by by Burton W. Wiand, Michael S. Lamont, and Jordan D. Maglich
In recent years, Ponzi schemes have captured national headlines and left a broad array of victims — often individual investors — devastated by the scheme’s aftermath. Trustees, receivers, and others who are appointed to do “clean-up” after these schemes collapse regularly use traditional state laws relating to fraudulent conveyances to recover “false profits”1 and other proceeds of Ponzi schemers’ largesse in order to gather monies to help remediate the damage caused by these schemes. Recently, as these schemes have proliferated, and charities have become frequent targets of claims for the return of purloined funds, charities have turned to state legislatures seeking immunity from the common legal remedies that allow the rightful owners and legitimate creditors to recover fraudulently transferred proceeds.
By definition, a Ponzi scheme is limited in duration, and can survive only so long as new investments exceed outflows to existing investors. Called the “lifeblood” of a Ponzi scheme, new investments are essential to the scheme, and are solicited in a variety of ways by the mastermind, both directly and indirectly. Those who perpetrate Ponzi schemes clearly fall in the definition of “confidence men” and one of the common ways used to generate confidence in themselves, their stature in their communities, and the legitimacy of their businesses is through charitable giving. Large publicized charitable donations often pay off handsomely as new investors are drawn by the perceived connection between the generosity and business success. When the schemes implode in the face of unsustainable redemption and payment obligations — as all Ponzi schemes do — it becomes apparent that these generous acts of charitable giving were not funded from business profits, but instead were made possible simply by stealing money from innocent investors. In the resulting equity receivership or bankruptcy, the court-appointed official is tasked with the recovery of assets that have been fraudulently transferred to third parties, including charitable organizations, and often represents a significant element in efforts to provide restitution for those victims that suffered devastating losses.
However, a proposed set of amendments to the Florida Uniform Fraudulent Transfer Act (FUFTA) would drastically limit creditors’ ability to recover fraudulently transferred assets from a charitable organization. The amendments, which would represent an unwarranted reach beyond even that afforded by federal law under the Bankruptcy Code, would essentially protect charitable organizations at the expense of fraud victims.2 This article will examine the critical differences between the amendments and federal law, as well as argue that a balancing of the equities clearly demonstrates that a receiver or bankruptcy trustee — rather than an elected body — is better equipped to make this decision.
Senate Bill 102 and Current State and Federal Fraudulent Transfer Legislation
Sponsored by Sen. Nancy Detert, R-Venice, SB 102 proposes substantial changes to FUFTA, F.S. §§726.101 et seq., under the guise of providing protections similar to those already afforded under the Bankruptcy Code. This is accomplished by 1) inserting definitions for a “charitable contribution” and a “qualified religious or charitable entity”; 2) imposing limitations on the recovery of fraudulent transfers from charitable organizations; and 3) requiring that the fraudulent transfer be made within two years of the commencement of receivership or bankruptcy proceedings in order to be recoverable. As discussed below, these amendments are well beyond the limited protections afforded in the Bankruptcy Code, and instead reflect the unavoidable result that charitable organizations will essentially be permitted to retain money stolen from fraud victims despite being in a much better financial position to recover from such financial devastation. In order to understand the implications of the bill, it is helpful to examine the protections — and limitations — currently available to a creditor under FUFTA and/or the Bankruptcy Code.
• FUFTA — Pursuant to FUFTA, a creditor is provided with two distinct theories of recovery against a third party: actual fraud and constructive fraud. Under a theory of actual fraud, codified at F.S. §726.105(a), it must be shown that the transferor made the transfers to the transferee with “actual intent to hinder, delay, or defraud” the transferor’s creditors. In the context of Ponzi scheme litigation, this “actual intent” requirement can be satisfied not only by the judicial finding that a Ponzi scheme existed,3 but even in the presence of “overwhelming evidence of actual fraudulent intent” without a Ponzi scheme presumption.4 A creditor proceeding under a theory of actual fraud may seek recovery of transfers made “within [four] years after the transfer was made or the obligation was incurred, or if later, within [one] year after the transfer...could reasonably have been discovered by the claimant.”5
The theory of constructive fraud is codified at F.S. §§726.106 and 725.105(1)(b), and does not require that actual fraudulent intent be proven if a creditor can show that the transfer(s) was made 1) without receiving reasonably equivalent value in exchange for the transfer, and 2) leaving the debtor with insufficient funds under several scenarios. These scenarios include if the debtor was insolvent or rendered insolvent at the time of the transfer, engaged or about to engage in a business or transaction while inadequately capitalized, or if the debtor intended to or believed he or she would incur debts beyond his or her ability to pay. A creditor proceeding under a theory of constructive fraud may seek recovery of transfers made within four years after the transfer was made.6
• 11 U.S.C. §548 — The Bankruptcy Code generally mirrors FUFTA in 11 U.S.C. §548, allowing a bankruptcy trustee to recover fraudulent transfers under both actual fraud and constructive fraud theories. Like FUFTA, actual fraud can be presumed from the existence of a Ponzi scheme. While the “look-back” period is limited to two years, the Bankruptcy Code authorizes a trustee to bring suit under either §548 or applicable state fraudulent transfer law. One difference between FUFTA and the Bankruptcy Code is the result of the Religious Liberty and Charitable Donation Protection Act of 1998. There, Congress amended §548 to clarify that “[a] transfer of a charitable contribution to a qualified religious or charitable entity or organization shall not be considered to be a transfer covered under paragraph (1)(B)” when the amount of that contribution did not exceed 15 percent of the debtor’s gross annual income or was consistent with the debtor’s previous practices in making charitable contributions.7 Rather than make this exception apply to both actual and constructive fraud theories, Congress expressly chose only to allow these protections to actions brought under a constructive fraud theory.8
• SB 102 — While the bill purports to bring FUFTA in conformity with bankruptcy law, a closer look at the proposed language shows several important departures from §548 that would have drastic ramifications on the efforts of receivers and trustees in Ponzi scheme litigation. As discussed above, the Bankruptcy Code only limits recovery of transfers to charitable organizations under a constructive fraud theory. Thus, under §548, when transfers were made with “actual intent to hinder, delay, or defraud”9 any creditor, a charitable organization is not permitted to retain transfers. However, under the bill, a charitable contribution received in good faith is not a transfer that is avoidable under FUFTA, subject to several narrow exceptions. Specifically, a charitable contribution is a fraudulent transfer only if 1) made by a natural person; 2) received on or within two years before the commencement date of an action under any state or federal law; 3) not received in good faith, and either a) the amount exceeds 15 percent of the gross annual income of the transferor for the year in which the transfer is made, or b) inconsistent with the practices of the transferor in making charitable contributions. Simply put, the bill would significantly expand protections for charitable organizations at the direct expense of fraud victims because, regardless of the nature of the transfer, a charitable organization will be allowed to retain stolen money as long as the contribution does not exceed 15 percent of the gross annual income of the transferor or the transfer was consistent with the practices of the transferor in making contributions.10
Another significant departure from bankruptcy law includes the carve-out of a two-year statute of limitations for claims brought against a charitable organization under either an actual fraud theory or a constructive fraud theory. While this would not only reduce the limitations period from four years to two years, the reduction would also totally eliminate the “discovery” provision afforded to claims under a theory of actual fraud. Such a provision is critical, as a Ponzi scheme by its nature is concealed for as long as possible, which in turn hampers investigative efforts once the scheme is uncovered. The proposed language seemingly dismisses such concerns, and would essentially wipe away the liability of charitable organizations as long as the fraudster managed to conceal his or her fraud for two years after making the donation. Some of the most notorious Ponzi schemes of late existed much longer than two years, with some spanning decades.
For example, Arthur Nadel was able to conceal his fraud for almost a decade, while Bernard Madoff concealed his for over two decades. In light of the length and size of those schemes, it took some time after their collapse to determine the whereabouts of the stolen funds — including if, when, and which charitable organizations received money and how much they received. Under SB 102, creditors would have no opportunity to recover transfers to charitable organizations made more than two years before the fraud was exposed and would have no opportunity to investigate matters without risking expiration of the statute of limitations.
Rather than bring FUFTA in conformity with relevant federal law, SB 102 would undermine the remedies available to court-appointed receivers and bankruptcy trustees in recovering fraudulent transfers from charitable organizations.
A Balancing of the Equities Clearly Disfavors SB 102
While a purely legal comparison between SB 102 and current state and federal fraudulent transfer laws presents several disparities, a balancing of the equities between providing additional protection to charities and the resulting impact on fraud victims further illustrates the case against SB 102. As discussed below, the amendments envisioned by SB 102 should be rejected because 1) a charity is far more likely to be in a better position to deal with such a situation; 2) a receivership or bankruptcy proceeding often represents one of the main sources of recovery for those victims whose financial livelihoods have been ruined; and 3) a bankruptcy trustee or receiver is vested with discretion in bringing clawback actions and is in a far better position to exercise this discretion than a congressional body.
While SB 102 goes to great lengths to immunize charities from having to return stolen funds from a Ponzi schemer, the bill seemingly casts aside the plight of victims whose lives were upended by the revelation that their entire investment — and sometimes life savings — were lost. Indeed, while charitable organizations frequently have a variety of fundraising avenues across their respective communities and often build up formidable endowments or asset reserves, scheme victims are often not as fortunate.11 To be fair, it certainly is not disputed that charitable organizations serve laudable functions within their communities and provide beneficial services. However, the fact remains that victims of a Ponzi scheme are left with little recourse and instead must place their hopes in the fate of the court-appointed receiver or trustee — if there is one appointed — to try and recover the greatest amount of assets possible — if any are left. Despite these best efforts, prospects are often bleak; the Internal Revenue Service implicitly estimates that the average investor recovery in a Ponzi scheme is less than 5 percent.12
In these cases and countless others, the receiver serves as the brightest hope of recovery in what is otherwise a grim prognosis. Yet, an across-the-board elimination of recovery from charitable entities decreases dollar-for-dollar their best-case recovery scenario.
Finally, SB 102 would unilaterally eliminate the discretion typically afforded to receivers and trustees. When presented with evidence that scheme proceeds were fraudulently transferred to a third party, the receiver or trustee must evaluate the prospects of recovery and whether such litigation would produce a benefit for scheme victims. This involves establishing communication with a potential clawback target and, in the event that the issue of financial hardship is raised, examining the target’s financial records to assess the validity of the claim. Such discretion is wielded in all actions, including those against charitable organizations. For example, in the Nadel scheme, the receiver declined to pursue litigation against numerous charities after being provided with sufficient documentation demonstrating a lack of financial capacity of a particular charity to meaningfully respond to monetary claims. Additionally, the receiver worked to negotiate settlements with other charities that hade the financial ability to return a portion of the funds while keeping their organization financially viable. Indeed, a large number of charitable organizations recognized their duty to return the transfers received by Nadel and did so willingly. Partially owing to these efforts, Nadel’s victims have thus far received distributions totaling nearly 40 percent of their losses. While a receiver has many potential avenues to seek recoveries, had SB 102 been passed, significant recoveries in the Nadel matter would have been impossible.
Bringing FUFTA in line with the Bankruptcy Code relating to protections afforded charitable organizations would have no serious impact nor provide any significant benefit. SB 102 instead goes far beyond making these laws consistent and effectively immunizes charities from fraudulent transfer actions. The amendments envisioned by SB 102 would make Florida only the second state to adopt such measures, and would do so at the direct expense of both present and future fraud victims.13 Rather than yield to the discretion afforded in such fact-specific situations, the Florida Senate will instead unilaterally strip that power from a receiver or trustee. Indeed, the decision marks the beginning of a slippery slope. Even now, the bill would immunize tax-exempt entities of a broad spectrum, and it can surely be anticipated that if this legislative effort is successful, a long line of other supposedly deserving entities and interests will form seeking similar protections. It is important to note that the bill’s proponents can point to no significant or equitable impact on any charitable organization. Discretion with respect to handling such matters is rightly left to the receiver or trustee, and the courts who supervise them, who are intimately familiar with the facts and equities of each situation.
1 “False profits” refers to monies received by scheme investors exceeding their original investments.
2 The efforts to shield charities through legislative immunities first began in Minnesota. A bill was introduced and passed in three days with the aim of protecting several charities from the receiver’s claims in the Thomas Petters receivership. This legislation cost defrauded victims potentially hundreds of millions of dollars in recoveries and allowed charities to retain those stolen funds to which they had no plausible legal claim.
3 In re McCarn’s Allstate Fin., Inc., 326 B.R. 843, 851 (Bankr. M.D. Fla. 2005).
4 In re Bayou Group, LLC, 439 B.R. 284, 307 (S.D.N.Y. 2010).
5 Fla. Stat. §726.110(1). Those defending FUFTA claims have asserted that a fraudulent transfer must have been made in furtherance of the Ponzi scheme. This is not a viable defense, as §726.105(a) does not limit avoidable transfers to only those “in furtherance” of a Ponzi scheme. Wiand, as Receiver v. Bishop Frank J. Dewane, et al., Case No. 10-cv-246-T-17MAP at 8 n.5 (M.D. Fla.) (Doc. 54) (allegation that “transfers were in furtherance of the alleged Ponzi scheme” is “unnecessary per FUFTA”).
6 Fla. Stat. §726.110(2).
7 11 U.S.C. §548(a)(2).
8 This bankruptcy provision was created in order to absolve charities from an obligation to repay tithes of individuals who filed for bankruptcy. Its scope has no impact or application on the claims of trustees and/or receivers to recover “false profits” under an actual fraud theory in clawback cases or the claims from which the charities are currently seeking immunity.
9 The “intent” is that of the perpetrator of the Ponzi scheme or transferor — not a charity or other transferee.
10 Notably, it is understood that fraud victims would not be able to receive a tax deduction for the money stolen from them and given to charities.
11 In the Nadel Receivership, numerous victims were elderly and had no or little ability to replace the retirement nest eggs that had been lost. The charities against whom claims were made all had multi-million dollar balance sheets as well as multi-million dollar annual budgets.
12 See Revenue Procedure 2009-20 providing for a deduction of up to 95 percent of the loss.
13 The use of receivers and trustees has become a common and important element of the enforcement and consumer and investor protection efforts of the Securities and Exchange Commission and other regulatory and law enforcement agencies. Legislation such as proposed in SB 102 would impede these important government efforts.
Burton W. Wiand and Michael S. Lamont are partners, and Jordan D. Maglich is an associate at Wiand Guerra King, P.L., in Tampa, where their practice involves white collar criminal defense, securities and regulatory matters, and court-appointed receiverships. Lamont and Maglich currently serve as counsel to Wiand, who currently serves as the court-appointed receiver for Arthur Nadel’s $330 million Ponzi scheme. Wiand and his team have instituted litigation against a number of individuals and entities that received fraudulent transfers from Nadel’s scheme, including numerous charities.
This column is submitted on behalf of the Business Law Section, Brian Keith Gart, chair, and Lynn Sherman, editor.