA. CODE ANN. 18-2-78(a); Notwithstanding voidability of a transfer or an obligation under this article, a good faith transferee or obligee is entitled, to the extent of the value given the debtor for the transfer or obligation, to: (1) A lien on or a right to retain any interest in the asset transferred [.] GA. CODE ANN. 18-2-78(d).
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U.S.C. 548(d)(2)(A) (emphasis supplied). 7/ Debt means liability on a claim[,] 11 U.S.C. 101(12), and claim includes a right to payment, whether or not such right is reduced to judgment, 11 U.S.C. 101(5)(A). These definitions serve as the foundation of the general rule in fraudulent transfer actions against investors in Ponzi schemes that good faith investors can retain payments up to their principal amounts. Donell v. Kowell, 533 F.3d 762, 771 (9th Cir. 2008), cert. denied, 129 S. Ct. 640 (2008) (good faith defense ... permits an innocent winning investor to retain funds up to the amount of the initial outlay). 8/ This is because [f]rom the time a defendant entrusted his money to the debtors, he had a claim against the debtors for the return of his money. Merrill v. Abbott (In re Indep. Clearing House Co.), 77 B.R. 843, 857 (D. Utah 1987) (en banc). See also Donell, 533 F.3d at 772 (investors are permitted to retain these amounts because they have claims for restitution or recision against
7/
Similarly, under Georgia law, [v]alue is given for a transfer or an obligation if, in exchange for the transfer or obligation, property is transferred or an antecedent debt is secured or satisfied[.] GA. CODE ANN. 18-2-73(a) (emphasis added). Although the Ninth Circuit in Donell was analyzing an action for disgorgement of profits as fraudulent transfers under the California Uniform Fraudulent Transfer Act, the court explained that Californias fraudulent transfer act and the federal bankruptcy codes fraudulent transfer provisions are almost identical in form and substance; therefore, we draw upon cases interpreting both. Donell, 533 F.3d at 769-70.
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the debtor that operated the scheme up to the amount of the initial investment). This claim represents an antecedent debt owed by the debtor to an investor, the satisfaction of which constitutes value for purposes of the Section 548(c) affirmative defense to a fraudulent transfer action. See Bayou Superfund, LLC v. WAM Long/Short Fund II, L.P. (In re Bayou Group, LLC), 362 B.R. 624, 634 (Bankr. S.D.N.Y. 2007) ([i]t is ... clear under the case law ... that persons who were induced by fraud to invest in the Bayou Hedge Funds or predecessor funds may have a state law claim for rescission, and that this tort claim is an antecedent debt which constitutes value for purposes of ... Section 548(c)). 9/ Because the transfer is deemed to have been made on account of the antecedent debt resulting from the claim for restitution or rescission, it makes no difference to the value analysis that the equity interests may have been worthless at the time of the transfer. The Ninth Circuit rejected the argument that the general rule should not apply when an investment takes the form of an interest in a limited partnership. See In re AFI Holding, Inc., 525 F.3d at 708-09. In AFI Holding, the investor was 9/ Payments above the amounts invested in a Ponzi scheme are not for value since [p]ayments in excess of amounts invested are considered fictitious profits because they do not represent a return on legitimate investment activity. Fisher v. Sellis (In re Lake States Commodities, Inc.), 253 B.R. 866, 872 (Bankr. N.D. Ill. 2000).
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a purported limited partner and, over the course of the scheme, had received both the return of his principal and purported profits. Id. at 702. AFI eventually filed for bankruptcy and the trustee brought adversary proceedings under California state fraudulent transfer law against certain AFI investors to avoid transfers they had received from AFI. 10/ Id. Like the bankruptcy court here, the Ninth Circuit disregarded the form of the investment: [a]lthough circumstances of the exchange were cloaked in terms of a partnership interest, we delve beyond the form to the substance of the transaction. Id. at 708. The court held that the transfer to the AFI limited partner of his principal amount was a transfer with respect to his restitution claim. Id. ([i]t is this restitution claim, in toto, that [the defendant] exchanged when AFI returned [his] principal investment amount). The court concluded that if it were found on remand that the investor took in good faith, he would be entitled to retain the amount that he initially invested with AFI. Id. at 709. While the Trustee would like this Court to disregard AFI Holding as wrongly decided, the opinion reveals that the Ninth Circuit thoughtfully analyzed
10/
The court noted that Californias fraudulent transfer statutes are similar in form and substance to the Bankruptcy Codes fraudulent transfer provisions, and therefore looked to cases analyzing the Bankruptcy Code provisions as persuasive authority. Id. at 703.
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the relevant case law in deciding that the investor had exchanged value for the return of his investment in the limited partnership. The same analysis should apply to the investors in this case. The Trustee purports to find support for his distinction between equity and debt for fraudulent transfer actions in the seminal case Eby v. Ashley, in which the court stated that the victim in a fraudulent investment scheme had the right to recover the money he invested from the moment that he was deceived into paying it. Eby v. Ashley, 1 F.2d 971, 973 (4th Cir. 1924), cert. denied, 266 U.S. 631 (1925). The Trustee argues that because the court in Eby viewed the agreement itself between the investor and the promoter of the fraudulent scheme as providing for the return of investment principal, see id. at 971-72, the investor had a separate claim for the return of his money, apart from the fraud. In the Trustees view, this renders the fact that the investor also had a fraud claim for restitution surplusage. (Trustees Br. 18-21.) The Trustee then distinguishes other cases that apply the general rule on the ground that they, like Eby, also involved debt claims and thus the defendants had no need for the surplusage of restitution claims. (Trustees Br. 22-25.) The Trustees reasoning is, of course, contrary to the Ninth Circuits decision in AFI Holding, which involved a limited partnership interest. It is also
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contrary to other decisions of the Ninth Circuit involving actions to recover payments to investors in Ponzi schemes. In a lengthy analysis of this area of the law in its recent Donell decision, the Ninth Circuit explained that the basis for the claim that establishes the exchange of value for the transfer sought to be avoided is not a contractual right to a return of principal, but the right of restitution arising from the investment in the fraudulent scheme. See Donell, 533 F.3d at 772. Its earlier United Energy decision also links the claim to the investors rights to restitution. See Wyle v. C.H. Rider & Family (In re United Energy Corp.), 944 F.2d 589, 595 (9th Cir. 1991) (the investors exchanged reasonably equivalent value when their rights to restitution were proportionately reduced by the power payments they received). Indeed, the trustee in United Energy, like the Trustee here, argued that the line of cases beginning with Eby was distinguishable because, in each case, the original investment instrument provided that the investor would recover his principal amount. United Energy, 944 F.2d at 595. The Ninth Circuit rejected this argument. Explaining that the Bankruptcy Codes broad definition of the term debt does not require that a debt be a contractual liability, the court concluded that the defrauded investors clearly had claims for rescission and restitution
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which arose when they bought the modules, regardless of whether there existed a contractual right to the return of principal. Id. at 595-96. Even when courts find that a payment in a Ponzi scheme case was on account of a contractual arrangement, they often make clear that a restitution claim is also available to support the finding that the defendant in a fraudulent transfer action gave value for the transfer. See Dicello v. Jenkins (In re Intl Loan Network, Inc.), 160 B.R. 1, 12 (Bankr. D.D.C. 1993) ([f]rom the time a defendant entrusted money to ILN, ILN was indebted to that defendant for the amount of his investment[;] [t]his debt arose either as the result of a contractual obligation or the defendants right to restitution) (emphasis added, footnote omitted); Indep. Clearing House, 77 B.R. at 857 ([w]e believe that the Codes definition of debt and its related terms is broad enough to cover the debtors obligation to return a defendants principal undertaking, whether that obligation was based on the contract between the debtors and the defendant or was based on the defendants right to restitution) (emphasis added). Significantly, the Independent Clearing House court went on to emphasize that the defendants contract claims were not critical to its decision: If there was not a valid contract between the debtors and a defendant, before the transfer the defendant would have had a claim for restitution, to prevent the debtors unjust enrichment. If there was a
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valid contract that gave the defendant an equity interest in the debtors business, as the trustee contends, the defendant would still have had a right to restitution if the debtors fraud induced him to enter into the contract. Id. at 857 n.24 (citation omitted). Finally, the Trustees argument against what he refers to as transmutation without articulation his shorthand for the bankruptcy courts deeming the payment on account of an equity interest to be payment in satisfaction of a fraud claim that was neither asserted nor proven is undermined by the numerous cases that, as the Trustee acknowledges, fully recognize the claims for restitution and rescission of defrauded investors, regardless of the fact that the defrauded investors had neither asserted nor proven their fraud claims at the time of the subject transfers. (Trustees Br. 46-47.) In support of his argument, the Trustee contends that it is well-established that any claimant must both provide notice of a claim and articulate the basis for the claim. (Trustees Br. 47.) But, if receiving the payment were conditioned on asserting the fraud claim, the investor would necessarily be aware of the fraudulent nature of the investment and thus would be unable to establish the good faith required for the affirmative defense. There is no reason for this Court to reject the longstanding analysis that allows an innocent investor in a Ponzi
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scheme who receives a payment that returns principal before the scheme collapses to assert the defense that the payment was received in good faith and for value. Moreover, the Trustees concerns about principles of notice and due process are present regardless of whether the unasserted claim is for equity or debt. Applying the general rule means that any innocent investor, whether the investment is debt or equity, who gets his principal back before the bankruptcy or receivership is favored over an investor who does not. The Trustees response, that the transmutation from equity to debt is somehow more problematic than the transmutation from debt to another form of debt, is both inconsistent with the case law that recognizes that defrauded equity investors have fraud-based debt claims at the time of the subject transfers and not relevant in the Ponzi scheme context, as discussed infra, pp. 22-24. B. Policy Reasons Support the View that There Should Be No Distinction Between Debt and Equity in the Context of an Action To Recover Principal Payments in a Ponzi Scheme Case.
There is no compelling reason why innocent investors who have what are purported to be debt interests in a Ponzi scheme should be allowed to keep principal amounts while innocent investors who have what are purported to be equity interests should not. Commission enforcement actions against perpetrators of Ponzi schemes involve a variety of investments, including notes (e.g., Donell,
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supra) and equity interests (e.g., AFI Holding, supra; Bayou Group, LLC, supra). Investors suffer the same harm regardless of the form the purported investment takes and the availability of the good faith-for value defense to a fraudulent transfer action should not depend on the happenstance of how the fraudster chooses to pitch the investment. Consistent with the general rule, innocent investors who redeem their investments before a Ponzi scheme collapses generally should not be liable for the return of principal amounts. This result reflects a balancing of interests. On the one hand, in an appropriate case, a bankruptcy trustee or a receiver in a Commission action can bring an action to recover fictitious profits. This is so even though it may create a significant hardship when an innocent investor ... is informed that he must disgorge profits he earned innocently[.] Donell, 533 F.3d at 776. In contrast, in most cases, the disruption to an innocent investor who has only gotten back the money he or she invested goes too far. See In re Indep. Clearing House, 77 B.R. at 887 ([t]he ideal solution, of course, would be for all undertakers to get back their original undertaking. But that solution presupposes that the original undertakings are still around to be gotten back, and it is clear that they are not).
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Similar considerations arise when the Commission asserts equitable disgorgement claims in its enforcement actions against relief defendants who have not themselves committed violations of the federal securities laws. The Commissions policy is that innocent investors who recover their initial investments before a Ponzi scheme collapses generally should not be liable for the return of principal. 11/ While there is arguably some merit to the Trustees view that fairness to all investors favors the recovery of money received by earlier investors so that it can be distributed pro rata, this consideration is outweighed by the hardship that would be inflicted on individual investors forced to return principal payments received in good faith. These are not payments for fictitious profits that, in a Ponzi scheme with no legitimate earnings, necessarily come from the money other investors contributed to the investment pool. Rather, principal amounts represent a return of the investors own contributions to the investment pool. The application of the principle that such investors are entitled to keep the amounts they invested should not turn on an illusory distinction between an investment in a Ponzi scheme structured as debt and a similar investment structured as equity. 11/ In asserting such equitable disgorgement claims, the Commission may in certain circumstances seek to recover payments of principal, especially when the payments are made to insiders or other favored investors.
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C.
The Trustees Arguments about the Differences Between Debt and Equity Are Not Persuasive in the Ponzi Scheme Context.
The policy reasons that generally underlie the priority of debt over equity in bankruptcy do not apply in the context of a fraudulent transfer action involving a Ponzi scheme. In a real business enterprise, creditors rely on the distinction between debt and equity. See Am. Broad. Sys., Inc. v. Nugent (In re Betacom of Phoenix, Inc.), 240 F.3d 823, 829 (9th Cir. 2001) (Shareholders expect to take more risk than creditors in return for the right to participate in firm profits. The creditor only expects repayment of a fixed debt. It is unfair to shift all of the risk to the creditor class since the creditors extend credit in reliance on the cushion of investment provided by the shareholders.). In the bankruptcy of an entity operated as a Ponzi scheme, however, the most significant claims are generally those of the defrauded investors, as opposed to those of ordinary trade creditors. Thus, while fraudulent transfer actions against equity holders in the context of a typical bankruptcy involving a legitimate enterprise would likely serve to redistribute assets from equity holders to creditors, in a Ponzi scheme, reallocation is primarily among investors of the same class. As the bankruptcy court observed, in a Ponzi scheme the fraudulent transfer laws, for the most part, result in an alteration of the distribution of assets among the defrauded victims. (Order 11.)
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Reliance on the principle that creditors have priority over equity holders does not make sense in this situation. The Trustees arguments about the distinctions between debt and equity are also inapposite in the Ponzi scheme context because of the nature of the value deemed to be given by investors to the debtor for purposes of the defense to a fraudulent transfer action. Because courts interpret this value to be the satisfaction of a claim for restitution or rescission, as opposed to the debt or equity interest itself, see discussion, supra, pp. 9-19, the nature of the underlying instrument is not relevant. The Trustee relies heavily on the Terry Manufacturing case to support his arguments about the differences in treatment accorded to debt as compared to equity. Alexander v. Albright (In re Terry Mfg. Co., Inc.), Nos. 03-32063, 053050, 2007 WL 274319, at *1 (Bankr. M.D. Ala. Jan. 25, 2007). Terry did not involve a Ponzi scheme. Instead, the case involved shareholders of a bankrupt company formerly run by two dishonest businessmen. Terry, 2007 WL 274319, at *2. In response to the trustees attempt to recover certain dividends as fraudulent conveyances under 11 U.S.C. 548 and Alabama state law, id. at *1, the shareholders claimed that they had been defrauded by the company and its principals and that the dividends they had received satisfied, in part, the restitution
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obligations owed to them. Id. at *5. The court dismissed the restitution argument, citing, among other reasons, the lack of precedent for the recharacterization of dividends as payments in satisfaction of a debt. Id. at *7. The court cautioned that, [i]f that were the case, in almost every corporate bankruptcy involving fraud, shareholders could advance their status and recharacterize their equity interests as unsecured claims sharing equally in the assets with the holders of unsecured claims. Id. This argument highlights why Terry is inapposite to the Ponzi scheme at issue. The IMA dispute primarily involves the distribution of assets among defrauded investors, not between creditors and equity holders. Finally, the Trustees arguments about equitable distribution are out of place in the context of a fraudulent transfer action. Unlike preference actions, which are intended to promote equality of distribution, fraudulent transfer actions are intended to ensure that the estate is not diminished. See United Energy, 944 F.2d at 597 (the policy behind section 548 is to preserve the assets of the estate).
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CONCLUSION For the foregoing reasons, the bankruptcy court correctly determined that the investors gave value for purposes of the fraudulent transfer laws to the extent that they received payments up to the amount of principal invested, and the order of the bankruptcy court should therefore be affirmed. Respectfully submitted, DAVID M. BECKER General Counsel MARK D. CAHN Deputy General Counsel JACOB H. STILLMAN Solicitor KATHARINE B. GRESHAM Assistant General Counsel /s/ Morgan Bradylyons MORGAN BRADYLYONS Attorney Securities and Exchange Commission 100 F. Street, NE Washington, DC 20549 (202) 551-7926 (Bradylyons) July 8, 2010
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CERTIFICATE OF COMPLIANCE I hereby certify that this brief complies with the type-volume limitations of Fed. R. App. P. 29(d) because this brief contains 5340 words, excluding the Certificate of Interested Persons and Corporate Disclosure Statement, Table of Contents, Table of Citations, Certificate of Compliance, and Certificate of Service. I also certify that this brief complies with the typeface requirements of Fed. R. App. P. 32(a)(5) and the type style requirements of Fed. R. App. P. 32(a)(6) because this brief has been prepared in a proportionally spaced typeface using WordPerfect 11 in 14 point Times New Roman type. /s/ Morgan Bradylyons MORGAN BRADYLYONS Securities and Exchange Commission July 8, 2010
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CERTIFICATE OF SERVICE I hereby certify that on July 8, 2010, I caused seven paper copies and one electronic copy of the Brief of the Securities and Exchange Commission, Amicus Curiae, to be served via UPS overnight delivery on the Clerk of the Court of Appeals for the Eleventh Circuit. I certify further that on that same date I caused one paper copy of the brief to be served via UPS overnight delivery on the following parties:
John W. Mills, Esq. Colin Bernardino, Esq. Kilpatrick Stockton 1100 Peachtree St. Suite 2800 Atlanta, GA 30309 Paul M Spizzirri, Esq. Spizzirri Law Offices 1170 Peachtree St., Suite 1200 Atlanta, GA 30309 Jonathan H Fain, Esq. Jonathan H. Fain and Assoc., PC 66 Lenox Pointe Atlanta, GA 30324
Mark S. Kaufman, Esq. Brian E. Bates, Esq. McKenna Long & Aldridge LLP 303 Peachtree St. NE, Suite 5300 Atlanta, GA 30308
Sharon M. Lewonski, Esq. Epstein, Becker & Green, P.C. 945 East Paces Ferry Rd., Suite 2700 Atlanta, Georgia 30326 Robert J. Mottern, Esq. Investment Law Group of Gillett, Mottern & Walker 1230 Peachtree St., Suite 2445 Atlanta, GA 30309
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Thomas M. Byrne, Esq. Angela R. Fox, Esq. Sutherland Asbill & Brennan LLP 999 Peachtree St., NE Atlanta, Georgia 30309-3996 Gregory T. Bailey, Esq. 571 Culberson Street Atlanta, GA 30310
Sblend A. Sblendorio, Esq. Catosha L. Woods, Esq. Hoge Fenton Jones & Appel, Inc. 4309 Hacienda Dr., Suite 350 Pleasanton, CA 94588 Christopher D. Phillips, Esq. Lamberth, Cifelli, Stokes, Ellis & Nason, P.A. 3343 Peachtree Rd. NE, Suite 550 Atlanta, GA 30326 Timothy Mungovan Jonathan Sablone Lee Harrington Joshua Barlow Nixon Peabody LLP 100 Summer St. Boston, MA 02110 William R. Lester, Esq. Fryer, Shuster & Lester, P.C. 1050 Crown Pointe Pkwy., Suite 410 Atlanta, GA 30338
Kevin A. Stine, Esq. Joshua Tropper, Esq. Baker, Donelson, Bearman, Caldwell & Berkowitz, P.C. 1600 Monarch Plaza 3414 Peachtree Rd. NE Atlanta, GA 30326 Heather D. Brown, Esq. Mark A. Kelley, Esq. Kitchens, Kelley, Gaynes, P.C. Eleven Piedmont Center - Suite 900 3495 Piedmont Road NE Atlanta, GA 30305 James K. Knight, Jr., Esq. 401 Atlanta St. Marietta, GA 30060
/s/ Morgan Bradylyons MORGAN BRADYLYONS

Perkins v. Haines - S.E.C.&#39;s Amicus Brief

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Case: 10-10683

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FACTS A. The Commissions Enforcement Action

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/s/ Morgan Bradylyons MORGAN BRADYLYONS

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Perkins v. Haines - S.E.C.'s Amicus Brief

Perkins v. Haines - S.E.C.'s Amicus Brief