Expert: Burden falls on Wilpons

Attorney Peter Davidson has filed hundreds of clawback lawsuits to recover false profits from Ponzi schemes. He articulates how Fred and Jeff Wilpon and Saul Katz may have to prove their innocence if the case went to trial, rather than trustee Irving Picard bearing the greater burden.

At first blush, when you reviewed the lawsuit, is there anything that stands out either favorably for the defendant or unfavorably?

“I think the thing that stands out most unfavorably is they previously had been involved in a Ponzi scheme where they got sued by a trustee and ended up paying all of the profit back, plus 40 percent of the principal investment. So they sort of knew what a Ponzi scheme was. And they had been involved in one. I think that’s a bad fact for them.”

I don’t believe anyone who knows the Wilpons would think they actually knew it was a Ponzi scheme, that Madoff was an outright crook. They had friends who they recommended to invest.

“That’s true with most everybody who invested with Madoff.”

But how difficult to prove is the should-have-known standard?

“It’s sort of tough. What happens is, the trustee can sue to recover the profit that people made. All he has to show is that the person who transferred the money to them, in this case Madoff, had the actual intent to hinder, delay or defraud his creditors. If there’s a Ponzi scheme, the court presumes that. It’s basically you can’t even challenge it.

“So to get the profit back, it’s almost strict liability. If you made a profit, and the entity that transferred you the money, the person was running a Ponzi scheme, you’ve got to give the profit back.

“In reality, the way the statutes read, and the way the courts have interpreted it, you actually really have to give everything back -- all of the transfers you made. The transfer doesn’t talk about profit or not. It talks about transfers.

“But there’s a defense. And the defense is: you acted in good faith and you gave reasonably equivalent value. That’s why generally, as long as you’re not an insider, or you didn’t know, or should not have known, you just have to give the profit back. But it’s a defense. Really, the defendants have to prove that they gave a reasonably equivalent value. The courts basically say that’s equivalent to what your investment was. But you also have to prove you were acting in good faith.

“That’s the real problem the defendants are going to have. It’s not clear-cut what constitutes good faith. And there’s a lot of cases out there that say if you should have been on inquiry notice, or if there are some factors that should have put you on notice, then you may not meet the good-faith standard and then you’re liable to have to return not only your profit but the investment that you got back.”

One of the things the Wilpons and Saul Katz say is, ‘Hey, look, government regulators did not catch this. How are we supposed to know what’s going on?’ I suppose the flip side is that Irving Picard is saying that these are not small-time investors. These are sophisticated investors.

“Big boys. This is not mom and pop. And when you read the complaint, Picard is saying, ‘You were on notice.’ You had your own internal investment advisors saying, ‘There’s something going on here. He can’t make these returns. We’ve tried to do it. There’s no way you can do it consistently every single year. And Madoff won’t tell us how he’s doing it.’

“I think [Picard] said that Merrill Lynch [which bought half of the Sterling-owned Sterling Stamos Hedge Fund] is saying in a directive that not only wasn’t Merrill Lynch supposed to invest in it, but they weren’t supposed to recommend it to any of their investors. Picard is going to point to a lot of little things and say you are on inquiry notice.

“And once you are on inquiry notice, and you went ahead and you didn’t go inquire, then that’s not good faith and you have to give the whole thing back.”

And when you say the whole thing back, any withdrawal from the fund in the past six years is the standard in New York?

“Any transfer within six years of the filing. Any payments you got back in the past six years.

“Like I said, the normal person that’s not an insider is going to be able to show good faith and equivalent value and just have to give back the profit. But Picard is taking the position as to these defendants that he’s entitled to all the payments they got because they’re not going to be able to show good faith.”

If this went to trial -- I know a lawsuit is just an allegation, it’s not substantiated -- but do you feel comfortable if everything outlined by Picard in Section IX were presented in court, that the Wilpons would be found to have been putting their head in the sand?

“Again, it’s [the defendants’] burden of proof. So Picard’s got it a little easier. He doesn’t have to prove it. They have to prove it. They have to prove they were acting in good faith. He’s just alleged various facts to disprove that.

“What's a jury is going to do? If they get a jury, who knows? Because juries are sometimes reluctant to have to do [seize principal]. … So you can never tell how it’s going to appeal to the jury. But I think Picard has probably got the better case because he’s going to show these were sophisticated people, and they had their own internal people telling them, ‘Don’t do this.’ And they were in some partnerships [such as Merrill Lynch]. And the partnerships didn’t do it. They only did it themselves.

“And they had a direct contact with Madoff. When they called, Madoff would pick up the phone. So all those are bad facts for them, I think.”

If Irving Picard could substantiate that they withdrew $300 million more from certain accounts than they put in, without even presuming bad faith, would you have to assume he wouldn’t settle for less than that figure? He’s seeking $1 billion, a lawyer working with him said.

“I can’t say what he’s going to settle for, because there’s a cost to pursuing it. But it’s not in the millions. To get the profit back, that’s a really easy case for the trustee. That’s why Picard has been so successful. Because all he has to do is prove it was a Ponzi scheme, which Madoff has admitted. And once he does that, it’s basically strict liability. All you have to do is prove they got the profit payments within the last six years and you win. That’s a summary judgment motion. So, yes, it’s going to be very hard for him to take less. Especially since he’s been a little emboldened because he’s done so well so far. Especially with a defendant who has got a deep pocket, I don’t know why he wouldn’t try and collect as much as he can.”

I’m sure if it went to a trial, the defendants would say, “Hey, the government didn’t catch this person, either.” Will that fall on deaf ears?

“Like I said, you can never tell what a jury is going to accept. But the test is: Should you have known there was something going on? And what due diligence did you do and what investigation did you do? And they have the problem that their own people said: ‘Don’t do it.’ So that really put them on notice. And it’s their burden, not [Picard’s].”

Would you outline your experience in these types of matters?

“I act as a receiver, but I also represent receivers in securities cases -- cases brought by the SEC or the Federal Trade Commission, or the California Department of Corporations. The lead case in the Ninth Circuit is called Donell v. Kowell. I represented Donell in that case before the Ninth Circuit successfully to be able to recover the profit payments from people. And I’ve brought about 350 or 400 lawsuits like this against people to recover the profits that they made in Ponzi schemes.”

Peter Davidson is one of the most well-recognized experts on clawback lawsuits and Ponzi scheme cases. He has authored several published articles on clawbacks with regard to Ponzi schemes, including "Clawbacks: Old Remedies --New Name," and "Ponzi Schemes, Receivers and Fraudulent Transfers: What Happens When the Pyramid Collapses."

Peter is a partner at Ervin Cohen & Jessup, a renowned business law firm in Los Angeles. With more than 30 years of legal experience, he has also handled numerous cases for government agencies such as the SEC, FTC, Commodities Futures Trading Commission and the Attorney General.