'Not All Securities Frauds are Ponzi Schemes' - U.S. Fifth Circuit
U.S. Fifth Circuit - The FindLaw 5th Circuit Court of Appeals Opinion Summaries Blog

'Not All Securities Frauds are Ponzi Schemes'

It’s easy to vilify the perpetrators and beneficiaries of securities fraud — the one percent living in their ivory towers with their golden toilets — so we usually don’t mind when the long arm of the law reaches into a bank account to retrieve ill-gotten gains.

It’s slightly harder to cheer for disgorgement, however, when the American Cancer Society (ACS) is being disgorged.

The Fifth Circuit Court of Appeals had similar misgivings last week, and ruled that a receiver had not made her case for recovering $240,000 in donations to the ACS.

In 2009, the Securities and Exchange Commission (SEC) accused several related corporations and individuals -- Giant Operating, LLC, George Wesley Harris, Stephen Christopher Plunkett, Giant Petroleum, Inc., and DSSC Operating, LLC, (which we'll refer to collectively as Giant) -- of securities fraud. Karen Cook was appointed receiver over their assets. Cook discovered that, before the SEC filed its civil complaint against Giant, the company made several charitable contributions to the ACS, totaling $240,000.

Cook moved to recover the amounts, claiming they qualified as fraudulent transfers under the Texas Uniform Fraudulent Transfer Act (TUFTA). The district court granted her motion, and entered judgment against the ACS for the full amount. The Fifth Circuit Court of Appeals reversed that judgment last week.

While Cook's motion was based on her assertion that Giant engaged in a "Ponzi-like fraud," the Fifth Circuit concluded that wasn't quite the case.

Giant raised about $13.4 million from investors through five unregistered securities offerings, all interests in oil-and-gas drilling programs. Investors were told that 80 percent of the offering proceedings would be spent on operational costs, and 20 percent would go to management costs. In reality, a large portion of the funds were funneled into other business accounts or used for personal expenses. From 2007 through 2009, Giant also donated a portion of the funds to ACS as a sponsor of the Cattle Baron's Ball. None of the money went back to the investors.

Transfers from a Ponzi scheme are "presumptively made with intent to defraud" because a Ponzi scheme is insolvent from inception as a matter of law. If Giant had, in fact, perpetrated a Ponzi scheme, the ACS donation recovery would be straightforward. ACS, as recipient of the Ponzi-funds, would have the burden of proving an applicable TUFTA defense.

ACS, however, argued that neither the record nor the evidence supported Cook's assertion that "Giant was a fraudulent Ponzi-type scheme." The Fifth Circuit Court of Appeals agreed, noting that "not all securities frauds are Ponzi schemes." Here, the absence of even a single investor payout contradicted Cook's Ponzi assertion. Fraudulent? Perhaps. Ponzi-like? No.

While the ACS may have received funds obtained through fraud, the organization gets to keep the money. The takeaway for charities in the unfortunate position of receiving fraudulent funds? If you choose to take your fight to court, you may end up winning.

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