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Securities and Exchange Commission v. Joseph S. Forte and Joseph Forte

May 16, 2012


The opinion of the court was delivered by: Diamond, J.


The Equity Receiver in this matter has asked me to approve proposals intended to maximize the recovery to innocent Investors defrauded by Joseph Forte's operation of a Ponzi scheme. (Civ. No. 09-63, Doc. No. 90; Civ. No. 09-64, Doc. No. 75.) Approximately one-third of Forte's Investors have objected. For the following reasons, I will overrule the objections and grant the Receiver's request.


On January 7, 2009, the Securities and Exchange Commission and Commodity Futures

Trading Commission brought civil enforcement actions against Joseph S. Forte and Joseph Forte, L.P. (the Partnership), alleging that Forte was running the Partnership as a Ponzi scheme. (Civ. No. 09-63, Doc. No. 1; Civ. No. 09-64, Doc. No. 1.) On September 30, 2009, I approved a Partial Final Judgment that reflected Forte's admissions of liability. (Civ. No. 09-63, Doc. No. 34.)

On March 30, 2009, I appointed Marion A. Hecht as Receiver of Defendants' assets. (Doc. No. 26.) I charged her and her Counsel, Lawrence T. Hoyle, with "assum[ing] control of, marshal[ing], pursu[ing], and preserv[ing] the Receivership Assets with the objective of maximizing the recovery of defrauded Investors and, to the extent that the assets recovered may be inadequate to make them whole, ensuring that the distribution of those assets is as just and equitable as practicable." (Id. at 3.) See Liberte Capital Group, LLC v. Capwill, 462 F.3d 543, 551 (6th Cir. 2006) (describing equity receiver's role (citing 13 James Wm. Moore et al., Moore's Federal Practice ¶¶ 66.02-.03 (3d ed. 1999)).

The Receiver and 94 of Forte's 125 Limited Partners concluded "tolling agreements" by which those Investors waived any limitations defense as to claims that were legally viable as of March 29, 2010-less than one year after Ms. Hecht's appointment. (Doc. No. 104 at 12.) The Receiver initiated "clawback" actions against those Investors who did not enter into tolling agreements, thus seeking to recover disbursements determined to be fraudulent. (Id.) See, e.g., Hecht v. Malvern Preparatory Sch., 716 F. Supp. 2d 395 (E.D. Pa. 2010).

The Receiver has filed the instant Motion for an Order Setting a Claims Bar Date, Establishing Claims Resolution Procedures, and Approving Distribution Methodology. (Doc. No. 90.) After meeting with Investor representatives, she twice revised the Proposed Order. (Doc. Nos. 97, 107.) The following Investors have filed objections to the Receiver's proposals: a Group represented by Stradley Ronon Stevens & Young LLP; a Group represented by Drinker Biddle & Reath LLP; and two individual Investors. (Doc. Nos. 100; 101; 102; 105, Exs. A, B.) The SEC has filed a Response in support of the proposals. (Doc. No. 99.)


The Receiver's Proposed Order (attached as Appendix A) provides that claims against the Estate must be submitted no later than the Claims Bar Date, which shall be published to Investors and potential creditors. After receiving all timely claims, the Receiver will file a Quantitative Claims Report that sets out the amount, validity, and payment priority of each claim. The Receiver will also conduct discovery to determine individual culpability and notice as to fraud. She will then file a Qualitative Claims Report in which she recommends that: 1) named Investors who were culpable participants in Forte's scheme may not receive equitable distributions; 2) Investors who were on "inquiry notice" of the fraud may receive distributions only if they first return the false profits and principal they withdrew while on inquiry notice, or reach a Court-approved agreement with the Receiver as to a distribution; and 3) Investors not on inquiry notice may receive their full equitable distributions.

If an Investor cannot resolve a dispute he or she has with the Receiver regarding a Claim Determination, the matter will be submitted to me for resolution. In deciding these disputes, I will apply the substantive law that would govern analogous ancillary litigation. Discovery will be permitted. See SEC v. Elliott, 953 F.2d 1560, 1567 (11th Cir. 1992) (summary procedures appropriate in receivership proceedings if they "permit parties to present evidence when the facts are in dispute and to make arguments regarding those facts").

At any time before I resolve a dispute, the Receiver may initiate ancillary litigation against the Investor, including a clawback action. This would operate as a stay of the dispute resolution proceeding before me. Once I resolve all disputes that are not stayed by ancillary litigation, the Receiver will submit to me a Final Claim Determination Report. If I approve the Report, the Receiver will distribute funds to Investors and other creditors, keeping only monies needed for the Receivership's continuing litigation, wind-up procedures, and the like. Half the Distribution Assets will be distributed using "Net Investment" methodology, and half using "Rising Tide" methodology.


A. Fairness

The Stradley Objectors contend that the proposed distribution "would produce an unprecedented, inequitable and arbitrary" redistribution of Receivership Assets. In their view, the Receiver's approach "punish[es] innocent investors" by preventing an Investor from obtaining an equitable distribution unless he first returns any false profits or principal he withdrew while on "inquiry notice." (App. A ¶ 10(e)(ii).) I do not agree.

Applying the Bankruptcy Code, the Third Circuit has defined "inquiry notice" as follows: If a transferee possesses knowledge of facts that suggest a transfer may be fraudulent, and further inquiry by the transferee would reveal facts sufficient to alert him that the property is recoverable, he cannot sit on his heels, thereby preventing a finding that he has knowledge.

In re Bressman, 327 F.3d 229, 236 (3d Cir. 2003) (quoting In re Sherman, 67 F.3d 1348, 1357 (8th Cir. 1995)); see also Alaska Elec. Pension Fund v. Pharmacia Corp., 554 F.3d 342, 347 (3d Cir. 2009) ("The inquiry notice determination requires a 'totally objective' analysis that pinpoints the time at which 'a reasonable investor of ordinary intelligence would have discovered the information [demonstrating possible liability] and recognized it as a storm warning.'" (quoting Mathews v. Kidder, Peabody & Co., Inc., 260 F.3d 239, 252 (3d Cir. 2001))).

Permitting "inquiry notice" Investors both to keep the funds they withdrew and to obtain equitable distributions would be unfair to those Investors who had no reason to suspect fraud, and so presumably withdrew little or no money before the Partnership collapsed. See Marion v. TDI Inc., 591 F.3d 137, 148 (3d Cir. 2010) (principal goal of receivership is fair distribution of assets (citing Wuliger v. Mfrs. Life Ins. Co., 567 F.3d 787, 795 (6th Cir. 2009))); SEC v. Wealth Mgmt. LLC, 628 F.3d 323, 332-33 (7th Cir. 2010) (same). I will not reward Investors with equitable shares if they choose to keep principal they withdrew after they had good reason to believe that Forte's "investment" regime was dishonest. (App. A ¶ 10(e)(ii).) See SEC v. Infinity Group Co., 226 F. App'x 217, 218 (3d Cir. 2007) ("District Courts have wide equitable discretion in fashioning distribution plans in receivership proceedings[.]" (citing SEC v. Black, 163 F.3d 188, 199 (3d Cir. 1998))); see also SEC v. Vescor Capital Corp., 599 F.3d 1189, 1194 (10th Cir. 2010) (district court has "inherent powers of an equity court to fashion relief"); SEC v. Enter. Trust Co., 559 F.3d 649, 652 (7th Cir. 2009) ("District judges possess discretion to classify claims sensibly in receivership proceedings."); SEC v. Basic Energy & Affiliated Res., Inc., 273 F.3d 657, 668 (6th Cir. 2001); Elliott, 953 F.2d at 1566.

The Stradley Objectors also argue that "reckless" participants in the Ponzi scheme should be allowed to receive equitable distributions. Again, I disagree. The Proposed Order provides:

[I]f the Receiver determines that an investor was a culpable participant in Joseph S. Forte's Ponzi scheme . . . [by] recklessly taking actions that furthered the Ponzi scheme . . . the Receiver shall recommend no distribution to that investor[.] (App. A ¶ 10(e)(i).) A person acts "recklessly" if he or she "realizes or, from the facts which he [or she] knows, should realize that there is a strong probability that harm may result[.]"

Archibald v. Kemble, 971 A.2d 513, 517 (Pa. Super. Ct. 2009) (quoting Restatement (Second) of Torts § 500 cmt. f (1965)).

Remarkably, the Stradley Objectors believe that Investors who acted recklessly are innocent. ("This approach would punish innocent investors that did not knowingly and intentionally participate in the fraud[.]") (Doc. No. 100 at 23.) It is difficult to accept that such a contention is made seriously. Those Investors who, by their reckless behavior, furthered Forte's Ponzi scheme plainly are not "innocent" and so are not entitled to the same relief as truly innocent Investors. See Enter. Trust Co., 559 F.3d at 652; SEC v. Byers, 637 F. Supp. 2d 166, 184 (S.D.N.Y. 2009) ("The Receiver's proposal to treat differently those involved in the fraudulent scheme when distributions are being made is eminently reasonable and is supported by caselaw." (citing Basic Energy, 273 F.3d at 660)).

The Stradley Objectors further argue that distributing half the Receivership Assets using the "Net Investment" methodology, and the other half using the "Rising Tide" methodology, is unfair, unnecessarily complex, and unprecedented.

Courts regularly employ these methodologies in distributing receivership assets. See, e.g., CFTC v. Lake Shore Asset Mgmt. Ltd., No. 07-3598, 2010 WL 960362, at *7-*9 (N.D. Ill. Mar. 15, 2010); SEC v. AmeriFirst Funding, Inc., No. 07-1188, 2008 WL 919546, at *6 (N.D. Tex. Mar. 13, 2008). Under the "Net Investment" methodology, an Investor's distribution is equal to the amount the Investor lost multiplied by the ratio of the total amount distributed to all Investors to the total amount lost by all Investors. (Doc. No. 90 at 35.) Under the "Rising Tide" methodology, assets are distributed to those Investors who lost the greatest percentage of their investment until their losses match those of other Investors who lost a smaller percentage. (Id. at 35-36.) "In general, the Net Investment methodology favors those investors with the greatest losses in absolute dollars; the Rising Tide methodology favors those investors who lost the greatest percentage of their investments." (Id. at 36.)

Because "more than half of the losses in absolute dollars were incurred by a handful of investors, while about half the losing investors lost over half of their investment," employing both methodologies is fairest. (Id. at 43-45.) Moreover, this hybrid approach is neither complex nor burdensome: the Receiver has already prepared spreadsheets by which she will determine individual distributions instantly with no additional cost. (Doc. No. 104 at 51.) Finally, because the actions of court-appointed receivers are not invariably reported or readily accessible, I cannot determine whether this hybrid approach is "unprecedented." Even if it is, that does not speak to its suitability here. Every receivership is as different as the manner by which investors are defrauded. Remedies appropriate for some estates may be unsuitable for others. Here, where over half the fraud loss was suffered by a small group of Investors, and half the losing Investors lost more than fifty percent of their investment, combining equally the Net Investment methodology (which will favor the first group) and the Rising Tide methodology (which will favor the second), whether "precedented" or not, is appropriate.

B. Efficiency

The Objectors next argue that individualized discovery and clawback actions will waste Estate funds. I am satisfied that the proposed procedures will benefit the Receivership. Pursuant to SEC guidelines, the Receiver must certify that any action she takes is likely to produce a net economic benefit. (Doc. No. 87, Exs. B, C.) This is consistent with the Receiver's intention to take discovery as to an Investor's state of mind only "[t]o the extent warranted by the size of an investor's claim[.]" (App. A ¶ 10(d).) Moreover, the Receiver has already taken discovery to identify those Investors from whom she will seek to recover principal. Finally, the Receiver and the SEC agree that my resolution of the key legal issues in dispute-standing, the lookback period, and the definition of "good faith"-will reduce litigation costs. (Doc. No. 99 at 1-2.)

The Objectors have also attacked as inefficient the requirement that "inquiry notice" Investors return false profits and principal before they may receive equitable distributions. I do not believe, however, that the requirement-which, as I have explained, is essential to promoting fairness-will encumber the equitable distribution of Estate Assets. On the contrary, the requirement will likely promote settlement and so advance the "orderly and efficient administration" of the Estate, and preserve Receivership Assets. (App. A ¶ 10(e)(ii).) Marion, 591 F.3d at 148 (quoting SEC v. Hardy, 803 F.2d 1034, 1038 (9th Cir. 1986)); see United States v. Acorn Tech. Fund, L.P., 429 F.3d 438, 443 (3d Cir. 2005) (court has interest in preventing drain on receivership assets); SEC v. Universal Fin., 760 F.2d 1034, 1038 (9th Cir. 1985) (court has interest in promoting judicial economy).

C. Pennsylvania Uniform Fraudulent Transfer Act

The Pennsylvania Uniform Fraudulent Transfer Act "protect[s] a debtor's unsecured creditors from unfair reductions in the debtor's estate" by allowing a claimant to avoid or annul a fraudulent transfer or obligation. 18A Summ. Pa. Jur. 2d Commercial Law § 22:1; see 12 Pa. Cons. Stat. §§ 5104, 5107; In re Blatstein, 260 B.R. 698, 707 (E.D. Pa. 2001). In a fraudulent transfer or clawback action, a transferee may raise the affirmative defense that he or she accepted the transfer in "good faith." 12 Pa. Cons. Stat. § 5108; Malvern, 716 F. Supp. 2d at 401.

The Stradley and Drinker Objectors argue that the Proposed Order violates PUFTA. (Doc. Nos. 100 at 5; 102 at 10.)

Return of Principal

According to the Objectors, the Qualitative Claims Determination process "rejects the good faith defense of investors who were merely on inquiry notice by requiring them to return principal." (Doc. No. 102 at 10.) ...

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