Fifth Circuit rules that Stanford Ponzi scheme’s net winners must disgorge profits

NEW ORLEANS – In a recently filed opinion the Fifth Circuit Court of Appeals affirmed the US District Court for the Northern District of Texas’ decision to grant the plaintiff-appellee’s motion for summary judgment in a Ponzi scheme case, thereby legally obligating the defendants-appellants to return monies paid in excess of their original investments.

The Fifth Circuit’s ruling concerns the Stanford Ponzi scheme, in which R. Allen Stanford owned a network of entities that sold certificates of deposit to investors through the Stanford International Bank Ltd.

Stanford and his employees told prospective investors that they would re-invest their money into lucrative securities with the goal of netting high rates of return. In reality, Stanford used the funds to pay prior investors the returns they had been promised.

Karyl Van Tassel, a certified public accountant, examined the Stanford entities’ books and testified that the scheme had been in existence from 1999 until 2008. When the pyramid finally collapsed, Stanford entities had collected over $7 billion by selling fraudulent CDs.

Both Stanford and his Chief Financial Officer James M. Davis are now serving federal prison sentences.

The Securities and Exchange Commission brought a civil suit against Stanford, his agents, and the Stanford entities, alleging violations of federal securities laws. The district court appointed Ralph S. Janvey as receiver over the Stanford entities. Janvey was instructed to preserve corporate resources and recover corporate assets that had been transferred fraudulently.

Some early investors actually did benefit from the Stanford Ponzi scheme because they withdrew their investments before the collapse. The receiver claims that these successful investments were actually funds stolen from other investors. Janvey has filed numerous fraudulent transfer claims against such investors with the goal of recovering these allegedly false profits. Janvey also moved for partial summary judgment on the Texas Uniform Fraudulent Transfer Act (TUFTA) claims relevant to the issue and this motion was granted.

The investor-defendants appealed, contesting that the district court erred in several respects regarding TUFTA – that Janvey did not have adequate standing to bring claims, that the claims were untimely, that the Act did not govern Janvey’s claims and that the defendant’s assets in IRAs are exempt from the act.

The defendants also argued that their status as “net winners” or end beneficiaries from the Stanford scheme was unconfirmed and that the court erred in holding that their ‘returns on investment’ were in fact fraudulent transfers.

The Fifth Circuit addressed the defendants’ arguments and first established that the case falls under TUFTA’s governance because Texas is the state in which the conflict exists. Stanford International Bank is incorporated in Antigua, an island in the West Indies, but the court stated that this is irrelevant to the case because Antigua “has no actual interest in the dispute.”

The decision states that prior opinions of the Fifth Court and district court have established that the Stanford Ponzi scheme was centered in Houston, Texas, and that Stanford’s numerous entities were only conduits through which the scheme was carried out.

With respect to Janvey’s standing, the defendants had argued that only a debtor’s creditors can bring fraudulent transfer claims, and that “a federal equity receiver has standing to assert only the claims of the entities in receivership and not the claims of the entities’ investor-creditors.”

Janvey argued that because Stanford and Davis caused the Stanford entities to make fraudulent transfers that eventually harmed the entities by dissipating their assets without receiving equivalent value in return, Stanford and Davis are actually viewed as debtors under TUFTA, and the Stanford entities are viewed as defrauded creditors.

The Fifth Circuit agreed with Janvey, thereby affirming his standing to pursue the TUFTA claims. The court ruled that Stanford’s “captive corporations” or entities, were not aware of the scheme when it was ongoing. Because of this, the Fifth Circuit held that “the corporations…through the receiver…may recover assets or funds that the principal fraudulently diverted to third parties.”

The defendants also contested that Janvey’s claims were barred by the statute of limitations. The decision states that under TUFTA, “an action seeking to void a fraudulent transfer must be brought within four years after the transfer was made…or, if later, within one year after the transfer…could reasonably have been discovered by the claimant.”

As Janvey was appointed on Feb. 16, 2009, the defendants argued that the suits should have been brought within a year of that date.

The court held that when Janvey was appointed in 2009, it “was not readily evident to him…that [the Stanford entities] were part of a massive Ponzi scheme perpetrated by Stanford beginning as early as 1999.” When he was appointed, Janvey retained Van Tassel to evaluate Stanford’s accounts.

The record states that it was “not until Aug. 27, 2009, that Davis pleaded guilty [to various offenses] and…disclosed facts indicating the true nature and duration of Stanford’s…massive Ponzi scheme.”

Because the two allegedly late suits in question were filed “less than one year after Davis’s guilty plea” and the defense has reportedly failed to prove that Janvey knew about the scheme for more than one year prior to filing the suits, the Fifth Circuit decided that Janvey’s TUFTA claims are not barred by the statute of limitations.

In examination of the case’s merits, the court found that under TUFTA, “the transferees’ knowing participation is irrelevant…for purposes of establishing the premise of…a fraudulent transfer.” Indeed, “the statute requires only a finding of fraudulent intent on the part of the ‘debtor.’”

The ruling states that Stanford’s principals, Stanford and Davis, had “created and perpetrated a ‘Ponzi scheme’” knowingly and that this is thoroughly evidenced by Van Tassel’s testimonies and research. While the defendants argue that Stanford entities’ accounting records demonstrated solvent business operations, the court notes that Davis himself admitted to “continued routine false reporting” which purportedly compromises such resources.

According to the record, Davis testified that “Stanford directed [him] to ‘make false revenues and false investment portfolio balances for the purpose of reporting false revenues’” in 1988, “shortly after opening Guardian International Bank, as SIB was then known, in Montserrat.”

The defendants also argued that SIB may have simply preferred one creditor over another. The court disagreed, stating that the Stanford principals were running an insolvent Ponzi scheme in which paid old investors with new investors’ investments. Stanford’s entities were not “innocent debtors preferring one creditor over another,” an as such the Fifth Circuit affirmed that “the Stanford principles transferred monies to the investor-defendants with fraudulent intent.”

The defendants further argued that they were owed antecedent contractual debt from SIB from the CDs they purchased, and believe that they should be permitted to keep their contractually guaranteed interest payments. Referencing In re Carrozzella & Richardson, the defense contested that “the debtor’s use of the investor’s funds for a period of time supported the payment of reasonable contractual interest.”

The district court rejected the defense’s argument because “the only claim [the defendants] have for their interest payments is a contractual one” which the court held to be unenforceable. However, the court agreed that the defendants “[gave] reasonably equivalent value to the extent that they received back their principal because they have actionable claims for fraud and restitution.”

The court went on to note that “for victims of a Ponzi scheme, everyone is a loser…allowing net winners to keep their fraudulent above-market returns in addition to their principal would simply further victimize the true Stanford victims, whose money paid the fraudulent interest.”

The Fifth Circuit agreed with the district court, stating that the Carrozzella & Richardson argument “depends on there being a ‘debt’ that the interest payments are reducing. Because TUFTA defines a ‘debt’ as being a ‘liability on a claim’, the investor-defendants must have a valid claim. Here, we conclude that there is no valid claim for interest; the CDs issued by SIB are void and unenforceable.”

The court went on to explain that “any recovery would not come from the debtor’s own assets because they had no assets they could legitimately call their own. Rather, any award of damages would have to be paid out of money rightfully belonging to other victims of the Ponzi scheme.”

The opinion states that “some [defendants] sought to shelter their net winnings as assets in IRA accounts exempted by Texas property code.” To qualify for such an exemption, a defendant “must establish that [they have] a legal right to the funds in the IRA.” Because the defendants have reportedly failed to offer evidence proving their legal right to the fraudulent transfer monies, the Fifth Circuit stands by the district court’s ruling which denied the exemption.

The Fifth Circuit concluded by declining to discuss certain defendants’ (Gary D. Magness, Magness Securities and Gary D. Magness Irrevocable Trust) argument concerning their establishment as “net winners” because Magness’ motion for summary judgment had been stayed by the district court at the time of the ruling.

The case was heard by Judges Patrick E. Higgenbotham, Edith Brown Clement and Stephen A. Higginson.

Case no. 13-10266.