A receiver appointed to collect assets dissipated by the perpetrator of a Ponzi scheme has been permitted to pursue a recovery action against a nonprofit private school that received “purported charitable donations” of more than $900,000 directly from the fraudulent partnership and another $200,000 from a foundation that received it from the partnership.  A federal District Court in Philadelphia has denied the school’s motion to dismiss the case.  (Hecht v. Malvern Preparatory School, E.D. PA, No. 10-1374, 5/26/10.)

Joseph S. Forte ran the scheme from 1995 to 2008.  According to the Court, he collected original cash investments of $78.6 million from 125 investors and represented investment returns of 18% to over 38%.  84 investors lost about $34 million while 41 were “net winners” of about $8.6 million.  Forte pled guilty to various fraud counts and was sentenced to 15 years in prison.  In 2009, the Securities and Exchange Commission asked the Court to freeze assets of the partnership and to appoint a receiver to recover what was possible for the benefit of the losing investors.

The receiver sued under the Pennsylvania Uniform Fraudulent Transfer Act to recover transfers made “with actual intent to hinder, delay or defraud” investors and under the common law rule of unjust enrichment.  The school raised a series of objections, some of which the Court said “border on the frivolous” but all of which were “meritless.”

The school argued that the claim was time-barred because of the one-year statute of limitations included in the Act, but the Court looked at the provision allowing suit within one year after the transfer was or could reasonably have been discovered.  Since the receiver was not appointed until 2009, and since the suit was filed within one year of her appointment, the Court concluded that it was timely.

Where an action is brought on behalf of an entity which has been defrauded by persons who completely dominate or control it, the Court said, the statute of limitations is tolled as to the controlling wrongdoers during the time of their domination and control.  The earliest the receiver could have learned of the fraud was the day she was appointed and the suit was timely thereafter.

The school argued that “winners” such as the foundation could keep their winnings if they could show good faith.  The Court pointed out that the defense also requires a showing of a fair exchange of value, and that the person asserting the defense has the duty to show good faith.  The complaint was silent on whether the foundation should have known that the investment returns were too good to be true and did not preclude the possibility that the foundation was on inquiry notice as to the source of the returns.  At this stage of the proceedings, it was not appropriate to dismiss.

The Court also held that the receiver had standing to sue to recover assets she said were rightfully those of the partnership, and that the unjust enrichment claim was viable.

YOU NEED TO KNOW

This scheme was not nearly as large as Bernard Madoff’s but still substantial and difficult for those involved.  The theories of this case could be used to pursue contributions in future Ponzi scheme cases as well.