Opinion ID: 777652
Heading Depth: 2
Heading Rank: 4

Heading: The Receivership Court's Authority to Order a Pro Rata Distribution

Text: 24 SECO's transfer of the shares to the defrauders without the protection of an express trust does not, however, necessarily defeat SECO's claim. Under state law, assets acquired by fraud are subject to a constructive trust for the benefit of the defrauded party. Restatement (First) of Restitution § 166 (1937). See Counihan v. Allstate Insurance Co., 194 F.3d 357, 361 (2d Cir.1999) (assets are held subject to constructive trust when a party ... is holding property `under such circumstances that in equity and good conscience he ought not to retain it') (quoting Miller v. Schloss, 218 N.Y. 400, 407, 113 N.E. 337 (1916)); Koreag, Controle et Revision S.A. v. Refco F/X Associates, Inc. (In re Koreag, Controle et Revision S.A.), 961 F.2d 341, 352 (2d Cir.1992) (applying New York law of constructive trust in a bankruptcy case). 25 In assessing the significance of whatever constructive trust might have arisen in this context, we note preliminarily that CBL's fraud concerned the false promises made with respect to CBL's sources of income, not with respect to the arrangements under which the shares would be transferred from SECO to CBL. Thus, just as we do not have a case involving shares transferred under an express trust, we also do not have a case where a party is fraudulently deceived into signing transfer papers that it was entitled to believe would have accomplished a transfer under an express trust. The actual transfer documents executed by SECO made clear on their face that SECO was transferring the shares to CBL accounts-not to Brandon and not in trust. 26 In any event, whatever beneficial interest SECO might have in the transferred shares, arising from a constructive trust, does not defeat the equitable authority of the District Court to treat all the fraud victims alike (in proportion to their investments) and order a pro rata distribution. Courts have favored pro rata distribution of assets where, as here, the funds of the defrauded victims were commingled and where victims were similarly situated with respect to their relationship to the defrauders. See Cunningham v. Brown, 265 U.S. 1, 13, 44 S.Ct. 424, 68 L.Ed. 873 (1924) (original Ponzi scheme case suspending tracing fiction in context where receivership fund consisted of money acquired by fraud perpetuated against many victims); Forex, 242 F.3d at 331-32 (affirming District Court's approval of pro rata distribution plan where party's assets were held by defrauder in segregated accounts); Commodity Futures Trading Commission v. Topworth International, Ltd., 205 F.3d 1107, 1115-16 (9th Cir.1999) (affirming District Court's approval of pro rata distribution plan where assets were commingled); United States v. 13328 and 13324 State Highway 75 North, 89 F.3d 551, 553-54 (9th Cir.1996) ( Real Property ) (same); United States v. Durham, 86 F.3d 70, 73 (5th Cir.1996) (affirming District Court's approval of pro rata distribution plan even though the majority of funds were traceable to specific claimants); Elliott, 953 F.2d at 1569-70 (affirming District Court's approval of pro rata distribution plan even though securities were traceable to claimants). 27 As the District Court noted, the use of a pro rata distribution has been deemed especially appropriate for fraud victims of a Ponzi scheme, see Cunningham, 265 U.S. at 7-9, 44 S.Ct. 424 (describing the scheme of Charles Ponzi), in which earlier investors' returns are generated by the influx of fresh capital from unwitting newcomers rather than through legitimate investment activity. Credit Bancorp (Plan) I, 2000 WL 1752979, at ; see also Hirsch v. Arthur Andersen & Co., 72 F.3d 1085, 1088 n. 3 (2d Cir.1995) (describing characteristics of Ponzi schemes). In such a scheme, whether at any given moment a particular customer's assets are traceable is a result of the merely fortuitous fact that the defrauders spent the money of the other victims first. Durham, 86 F.3d at 72 (internal quotation marks omitted). 28 SECO points out that three of the decisions relied on by the District Court, Topworth, Durham, and Real Property, all involved cash, which is fungible, whereas the pending case involves identifiable shares. But Elliott, also relied on by the District Court, involved identifiable shares, and the cash at issue in Durham and Forex was traceable to particular customers. Pro rata distributions were approved in all three cases. 29 Elliott is the case most analogous to ours. The investors there executed written agreements loaning the securities to the defrauders. They delivered the securities with a power of attorney, in return for a promissory note, which was equal to the market value of the securities and which stated that monthly interest payments would be made. Elliott, 953 F.2d at 1568-69. The Eleventh Circuit concluded that what in fact transpired was that the investors unwittingly transferred legal title in the securities to the fraudulent investment scheme. Id. at 1569. Our case is at least as strong for pro rata distribution as Elliott because the transfer documents executed by SECO directed its agent at Merrill Lynch to transfer the shares into CBL accounts, SECO agreed that CBL would have authority to transfer the shares out of those accounts, and SECO was informed why CBL (and ultimately the investors) would benefit from having the shares included as off-balance-sheet assets of CBL. Thus, the facts putting SECO on notice that it was not transferring its shares in trust were fully known to SECO, even if it was unwittingly, Elliott, 953 F.2d at 1569, unaware of the legal consequences of these facts. 30 The cases relied on by SECO that involved Ponzi schemes and permitted the return of identifiable assets to particular victims are distinguishable. In those cases the reason the assets were returned was not merely because they were traceable, but because the assets had somehow been segregated in the manner of true trust accounts and/or had never been placed in the defrauder's control. See Black, 163 F.3d at 196-97 (affirming District Court order allowing return of assets held in custodian accounts that were never pooled or in the control of the defrauder, but noting that District Court had not finally adjudicated distribution and had left open possibility that victims whose assets were pooled might have a cause of action against non-pooled victims); Anderson v. Stephens, 875 F.2d 76, 80 (4th Cir.1989) (ordering return of assets that were deposited in defrauder's account after account had been frozen by the district court, on the ground that the asset freeze precluded the bank from conducting further transactions); City of Philadelphia v. Lieberman, 112 F.2d 424, 426 (3d Cir.1940) (ordering return of assets that had been placed in actual trust account beyond the control of the insolvent). Also inapposite are cases relied on by SECO that preferred the interests of defrauded victims over the interests of general creditors, see Gorman v. Littlefield, 229 U.S. 19, 25, 33 S.Ct. 690, 57 L.Ed. 1047 (1913) (Court refused to allow wrongfully converted property to be used to pay general creditors), or that recognized the claim of the holder of a perfected security interest, Foothill Capital Corp. v. Clare's Food Market, Inc. (In re Coupon Clearing Service, Inc.), 113 F.3d 1091, 1098-99 (9th Cir.1997). 10