PONZI SCHEMES, RECEIVERS AND INVESTOR FUNDS: GUIDANCE

In the stream of Ponzi scheme and other investment fund fraud cases that have been brought by DOJ, the SEC, the CFTC and private litigants, there is frequently a mad scramble for the money. The SEC and CFTC typically seek a freeze order. Frequently, a receiver will be appointed to marshal the assets and pursue claims for the defrauded investors. Private litigation often follows.

Almost lost in the tangle of claims is the investor who wants his or her money back. Sometimes, that means their account balance as shown on statements that they received from the fund. Typically, those statements depict principal along with its appreciation from whatever trading scheme the fraudster claimed to be implementing. Sometimes that means just the principal. All too frequently, it is whatever they can get.

In the maze of claims, those who should be on the same side sometimes end up on opposite sides. Such is the case in Janvey v. Adams, Case No. 09-10761 and Janvey v. Letsos, Case No. 09 – 10765, both decided by the Fifth Circuit Court of Appeals on November 13, 2009. The cases arise out of the alleged Ponzi scheme operated by the Stanford companies, reputedly a network of some 130 entities in 14 countries controlled by R. Allen Stanford. In the SEC’s enforcement action, SEC v. Stanford Int’l Bank, Ltd., Case No. 3-09-0298 (N.D. Tex. Filed Feb. 17, 2009), discussed here, the agency obtained a freeze order over funds belonging to the Stanford parties. The district court also appointed Ralph S. Janvey as Receiver with significant authority. The court granted a preliminary injunction prohibiting any disbursement of funds or securities.

Subsequently, the Receiver named as “relief defendants” several hundred investors who had invested in, and received proceeds from, Stanford CDs. These of course are the victims of the fraud. Some of these investors received principal payments while others were paid interest. The SEC argued that the Receiver was asserting “clawback” claims which were inequitable because they were brought against innocent investors. The district court agreed and denied a request to freeze the return of principal payments from the CDs, but permitted one as to the interest.

The Fifth Circuit affirmed as to the principal payments but reversed as to the interest. A relief defendant – actually a “nominal defendant” – is not accused of any wrong doing, the court explained. A person is only added as a relief defendant to facilitate collection. Accordingly, a federal court may order equitable relief against such a defendant only where “that person (1) has received ill-gotten funds, and (2) does not have a legitimate claim to those funds.” Where the party has a legitimate ownership interest in the property however, the person is not properly joined as a relief defendant.

In this case, the Receiver satisfied the first prong of the test. The payments to investor defendants came from funds that had been ill-gotten by the Stanford interests. The Receiver however, failed to establish the second prong of the test. Here, there is no question that the investors had investments in the CDs. That ownership interest precludes the person from being a proper relief defendant. Accordingly, the district court lacked authority to freeze the investor defendants’ assets. The SEC supported the investors in the assertion of this position.

The court’s decision in Janvey constitutes an important reaffirmation and clarification of the basic theory of relief defendants. With many investors, receivers and government agencies are pursing limited pools of funds left in the wake of collapsed Ponzi schemes and investment funds, the decision offers clear guidance on the basic principles which apply to adding persons as relief defendants.

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