By: Scott B. Riddle, Esq.
This opinion is courtesy of Greg Hays, CPA, who acts as a receiver in several cases (including this case).
S. Gregory Hays, as Receiver for Mobile Billboards of America, Inc. v. Adam, et al., Case 1:05-cv-2705-CAP (N.D. Ga. March 1, 2007).
The basic facts, as alleged in the Complaint and taken as true for the motion, are as follows –
From 2001 through 2004, Mobile Billboards of America, Inc. (“MBA”) used a network of sales agents to sell more than $60 million in bogus mobile billboard investments to investors as part of a massive Ponzi scheme. The sales agents, including the defendants in this case, were members of organizations assembled by “master sales agents.” MBA typically paid a 27% commission per billboard sale to one of the master sales agents, who in turn made a commission payment to the individual within his or her organization that actually made the sale. The agents received sales commissions and bonuses for their participation in the mobile billboard scheme. These high commission rates were not disclosed to investors during the sales process. The plaintiffs claim that the fraudulent billboard investments
sold by the sales agents were unregistered securities. The agents sold the unregistered securities and received commissions from the sales even though they were not registered securities dealers. The Ponzi scheme was dependent upon the sales agents’ efforts in
soliciting investors. Agents were compensated with more than $19 million in commission payments….
The Receiver filed this action on October 18, 2005, seeking an accounting and recovery of the commissions and bonuses paid to the defendants pursuant to the investment scheme. The defendants filed the motion to dismiss now under consideration on October 9, 2006.
The defendants argue that the Receiver’s complaint should be dismissed pursuant to Federal Rule of Civil Procedure 12(b)(6) based on the doctrine of in pari delicto. Essentially, the defendants argue that because MBA and its affiliated entities perpetrated the fraud, the Receiver lacks standing to bring claims against the defendants. As this court has already held in Hays v. Paul, Hastings, Janofsky & Walker LLP, No. 1:06-CV-754-CAP [Doc.No. 31, at 25-27] (N.D. Ga. Sept. 14, 2006), however, this argument fails.
The court held that the doctrine of in pari delicto was inapplicable as a defense –
The defendants argue that Georgia courts would bar the Receiver from pursuing them for the (ultimate) benefit of defrauded investors. As it previously held in Paul, Hastings, however, the court concludes that it is likely that Georgia courts would not apply the defense of in pari delicto under the circumstances ofthis case. Georgia law follows the well-settled maxim that “equity seeks to do equity,” O.C.G.A. § 23-1-8 (2004) (“Equity considers that done which ought to be done and directs its relief accordingly”), and Georgia courts have historically exercised their equitable powers to bar the use of equitable defenses where the result would be harm to innocent third parties, such as creditors. See Brooke v. Kennedy, 172 Ga. 461, 158 S.E. 4 (1931). This is so because the doctrine of in pari delicto “is based on the principle that to give the plaintiff relief would contravene public morals and impair the good of society. Hence, it should not be applied in a case in which to withhold relief would, to a greater extent, offend public morals.” Gaines v. Wolcott, 119 Ga. App. 313, 317, 167 S.E.2d 366, 370 (1969), aff’d, 225 Ga. 373, 169 S.E.2d 165 (1969).
If the court were to apply the doctrine of in pari delicto in this case, the result would be the protection of the alleged wrongdoers and the punishment of the innocent victims. Thus, the court concludes that Georgia courts would look to the equities of the situation and refuse to bar relief where the one in pari delicto is eliminated from the suit and the recovery would ultimately go to innocent victims.
The court notes that the defendants’ argument in the motion at hand relies largely on the Seventh Circuit’s decision in Knauer v. Jonathon Roberts Financial Group, Inc., 348 F.3d 230 (7th Cir. 2003).1
1 The defendants also cite a number of bankruptcy cases to
support their argument. However, the Eleventh Circuit has made it
clear that a bankruptcy trustee is governed by the Bankruptcy Code,
which does not apply in this case. See Official Committee of
Unsecured Creditors of P.S.A., Inc. v. Edwards, 437 F.3d 1145
(noting that the case was governed by the Bankruptcy Code and not
the law governing receiverships). The bankruptcy cases cited by
the defendants are thus inapplicable.
Knauer, however, is not controlling law for this court and in fact represents a minority position on the issue. Moreover, Knauer is factually distinguishable from the instant case. In Knauer, the receiver sued brokerage houses that maintained the securities licenses of the perpetrators of a Ponzi scheme under theories of negligent supervision and respondeat superior. Id. at 234. However, in Knauer, unlike this case, there was “no allegation whatsoever that the defendants were directly involved [in] or benefitted” from the fraud. Id. at 237. The court noted that if there had been direct involvement, or if the brokerage houses had received some tangible benefit from the Ponzi scheme, it would have reached a different decision. Id. at 237, n.6. In the case at hand, taking the allegations in the complaint as true, the defendants not only directly benefitted from the Ponzi scheme, they in fact directly facilitated it.
Accordingly, the court finds that the Seventh Circuit’s decision in Scholes v. Lehmann, 56 F.3d 750 (1995), regarded as the touchstone case on this issue, is more analogous to this case. See Stenger v. World Harvest, No. 1:04-CV-151-RWS, 2006 U.S. Dist. LEXIS 15108, at *15 (N.D. Ga. March 32, 2006) (noting that Scholes is “the seminal case in this area of the law”). In Scholes, the receiver sought to recover from defendants who were some of the primary recipients of funds from a Ponzi scheme. Id. at 755-61.
The court held that because the receiver only sought to maximize the value of the receivership corporations for the benefit of their creditors and investors, the receiver was not barred from recovering corporate assets from the defendants. Id. (“the defense of in pari delicto loses its sting when the person who is in pari delicto is eliminated.” This court now rejects the defendants’ in pari delicto argument for the same reason.