IN RE: LEW PERRIN MCGEE                     CASE NO. 97-50234

 

UNITED STATES BANKRUPTCY COURT

EASTERN DISTRICT OF KENTUCKY

LEXINGTON

 IN RE:

 

LEW PERRIN MCGEE                     CASE NO. 97-50234

 

DEBTOR

 

ROBERT J. BROWN, TRUSTEE                 PLAINTIFF

 

VS.                             ADVERSARY NO. 99-5020

 

DONALD M. ROSER,

UNKNOWN DEFENDANT,

AND LEW PERRIN MCGEE                     DEFENDANTS

 

 

MEMORANDUM OPINION

 

 

            The plaintiff, Robert J. Brown, is the chapter 7 trustee in bankruptcy of the defendant, Lew Perrin McGee, the debtor, who, as the proprietor of an insurance agency known as Perrin McGee & Co., used the agency as a front for operating a Ponzi scheme.

            The defendant Donald M. Roser is a victim/beneficiary of McGee’s Ponzi scheme; a victim in that he turned over to McGee a total of $100,000 for what he understood was an investment opportunity with The Equitable Life Assurance Society, for which McGee was an agent; a beneficiary in that Roser received back from McGee $21,317.53 in interest and late fees on personal notes McGee gave Roser as evidence of investments.

            Mr. Roser is an 81-year old retiree who entered the hardware business in 1953 after service in the Marine Corps during World War II, and was in that business for 17 years.  Later he worked in the tack (horse equipment) business for Albright Tack Shop and for Kentucky Tack Shop. He and his wife, Mary J. Roser, reside in Lexington.  They own and operate a 153-acre farm in Scott County on Paynes Depot Road, near Georgetown, Kentucky.

            The Rosers are members of the Hunter Presbyterian Church in Lexington, Kentucky.  They met McGee at the church in 1960.  McGee sang in the choir; Mrs. McGee played the organ.  McGee was a close friend, but the Rosers met him socially only at church.  They knew McGee was an agent for Equitable Life Insurance Company.  Mr. Roser had purchased life insurance policies on himself and a daughter from McGee.  Mr. Roser received annual statements from Equitable showing the cash surrender value of the policies.  He made yearly premium payments to Equitable, by checks made payable to Equitable, not to McGee.

            In 1990 or 1991, Mrs. Roser received an inheritance of approximately $200,000 from an aunt who died in 1990.  The Rosers had this money invested conservatively in CD’s at local banks, earning interest at 6% to 8%.

            According to Mr. Roser, McGee did not know about these inherited funds.

            On or about November 5, 1992, McGee visited the Rosers at their home with a proposal for an attractive investment opportunity which Equitable was making available only through its “Hall of Fame” agents such as himself.  He could make this investment vehicle available to the Rosers only if they gave him the money to make the investment in his own name.  McGee stated he could make the investment for the Rosers in this new Equitable investment plan at a guaranteed interest rate of 8.5% per annum.  McGee emphasized the size, reputation, and reliability of Equitable, and the safety of an investment with Equitable.

            On November 5, 1992 the Rosers gave McGee $25,000 for investment with Equitable as evidenced by a check for $25,000 signed by Mrs. Donald M. Roser bearing the notation “loan,” and as evidenced by McGee’s note for that amount payable to Mr. & Mrs. Donald M. Roser bearing interest at the rate of 8.5% for three years only.

            On November 19, 1992, the Rosers “invested” an additional $10,000 through McGee with Equitable as evidenced by a check for that amount signed by Mrs. Roser, payable to McGee and by McGee’s note to the Rosers for $10,000 bearing interest at the rate of 8.5% for three years.

            On July 2, 1993, the Rosers “invested” an additional $38,000 through McGee with Equitable as evidenced by a cashier’s check in that amount payable to themselves and endorsed to McGee and McGee’s note of that date for the same amount payable to the Rosers bearing interest at 8.5% for three years.

            On December 9, 1994 the Rosers “invested” an additional $22,000 through McGee with Equitable as evidenced by their check for that amount payable to McGee and McGee’s note for the same amount payable to the Rosers bearing interest at 8.5% for three years.

            On December 17, 1994 the Rosers “invested” an additional $5,000 through McGee with Equitable as evidenced by their check for that amount payable to McGee bearing the notation “Loan.”

            This latter transaction brought the total amount “invested” by the Rosers with Equitable through McGee to $100,000.

            On December 17, 1994 McGee executed a note for $100,000 payable to the Rosers bearing interest at 8.5% for three years only.  The earlier notes executed by McGee to the Rosers on November 5, 1992, November 19, 1992, July 2, 1993, and December 9, 1994 were subsumed by the $100,000 note.  McGee requested that all old notes be returned to him marked paid in full.  It is not clear from the record whether the “old” notes were returned to McGee, although presumably they were.

            The Rosers periodically received checks from McGee bearing the notation “interest on note” which they believed represented returns on their investment with Equitable.

            The checks received by the Rosers from McGee were as follows:

                        Date                        Amount

 

                        2-8-93                        743.75                        For interest

                        5-3-93                        743.75                       

                        8-2-93                        1,012.91                       

                        11-5-93                        1,551.23                       

                        5-13-94                        1,551.23                       

                        8-9-94                        1,551.23                       

                        11-8-94                        1,551.23                       

                        2-7-95                        1,886.97                       

                        4-28-95                        2,125.00                       

                        1-30-96                        2,125.00                       

                        4-4-96                        2,125.00                       

                        8-1-96                        2,225.00                        Interest on note

                                                                        plus $100.00 late fee

                        11-4-96                        2,125.00                        Interest

                                                21,317.30

 

            The debtor did not invest the monies he received from the Rosers with Equitable.  In fact, there was no special investment with Equitable available to “Hall of Fame” Equitable agents as represented by the debtor to extract monies from fellow parishioners, customers of his insurance agency, and friends of acquaintances of such customers.  Rather, the debtor deposited the monies he received from such investors in his personal bank account at Bank One, Account No. 361-1843.  He used funds obtained from new investors to make interest payments on notes he had executed to prior investors.

            The interest payments the debtor made on the notes induced investors such as the Rosers to turn over additional sums to the debtor for investment through him with Equitable.  The debtor made the “interest payments” to the Rosers to induce them to make additional investments and not with a design to prefer them to the exclusion of other creditors.  The debtor prepared and sent IRS 1099 forms to investors showing the amount of interest income to be reported on their income tax returns.  Sometimes the debtor used his home address and sometimes his office address in the box for the payor’s name and address on the 1099 forms.

            The debtor was operating a classic Ponzi scheme deluding investors into believing they were earning interest on investments when in fact the debtor was not investing funds entrusted to him for investment, but rather was using the funds for his own purposes.  There are indications the debtor formed Subchapter S corporations as vehicles for the purchase of other insurance agencies in several states and may have used some of the funds entrusted to him for investment for the purchase of such agencies.  These agencies failed when the debtor’s Ponzi scheme was exposed.

            From 1991 until early 1995 the debtor was a registered broker-dealer agent employed by Equico Securities, Inc. and a registered insurance agent for The Equitable Assurance Society of the United States, Equico’s parent company.  He was licensed by the Commonwealth of Kentucky to sell securities and insurance.  As previously indicated, the debtor used his insurance agency, Perrin McGee & Company, as a front for his Ponzi scheme commencing perhaps as early as 1990.

            The debtor’s employment with Equico Securities, Inc. and Equitable Life Insurance Company was terminated April 4, 1995.  However, his licenses to sell securities and insurance were not terminated by the Commonwealth of Kentucky until much later.  He was able to continue his Ponzi scheme operation until the end of 1996.

            The parties have stipulated by reference to their joint stipulations filed in Adversary Proceeding No. 99-5037 that between January 1, 1992 and December 31, 1996 numerous named individuals entrusted to the debtor monies in the total amount of $4,097,781.07 on representations of the debtor such monies would be invested by him in their behalf in legitimate income earning vehicles, including special investment opportunities available to him with Equitable as one of Equitable’s top agents.  As previously indicated the debtor did not invest these monies, but rather deposited the monies in his personal bank account at Bank One, and used the monies for other purposes, including the payment of interest on notes he had given to investors as evidence of the monies “loaned” to him for investment in their behalf.

            After his Ponzi scheme unraveled the debtor filed a petition for relief under chapter 7 of the Bankruptcy Code in this court on February 5, 1997.  The debtor did not oppose objections to his discharge and an order was entered denying him a discharge in bankruptcy.  This rendered moot a multiplicity of adversary proceedings by investors to have debts owed to them by the debtor excepted from discharge.

            Subsequent to bankruptcy the debtor was indicted by a state court grand jury on 41 counts of theft by deception, 54 counts of securities fraud, and 54 counts of sale of unregistered securities.  On March 13, 1998 the debtor entered a plea of guilty to numerous counts of theft by deception and a guilty plea to seven counts of sale of unregistered securities.  The debtor is serving a term in state prison for these crimes.

            The indictment for sale of unregistered securities is based on an agreed order entered into by the debtor and the Commonwealth of Kentucky Department of Financial Institutions on June 13, 1997 which recites and finds that the notes issued by the debtor, such as the notes he issued to the Rosers in this matter, constitute securities within the express meaning of KRS 292.310(13) and were fraudulent pursuant to KRS 292.330(1).

            Thereafter, the Commonwealth of Kentucky Department of Financial Institutions brokered a settlement between Equitable and investors who were victims of the debtor’s Ponzi scheme during the period the debtor was employed as registered broker-dealer by Equitable.  Those who accepted the settlement offer were paid by Equitable the amount they had entrusted to the debtor for investment less the amount they had received back in payments from the debtor.  The victims were not made entirely whole because they had to pay their own attorney fees, and as illustrated by this adversary proceeding were left exposed to actions such as this by the chapter 7 trustee for recovery of the payments they had received from the debtor.  Also, the victims must pay their attorney fees for defending actions by the trustee to recover as fraudulent or preferential the payments received by them from the debtor.  In this sense, the settlement brokered by the Department of Financial Institutions has afforded less than adequate protection for victims of the debtor’s Ponzi scheme.  As indicated by the testimony of Mr. Roser he received from Equitable on his $100,000 investment  approximately $79,000 ($100,000 - $21,317.30 = $78,682.70), from which he had to pay attorney fees for representation in the settlement negotiations, and now must pay additional fees for defending himself from the claims of the trustee in this adversary proceeding.  The settlement was helpful but has provided inadequate protection for the 40 or more investors from whom the trustee seeks recovery of payments they received from the debtor, on the grounds the payments are avoidable by the trustee as fraudulent or preferential transfers of property of the debtor.

            The complaint of the trustee is grounded on title 11 U.S.C. 544(b), 547, 548 and 550, and on Kentucky Revised Statutes, KRS 378.010, 378.020 and 378.060.

            Title 11 U.S.C. 544(b) empowers a trustee in bankruptcy to avoid any transfer of an interest of the debtor in property that is voidable under applicable law (in this instance Kentucky law) by a creditor holding an allowable unsecured claim against the debtor.  Section 544(b) creates federal causes of actions whereby the trustee may avoid transfers of property by the debtor to the extent an unsecured creditor of the debtor can avoid such transfers under any applicable state law.

            KRS 378.010 voids transfers of property of a debtor made with intent to hinder, delay or defraud creditors.  However, creditors cannot avoid a transfer to a purchaser for a valuable consideration unless it appears such purchaser had notice of the debtor’s fraudulent intent.

            KRS 378.020 voids as to existing creditors voluntary transfers of property of a debtor made without valuable consideration, but does not void such transfers as to subsequent creditors or purchasers.

            The statute of limitation with respect to actions to avoid transfers of property of a debtor for actual fraud under KRS 378.010 or constructive fraud under KRS 378.020 is five years.  KRS 413.120(12).

            Relying on these statutes the trustee seeks to avoid and recover for the bankruptcy estate payments totaling $21,317.30 received by Mr. Roser from the debtor within five years of bankruptcy.

            KRS 378.060 provides that any act or device done or resorted to by a debtor, in contemplation of insolvency and with a design to prefer one or more creditors to the exclusion, in whole or in part, of others, shall operate as an assignment and transfer of all the property of the debtor, and shall inure to the benefit of all his creditors.

            The statute of limitations for avoiding preferential transfers of property of the debtor under KRS 378,.060 is six months after delivery of the property transferred.  KRS 378.070.

            The complaint of the trustee seeks to recover under this statute payments totaling $4,350 received by Mr. Roser from the debtor within six months of bankruptcy.

            Relying on the preference provisions of the Bankruptcy Code, 11 U.S.C. 547, the trustee seeks to recover one payment in the total amount of $2,125.00 made by the debtor to Mr. Roser within 90 days of bankruptcy.

            Finally, in reliance on title 11 U.S.C. 548(a)(1)(A) or in the alternative, on 548(a)(1)(B) the trustee seeks to recover as actually or constructively fraudulent payments totaling $6,475.00 made by the debtor to Mr. Roser within one year of bankruptcy.

            Defendant Roser pleads by way of defense that this action was not timely commenced by the trustee, that he gave valuable consideration for each payment he received, that he acted in good faith and without any knowledge that McGee was at or near insolvency or that McGee was operating a Ponzi scheme.

            Defendant Roser further alleges that at all relevant times he believed the payments made to him by the debtor represented returns on his investment with Equitable through McGee.

CONCLUSIONS OF LAW:

            In a separate opinion this day entered in Adversary Proceeding No. 99-5037, the trustee’s action against Lorenzo Brandenburg, the court concludes such action was timely filed.  The court adheres to that conclusion in this action which was filed on the same date.

            Also, in its separate opinion in Adversary Proceeding No. 99-5037, the court concludes that KRS 292.480(1) provides the exclusive remedy for a person defrauded in the sale or purchase of a security.  The court further concludes that under this statute all persons swindled in the purchase of securities (the debtor’s personal notes), victims of the debtor’s Ponzi scheme, have causes of action (claims) only against the debtor for damages as fixed by the statute.  The court further concludes that under KRS 292.480(1) there is no implied right of a victim of the debtor’s Ponzi scheme to sue another victim of the scheme to void payments received by the latter and to recover those payments for the benefit of all victims of the scheme.

            KRS 292.480(1) accommodates payments received by a victim of securities fraud by requiring the payments to be credited to reduce the victim’s damages.  The statute does not void such payments as either fraudulent or preferential.  Because there is no implied right of one victim of securities fraud to sue another victim under this statute, the court is of the opinion the rights of the trustee in bankruptcy are similarly limited and therefore the trustee has no right standing in the shoes of a victim/creditor of the debtor to sue another victim/creditor.

            KRS 378.010 and 378.020, which void transfers of property of a debtor which are actually or constructively fraudulent, are followed by KRS 378.030 which provides that any party aggrieved by a fraudulent conveyance, transfer or mortgage of real property may file a petition in equity against the parties thereto thereby creating a lis pendens upon the property.  There is an implied right of a creditor aggrieved by a fraudulent transfer of personal property to sue under this statute as well.

            KRS 378.060, which provides that acts of a debtor done in contemplation of insolvency with a design to prefer one or more creditors to the exclusion of others, shall operate as an assignment or transfer of all property of the debtor for the benefit of all creditors, is followed by KRS 378.070 which provides any person interested may file a petition against the debtor and the transferee requesting the court to take control of and administer the debtor’s property for the benefit of creditors generally.

            There is no comparable provision in the Kentucky Blue Sky Law permitting an aggrieved party or a party in interest to sue to recover payments made by a defrauding seller to a defrauded purchaser of a security.  In City of Owensboro v. First U.S. Corp., 534 S.W.2d 789 (Ky. 1975), the Kentucky Court of Appeals held that the Kentucky Blue Sky Law provides the exclusive civil remedy for a defrauded purchaser of a security.  Carothers v. Rice, 633 F.2d 7, at pg. 11 (6th Cir. 1980).  In Carothers the Court of Appeals for this circuit so interpreted the holding of the Kentucky Court of Appeals in the City of Owensboro case.

            The court believes this is the humane construction of the law of Kentucky with respect to victims of a Ponzi scheme.  To hold that there are cumulative civil remedies under Chapter 378 of the Kentucky Revised Statutes is to heap insult upon injury suffered by victims of the scheme.

            In its opinion in Adversary Proceeding No. 99-5037 the court concludes on the facts of that matter, and hereby concludes on the facts of this matter, that the trustee has not made a case for recovery under the provisions of Chapter 378 of the Kentucky Revised Statutes or under title 11 U.S.C. 348, because the payments in question were received by Mr. Roser in good faith for value paid to the debtor in excess of the payments received from the debtor.

            Accordingly, the court is of the opinion the complaint of the trustee in this adversary proceeding insofar as the complaint is based on Kentucky fraudulent and preferential conveyance statutes and title 11 U.S.C. 348 should be dismissed.

            In Count V of the complaint the trustee seeks to avoid under title 11 U.S.C. 547 and recover for the bankruptcy estate one payment in the amount of $2,125.00 made by the debtor to Mr. Roser on November 4, 1996, within 90 days of bankruptcy.  This payment did effect a preferential transfer of property of the debtor.  As noted by the court in footnote 8 to its opinion in Adversary Proceeding No. 99-5037, the trustee’s action against Mr. Brandenburg, it is the effect of the payment rather than the motive of the debtor in making the payment that is controlling under this section of the Bankruptcy Code.  The trustee would be entitled to summary judgment on this count of the complaint except for the issue of Mr. Roser’s right to assert the defense of recoupment.

            In this matter, as in the Brandenburg matter, the court finds the bankruptcy estate’s and defendant Roser’s claims against each other arise from the same transaction, the fraudulent security represented by the debtor’s $100,000 note of December 17, 1994, into which prior transactions of the parties were subsumed.  Because defendant Roser’s claim against the debtor and the trustee’s claim against defendant Roser arise out of the same transaction, and because the court is completely satisfied that Mr. Roser acted in good faith, the court concludes defendant Roser is

entitled to exercise the defense of recoupment.

            Dated this _____ day of November 2000

                        By the court –

 

                        __________________________

                        JOE LEE

                        U.S. BANKRUPTCY JUDGE

 

Copies to:

 

Robert J. Brown, Esq., Trustee

Mary Fullington, Esq., Attorney for Trustee

Kevin G. Henry, Esq. Attorney for Defendant Roser

David R. Irvin, Esq.

Jennifer Philpot, Esq.

 


UNITED STATES BANKRUPTCY COURT

EASTERN DISTRICT OF KENTUCKY

LEXINGTON

 

IN RE:

 

LEW PERRIN MCGEE                     CASE NO. 97-50234

 

DEBTOR

 

ROBERT J. BROWN, TRUSTEE                 PLAINTIFF

 

VS.                             ADVERSARY NO. 99-5020

 

DONALD M. ROSER,

UNKNOWN DEFENDANT,

AND LEW PERRIN MCGEE                     DEFENDANTS

 

 

ORDER

 

            In conformity with the memorandum opinion of the court this day entered, the court finds the complaint of the trustee in this adversary proceeding should be and hereby is DISMISSED.

            In the event any of the counts of the complaint should be reinstated, defendant Roser may amend his answer to the complaint to assert the defense of recoupment.

            Dated this _____ day of November 2000

                        By the court –

 

                        __________________________

                        JOE LEE

                        U.S. BANKRUPTCY JUDGE

Copies to:

Robert J. Brown, Esq., Trustee

Mary Fullington, Esq., Attorney for Trustee

Kevin G. Henry, Esq. Attorney for Defendant Roser

David R. Irvin, Esq.

Jennifer Philpot, Esq.

U.S. Trustee